Stripping Liens in Bankruptcy

BY JAY AND ARTHUR WINSTON, WINSTON & WINSTON, P.C.

Section 1322(b)(2) of the Bankruptcy Code states as follows:

“the plan (debtors plan of payment in Chapter 13) may modify the rights of holders of secured claims, other than a claim secured by a security interest in real property that is the debtors principle residence or of holders of unsecured claims or leave unaffected the rights of holders of any class of claims”.

A “strip down” occurs when the balance on a mortgage ($71,000) is reduced to the market value of the security (home – $23,000).

Section 506 of the Bankruptcy Code provides as follows:

“an allowed claim of a creditor secured by a lien on property in which the estate has an interest, or that is subject to set off under Section 563 of this title, is a secured claim to the extent of the value of such creditor’s interest in the estate’s interest in such property, or to the extent of the amount subject to set off, as the case may be, and is an unsecured claim to the extent that the value of such creditor’s interest or the amount so subject to set off is less than the amount of such allowed claim. Such value shall be determined in light of the purpose of the valuation and of the proposed disposition or use of such property, and in conjunction with any hearing on such disposition or use, or on a plan affecting such creditor’s interest.”

The Supreme Court considered the application by a debtor to “strip down” the homestead lenders secured claim of $71,000 to the home’s reduced value of $23,500. The Supreme Court prohibited this option under Section 506 by stating that Chapter 13 prohibits the debtor from reducing an unsecured homestead mortgage to the fair market value of the mortgage residence. The Supreme Court recognized that claims in bankruptcy could be broken down between secured and unsecured parts, but at the same time they concluded that the Section 1322(b)(2) protected the unsecured components of a partially secured claim. Unfortunately, the Supreme Court did not decide whether their holding should be extended to wholly unsecured homestead mortgages. In Nobelman v. American Savings Bank, 508 U.S. 324 (1993)

This issue has considerably divided the bankruptcy courts as well as the district courts. The majority view seems to follow the reasoning that the anti-modification provisions protect only the under secured and not the wholly unsecured homestead lenders. Under this theory, if the mortgage was $50,000 and the security was worthless, the claim would automatically become an unsecured claim rather than a secured claim. The minority view takes the opposite position. The fact that a claim is under secured does not mean that the mortgagee is limited by the valuation of its secured claim. The emphasis in this type of reasoning is on the homestead lender rather than on the value of the collateral that shields the claim from modification. Therefore, if it is a homestead lender, the secured mortgage is protected just as if the collateral was of some value. The Circuit Court of Appeals of 11^th Circuit has provided an in depth analysis of this issue and sided with the majority opinion. Tanner v. FirstPlus Fin., Inc. (In re Tanner) 217 F. 3d 1357 (11^th Cir., 2000)