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Mortgage lien stripA very recent opinion from the Bankruptcy Appellate Panel for the Ninth Circuit (“BAP”) establishes the legitimacy of something I have been doing in Chapter 20 cases.  It’s nice to know I was right all along.  This post brings you up to speed on the good news for debtors in the BAP case.  A bit of background will help to put the case into its proper perspective.

If you are new to bankruptcy practice, and have given the Bankruptcy Code a cursory glance, you might think I am out of my mind referring to a Chapter 20 bankruptcy in the tile to this post.  After all, the Code doesn’t even have a Chapter 20.  (Whether or not I am out of my mind is best left to the many voices in my head to determine.  What did you say?  Are you calling my dog a liar?)  The term, “Chapter 20” is used by bankruptcy attorneys to refer to a Chapter 7 followed by a Chapter 13.  Since 7 + 13 = 20, Chapter 20 is used as a short hand.

I.  Reasons For Doing A Chapter 20

Since Chapter 7 discharges most debts without the debtor having to make any payments to creditors, why would anyone want to do a Chapter 20?  One reason lies in 11 U.S.C. § 109(e)’s debt ceilings (I have corrected the dollar amounts, which haven’t been updated at the linked site for quite some time.):

Only an individual with regular income that owes, on the date of the filing of the petition, noncontingent, liquidated, unsecured debts of less than $383,175 and noncontingent, liquidated, secured debts of less than $1,149,525, or an individual with regular income and such individual’s spouse, except a stockbroker or a commodity broker, that owe, on the date of the filing of the petition, noncontingent, liquidated, unsecured debts that aggregate less than $383,175 and noncontingent, liquidated, secured debts of less than $1,149,525 may be a debtor under chapter 13 of this title.

Based on this Code section, if a debtor has more than $383,175 in noncontingent (i.e., doesn’t depend on a triggering event for its validity), liquidated (i.e., the dollar amount of the debt is certain), unsecured (i.e., there is no collateral securing the debt) debt, then Chapter 13 is unavailable.

Since Chapter 7 has no debt ceilings (though it does have income ceilings, which can be made precise using 11 U.S.C. § 707(b)), the debtor can first do a Chapter 7 to get rid of as much unsecured debt as possible, and then do a Chapter 13 to deal with debts that weren’t discharged in the prior Chapter 7, or to catch up on a delinquent mortgage.
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I.          What Is Mortgage Rescission?

Rescission is a way for a borrower to get out of a mortgage that was fraudulently or deceptively originated.  For example, if the lender misrepresented the terms of the mortgage by failing to disclose a balloon payment, or the nature of the adjustable rate, or advised the borrower to inflate income to qualify for a larger loan – gasp! does this sort of thing ever happen? up until recently, all the time – the borrower may cancel the loan.

II.        The Legal Foundation For Mortgage Rescission

The main statutory vehicle for rescission is the Truth in Lending Act (“TILA”), 15 § U.S.C. 1601 et seq., and its regulatory partner, Regulation Z, 12 C.F.R. 226.31, et seq..  TILA and Regulation Z are complicated, so it is easy for a creditor to violate them.  The most common violations involve inadequate disclosures.  See 15 U.S.C. §§ 1638(a)-(b)(1) for some of the required disclosures.  Regulation Z has its own plethora of required disclosures.
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In my last post I discussed the three basic requirements a Chapter 13 plan must meet to get confirmed.  In this post I will discuss a powerful Chapter 13 tool that has no Chapter 7 analogue:  lien stripping.  (No, it’s not X-rated.)

I.          Lien Stripping On The Debtor’s Primary Residence

First the bad news:  In Nobelman v. American Savings Bank, 508 U.S. 324 (1993) the U.S. Supreme Court held that an under-secured – i.e., “partially secured” – mortgage on the debtor’s primary residence is protected up to the full amount of the debt in the sense that the unsecured portion cannot be stripped off.

Now the good news:  Any wholly unsecured mortgage on the debtor’s primary residence can be stripped off and treated as if it were ordinary general unsecured debt.  Thus, a second mortgage can be stripped off, put into the Chapter 13 plan, and paid off at the same percentage as the other general unsecured debts – which is usually a small percentage.  This means that the debtor can have the second mortgage extinguished in five years, after having paid only a small percentage of that mortgage.
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