Another Appeals Court Circuit Approves Second Mortgage “Stripping,” Even in No-Discharge Chapter 13 Cases

The Bankruptcy Appellate Panel for the federal Eighth Circuit Court of Appeals has added its voice to the other nine circuits that have have ruled in favor of wholly unsecured second mortgage lien stripping in chapter 13.  This means that debtors in the Eighth Circuit (Minnesota, North Dakota, South Dakota, Iowa, Missouri, Nebraska, and Arkansas) are virtually assured of being able to strip junior mortgages, in appropriate cases.  What's more, the appeals court did so in a chapter 13 case which followed on the heels of achapter 7 (a so-called "chapter 20″ case).  This makes for the first federal appellate court ruling to allow lien stripping in chapter 20 cases.

This case, In re Fisette, No. 11-6012 (8th Cir. BAP Aug. 29, 2011), involved a debtor who had filed chapter 7 in 2009.  He received a discharge of debts, and he elected to retain his home, continuing payments without formally reaffirming on any of his three mortgages.  By 2010, he had fallen behind on mortgage payments.  He filed chapter 13 to gain extra time to catch up on the back mortgage payments.  Because he had received a chapter 7 discharge within the prior four years, he was not eligible for a discharge in his new chapter 13 case, unlike most chapter 13 debtors.

The debtor's chapter 13 plan stated that his home was appraised at a value of $145,000.00, and that his first mortgage had a total balance owed in excess of $145,000.00.  This rendered his second and third mortgages unsecured by any actual value in the real estate.  Because the supposedly secured junior mortgages were, in actuality, unsecured by any value in the home, the chapter 13 plan proposed to strip them off using the bankruptcy code's section 506(a).

The appeals court agreed with the debtor that sections 1322(b)(2) and 506(a) should be read together to allow wholly unsecured junior mortgage lien stripping on homestead real estate.  Due to the recent national trend of falling real estate values, the use of chapter 13 to strip second or third mortgages has become an important part of the debtor's arsenal of bankruptcy remedies to be used against creditors.  The Eighth Circuit joined the unanimous voices of other federal appeals courts in approving the availability of this remedy for chapter 13 debtors.

Perhaps more importantly, the appeals court approved lien stripping in a chapter 20 case, where no discharge could be granted.  It rejected arguments that section 1325(a)(5)(B) required full payment of an unsecured junior mortgage unless the debtor was eligible for a chapter 13 discharge, ruling that section 1325(a)(5) applies only to secured creditors.

Although bankruptcy courts around the country have been split on the issue of chapter 20 no-discharge lien stripping, the Fisette ruling now arms debtors with the first federal appeals court decision approving the practice.

by Craig Andresen

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