Another Federal Appeals Court Approves Bankruptcy Lien Stripping

The United States Bankruptcy Appellate Panel for the Eighth Circuit is the latest federal appellate court to approve a debtor's plan involving lien stripping of unsecured second mortgages. The opinion marks the first time that this has been allowed for a Chapter 13 bankruptcy that came subsequent to the petitioner's Chapter 7 discharge, a sequence known as Chapter 20 bankruptcy.

The debtor had completed the Chapter 7 bankruptcy process less than a year before filing for Chapter 13 bankruptcy protection. He had elected to keep his home and continue to pay three separate mortgage payments while discharging unsecured debt via Chapter 7. After soon falling behind on payments, he sought further help under Chapter 13.

Because the first mortgage on his home exceeded the appraised value of the home, there was no equity left to secure the second and third mortgages. He therefore proposed a Chapter 13 debt plan that stripped the junior mortgages pursuant to section 506(a) of the bankruptcy code. The United States Bankruptcy Court denied confirmation of the plan based on section 1322(b), which provides exceptions from Chapter 13 modifications for debts secured by an interest in a principal residence.

After reviewing the debtor's appeal, the Eight Circuit Bankruptcy Panel held that the two sections must be read together to allow lien stripping under Chapter 13, a legal option that has been recognized by other federal appeals courts, including the Seventh Circuit. Even more notable to bankruptcy experts is the fact that it occurred in a "Chapter 20 bankruptcy" setting, in which discharge of debt is generally prohibited due to recent Chapter 7 proceedings for the same debtor.

For individuals and couples who are striving to stay in a family home, lien stripping through bankruptcy has become an increasingly viable option for effective debt relief. A stripped junior mortgage becomes classified as unsecured debt, meaning that the debt need only be repaid on the same prorated terms as other unsecured debt such as medical bills and credit card debt. A Chicago bankruptcy attorney can explain the precise implications of the latest legal developments for the Illinois bankruptcy process.

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