Stripping of Liens in Bankruptcy

Background & Analysis

When a person files bankruptcy, the bankruptcy does not automatically remove mortgages, judgments, and other liens from the debtor’s property. All that the bankruptcy does is discharge the debt so that the debtor is no longer personally liable for the debt. Mortgages, judgments, and other liens - for which the debt was discharged, remain liens on the property. However, one way to remove a junior mortgage from property in a bankruptcy is with an order stripping the junior mortgage from the property. This type of bankruptcy order is commonly referred to as an order stripping liens or a stripping lien order. The factual basis for stripping a junior mortgage from property is that the amount owed on the first mortgage exceeds the value of the property so that the junior mortgage is totally unsecured.

There has been a legal debate for many years as to whether stripping liens is authorized in Chapter 7 bankruptcies. The U.S. Supreme Court settled that debate on June 1, 2015 when it decided the Bank of America v. Caulkett case at 135 S.Ct. 1995 (SC 2015). In Caulkett, the U.S. Supreme Court held that a debtor in a Chapter 7 bankruptcy may not void or strip-off a junior mortgage under §506(d) of the bankruptcy code when the debt owed on the senior mortgage exceeds the value of the property. Due to the Bank of America v. Caulkett decision, WFG will not rely on orders stripping liens in current Chapter 7 bankruptcies to insure over junior mortgages. However, WFG will consider relying on an order stripping a junior mortgage in an old Chapter 7 bankruptcy if the Chapter 7 bankruptcy was closed one year prior to the date of the Bank of America v. Caulkett decision. Agents must obtain prior written approval from WFG’s Underwriting Department to insure over a junior mortgage stripped in an old Chapter 7 bankruptcy.

The Bank of America v. Caulkett case did not affect the authority to strip junior mortgages in Chapter 13 bankruptcies in states located in the 3d, 5th, and 11th Federal Circuits. The reason for the different treatment of orders stripping liens in Chapter 7 bankruptcies and Chapter 13 bankruptcies is due to a bankruptcy code provision that authorizes a debtor in a reorganization bankruptcy such as Chapter 13 to modify the rights of a holder of a junior mortgage when there is no equity in the property to secure that junior mortgage. It is that provision of the bankruptcy code that authorizes a Chapter 13 debtor to modify a junior mortgage to strip it from the property when the value of the property is insufficient to secure the entire amount of the junior mortgage. Chapter 7 bankruptcies are not reorganization bankruptcies like Chapter 13s so the bankruptcy code provision that authorizes a Chapter 13 debtor to modify a junior mortgage is not available in Chapter 7 bankruptcies. While WFG will not rely on orders stripping liens in current Chapter 7 bankruptcies, we will continue to rely on orders stripping liens in Chapter 13 bankruptcies to insure over stripped junior mortgages in states located in the 3d, 5th, and 11th Federal Circuits.

WFG’s Underwriting Position On Stripping Liens In Bankruptcy After The Bank Of America v. Caulkett Decision

Chapter 7 Bankruptcies

• WFG will not rely on orders stripping liens in current Chapter 7 bankruptcies to insure over junior mortgages.
• WFG will consider relying on an order stripping a junior mortgage in an old Chapter 7 bankruptcy if the Chapter 7 bankruptcy was closed one year prior to the date of the Bank of America v. Caulkett decision i.e. June 1, 2014 or before.
• Prior written approval from WFG’s Underwriting Department is required to insure over a junior mortgage stripped in an old Chapter 7 bankruptcy.

