Thursday, August 04, 2011

Use Of 'Chapter 20' Bankruptcy In 2nd Mortgage Lien-Stripping Case To Circumvent Unsecured Debt Limitation Under Chapter 13 To Unload $390K Loan?

The following facts have been roughly adapted from a recent ruling of a U.S. Bankruptcy Court:
  • The homeowners in this case owned a primary residence that was valued at $967,500, and subject to a first mortgage of $1,264,327.41, and which left the homeowners completely underwater.

  • On top of that, they owed additional money on a second mortgage in the amount of $392,927.

  • Under the applicable rules of a Chapter 13 bankruptcy, a lien for a claim that is entirely unsecured, based upon the value of their primary residence and the amount of the first priority lien against the residence, can generally be avoided as an encumbrance against the home, leaving the debt itself subject to discharge just as any other unsecured debt.

  • However, bankruptcy law limits the use of a chapter 13 filing to those debtors with unsecured debts of less than $360,475.

  • Because the amount of the homeowners' 2nd mortgage ($392,927) exceeded the maximum Chapter 13 limit (less than $360,475), the homeowners were precluded from filing under Chapter 13, right?

Apparently, in the view of U.S. Bankruptcy Judge Edward D. Jellen, not really. What the homeowner appears to have done is the following:

  • Debtors first filed a chapter 7 petition, and received a discharge on March 16, 2010.

  • The discharged eliminated all personal liability the homeowners had in connection with the promissory note secured by the 2nd mortgage, but left the lien of the mortgage itself in tact.

  • Less than 11 months later, on February 7, 2011, Debtors filed a chapter 13 petition (a situation where a debtor files a Chapter 7 bankruptcy petition in which a discharge is obtained, followed by a Chapter 13 petition shortly thereafter, is sometimes informally referred to as a 'Chapter 20' bankruptcy - '7+13=20').

  • The homeowners then asked the court to remove the lien of the mortgage because, based on the value of the home ($967,500) and the amount on the 1st mortgage ($1,264,327.41), the 2nd mortgage was completely unsecured and, therefore, was subject to the Ch.13 lien-stripping provisions of Chapter 13.

  • The 2nd mortgage holder objected, citing the $360,475 unsecured debt limitation under Chapter 13.

  • In making their argument, the homeowners asserted that, because they are no longer personally liable for $392,927 debt secured by the 2nd mortgage, that debt should not be included in the calculation for applying the unsecured debt limitation.

Based on his analysis of the applicable statute and case law, Judge Jellen agreed with the homeowners, and accordingly, overruled the objection of the 2nd mortgage holder.(1)

For the ruling, see In Re Shenas, Case No. 11-41332 EDJ (Bankr. N.D. Cal. July 28, 2011).

(1) Judge Jellen's analysis follows (bold text is my emphasis):

  • On February 7, 2011, Debtors filed the current chapter 13 petition. The chapter 13 plan proposed by the Debtors provides for the avoidance of Green Tree's lien because it is wholly unsecured. Chapter 13 Plan, doc. no. 15; In re Zimmer 313 F. 3d 1220, 1226-27 (9th Cir. 2002).

    Scovis v. Henrichsen, the Ninth Circuit held that eligibility for chapter 13 should be determined by the debtor's originally filed schedules, and that the undersecured portion of a secured debt is to be counted as unsecured debt for purposes of the § 109(e) calculation.[2] Scovis v. Henrichsen, 249 F.3d 975, 982-84 (9th Cir. 2001).

    Debtors herein scheduled Green Tree's claim as entirely unsecured, based upon the value of their primary residence and the amount of the first priority lien against the residence.
    [3] See Schedules A and D, doc. no. 16. As Green Tree applies the Scovis holding, its $392,927 claim should be characterized as unsecured, rendering Debtors ineligible for relief under chapter 13.

    The court disagrees. The debtors received a chapter 7 discharge before they filed the current chapter 13 case. That discharge operated to render their debt to Green Tree unenforceable as a personal liability of the Debtors. Section 524(a).

    Being unenforceable as a personal liability, the debt is not allowable as an unsecured claim in this case. Sections 502(b) and 506(a). It follows that the Debtors do not owe any unsecured debt to Green Tree for purposes of the unsecured debt limitation of § 109(e).
    Cavaliere v. Sapir, 208 B.R. 784, 787 (D. Conn. 1997) (holding that a secured claim discharged in a prior chapter 7 case, and unenforceable under § 502(b)(1) in the current chapter 13 case, should not be included in the § 109(e) eligibility calculation); In re Osborne, 323 B.R. 489 (Bankr. D. Or. 2005)(holding similarly in the context of a chapter 12 petition).

    Quintana v. IRS, 915 F.2d 513 (9th Cir. 1990), is not to the contrary. In that case, the Ninth Circuit held that the entire amount of a creditor's claim must be included in the eligibility determination, despite the creditor's waiver of a deficiency judgment in an upcoming foreclosure action, and the potential for offset by damages alleged by the debtor. Id. at 517. However, Quintana is readily distinguished from the present case because the chapter 7 discharge that rendered the Green Tree claim unenforceable as a personal liability against the Debtors was entirely consummated prior to the filing of the petition herein. See In re Osborne, 323 B.R. at 492.

    At the July 21, 2011 hearing, counsel for Green Tree argued that because the Debtors have not yet filed their motion to avoid its lien through their chapter 13 plan, Green Tree held an extant lien on the petition date, and its lien must be included in the § 109(e) calculation under Scovis.

    The court is not persuaded. Bankruptcy Code § 502(b)(1) provides that a claim shall not be allowed if it is unenforceable "under any agreement or applicable law". The legal bases for avoiding a wholly unsecured lien against real property are well-established. Green Tree does not have an enforceable claim in this case, and did not have one at the petition date. See, e.g.,
    Scovis, 249 F.3d at 983 ("a claim secured only by a lien which is avoidable by a declared exemption is unsecured for § 109(e) eligibility purposes.").

    The court holds that the $392,927 claim asserted by Green Tree is not properly included in the unsecured debt calculation for purposes of § 109(e) eligibility because it is not enforceable against the debtors. See
    Cavaliere v. Sapir, 208 B.R. at 787.

    The objection to eligibility raised by Green Tree is therefore OVERRULED. The court will issue its order accordingly.