The Lawletter Vol 35 No 12, August 26, 2011
In In re Okosisi, No. BK-S-09-27113-BAM, 2011 WL 2292148 (Bankr. D. Nev. May 16, 2011), the debtors found themselves in a familiar dilemma. At the time of filing, their principal residence had a fair market value of $342,000. This property was encumbered by a first-priority mortgage in favor of Citimortgage for $383,000 and a second-priority mortgage in favor of Nevada State Bank for $302,125. Citimortgage's claim was thus undersecured, and Nevada State Bank's claim was wholly unsecured. The debtors had previously been discharged in Chapter 7, but within two years they filed a Chapter 13 petition to reschedule some secured debts and tax claims. They were, of course, ineligible for a discharge because of the Chapter 7 discharge. Cases of this kind are sometimes referred to as "Chapter 20" cases.
Outside of bankruptcy, if a creditor has a valid security interest, regardless of the collateral's value, it may be thought of as a secured creditor. In bankruptcy, a creditor is a secured creditor only if its claim is so classified. If the claim is not so classified, the once‑secured creditor will have an unsecured claim and will thus be an unsecured creditor for purposes of the bankruptcy case. Thus, while Citimortgage's claim was partially secured, Nevada State Bank's claim was wholly unsecured, at least for bankruptcy purposes.
When the collateral securing the debt is the debtor's principal residence, 11 U.S.C. § 1322(b)(2) prohibits the debtor from modifying the rights of a security holder. In this case, however, because Nevada State Bank's claim was wholly unsecured, its lien could be "stripped off," leaving it with an unsecured claim, notwithstanding the antimodification provision, § 1322(b)(2). Virtually all courts to have considered the issue have concluded that this outcome is mandated by Nobelman v. American Savings Bank, 508 U.S. 324 (1993).
For those debtors who successfully confirm and complete a Chapter 13 plan, the Chapter 13 discharge operates as a permanent injunction against the collection of debts to the extent of the debtor's personal liability on the debt. 11 U.S.C. § 524. It is important to note, however, that just because a debtor receives a discharge in bankruptcy, the debt does not simply vanish. The debt remains, but personal liability on the debt has been removed. Liens on property of the Chapter 13 bankruptcy estate, if not properly addressed through the Chapter 13 plan, remain on the encumbered property, and once the automatic stay is lifted by entry of the discharge, the creditor is free to exercise any nonbankruptcy collection remedies attributable to its valid security interest in the property. In the normal Chapter 13 case, when the debtor avoids the lien through a confirmed plan and also receives a discharge after having completed all plan payments, the debt also remains. Both the personal liability for the debt and the lien allowing the creditor to proceed against the property have been removed, making the debt uncollectible.
Some courts have concluded that a Chapter 13 debtor is prohibited from confirming a Chapter 13 plan which removes a lien from real property when the debtor has previously filed a Chapter 7 case and received a discharge. In re Gerardin, 447 B.R. 342, 352 (Bankr. S.D. Fla. 2011) (holding that Chapter 20 debtor could not avoid lien because of ineligibility for discharge). The Okosisi court disagreed, concluding that the claim of a formerly secured creditor, such as Nevada State Bank, once it has lost its secured status, is unsecured thereafter for all purposes. Accordingly, the debtor, having stripped off the lien, may treat it under the plan as though it were an unsecured claim, denying the creditor the status of a secured creditor thereafter even though the Chapter 13 debtor cannot obtain a discharge.
Chapter 20 cases present exceedingly complex and difficult issues, as Okosisi demonstrates. Counsel must carefully review the state of the law in a particular jurisdiction before advising the client on potential bankruptcy options. These issues become increasingly important as more and more homeowners find their home loans "underwater" and seek to restructure the loans in Chapter 13 to avert foreclosure.