Tuesday, May 29, 2012

Lien Strip Second Mortgage in Chapter 7: In re McNeal (11th Circuit).

It had been widely held (after the Supreme Court's decision in Dewsnup) that consumer debtors could not strip off the second mortgage on their home when the second mortgage was wholly unsecured - that to do so must occur in Chapter 13.

However, last week, the Court of Appeals for the 11th Circuit held that it was reversible error to deny a Chapter 7 debtor the opportunity to strip off a second mortgage that was wholly unsecured.  See ( In Re: LORRAINE MCNEAL) MCNEAL, Plaintiff-Appellant, versus GMAC MORTGAGE, LLC, HOMECOMINGS FINANCIAL, LLC, a GMAC company, Defendants-Appellees.
No. 11-11352 Non-Argument Calendar , (11th Cir. 2012).

Understanding Lien stripping: For example, let's say you own a home and it has two mortgages on it.  You obtain an appraisal of the home, or consult with a realtor to learn your home's fair market value.  The balance due on your first mortgage is $100,000 and the balance due on your second mortgage is $50,000.  The appraiser states that your house is only worth $100,000.  That means that your second mortgage of $50,000 is wholly unsecured, or "under water".

In Chapter 13, if your second mortgage is wholly unsecured, or under water, you can remove the second mortgage forever (as long as you complete your Chapter 13 plan).

Now, the Court of Appeals for the 11th Circuit has held that you can do this in Chapter 7 as well.

The McNeal Case
Lorraine McNeal appealed the district court's affirmance of the bankruptcy court's denial of McNeal's "Motion to Determine the Secured Status of Claim." In her motion, McNeal sought to "strip off"1 a second priority lien on her home, pursuant to 11 U.S. C. Section 506(a) and (d).  Reversible error was shown; and thus the Court of Appeals for the 11th Circuit reversed and remand for additional proceedings.

In bankruptcy terms, a "strip down" of an undersecured lien reduces the lien to the value of the collateral to which it attaches and a "strip off" removes a wholly unsecured lien in its entirety.

McNeal filed a voluntary petition for bankruptcy under Chapter 7 of the Bankruptcy Code. In her petition, McNeal reported that her home was subject to two mortgage liens: a first priority lien in the amount of $176,413 held by HSBC and a second priority lien in the amount of $44,444 held by Homecomings Financial, LLC, a subsidiary of GMAC Mortgage, LLC (collectively, "GMAC"). McNeal also reported that her home's fair market value was $141,416. The parties do not dispute these factual allegations.

McNeal then sought to "strip off" GMAC's second priority lien, pursuant to Sections 506(a) and 506(d). McNeal contended that, because the senior lien exceeded the home's fair market value, GMAC's junior lien was wholly unsecured and, thus, void under Section 506(d). The bankruptcy court denied the motion, concluding that 506(d) did not permit a Chapter 7 debtor to "strip off" a wholly unsecured lien. The district court affirmed. McNeal appealed to the Court of Appeals for the 11th Circuit.

That GMAC's junior lien is both "allowed" under Section 502 and wholly unsecured pursuant to 506(a) is undisputed.  To determine whether such an allowed -- but wholly unsecured -- claim is voidable, we must then look to Section 506(d), which provides that "[t]o the extent that a lien secures a claim against a debtor that is not an allowed secured claim, such lien is void."

Section 506(a) provides in pertinent part:An allowed claim of a creditor secured by a lien on property in which the estate has an interest . . . is a secured claim to the extent of the value of such creditor's interest in such property . . . and is an unsecured claim to the extent that the value of such creditor's interest . . . is less than the amount of such allowed claim.

Several courts have determined that the United States Supreme Court's decision in Dewsnup v. Timm, 502 U.S. 410 (1992) -- which concluded that a Chapter 7 debtor could not "strip down" a partially secured lien under Section 506(d)  -- also precludes a Chapter 7 debtor from "stripping off" a wholly unsecured junior lien such as the lien at issue in this appeal.  But the present controlling precedent in the Eleventh Circuit remains the court's decision in Folendore v. U.S. Small Bus. Admin, 862 F. 2d 1537 (1989). In Folendore, the court concluded that an allowed claim that was wholly unsecured -- just as GMAC's claim is here -- was voidable under the plain language of Section 506(d). 

Because Dewsnup disallowed only a "strip down" of a partially secured mortgage lien and did not address a "strip off" of a wholly unsecured lien, it is not "clearly on point" with the facts in Folendore or with the facts at issue in this appeal.  Because -- under Folendore -- GMAC's lien is voidable under Section 506(d), we reverse and remand for additional proceedings consistent with this [the McNeal] decision.

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