Chapter 13 Bankruptcies

• For property located in states in the 3d, 5th, and 11th Federal Circuits, the requirements to insure over a stripped junior mortgage are, as follows:
  • 1. Record a certified copy of the Motion To Strip the Junior Mortgage. Agent must confirm that the mailing matrix in the bankruptcy case shows that a copy of the Motion was mailed to the lender - whose mortgage was stripped, the bankruptcy Trustee, and to all creditors.
  • 2. Record a certified copy of the Notice of Hearing on the Motion To Strip the Junior Mortgage. Agent must confirm that the mailing matrix in the bankruptcy case shows that a copy of the Notice of Hearing on the Motion To Strip the Junior Mortgage was mailed to the lender - whose mortgage was stripped, the bankruptcy Trustee, and to all creditors.
  • 3. Record a certified copy of the Order Granting the Motion to Strip the Junior Mortgage. Agent must confirm that the mailing matrix in the bankruptcy case shows that a copy of the Order Granting the Motion to Strip the Junior Mortgage was mailed to the lender - whose mortgage was stripped, the bankruptcy Trustee, and to all creditors.
  • 4. Review the bankruptcy docket to confirm that the Order Granting the Motion to Strip the Junior Mortgage was not appealed.
  • 5. Record a certified copy of the debtor’s discharge. Even after an order stripping a junior mortgage is entered, that mortgage remains a lien on the property until the debtor receives a discharge. That is why all orders stripping liens are conditioned on the debtor obtaining a discharge in the bankruptcy. Therefore, if the debtor has not received a discharge, we cannot rely on the order stripping lien to insure over that junior mortgage.
  • 6. Agent must obtain prior approval from WFG’s Underwriting Department to insure over a junior mortgage stripped in a Chapter 13 bankruptcy.

Chapter 11 Bankruptcies

• WFG will rely on a bankruptcy court order “stripping down” or “stripping off” a lien appropriately entered in a Chapter 11 bankruptcy.

Orders To Sell Free & Clear

• WFG will continue to rely on appropriately entered orders authorizing sale of property "free and clear" of liens under Bankruptcy Code §363(f).

States in the 3d, 5th, and 11th Federal Circuits

• 3d Federal Circuit: Delaware, New Jersey, Pennsylvania.
• 5th Federal Circuit: Louisiana, Mississippi, Texas.
• 11th Federal Circuit: Alabama, Florida, Georgia.

Preliminary Notes for Underwriting

(Not based on full research)

• The Caulkett case interprets a provision of general applicability to all types of bankruptcy. In a Chapter 13 context, the U.S. Supreme Court has previously held that a partially unsecured lien against the debtor’s homestead may not be “stripped down” But that ruling was based on a specific provision of chapter 13. Section 1322(b)(2), which the court concluded prohibits a Chapter 13 debtor from relying on §506(a) to reduce an undersecured homestead mortgage to the fair market value of the mortgaged residence. Nobelman v. American Sav. Bank, 508 U.S. 324, 113 S.Ct. 2106, 124 L.Ed.2d 228 (U.S. 1993). While Nobelman held that a an undersecured 2d mtg on homestead cannot be stripped down under 1322(b)(2), the 11th Circuit in Tanner V. FirstPlus, 217 F.3d 1357 (11th Cir. 2000) interpreted Nobelman and held that the “principal residence” exception to mortgage modifications under 1322(b)(2) does not apply if the 2d mortgage on the homestead is wholly unsecured. See also, In Re: Scantling 754 F.3d 1323 (11th Cir. 2014). In Re: Woolsey, 696 F.3d 1266 (10th Cir. 2012) includes an interesting discussion of whether this logic is correct, but also holds that a homestead lien may not be partially stripped in a Chapter 13.

*11 U.S. Code § 1322 - Contents of plan
(b) Subject to subsections (a) and (c) of this section, the plan may—
(1) designate a class or classes of unsecured claims, as provided in section 1122 of this title, but may not discriminate unfairly against any class so designated; however, such plan may treat claims for a consumer debt of the debtor if an individual is liable on such consumer debt with the debtor differently than other unsecured claims;
(2) modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor’s principal residence, or of holders of unsecured claims, or leave unaffected the rights of holders of any class of claims;

• 11 USC 1322(b)(2) allows a Chapter 13 Plan to modify the rights of holders of secured claims. And 11 USC 1325 (a)(5)(B)(I)(bb), with respect to each allowed secured claim, provides that a Plan will be confirmed if the plan provides that the holder of such claim retains the lien securing the claim until the earlier of payment of the claim or a discharge is entered. Accordingly, all orders stripping liens provide that they are not effective until a discharge is entered. That section does go on to say that if the case is dismissed or converted without completion of the Plan that the lien will be retained.