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Chapter 7 Lien Stripping in Bankruptcy – US Supreme Court Weighs In

Chapter 7 Lien Stripping violates the bankruptcy code according to the Supreme Court decision in Bank of America v. Caulkett.

In a recent ruling, the United States Supreme Court ruled that debtors in a chapter 7 bankruptcy can no longer strip wholly unsecured mortgages (e.g., a $200,000 home with a $210,000 first mortgage and a $50,000 second mortgage)  from their real property (home or investment property) pursuant to 11 USC 506(d) if the mortgage is both secured by a lien and allowed under 11 USC 502 (referenced as ‘Chapter 7 lien stripping’).

Previously, the 11th Circuit (which governs Florida Bankruptcy Courts) was bound by its prior decisions that expanded the requirement of 506(d) where the lien was not allowed and therefore void. The implications of this ruling will affect a limited number of Chapter 7 bankruptcy petitions, due in large part to the rising values of homes and the impact this has on subordinate liens (second mortgages, HOA liens, mechanics liens).

Put simply, prior to the decision, if a Chapter 7 debtor owned property worth $100,000, but had a first mortgage of $120,000 and a second mortgage of $40,000, the debtor could “strip” or void the mortgage thereby making only the first mortgage secured. This is no longer the case and where there is an allowed secured claim, even if totally unsecured in a value sense, the lien would still then attach to the property for the statutory enforcement period pursuant to the statute of repose.

It is important for individuals closing on real property where they have stripped a lien to know of this recent change in the  law. Further, it is important for those that have closed on real property to know what what implications this may have on the marketability of their title going forward.

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