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Lienstripping at a Glance by Los Angeles Bankruptcy Lawyer

U.S. Supreme Court rules on 6/1/15 that Chapter 7 debtors CANNOT "lienstrip" a junior lien, even if that junior lien is completely "under water", meaning there is not even $1 of equity available to pay the junior lien, after the senior lien(s) are paid in full.

The U.S. Supreme Court on June 1, 2015, unanimously held in Bank of America, N.A. v. Caulkett that a Chapter 7 debtor cannot "strip off" even a totally underwater mortgage under § 506(d), reversing the Eleventh Circuit. In so holding, the Court not only reaffirmed but extended its controversial decision in Dewsnup v. Timm, 502 U.S. 410 (1992), in which the Court had held that a Chapter 7 debtor cannot "strip down" a partially underwater mortgage under § 506(d). Many observers had thought -- especially after oral argument in Caulkett -- that the Court might take this opportunity to overturn its much-criticized Dewsnup decision, or at the very least confine it to partially underwater mortgages. Instead, much as Mark Twain once quipped that "the reports of his death were greatly exaggerated," the reports of Dewsnup's demise proved premature. Writing for the Court, Justice Thomas concluded that "Dewsnup's construction of "secured claim" resolves the question presented here." The Court's decision in Caulkett now indicates that mortgage liens are sacrosanct in Chapter 7, irrespective of whether they are partially or totally underwater. Whether they will be so in Chapter 13 remains to be seen, but mortgagees have a plausible argument to extend Caulkett there as well.

  • Debtors want to "Lienstrip" secured debts, because bankruptcy discharge does not get rid of liens; discharge only eliminates debtor’s "in personam" liability, it does not eliminate "in rem" liability (i.e. liens remain on collateral liens were on pre-petition).
  • Lienstripping a totally under water junior lien turns the creditor’s claim from secured to general unsecured.
  • 9th Circuit In re Zimmer case, 313 F.3d 1220 (9th Cir. 2002) and 9th Circuit BAP In re Lam case, 211 BR 36, 37, fn.2 (9th cir. BAP 1997), are a case law exception to the Bankruptcy Code’s prohibitions [found at 11 USC §1322(b)(5) and 11 USC §1123(b)(5)] on an individual debtor’s lienstripping DOT debt secured only by a lien on the individual debtor’s principal residence. Zimmer and Lam allow lienstripping junior DOT debt on debtor’s principal residence that is totally "under water" (not even $1 of equity available for it after 1st DOT is paid in full). Some judges allow debtor to seek to do a Lam/Zimmer lienstrip by motion; some judges require debtor to bring an adversary proceeding to seek to do a Lam/Zimmer lienstrip, in a Chapter 13 case, and the lien-stripped junior lien is then treated as general unsecured debt in the Chapter 13 plan. In Chapter 11 case, lienstripping is done through the Chapter 11 plan.
  • Modify OR Cure a single Secured Debt, Not Modify and Cure: Chapter 13 Plan cannot both cure default on, AND modify (aka "lienstrip") the same secured debt. In re Enewally, 368 F.3d 1165, 1172 (9th Cir. 2004) Probably same restriction in Chapter 11 plan.
  • Using 11 USC §506(a) to bifurcate an undersecured secured claim into two claims - a secured claim of the amount of the fair market value of the collateral available to pay that secured claim, plus a general unsecured claim for the remainder of the amount owed.
  • The (smaller) secured claim that results from a11 USC §506(a) bifurcation of an undersecured secured claim into a secured claim, and an unsecured claim, must be paid in full, with interest, through the Chapter 11 or 13 plan.
  • The unsecured claim that results from the 11 USC §506(a) bifurcation can be treated in the Chapter 11 or 13 plan like any other general unsecured claim, which usually means being paid substantially less than 100% of what is owed.
  • If Chapter 11 debtor which has lien-stripped does not receive a Chapter 11 discharge, the lienstrip will "undo", with the creditor going back to its rights under non-bankruptcy law.
  • Majority of case law holds if Chapter 13 debtor who has lien-stripped does not receive Chapter 13 discharge, the lienstrip will "undo", creditor goes back to its rights under non-bankruptcy law; minority case law holds debtor can lienstrip in chapter 13, even if debtor is ineligible to receive a discharge in Chapter 13 case.
  • Debtor must pay the secured claim that results from doing an 11 USC §506(a) bifurcation over life of Chapter 11 or 13 plan, which may not be feasible in Chapter 13, where maximum plan is 5 years, and which may require doing a longer than 5 year plan in Chapter 11.
  • Long 11 or 13 plan length is undesirable for individual Chapter 11 debtor, and for Chapter 13 debtors. In both Chapter 11 and 13, individual debtor must pay debtor’s monthly disposable income into debtor’s Chapter 13 or 11 plan, for full life of plan.

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