Mortgage Liens: Can Liens Be Stripped Off in a Chapter 13?

Woolsey v. Citibank, N.A. (In re Woolsey), 696 F.3d 1266 (10th Cir. 2012)  –

A Chapter 13 plan proposed to strip off the lien of a junior residential mortgage that was totally underwater.  The bankruptcy court sustained an objection to the lien stripping and denied confirmation of the plan.  The district court affirmed, and the case went up to the 10th Circuit.  The 10th Circuit reluctantly agreed – BUT

Section 506(a)(1) of the Bankruptcy Code provides that an “allowed claim” of a creditor that is secured by a lien is a “secured claim” to the extent of the value of the interest in the collateral, and an unsecured claim to the extent of any deficiency.  Section 506(d) provides that “to the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void” (subject to certain exceptions that are not relevant).

In Woolsey the value of the property was less than the amount of a senior mortgage, so the junior mortgage was treated as wholly unsecured under Section 506(a).  Thus, the debtors argued that, while the claim was allowed, it was not an allowed secured claim.

Although this reading of Section 506 may be logical, it was rejected by the U.S. Supreme Court in the context of a chapter 7 liquidation case.  (See discussion of Dewsnup in Mortgage Liens: Can Liens Be “Stripped Off” (vs. “Stripped Down”) in a Chapter 7 Case?.)  As discussed by the 10th Circuit, the Supreme Court decided that Section 506(d) used the term “allowed secure claim” to mean a claim “allowed” under Section 502 and “secured” by a lien under state law, so that the issue of value under Section 506(a) was not relevant.

The 10th Circuit was clearly skeptical of the Supreme Court’s reasoning, but it concluded:

Right or wrong, the Dewsnuppian departure from the statute’s plain language is the law.  It may have warped the Bankruptcy Code’s seemingly straight path into a crooked one.  It may not be infallible.  But until and unless the Court chooses to revisit it, it is final.

Notwithstanding this precedent, the debtors attempted to argue that Section 506(d) could be read to mean one thing in a chapter 7 case, and a different thing in a chapter 13 case.  While again acknowledging the logic of the arguments, the 10th Circuit simply could not bring itself to read Section 506(d) as having two different meanings.  It characterized this as “a ploy not just frowned upon but methodologically incoherent and categorically prohibited.”  The court reiterated: “Dewsnup may be a gnarled bramble blocking what should be an open path.  But it is one only the Supreme Court and Congress have the power to clear away.”

With that said, the court also emphasized that “many courts seeking to avoid Dewsnup’s pinch have invoked the provisions specific to the reorganization chapters to permit the removal or stripping down of liens unsupported by value.”  For chapter 13 cases, the relevant provision is Section 1322(b)(2), which says that a plan may “modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor’s principal residence.”

When the Supreme Court addressed lien stripping in a chapter 13 case, it found that a lien could not be “stripped down” where the mortgage was partially underwater, resulting in a secured claim for the value of the collateral and an unsecured claim for the deficiency under Section 506(a).  (See discussion of Nobelman in Mortgage Liens: Can Liens Be “Stripped Off” (vs. “Stripped Down”) in a Chapter 7 Case?.)

However, courts have read Nobelman to suggest that there must be some value in order for the claim to be secured for purposes of Section 1322(b).  Thus, in the case of a junior mortgage lien that is entirely underwater and treated as an unsecured claim, at least six circuits have allowed a debtor to use Section 1322(b) to strip off the lien, even though the mortgage was secured by the debtor’s principal residence.

In addition to this uniformly favorable circuit court precedent, a favorable discussion of lien stripping under 1322(b)(2) by the bankruptcy court, and an amicus that “ably argued” the issue, the 10th Circuit specifically asked for supplemental briefing on “whether § 1322(b)(2) permits a Chapter 13 debtor to remove a wholly unsecured lien even if § 506(d) does not.”  (Hint, hint.)

In response, the Woolseys “emphatically announced ‘[t]here is no Code provision other than 11 U.S.C. §506(d) that declares void a wholly unsecured lien.’”  The court declined “to foist on litigants arms they so avidly refused to take up in the adversarial arena” and announced that “in deference to their wishes, we opt today against forcing a §1322(b)(2) argument onto the unwilling Woolseys and leave that statute and its meaning for another day when a bankruptcy petitioner actually wants to pursue the question.”

So, the 10th Circuit affirmed, but limited its decision to finding that as long as Dewsnup remains law, Section 506(d) does not provide the basis for stripping a lien – in other words, it affirmed – BUT

As discussed by the 10th Circuit, Dewsnup pretty clearly holds that a lien can ride through bankruptcy in a chapter 7 liquidation proceeding.  However, there has been a concerted effort to limit the effect of Dewsnup to Chapter 7 cases.

It would be interesting to learn why the Woolseys did not pursue the suggested Section 1322(b) argument.  Regardless, the 10th Circuit was as clear as it could be that if someone wants to make the argument that a totally underwater lien can be stripped in a chapter 13 case, it will join the 2nd, 3rd, 5th, 6th, 9th, and 11th Circuits in permitting a debtor to use Section 1322(b)(2) to strip off the lien.

Vicki R. Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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