By John C. Lynch, Jeffery W. Cavender and Matthew R. Brooks
The U.S. Court of Appeals for the Eleventh Circuit has ruled that Chapter 7 debtors can strip off, or void, wholly unsecured mortgage liens. The per curiam opinion, issued May 11, 2012, marks a significant departure from the standard Chapter 7 practice in most districts.
In deciding McNeal v. GMAC Mortgage, LLC, et al. (In re McNeal), 11-11352, (11th Cir., May 11, 2012) [enhanced version available to lexis.com subscribers], the appeals court disregarded the seminal 1992 U.S. Supreme Court decision in Dewsnup v. Timm [enhanced version available to lexis.com subscribers], in which the Supreme Court held that a Chapter 7 debtor could not "strip down" a partially secured lien to the value of the collateral under section 506(d) of the Bankruptcy Code. Instead, the court relied on a 1989 11th Circuit opinion, Folendore v. United States Small Bus. Admin., 862 F.2d 1537 (11th Cir. 1989) [enhanced version available to lexis.com subscribers], in which the court held that wholly unsecured junior liens are void under section 506. Because Dewsnup concerned a strip down and not a strip off, the court felt bound to follow Folendore, not Dewsnup.
The opinion is a departure from decisions from the Fourth, Sixth and Ninth Circuits that have applied the logic from Dewsnup to prohibit strip off in Chapter 7 cases. As a practical consequence of the opinion, investors can no longer feel secure that second and third priority liens will ride through a Chapter 7 bankruptcy.
Also, the opinion may have a significant impact in the Chapter 13 context, particularly in "Chapter 20" cases in which a debtor first files a Chapter 7 case to discharge unsecured debt and then later files a Chapter 13 case to address an arrearage on a principal mortgage. Whereas previously lenders could largely disregard motions to strip liens in the Chapter 7 arena, they will now need to closely monitor consumer cases and evaluate potential objections and defenses.
Troutman Sanders' bankruptcy and financial services litigation groups routinely represent mortgage lenders and servicers in bankruptcy matters. Please contact a member of these groups to discuss how Troutman Sanders can assist you going forward in light of the McNeal opinion.
©Troutman Sanders LLP
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