Court rules that debtors can strip off liens with a Chapter 7 bankruptcy case

Consumers in Georgia and Florida got a big boost from the Eleventh Circuit Court of Appeals in Atlanta (left) recently, when that court became the first appellate level body to approve — and the first to even discuss — lien-stripping in Chapter 7 bankruptcy.

The topic has caused controversy among bankruptcy judges for decades. The recurring question is whether a secured loan, for example a second mortgage, that is completely underwater can be eliminated when filing a Chapter 7 case, or whether debtors with this as a goal have to resort to the more costly and time consuming Chapter 13 or Chapter 11 proceedings.

The text of Chapter 7 doesn’t say one way or another, hence the controversy. At issue is the wording of bankruptcy code section 506 (d), which appears to allow liens to be stripped, but doesn’t specify if an individual debtor has a personal right to do it.

In the case of McNeal v. GMAC, the Atlanta judges said the debtors do have such a right. In the process, they sidestepped the most frequent obstacle, the Supreme Court’s 1992 ruling in a case called Dewsnup, which said there can’t be any Chapter 7 lien-stripping for loans that are partially secured.

Because the Atlanta judges consider the Dewsnup case limited to partially-secured loans, they said it didn’t apply to completely unsecured loans, and followed the 1989 Eleventh Circuit In re Folendore case to allow the debtors to strip off their second mortgage.

Nationally, this argument has a checkered history. Most notably, two judges on Long Island supported Chapter 7 strip-offs in 2009 and 2010, but another judge there did not.

The $64,000 question for New Englanders may be whether any judge in this area will adopt the Eleventh Circuit’s reasoning, which is only binding law in Florida and Georgia. No sitting bankruptcy judge in Massachusetts or New Hampshire has ever commented in print on the Folendore case, so at this point their opinions and attitudes on the topic are unknown.

Another possibility, though less likely, is that the US Supreme Court could hear GMAC’s appeal in the McNeal case. Stay tuned for an update on that!


By Doug Beaton

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