Will Your Junior Lien Be Stripped?

The Fourth Circuit Court of Appeals recently ruled that the anti-modification provision of 11 USC 1322 does not prevent junior liens that are completely “underwater,” from being stripped, regardless of whether or not the creditor filed a proof of claim. In Burkhart v. Grigsby, 886 F.3d 434 (2018), the Fourth Circuit Court of Appeals held that whether or not a Chapter 13 debtor may strip off mortgage liens is decided by the application of 11 USC § 1322(b) and not 11 USC §506(d).

Burkhart involves a Chapter 13 Bankruptcy case filed in Maryland.  At the time of filing, the debtors’ principal residence was valued at $435,000 and encumbered by four liens.  Creditor A had a first lien in the amount of $609,500; Creditor B had a second lien in the amount of $49,411.80 and a third lien in the amount of $78,289.11; Creditor C had a fourth lien in the amount of $105,995.75.  The debtors filed an adversary proceeding to strip the liens held by Creditors B and C.  Creditor C filed a proof of claim on its lien; Creditor B did not file a proof of claim on either of its liens.  Neither creditor B or C answered the adversary proceeding.

The bankruptcy court entered a default judgment against Creditors B and C, stripping Creditor C’s lien, but refused to strip Creditor B’s liens on the basis that §506(d)(2) prohibits lien avoidance where no proof of claim has been filed.  The debtors appealed to the district court which agreed with the bankruptcy court’s ruling.  Specifically, the district court found that a lien strip could not occur until the claim had been filed and valued.  According to the district court, after the claim is valued under §506(a) (which cannot happen until a proof of claim is filed), then the provisions of 11 §1322(b)(2) are applied to determine whether or not the lien may be stripped.  The 4th Circuit disagreed with the district and bankruptcy court’s analysis.

In Burkhart, the court makes it clear that what matters in a situation where the value of the liens secured by an interest in the debtors’ principal residence are far greater than the value of the debtors’  home, is that the bankruptcy court has the authority, if not duty, to determine the value of the debtors’ principal residence.  Where, as in Burkhart, the lienholder’s security interest has no “actual value,” the Fourth Circuit says that such a claim may be stripped under the provisions of 1322(b).

Published by Joseph J. Vonnegut on May 11, 2018.