North: Chapter 20 Lien Strips OK in Northern District of California

“Chapter 20” is the term commonly applied to situations where a debtor files a Chapter 7 bankruptcy case and then some time shortly after receiving a discharge, files a Chapter 13 case.

Why might someone do this? Here’s a common hypothetical: A debtor cannot file Chapter 13 because her unsecured debts exceed the $360,475 Chapter 13 limit. Instead, she files a Chapter 7 case and receives a discharge, reducing her unsecured debts to $0. However, she still has a second mortgage on her house, and the first mortgage is “under water.” That second mortgage was not stripped because lien stripping is not available in Chapter 7. Can she then file a subsequent Chapter 13 case (for which she now qualifies) in order to strip the second mortgage?

Some courts have responded with a no, agreeing with trustees that § 1325(a)(5)(B)(i)(I), read in conjunction with § 506(d), makes lien stripping dependent on the debtor receiving a discharge. However, this debtor has already received a discharge in her Chapter 7 case and is not entitled to a second one. Ipso facto, no discharge, no lien strip.

In an opinion issued on October 15, 2012 the case of In re North, Judge Efremsky of the United Bankruptcy Court for the Northern District of California came down on the other side of the argument, finding that permanent lien stripping is dependent not on receipt of a discharge, but on completion of the Chapter 13 Plan’s payments.

Thus, since the Chapter 7 case extinguishes the debtor’s personal liability for the second mortgage but not the creditor’s in rem rights (i.e. the lien), since and those in rem rights can be restructured in Chapter 13 (i.e. the lien stripping, which is permissible under the rationale above), at the completion of the debtor’s Plan the creditor is question has no recourse against either the person or the property. The is, for all effective purposes, gone.

Thus Chapter 20 cases, and the ability to strip liens within them, remain a powerful tool in the hands of debtors, especially in Northern California where the regularity of million-plus mortgages puts many ordinary homeowners in danger of running afoul of the debt limits. However, Chapter 20 cases are rife with other potential pitfalls, not least of which are bad faith issues, and so you should make sure you find a lawyer who knows what he or she is doing. Additionally, the Chapter 13 Trustee in the North case has indicated that she intends to appeal the decision.

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