Court Requires Debtor to Pay Discharged Mortgage through Plan

Posted by NCBRC - August 24, 2021

In a poorly-reasoned opinion ignoring basic principles of bankruptcy, the Bankruptcy Court for the Eastern District of New York held that a junior mortgagee’s lien could be stripped in the debtor’s chapter 13 case, but the claim must be treated as a general unsecured claim despite the fact that the debtor discharged her personal liability on the debt in a prior chapter 7 bankruptcy. In re Hopper, No. 21-70139 (Bankr. E.D.N.Y. Aug. 5, 2021).

Approximately twelve years before filing for chapter 13 bankruptcy, the debtor obtained a discharge in a chapter 7 bankruptcy including her in personam liability for the junior mortgage on her residence held by Real Time Resolutions. In her plan, which proposed to pay 100% to unsecured creditors, the debtor sought to strip off Real Time’s junior lien as wholly unsecured and reduce Real Time’s claim to zero. Although Real Time did not object to the debtor’s proposed plan, the court held a hearing at which the debtor and the trustee appeared.

In deciding that the claim could not be reduced as requested by the debtor, the bankruptcy court stated: “Simply put, the Debtor asks the Court to enter an order that divests Real Time of any rights it may have under the mortgage lien that survived the prior chapter 7 and simultaneously prevents Real Time from receiving any compensation for the taking of its property under the Debtor’s proposed plan.”

In its analysis, the court struggled to reconcile Johnson v. Home State Bank, 501 U.S. 78 (1991), which held that the debtor’s in personam liability is eliminated upon receipt of chapter 7 discharge, Dewsnup v. Timm, 502 U.S. 410, 417 (1992), where the Court held that unsecured junior mortgage liens pass through chapter 7 bankruptcy unaffected, and section 1322(b)(2) which permits a chapter 13 debtor to strip off a wholly unsecured lien.

The court noted that some cases dealing with the issue, such as In re Miller, 462 B.R. 421, 431 (Bankr. E.D.N.Y. 2011) (citing In re Hill, 440 B.R. 176, 182-83 (Bankr. S.D. Cal. 2010)); In re Akram, 259 B.R. 371 (Bankr. C.D. Cal. 2001); In re Gounder, 266 B.R. 876 (Bankr. E.D. Cal. 2001), treated the lienholder’s claim as a nonpriority unsecured debt as the trustee proposed to do here. Those cases reasoned that, in chapter 13, section 506(a) requires valuing the secured claim at zero, but says nothing about reducing the value of the remaining unsecured claim.

On the other hand, the court cited In re Rosa, 521 B.R. 337, 339 (Bankr N.D. Cal. 2014), for the opposite position. There, the court reduced the lienholder’s claim to zero on the basis that the discharge injunction prevents the debtor’s in personam liability from being resurrected in the later chapter 13 bankruptcy case. The court in Rosa found that once the lien is stripped in chapter 13, the remaining unsecured claim is not an allowed claim under § 502(b). That court found that the approach taken by courts allowing the unsecured claim fail to “cogently explain why, after eliminating their in rem rights through a motion to value, these lienholders held allowed, unsecured claims for discharged debts [in the chapter 13 case].” The Rosa court further found that the definition of “creditor” in section 101(10) as an entity with a claim against the debtor, “limits the universe of allowable unsecured claims to those with claims that have not been discharged.”

The court here disagreed with the court in Rosa and joined the cases holding the opposite view. It found that the discharge injunction does not eliminate the creditor’s claim against the debtor, it merely precludes the creditor from attempting to collect on that claim from the debtor. “Contrary to the court’s analysis in In re Rosa, 521 B.R. at 340, the decision by Real Time to file a proof of claim in this case is not an act to collect a discharged debt and does not run afoul of § 524.” The court reasoned that Real Time retained more than just a lien at the close of the debtor’s chapter 7, it retained the parcel of rights including “’the right to repayment of the principal in monthly installments over a fixed term at specified adjustable rates of interest, the right to retain the lien until the debt is paid off, [and] the right to accelerate the loan upon default and to proceed against [the debtor’s] residence by foreclosure and public sale. …’ In re Nobelman, 508 U.S. at 329.”

The court turned to section 522(c) which it found limits a court’s power to change or disallow a claim by codifying the long-standing rule that a lien passes through bankruptcy unaffected. The fact that a lien may be voided under section 506(d) does not likewise void the claim. The only way to disallow the claim is through section 502, and here the debtor has not moved for disallowance under that section.

Furthermore, the court found that under section 502(b)(1) a claim may be disallowed when, under applicable law, it is unenforceable against the debtor or against the debtor’s property. The court found the applicable law here is New York property law which provides that a junior mortgage holder has the right to foreclose even if foreclosure would not result in any recovery by that lienholder. “Real Time’s rights exist unless Real Time is paid in full on its claim. As such, Real Time’s claim is fully enforceable and cannot be disallowed under § 502.”

Citing the Fifth Amendment to the U.S. Constitution, the court went on to say that “[a]llowing the Debtor to avoid all obligations under a mortgage because the lien was stripped would permit using the Code to deprive a creditor of substantive rights without providing the creditor with just compensation.”

The court granted the debtor’s motion insofar as it sought to strip the lien but denied the debtor’s motion to value Real Time’s claim at zero.

The debtor has filed an appeal to the district court, case no. 21-4716.

Hopper Bankr ED NY 2021


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