Bankruptcy

Can a Wholly Unsecured Second Mortgage be Stripped Off in a Chapter 7 Bankruptcy?

By Dan Press, Virginia and D.C. Bankruptcy Attorney

If the amount of the first mortgage on a property exceeds the value of the property, it is generally accepted that in Chapter 13, or 11 or 12, a second mortgage or any other junior lien can be avoided, or “stripped off,” and treated as unsecured debt.  However, conventional wisdom is that it cannot be done in a Chapter 7, but I believe that it can, and so does Bankruptcy Judge Dorothy Eisenberg in the Eastern District of New York (Long  Island).

In the case of the Lavelles, the Debtors owned a house valued at $400,000.  Bank of America held the first mortgage in the amount of $411,183, and a second mortgage in the amount of $9,904.   After the Lavelles filed bankruptcy, Bank of America asked Judge Eisenberg for permission to foreclose on the second mortgage –  for “relief from the automatic stay” — but the Lavelles argued that they could not foreclose because the second mortgage should be avoided as wholly unsecured and not treated as secured debt. 

Judge Eisenberg agreed.  Not only could they not foreclose, but the lien was permanently voided.  While the Supreme Court, in a case called “Dewsnup,” has held that partially secured claims (like the Lavelles’ first mortgage) cannot be “stripped down” in Chapter 7, it has never ruled on the issue of a wholly unsecured second mortgage.  Judge Eisenberg explained that the well-recognized holdings in Chapter 13 clearly demonstrate that under the Bankruptcy Code it is appropriate to distinguish partially secured liens from wholly unsecured liens, and that there is no reason why in a Chapter 7 context the same language in the Bankruptcy Code should not void the lien of a wholly unsecured claim.

What does this mean for you?  It may mean that you can file Chapter 7 and avoid a second mortgage while not having to make payments over 3-5 years on a Chapter 13 case.  It may mean that you can strip a second mortgage in a Chapter 7 even if you are not eligible for Chapter 13.  But not all judges agree with Judge Eisenberg.  In fact, two Courts of Appeals have ruled against “lien stripping” in Chapter 7.  So your right to do this is not a sure thing.  But I think it’s worth a try in appropriate cases.

Full post as published by Bankruptcy Law Network on February 11, 2010 (boomark / email).