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Lien Stripping: Eliminating Mortgages and Lines of credit HELOC's in Chapter 13 Bankruptcy



The process of stripping a lien in a Chapter 13 bankruptcy case involves filing a lawsuit (or in some jurisdictions via motion or conspicuous plan provision) as a separate action in a Chapter 13 bankruptcy case to request that the Bankruptcy Court enter an order removing the junior lien from the record title to the property.  A successful lien stripping action currently requires the Chapter 13 Debtor to eliminate an unsecured lien only after she/he completes the Chapter 13 plan.

A Chapter 13 lien stripping action can be challenging in a number of respects.

1.  Debtor Must Name Correct Lienholder. When pursuing a lien stripping action, the Debtor must identify and properly serve the correct lienholder in order to effectively eliminate the lien.  If a Debtor's loan has been securitized (i.e. sold a bunch of times), the lienholder on file with the recorder's office may not be the appropriate entity to serve with the lien stripping action.  Oftentimes, the lienholder (called beneficiary) identified by the deed of trust on file with the recorder's office appears something like this: "MERS, as nominee for _________________."  Mortgage Electronic Registration Systems, Inc., or MERS, is merely a database where mortgage loans are transferred by and between registrants of the MERS system.  Worse, the company collecting monthly payments is most likely a servicer of the loan.  entity known as a Servicer.  A Servicer is similar to a debt collector and, in most cases, maintains no ownership in the underlying loan.  Therefore, it is important to retain an attorney experienced with mortgage securitizations and the parties involved before filing a Chapter 13 case.

2.  Debtor Must Complete Chapter 13 Plan.  Although there is no legal basis under 11 U.S.C. 506(d), Chapter 13 filers are required to complete their Chapter 13 plan in order for the lien to be stripped.  This is not required in all jurisdictions.  In fact, in three states a lien can be stripped in a Chapter 7.  Unfortunately, given life events such as job loss, divorce, and health problems, very few Chapter 13 cases are completed.  Most Chapter 13 cases wind up in dismissal or conversion to Chapter 7.

3.  Debtor Must File a Separate Lawsuit.  In the Western District of Washington, Chapter 13 filers are required to file a separate lawsuit in their Chapter 13, called an adversary proceeding, in order to strip the lien.  In comparison, other jurisdictions allow the lien to be stripped by motion or as a conspicuous plan provision (with a valuation hearing).  The cost of a contested adversary proceeding can result in exorbitant legal fees and expert witness costs that offset the savings on the lien stripping action.

4.  Debtor Must Prove No Equity Securing Lien.  506(d) allows lien stripping so long as there is NO equity securing the lien to be stripped:

(d) To the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void, unless—(1) such claim was disallowed only under section 502 (b)(5) or 502 (e) of this title; or (2) such claim is not an allowed secured claim due only to the failure of any entity to file a proof of such claim under section 501 of this title.

Therefore, a Chapter 13 filer must obtain an appraisal or other court-approved valuation of the property subject to the lien stripping action in order to prevail in the adversary proceeding.  Oftentimes, a comparative market analysis (CMA) performed by a realtor will suffice if there is no objection to value.  If a lender objects to value, an appraisal may be necessary.

As you can see, lien stripping in the Western District of Washington is fraught with obstacles.  Alternatives to lien stripping include discharging the debt and allowing the lien to remain on the Property in a Chapter 7.  After discharge, the Client may negotiate with the lienholder to propose a settlement with the lender in which the lender reconveys the lien to the Client.  Another option is to negotiate an out-of-bankruptcy settlement with the junior lienholder and avoid a Chapter 13 filing altogether.

For more information on lien stripping in Chapter 13, please feel free to call us at:  (206) 442-9500.  If you prefer to submit your inquiry in writing, please feel free to email us at: [email protected]

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