REMBAUM'S ASSOCIATION ROUNDUP | The Community Association Legal News You Can Use

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LIEN STRIPPING, A DIRTY PHRASE

In Bank of America, N.A. v. Caulkett, the United States Supreme Court granted certiorari, and thus has agreed, to address whether the Bankruptcy Code permits a Chapter 7 debtor to “strip off,” or void, a junior mortgage lien in its entirety when the outstanding debt owed to a senior lienholder exceeds the current value of the collateral, an issue on which the Courts of Appeal are divided.

Imagine: Your association is owed thousands of dollars from a delinquent member who has not paid their mortgage either. The lender, being “on the ball,” begins to foreclose its mortgage. At some point, the board authorized an association assessment lien to be recorded against the property, too. Six to nine months later, the lender’s lawsuit is almost over. Then, without warning, the association is placed on notice that the debtor filed a Chapter 7 bankruptcy in Federal court. By operation of law, the lawsuit grinds to a screeching halt much like a racecar slamming into a concrete wall.

No further action can be taken until either the bankruptcy is discharged (the case is over) or the lender receives the express permission from the bankruptcy court to continue foreclosing the property in exchange for an agreement that the lender only seeks to acquire the delinquent member’s property and will not seek monies due and owing on the mortgage. Meanwhile, the association still has its assessment lien recorded against the property, meaning that there is still a chance the association can receive the monies it is still owed, especially if a third party purchaser acquires the property. Right? Well, not if during the bankruptcy the debtor “strips” the association’s assessment lien; a process referred to as “lien stripping.”

Lien stripping occurs when the court grants a request to wipe out all liens that are inferior to a superior lien. In the association’s case, it means that if the bankruptcy court were to allow lien stripping, the association would have no chance whatsoever of recovery of back assessments due and owing which, without going out on a limb, is extremely unfair to the association. Not all bankruptcy courts permit lien stripping. Some do, and some don’t. In such cases, where Federal Circuit Courts acting in their capacity as appellate courts disagree with one another, the United States Supreme Court has the right to examine the differing lower appellate court decisions; a process referred to “certiorari.”

Previously, the Supreme Court held that Section 506(d) of the Bankruptcy Code, which provides that a lien is not valid to the extent that it secures a claim against the debtor that is not an “allowed secured claim,” does not allow a Chapter 7 debtor to “strip down” a mortgage lien to the current value of the collateral. This will become VERY important for reasons explained below.

On the other hand, the Eleventh Circuit (with jurisdiction over the Middle District of Alabama, Northern District of Alabama, Southern District of Alabama, Middle District of Florida, Northern District of Florida, Southern District of Florida, Middle District of Georgia, Northern District of Georgia and Southern District of Georgia) held that a Chapter 7 debtor may “strip off” a valid junior lien on the debtor’s house when the debt owed to a senior lienholder exceeds the house’s current value, relying on controlling precedent that the Eleventh Circuit believed distinguishes its decisions from the Supreme Court’s rationale. Similarly, in other cases, the bankruptcy court, in unpublished decisions, entered orders voiding wholly unsecured second priority liens on residential property owned by the Chapter 7 debtors which, in unpublished orders, the district court has affirmed.

In its petitions for certiorari to the Supreme Court, a junior lienholder argued that the Eleventh Circuit’s position is irreconcilable with the Supreme Court’s decision that the Bankruptcy Code does not allow a Chapter 7 debtor to “strip down” a mortgage lien. The petition asserted that, because the junior lienholder had valid claims for the money loaned to the debtors, the Bankruptcy Code provided no basis for the debtors to “strip off” the subject liens. Furthermore, the petition continued, the fact that a mortgage is underwater matters only to the treatment of the creditor’s claim as “secured” or “unsecured” and has no effect on the treatment of the creditor’s lien under Section 506(d) of the Bankruptcy Code.

Hopefully, the United States Supreme Court will explain that lien stripping is not permitted, keeping association liens alive after bankruptcy proceedings and thereby providing the association a better chance of collecting past due assessments!