The United States Supreme Court recently decided an important issue regarding Chapter 7 bankruptcy filings. The bankruptcy code provides different types of bankruptcy cases that can be filed by individuals or entities. Two of the most prominent types of bankruptcy for consumers are Chapter 7 and Chapter 13. The primary purpose of a Chapter 7 bankruptcy is to liquidate a debtor’s debts in order to obtain a fresh start. A Chapter 13 bankruptcy is a longer process which allows a debtor to pay creditors pursuant to a court ordered payment plan which typically lasts either three to five years.
Many consumers who own real property subject to a mortgage lien that is upside down, i.e., the mortgage debt is greater than the current market value of the home, utilize the benefits of a Chapter 7 or 13 bankruptcy. Typically a mortgage lien is considered a secured debt and the lender’s claim to possession of the mortgaged property cannot be removed by filing a bankruptcy petition. A bankruptcy only has the power to remove a debtor’s monetary liability under an underlying promissory note. Thus, after the bankruptcy is over a debtor still needs to make payments on the mortgage in order to avoid the lender trying to acquire the mortgaged property through a foreclosure proceeding.
The recent ruling by the Supreme Court will affect consumers who are upside down and own real property which is subject to more than one mortgage lien. Consumers in this situation may have previously been able to utilize a Chapter 7 bankruptcy to effectively “strip” a second mortgage lien if the amount of the first mortgage lien exceeds the home’s current market value. The Supreme Court’s ruling in Bank of America, N.A. v. Caulkett / Case No. 13-1421, holds that a debtor in Chapter 7 can no longer “strip” a second mortgage lien. As a result, debtors can now only “strip” second mortgage liens in the more expensive and time consuming Chapter 13 bankruptcy.
Prior to this ruling courts in the Eleventh Circuit, the appellate circuit for the State of Florida, allowed a debtor to “strip” a second mortgage lien in a Chapter 7 bankruptcy. The Supreme Court’s ruling effectively overrules such prior case law. This ruling can have significant impact on the decision of what type of bankruptcy should be pursued by a debtor. Deciding whether to file bankruptcy and under which Chapter are important decisions that need to be made with advice of a licensed attorney.