In a tough opinion for creditors, the Ninth Circuit has ruled that “Chapter 20” debtors can still take advantage of lien stripping, the bankruptcy tool that effectively bars wholly unsecured junior lien holders from foreclosing on a debtor’s property. Chapter 20 is a colloquial term used for the practice of filing for Chapter 13 bankruptcy on the heels of a Chapter 7 discharge.
In re Blendheim involved a married couple that filed bankruptcy during the housing crisis. The Blendheims filed for Chapter 13 reorganization after their Chapter 7 discharge. Creditors argued that because the 2005 Amendments to the bankruptcy code provides that debtors may not receive a discharge in their Chapter 13 case if they received a Chapter 7 discharge within the prior four years, then this rule effectively bars lien-stripping in the same situation. The Ninth Circuit rejected this argument, holding that the amendments do not make Chapter 20 debtors ineligible for lien stripping under the debtor’s subsequent filing.
With its opinion, the Ninth Circuit joins the Eleventh and Fourth Circuits in agreeing that “Chapter 20” debtors may strip wholly unsecured liens under § 506(d) of the Bankruptcy Code. These circuits cover federal district courts in Florida, Georgia, Alabama (Eleventh Circuit); Maryland, Virginia, West Virginia, North Carolina, South Carolina (Fourth Circuit); and Washington, Montana, Oregon, Idaho, Nevada, California, Alaska, and Arizona (Ninth Circuit).
Creditors should be aware that the Supreme Court recently ruled that debtors cannot lien strip in a Chapter 7 bankruptcy case. However, creditors should continue to exercise caution when evaluating second or third mortgages as this opinion reinforces a debtor’s ability to strip wholly unsecured liens in Chapter 13 or “Chapter 20” bankruptcy proceedings.