Recently in
In
re Guerra, the Bankruptcy Court for the District of Massachusetts
joined the majority of courts in finding that United States Supreme Court’s decision
in
Bankof Am. v. Caulkett does not affect a chapter 13 debtor’s ability to
strip off a second mortgage. In
Caulkett, the Supreme Court held
that a debtor in a chapter 7 bankruptcy may not void a junior mortgage lien
under
11
U.S.C. § 506(d) when the debt owed on a senior mortgage lien exceeds
the current value of the collateral.
Prior to Caulkett, it was well established in the
First Circuit that a chapter 13 debtor could “strip off” a wholly unsecured
mortgage. In the chapter 13 plan context, “strip off” means discharging a
creditor’s junior mortgage on real property where the junior mortgage has no
value because the amount of senior liens and encumbrances exceeds the value of
the property.
In
Guerra, the debtors sought to strip off a second
mortgage through their chapter 13 plan. Under the chapter 13 plan, the second
mortgage was treated as a wholly unsecured claim subject to discharge under
11
U.S.C § 1328(a). The second mortgage holder objected and argued
that
Caulkett prohibits the debtor from treating an “underwater” second
mortgage as unsecured.
The Bankruptcy Court disagreed with the junior mortgage
holder and concluded that
Caulkett had no effect on the interpretation
of the interplay between §§
506(a)
and
1322(b)(2)
of the Bankruptcy Code. As such, the ability to strip off and discharge a
wholly unsecured mortgage lien in a chapter 13 plan remains an option for
debtors.
The junior mortgage holder also argued that its lien
couldn’t be stripped because (according to its appraisal) the value of the
property had increased during the 15+ months since the filing of the bankruptcy
case, to the point where there was now enough value to recoup at least some of
the second mortgage debt. In other words, the second mortgage claim
wasn’t “wholly unsecured.” That argument didn’t work either. For a
variety of reasons, the Bankruptcy Court ruled that for lien stripping
purposes, a mortgaged property should be valued at the outset of the
case. Because there was apparently no dispute that the mortgaged property
was worth less than the balance outstanding on the first mortgage when the case
was filed, the Court concluded that the second mortgage claim was completely
underwater as of the petition date, and that the debtors’ chapter 13 plan could
therefore strip the second mortgage lien and treat that claim as unsecured.
As “strip off” is still an option for debtors, in order to
protect their security interest, junior creditors should be mindful of debtor
estimates of value in their petition and schedules, which could tee up a
chapter 13 plan to strip junior liens.
