Lien Stripping Gets Shot in Arm by Eleventh Circuit

Seal of the United States Court of Appeals for...

Seal of the United States Court of Appeals for the Eleventh Circuit. (Photo credit: Wikipedia)

The Eleventh Circuit Court of Appeals in Atlanta, Georgia, recently provided a shot in the arm for lien stripping off wholly unsecured liens in a Chapter 7 bankruptcy. The decision was passed down on May 11, 2012.

In In re McNeal, No. 11-11352, the court found that once a lien is determined to be wholly unsecured under section 506(a) it may be stripped off under section 506(d), which provides “[t]o the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void.”

Secured liens typically pass through bankruptcy unscathed. They cannot be discharged in a Chapter 7.

Recently, questions have arisen within bankruptcy courts about liens that are related wholly to unsecured debt. In bankruptcy circles, a secondary lien becomes wholly unsecured when the secured asset loses its market value to at or below the primary loan value. Historically, primary or secondary liens have not been stripped in a Chapter 7 bankruptcy. In re McNeal changes all of that.

McNeal, after filing for bankruptcy under a Chapter 7, reported that her mortgage was subject to two mortgage liens, $176,413 held by the primary lender and a second priority loan in the amount of $44,444. Her fair market value on the home was reported at $141,416, to which none of the parties disputed.

McNeal sought to strip off the second priority lien based on the grounds the primary lien exceeded the fair market value, and the junior lien was now wholly unsecured.

McNeal’s attorneys used 506 (d) of the code to support their claim but was denied by the bankruptcy court. The district court affirmed the bankruptcy court ruling.

McNeal then appealed to the Eleventh Circuit Court of Appeals which reversed and remanded the decision based on the fact that the Supreme Court’s decision in Dewsnup v Timm, 502 U.S. 410 (1992), was not clearly on point. Under the prior panel precedent rule, “a later panel may depart from an earlier panel’s decision only when the intervening Supreme Court decision is clearly ‘on point.’”

In this particular case, the Eleventh Circuit Judge deemed that this case was not on point in Desnup v Timm because the finding was based on the stripping of a lien during a Chapter 7 that was partially secured instead of wholly unsecured. This small difference was enough for the judge to take the minority view that a wholly unsecured debt voids a lien under section 506 (d).

Typically in times past, a debtor would file a Chapter 13 if they wanted to strip a lien on a secured debt. The results of In re McNeal sets a precedent now where you might be able to strip a lien while filing a Chapter 7. This is the first circuit level court to reach this decision.

Only time will tell how the decision affects the rest of the Chapter 7 filings. If you have mortgage issues, it would be best to consult with your bankruptcy lawyer before you make any plans to live without one of its secondary liens.

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