Lien Stripping Prohibited If Debtor Is Ineligible For Discharge

Chapter 13 debtors who are ineligible for a discharge may not strip mortgage liens, even if the liens are wholly unsecured. This is a growing consensus among a majority of bankruptcy courts, and is a result of the interplay between two Bankruptcy Code provisions enacted in the 2005 BAPCPA amendments.

The first provision is that a debtor is not eligible for a discharge in Chapter 13 if the case is filed less than four years after obtaining a discharge in a Chapter 7, 11 or 12,¹ or less than two years after a discharge in a Chapter 13.² Previously, there were no grounds to deny discharge in Chapter 13 if a debtor was a frequent filer, or more to the point here, filed a “Chapter 20.”  A “Chapter 20” is obtaining a Chapter 7 discharge as to all unsecured debt, and then filing a Chapter 13 to cure defaults on secured debt to avoid repossessions and foreclosures.

The second provision is that a secured creditor has the right to retain its lien on an “allowed secured claim” until the earlier of 1) payment in full of the balance under non-bankruptcy law, or 2) a Chapter 13 discharge.³  This was enacted to end common plan provisions that required release of a lien before a Chapter 13 discharge or payment of any unsecured portion once the secured portion of a claim was paid.  If the case was later converted or dismissed, the creditor had lost its lien.

Combined, these two provisions work to prohibit lien stripping when a debtor is ineligible for a Chapter 13 discharge. If a lien must remain until the earlier of discharge or payment in full of the non-bankruptcy balance, then the earlier event will be full payment because no discharge will be entered.  This operates to prohibit lien stripping when the debtor is ineligible for a discharge– the lien must remain until the underlying claim is paid in full, even if it is wholly unsecured. 

Debtors have claimed that they can avoid the lien retention statute if a mortgage is wholly unsecured by arguing a wholly unsecured mortgage lien is an unsecured claim in actuality and the statute only applies to “allowed secured claims”.  Likewise, by calling such a claim unsecured because of the absence of any equity, they have also argued that the lien is void by operation of law under 11 U.S.C. § 506(d), which states:  “To the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void.”  (Emphasis added.)  Neither one of these arguments has been successful. 

A recent case decided in the Northern District of Illinois,⁴ rebuffed this reasoning using established case law and explained what an “allowed secured claim” is.  Claim “allowance” is the process of putting a claim in line for payment. A claim is allowed unless it is objected to.⁵  Claims may only be disallowed on specific grounds enumerated in the Bankruptcy Code.⁶  A secured claim may not be disallowed simply because there is no equity in the collateral.  Hence, when any secured claim is filed, it is “allowed”.

A claim is a “secured claim” if a creditor has recourse to collateral, most commonly in the form of a lien.⁷  The value of the lien is a separate issue,⁸ and does not determine whether the claim is “secured” or not. If a claim has an underlying lien, it is a “secured claim”.  

A wholly unsecured mortgage claim is an “allowed secured claim” because it is allowed and because it has recourse to real estate by the lien.  Thus, debtors may not declare such a claim “void” under 506(d) or skirt the lien retention requirement by claiming an unsecured mortgage lien is not an “allowed secured claim”.

This is a powerful tool when a debtor is not eligible for a discharge.  It will prevent the stripping and discharge of wholly unsecured liens.  Only the Ninth Circuit has case law that allows lien stripping when a debtor is not eligible for a Chapter 13 discharge.⁹  If a debtor files a Chapter 13 and seeks to strip a lien within four years of obtaining a Chapter 7 discharge or within two years of obtaining a Chapter 13 discharge, creditors should consult with their bankruptcy counsel to determine whether to object to the proposed lien strip.