lady justice

New 11th Circuit Case allows avoidance of Second Mortgages in Chapter 7

On May 11, 2012, the 11th Circuit Court of Appeal (whose decisions are binding in Florida) published its opinion in In re: McNeal. In the opinion, the 11th Circuit ruled that a wholly unsecured second mortgage lien can be stripped off of the property in a Chapter 7 Bankruptcy.

For those of you not familiar with bankruptcy, in both a Chapter 7 and a Chapter 13, a debtor's obligation to pay creditors for debts that existed prior to the filing of a bankruptcy petition is excused upon the Court's issuance of a discharge. In other words, the debtor no longer has to repay his or her creditors who were listed in the bankruptcy petition upon receipt of a discharge. However, when the debt is secured by a mortgage, the discharge of the obligation to repay a creditor does not affect the mortgage lien against the property. In other words, even after discharge, a first mortgage or second mortgage lender can file an action for foreclosure to obtain ownership of the property but cannot pursue the discharged debtor for repayment of the unpaid balance of the loan. As a result, typically a Chapter 7 debtor would almost always lose their underwater property to foreclosure, while a Chapter 13 debtor might be able to retain their home if the home had both a first and second mortgage and home's value was less than the balance on the first mortgage. The decision in McNeal changed all that.

At the debtor, Larraine McNeal filed a voluntary petition for bankruptcy under Chapter 7. The petition reported that her home was subject to two mortgage liens and that her home’ fair market value was $141,416

Because the value of her home was less than the balance on the first mortgage, in bankruptcy terms, the second mortgage was "wholly unsecured." Prior to the McNeal decision, only a Chapter 13 debtor could request that the bankruptcy court "strip off" the second mortgage lien and allow the debtor to retain the property burdened only by the first mortgage. However, the McNeal court decided that a Chapter 7 debtor also has the ability to retain his or her property after discharge with only a first mortgage lien against the property.

This case will certainly be helpful to may debtors who desire to retain their underwater property at a more affordable monthly payment obligation - a payment obligation that does not include a payment on the second mortgage.