• Home
  • Bankruptcy in Brief
  • ABC’s of Bankruptcy
  • Considering Bankruptcy
  • True Stories
  • Chapter 13
  • Blog
  • About Us

Northern California Bankruptcy Lawyer

On The Bankruptcy Soapbox

The Soap Box
  • How bankruptcy works
  • Mortgage Matters
  • Consumer Rights
  • Newsworthy
  • You & Your Lawyer
  • Small Business
  • Family Law

Discharged Debts Don’t Bar Chapter 20 Lien Strip

By Cathy Moran

304526237_6d1acf58bb_z_opt

Underwater liens that linger after an earlier bankruptcy don’t count in Chapter 13.

At least, they don’t count against the unsecured debt limit that restricts entry into Chapter 13, says the 9th Circuit Bankruptcy Appellate Panel in Free.

Great news for homeowners for whom Chapter 13 was not initially available because they exceeded the debt limits.

Free settles the question of whether the lien that passed through a prior bankruptcy case is a “debt” counted for eligibility purposes in a subsequent Chapter 13 if there is no collateral value to secure it.  The answer is no.

Neither the Code nor case law compels inclusion of the discharged in personam liability in such calculation.

What survives a bankruptcy discharge

Without getting so technical that only a lawyer would care, the problem when a Chapter 13 case is filed after a Chapter 7 is characterizing what’s left of the liens in effect when the 7 was filed.

The Chapter 7 discharge eliminated any personal liability of the debtor for the debt that was secured by a lien, but left the lien as a valid charge on any collateral to which it had attached.

Chapter 13 eligibility is limited to a certain amount of secured debt and a certain amount of unsecured debt.  But a debt is secured only if the debtor owns property with value that is available to that lien creditor.

So, does a lien for which there is no value in the collateral and no personal liability of the debtor have to be counted when figuring the debtor’s eligibility for 13?

The answer is critical because voluntary liens like mortgages can be voided only in Chapter 13.  (That’s a slight overstatement, but it is accurate as to most homeowners.)

Underwater liens don’t count

The debtors in Free had two liens on their home junior to their first.  They filed Chapter 7, got a discharge, then filed Chapter 13 so they could strip off of their home the two junior liens.

Those liens weren’t secured claims, because the first mortgage itself was larger than the value of the home.  Were those liens then unsecured claims, having passed through the earlier bankruptcy case?

If the two junior liens were “claims” for purposes of the bankruptcy code, their size would disqualify the Frees from Chapter 13.

The BAP distinguished prior case law and found that there was no liability of the Frees on account of these liens and therefore, the unpaid balances on those liens didn’t count.

Encouraging for me was the court’s deference to the Congressional goal of encouraging filing of Chapter 13.

We do not see how the purposes of a chapter 13 reorganization are met by counting the discharged unsecured obligations of the chapter 20 debtor in the eligibility calculation.

Analytically, I’ve argued this point unsuccessfully a couple of times before bankruptcy courts in the Northern District of California.  It’s really nice to have the issue settled as I had argued it should be.

Chapter 13 in the bigger picture

The Chapter 13 debt limits have been a bottleneck for too many homeowners in Silicon Valley.  The unfettered lending that preceded the Great Recession left many with mortgage debt that is still greater than the value of their homes.

This decision, coupled with the 9th Circuit’s recent decision in Blendheim that determined that liens could be stripped in a Chapter 13 even when the debtor wasn’t eligible for a discharge, enables a larger slice of homeowners here to conform the lien situation to today’s real estate values.

In a rising real estate market, it affirms the utility of “Chapter 20”, a strategy of filing Chapter 7 to eliminate personal liability for as much debt as possible, then filing a Chapter 13 to strip liens and pay obligations that survived the Chapter 7.

Where do you find Chapter 20

Because, there is another unsettled question afoot about real estate appreciation during a Chapter 13.  Is that appreciation at risk of being appropriated to pay creditors based on the change in values after the 13 is filed?

By eliminating as many creditor claims as possible in the Chapter 7, a Chapter 20 debtor reduces the universe of creditors who have skin in this game.

Yay, Chapter 20.

Image courtesy of Anssi Koskinen and Flickr

More from the Soapbox

  • Pay No Tax On Discharged DebtPay No Tax On Discharged Debt
  • How 13 Works To Save Your House From ForeclosureHow 13 Works To Save Your House From Foreclosure
  • What Creditors Of PG&E Need To Know About BankruptcyWhat Creditors Of PG&E Need To Know About Bankruptcy
  • Small businesses increasingly seek bankruptcy reliefSmall businesses increasingly seek bankruptcy relief
  • File Your Tax Return Or Get An Extension?File Your Tax Return Or Get An Extension?

Filed Under: Chapter 13, How bankruptcy works, Newsworthy, Real property & mortgages

About Cathy Moran

I'm a veteran bankruptcy lawyer and consumer advocate in California's Silicon Valley. I write, teach, and speak in the hopes of expanding understanding of how bankruptcy can make life better in a family's future.

Coronavirus & Your Finances

About The Soapbox

You've arrived at the Bankruptcy Soapbox, a resource of bankruptcy information and consumer law.

Soapbox is a companion site to Bankruptcy in Brief, where I try to be largely explanatory and even handed (Note I said "try").

Here, I allow myself to tell stories and express strong opinions on how I think law should work for the consumer and small businesses when it comes to debt.

Moran Law Group
Bankruptcy specialists for individuals and small businesses in the San Francisco Bay Area

How Bankruptcy Works

What Everyone Knows About Bankruptcy: Not

Lots of people profess to know all about bankruptcy. Whether they have good information or not. But other professionals should know better than to advise people about the workings of bankruptcy. And if they don't know better, they should be made to pay, in some exquisitely painful way, for the harm they … Read more

More Posts from this Category

643 Bair Island Road
Suite 403
Redwood City, CA 94063
Phone: (650) 694-4700

Categories

All content copyright © Moran Law Group. All rights reserved.