Friday, January 22, 2010

Lien Strip-Off Via Plan Confirmation Process Not Permitted; Adversary Required

In re Forrest, 410 B.R. 816 (Bankr. N.D.IL 2009)(J. Schmetterer). In Forrest, the court reviewed a debtor’s attempt to strip-off and avoid a lien on a junior mortgage by inserting lien stripping language in the chapter 13 plan with the hope that the court would confirm the plan containing said language. The creditor objected asserting that a wholly unsecured second mortgage cannot be avoided via the plan confirmation process. Instead, the creditor asserted that lien stripping and avoiding can only be accomplished via an adversary proceeding.
The Forrest court presented the issue before it as whether a debtor may strip off a junior mortgage that is allegedly wholly unsecured through a chapter 13 plan, rather than through an adversary proceeding. Ultimately, the court held that the debtor may NOT strip off the junior mortgage through the chapter 13 plan because the Bankruptcy Code, Bankruptcy Rules, and the US Constitution require debtor to file an adversary proceeding to do so.

The court noted that chapter 13 plans normally provide extensive financial details. However, the court also noted that it is not common that plans include provisions in the nature of declaratory judgments that purport to adjudicate legal issues between parties if the plan is confirmed.

The Forrest court noted that the Seventh Circuit Court of Appeals rejected such an effort by a student loan debtor attempting to discharge student loan debt by a similar tactic in In re Hanson, 397 F.3d 482, 284 (7th Cir. 2005). The Seventh Circuit believed that the tactic of utilizing the plan to obtain a “declaratory judgment” was employed by debtor’s in the hope that an unsuspecting bankruptcy court would confirm the plan and thus bind the lender who failed to recognize the ploy in time to object to confirmation.

The Forrest court also believed that the Bankruptcy Code and Bankruptcy Rules require an adversary proceeding to strip off and avoid a lien. The court noted that Rule 7001 required an adversary proceeding to determine validity, priority, or extent of lien or other interest in property. The court believed the stripping and voiding of a wholly unsecured lien has the same result as declaring the lien void in an adversary proceeding--- namely, the entire claim is treated as an unsecured claim.

The court objected to debtor’s attempt to flaunt both substantive and procedural provision of the Bankruptcy Code and Rules through a meaningless incantation inserted into the proposed plan. In particular, the court focused on the heightened notice provisions set forth in the Code and Rules.

The court believed debtor’s failure to comply with the heightened notice provisions violated the US Constitution by depriving the junior mortgagee of life, liberty, or property, without due process of law. Therefore, the court held that where the Bankruptcy Code and Bankruptcy Rules require the debtor to prosecute an adversary proceeding, the debtor cannot instead include a provision in the Chapter 13 plan and expect it to bind the junior mortgagee.

Warmest Regards,

Bob Schaller

Your Lien Stripping Defense Blog
By: Attorney Robert Schaller (Bob's bio) of the Schaller Law Firm

Bob is a member of the American Bankruptcy Institute and the National Association of Consumer Bankruptcy Attorneys.

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