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Lien Stripping of an Unsecured Junior Lien By A Homeowner In A Chapter 7 Bankruptcy

Is It The End Of The Line For A “Strip Off” Of A Wholly Unsecured Junior Lien By A Homeowner In A Chapter 7 Case?

We should soon know. The Eleventh Circuit Court of Appeals located in Atlanta, GA is the appellate court for federal courts located in Georgia as well as those federal courts located in Florida and Alabama. Under the authority of Folendore v. SBA decided in 1989, the Eleventh Circuit has held that a debtor in a Chapter 7 case can “strip off” junior liens so that not only can the personal liability of the debt on the note be discharged and eliminated, but the lien can be avoided and can be recorded as void in the Superior Court where the residence is located. This has been huge for homeowners in Georgia. The junior lien can be “stripped off” in cases in which the debt owed on the senior lien is more than the homes current value. In such a case, under the Bankruptcy Code, the junior lien is considered to be wholly unsecured and “totally underwater” and may be treated as an unsecured claim in the Chapter 7 case.

This has been a major financial benefit for Georgians, but it could  all come to an end. Circuit Courts in the Fourth, Sixth and Seventh Circuits have denied debtor’s attempts to “strip off ” junior liens on the basis of Dewsnup v. Timm, a U.S.Supreme Court decision decided in 1992,  In 2012, in  McNeal v. GMAC Mortgage, LLC,, a Three-Judge Panel of the Eleventh Circuit revisited the issue and concluded that it was not bound by the reasoning used by the Supremes in the 1992 case, because, among other things, Dewsnup involved an attempt to “strip down” a lien, and not to “strip off” a lien.

As a result, lien “strip offs” in Georgia have continued apace. One of the Bankruptcy Judges in the Northern District of GA calculated that in the Northern District of GA alone, by March 3, 2013, debtors had filed more than 500 actions to strip liens in Chapter 7 cases.  An attorney for Bank of America has stated that more than 40 such actions were docketed in the Northern District of GA just in February, 2014. On  November 17, 2014, the Supreme Court agreed to hear two cases out of Florida—cases being contested by Bank of America—which involve the issues that were before the Panel of Judges in the McNeal case . Commentators expect that the Court will hear oral arguments in March, 2015 and reach a decision by late June, 2015. The reasoning used in the 1992 Dewsnup decision was roundly criticized as inconsistent with the Bankruptcy Code enacted in 1978. Should the Court validate the reasoning used in  Dewsnup, we can find some small comfort in a quote by Justice Jackson: “We are not final because we are infallible, but we are infallible only because we are final” .Stay tuned.

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