If you have second mortgage on your home and have already filed Chapter 7 bankruptcy, filing a Chapter 13 to strip (wipe out) your second mortgage may be a viable option. This strategy (7 followed by 13) is commonly referred to as a “Chapter 20.”
But I thought I had to wait several years before filing another bankruptcy?
While it’s true that there are time limits you must wait prior to getting a discharge in your second bankruptcy case (for example eight years from Chapter 7 filing to Chapter 7 filing), there is no limit on how long you must wait from one bankruptcy filing to the next. Obviously, if you need a discharge for debts which arose after your first filing, you need to pay attention to the waiting periods required in the Code.
But what if I don’t need a discharge and want to accomplish some other goal allowed under the Bankruptcy Code?
Then “Chapter 20” might be right for you. And one objective might be to strip off a junior (2nd, 3rd, etc.) mortgage which is wholly unsecured.
Let’ say your house is worth $300,000 but you owe $330,000 on your first mortgage. Let’s further assume that you have a second mortgage for $100,000. You may be making your first mortgage payments like clockwork. Maybe you received a mortgage modification to cure the arrears and reduce the payments on the first mortgage. Still, there’s the elephant in the room: the second mortgage.
First, you might not be able to afford the payments on the second mortgage. Second, the house might be “under water”–worth far less than what you owe. Although you may have filed a Chapter 7 bankruptcy and gotten a discharge, Chapter 13 is still available to help with your problem with your second mortgage. (For an in-depth discussion and background of how this works in Chapter 13, see “Mortgage Stripping in Bankruptcy.”)
The 4th Circuit just ruled on Chapter 20 bankruptcy a couple of months ago
The 4th Circuit Court of Appeals (the appeals court for bankruptcy courts in Maryland, Virginia, West Virginia, North Carolina and South Carolina) just made it clear that Chapter 20 is available and was not prohibited by the modifications of our Bankruptcy Code in 2005. In In re Davis, the Court first reiterated that the Bankruptcy Code allows debtors to strip off a wholly unsecured mortgage in Chapter 13, holding that “the Bankruptcy Code permits the stripping off of valueless liens in Chapter 13.”
The Court then turned its attention to the issue of whether this “stripping off” was allowable in a Chapter 13 case following a Chapter 7 in which the debtor was not eligible for a discharge in the second case–in other words in a “Chapter 20” case. Quoting Branigan v. Bateman (In re Bateman), 515 F.3d 272, 283 (4th Cir. 2008), the Court stated, “it is the ability to reorganize one’s financial life and pay off debts, not the ability to receive a discharge, that is the debtor’s ‘holy grail.’” The Court specifically noted that the debtor might opt to file bankruptcy even when no discharge is available “to cure a mortgage, deal with other secured debts, or simply pay debts under a plan with the protection of the automatic stay.” Put simply, filing bankruptcy isn’t all about the discharge; debtors can get other benefits as well.
BAPCPA (the 2005 Bankruptcy Code) didn’t change anything, either
The Court also rejected the Chapter 13 bankruptcy trustee’s argument that the 2005 revisions in the Bankruptcy Code modified the debtor’s ability to strip off valueless liens. “BAPCPA did not amend sections 506 or 1322(b), so the analysis permitting lien-stripping in Chapter 20 cases is no different than that in any other Chapter 13 case.”
Still, good faith is required
However, the Court made it clear that, as with any Chapter 13 filing, the debtor must propose the plan in good faith.
Good faith is difficult–perhaps impossible–to define. It’s not one thing but the totality of the debtor’s conduct, both pre-filing and post-filing. In this context, I believe the Court would look at several factors such as: (1) the debtor’s circumstances during the Chapter 7 filing (Could the debtor have filed a 13 in the prior case? Why did the debtor file a 7? How much were the debtor’s mortgage payments? Has the debtor’s income or expenses changed?); (2) efforts made by the debtor to avoid the subsequent bankruptcy filing (Has the debtor attempted to negotiate some resolution with the second mortgage holder? Were meaningful offers made?); (3) other purposes the debtor might accomplish with the Chapter 13 filing (like paying off cars or other secured debts); and (4) any other relevant facts relating to the filing.