Usually when bankruptcy lawyers discuss the benefits of successive New York bankruptcy filings, the “chapter 20” strategy comes up (less so the “reverse chapter 20“). Debtors who discharge an underwater junior mortgage in chapter 7 must continue to make the mortgage payments if they wish to avoid foreclosure. They can file a chapter 13 case with an eye to stripping the lien and not obtaining another discharge. The strategy has benefits and drawbacks, but there’s a ray of good news out there: The U.S. Supreme Court has granted certiorari to a pair of debtors who sought to strip an underwater junior lien in chapter 7 and not bother with chapter 13.
At issue is the interpretation of Section 506(d) of the Bankruptcy Code, which states that, “To the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void.” (There are exceptions to the rule, but they aren’t relevant.) In a 1992 case, Dewsnup v. Timm, the Supreme Court held that a debtor could not “strip down” a mortgage lien to the value of the property. Stripping down (or “cramming down”) is possible for vehicles in chapter 13, but it’s not allowed for houses. The respondents (the chapter 7 debtors) successfully persuaded the U.S. Court of Appeals for the Eleventh Circuit that “stripping down” a lien is not the same as “stripping off” a lien entirely, so they should be allowed to do the latter.
The petitioner-creditor, Bank of America, will point to cases in two other federal circuit courts that decided that strip-offs were disallowed. It’s unsurprising that the Supreme Court would take the case when there’s a significant break in how the Bankruptcy Code is interpreted in different parts of the country. Bank of America will also argue that the fact that the mortgages are underwater is only relevant to whether they are treated as secured or unsecured debts in Section 506(a) of the Bankruptcy Code and that the present bankruptcy practice of allowing liens to pass through chapter 7 should continue.
Information on Bank of America v. Toledo-Cardona can be found here.
If the Supreme Court decides in favor of the respondents, then it would be a substantial boon to New York homeowners whose junior mortgages are underwater. They will be able to save much time and effort resolving their burdens with only one quick chapter 7 case rather than a chapter 13 case as well.
For answers to more questions about bankruptcy, the automatic stay, effective strategies for dealing with foreclosure, and protecting your assets in bankruptcy please feel free to contact experienced New York bankruptcy attorney Bruce Weiner for a free initial consultation.
