Striping Off Wholly Unsecured Mortgages in Chapter 7

On May 11, 2012, the Eleventh Circuit Court of Appeals issued an unpublished opinion which will significantly change the local bankruptcy practice as it relates stripping off wholly unsecured mortgages. See, McNeal v. GMAC Mortgage LLC et al., Case No. 11-11352 (11th Cir. 2012). Prior to this recent Eleventh Circuit opinion, it was commonly understood that wholly unsecured mortgages could not be stripped off in a chapter 7 bankruptcy (although they could be stripped off in a chapter 13). This “understanding” was based in large part on the United States Supreme Court’s decision in Dewsnup v. Timm, 112 S. Ct. 773 (1992) which held that a chapter 7 debtor could not “strip down” a partially secured lien under 11 U.S.C. 506(d).

In McNeal, the debtor sought to “strip off” a second mortgage which was wholly unsecured, i.e., the amount of her first mortgage exceeded the value of her home. The bankruptcy court denied the debtor’s request and the district court affirmed. On appeal to the Eleventh Circuit, it was undisputed that the second mortgage was both an allowed claim pursuant 11 U.S.C. §502 and wholly unsecured pursuant to 11 U.S.C. § 506(a). In determining whether the second mortgage was voidable, the Eleventh Circuit looked to 11 U.S.C. § 506(d). In its analysis, the Eleventh Circuit recognized that several courts interpreted the Supreme Court’s Dewsnup decision to also preclude a chapter 7 debtor from “striping off” a wholly unsecured junior lien. Notwithstanding the other court’s decisions, the Eleventh Circuit found that the controlling precedent, in the Eleventh Circuit, remains its prior decision in Folendore v. United States Small Bus. Admin., 862 F.2d 1537 (11th Cir. 1989). In Folendore, the Court concluded that an allowed claim that was wholly unsecured was voidable under the plain language of 11 U.S.C. 506(d). In McNeal, the Court disagreed with the few bankruptcy courts within the Eleventh Circuit which treated Folendore as abrogated by Dewsnup, and noted the Supreme Court’s limitation in Dewsnup to the precise issue raised by the facts of that case.

The McNeal decision will significantly impact a debtor’s decision on whether to file a chapter 7 or chapter 13 bankruptcy. Until now, it was common practice for a debtor to choose to file a chapter 13 (as opposed to a chapter 7) for the sole purpose of stripping off wholly unsecured junior lien(s). However, now, as a result of the McNeal decision, debtors may choose to strip off wholly unsecured liens in a chapter 7 and avoid making plan payments over 5 years necessary in a chapter 13.

This article was submitted by Marc P. Barmat, Furr and Cohen, P.A., One Boca Place, Suite337 West, 2255 Glades Road, Boca Raton, FL 33431; mbarmat@furrcohen.com

§506(d) provides: To the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void, unless-

  1. such claim was disallowed only under section 502(b)(5) or 502(e) of this title; or
  2. such claim is not an allowed secured claim due only to the failure of any entity to file a proof of such claim under section 501 of this title.

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