Federal Circuit Court Liberalizes Chapter 13 Stripping Of Unsecured ...

Because of substantial decline in Florida real estate values Chapter 13 bankruptcy is commonly used to strip off second and third mortgages from the debtor’s upside down  primary residence. Junior mortgages are not stripped off the residence at start of the Chapter 13. If that were the case then homeowners could file the Chapter 13 to wipe out the junior mortgage and quit payments soon thereafter. No, debtor’s junior mortgages are stripped at the “back end”, that is, at the end of the Chapter 13.

There is a difference of opinion regarding whether the debtor’s junior mortgages are stripped off upon successful completion of the Chapter 13 plan or upon entry of the Chapter 13 discharge. Why does that make any difference since the discharge is entered when the debtor successfully completes the Chapter 13 plan payments.  It makes a difference because under the 2005 bankruptcy law debtors who file Chapter 7 bankruptcy are not eligible for a discharge in a Chapter 13 filed four years after a Chapter 7. A debtor can still file a  Chapter 13 within the four years and complete a bankruptcy plan, but he cannot get the Chapter 13 discharge.

If a Chapter 13 strip the junior mortgages upon completion of a Chapter 13 plan then debtors can file a Chapter 7 to wipe out credit card debt, and immediately following the Chapter 7 discharge they can file a Chapter 13 to address their junior mortgages on their upside down home. If the mortgage strip requires a Chapter 13 plan completion and a Chapter 13 discharge then Chapter 7 debtors have to wait four years to address their home mortgages.

Recently, the Eighth Circuit Court of Appeals issued a ruling that debtors can strip unsecured junior mortgages upon the successful completion of a Chapter 13 plan, and mortgage stripping does not require a Chapter 13 discharge. (Case No. 11-6012 , In re Fisette). This case is not binding in our appellate district, and as far as I know, Florida bankruptcy courts require a Chapter 13 discharge to strip unsecured junior mortgages.

The Eighth Circuit court pointed out that there is a split of authority across the county on this issue. I think this is the first Circuit court decision on the issue. It will be interesting to see if the decision is sufficiently persuasive to give upside down homeowners here and elsewhere better bankruptcy options.