Can Chapter 13 Still Strip 2nd Mortgages? Yes!

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It’s back to the future time again, and this time it seems like the lawyers stole our flux capacitor!

You can use Chapter 13 to “strip off” a home equity or other 2nd mortgage on a home, if there is no value (equity) after the main mortgage debt is subtracted. Every significant court dealing with this has said so. That’s been the rule for 20 years in some places. (In St. Louis, I litigated our case on this in 1994, for example.) Congress has tinkered with the law several times since this tool developed and has never taken it away. It’s about as “settled” as the law can get.

Or so you would think.

Lately attorneys have been trying out a tool — 506(d) — for this job. It is not designed for the work. And they’ve been shot down by courts of appeal twice, so far.

This provision, 506(d), sounds like it does the job. It says liens without “value” are “void.” But the Supreme Court long ago ruled, in effect, that “void” in 506 only really means that they do not have value but doesn’t actually modify the lien. (It’s like a gun without a bullet.)

So the courts of appeal (7th and 10th circuits) — in moves that should shock absolutely no one at all — said they’ll follow the Supreme Court, thank you.

But does that mean all hope is lost for underwater homeowners? Of course not.

The Tenth Circuit itself clearly pointed out that the party in its case was refusing to use the tool that would very, very, very likely work, Sec. 1322.

The hitch is, [they] didn’t choose to pursue this line of argument before this court in their initial briefs. What’s more, they have now expressly repudiated it in a supplemental submission. This even though the bankruptcy court offered a favorable discussion of lien stripping under § 1322(b)(2), uniform circuit precedent endorses it…[they refused to pursue this argument] So in deference to their wishes, we opt today against forcing a § 1322(b)(2) argument onto the unwilling [parties] and leave that statute and its meaning for another day when a bankruptcy petitioner actually wants to pursue the question. And the Seventh Circuit said the same thing. In the 7th, the debtor argued that he was somehow barred from using the standard issue Chapter 13 tools, like 1322(b)(2), due to the sovereign immunity of the IRS (the lien holder there) and insisted on pursuing 506(d). The circuit repeatedly endorsed the 10th Circuit’s decision which invited — nay, begged — for a 1322(b)(2) argument to be presented. But alas it was not.

Does this mean that in the 7th and 10th Circuits (or anywhere else) that no-equity junior liens on homes are now protected in Chapter 13?

Not even close.

What these cases demonstrate is that bad strategies create confusion. The judges of the 10th could foresee this with their extended criticism of the strategy. But the judges of the 7th simply dealt with the matter at hand and disposed of the case in the only way available to them. Neither were dealing with the broader – overwhelmingly settled – question of whether there is a tool for the job. Because, as the 10th said, they weren’t asked to do so.

So for anyone looking for the Ch. 13 flux capacitor needed to strip 2nd mortgages, it’s right there under your nose. You just have to read the dozens and dozens of cases which show you how to use it.

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