As with all legal questions, the answer is it depends. While the Supreme Court has ruled that you can not strip a second mortgage in a Chapter 7 proceeding, you still may be able to file a subsequent Chapter 13 case to achieve the goal.
So the issue really depends upon whether you can qualify for Chapter 13 relief and whether such plan is proposed in good faith.
This “double bankruptcy” is often referred to as a Chapter 20, which essentially is a Chapter 7 followed by a Chapter 13. Unfortunately, a Chapter 20 usually brings up issues of bad faith and Bankruptcy Courts highly scrutinize these filings. Lien stripping in the subsequent Chapter 13 case entails both qualifying for Chapter 13 relief and qualifying for lien stripping within that chapter.
To strip a second or junior mortgage on the personal residence in the subsequent Chapter 13 requires proving Chapter 13 eligibility (you have income and are within the debt limitations) and that the lien is totally unsecured (the value of the house is less than the first mortgage debt). For more information on the specific qualifications of lien stripping, please click my blog here.
Most issues arise over whether the subsequent filing was done in good faith or not. Bad Faith frequently arises when individuals attempt to take advantage of both chapters where such advantages are not typically available in either chapter. For instance, filing a Chapter 7 to remove the unsecured debt for a later Chapter 13 solely in an attempt to reduce the Chapter 13 payments due to the lower debt load, is often viewed as bad faith.
On the other hand, reducing the unsecured debt in a prior chapter 7 case in an effort to qualify under the debt limits in the later Chapter 13 case, thus saving the fees, costs, and requirements in avoiding a Chapter 11 case, is generally considered not bad faith. Its a very fine line, but very important distinction between reducing monthly payments and reducing debt to qualify.
By the same token, the sudden drop in real estate values after the filing of a chapter 7(wherein one would not have qualified for lien stripping with previous values), which makes lien stripping a possibility now, would also be considered in good faith.
So what then gets paid in the subsequent Chapter 13 since all debt was previously discharged? Courts continue to struggle with this dilemma in Chapter 20 cases. On the one hand, there is no longer any unsecured debt due to the previous discharge under 11 USC 524. So technically, when the Chapter 13 is filed, the only debts that might remain are secured debts, taxes, student loans, non-dischargeable debt, other priority debt, and post chapter 7 debt. But assuming none of this other debt remains and the only purpose of the Chapter 13 is to strip the lien, does anything get paid?
The majority of Courts are now holding that while the secured lien is now voided and the debtor no longer personally owes any of the debt, a new unsecured debt is still created. Even though the prior Chapter 7 discharged this debt as a personal liability of the debtor and it can not be collected against the debtor personally, it is an unsecured debt that can be collected against the Chapter 13 estate. As such, most Bankruptcy Courts are now allowing these unsecured claims to be paid over a 3 to 5 year plan, even though the debtor no longer personally owes it.
So what then happens on discharge? Since under the new bankruptcy laws, a chapter 13 will not receive any discharge if filed within 4 years of a chapter 7, does the debtor now personally owe a huge unsecured debt upon completion of their chapter 13? No, as previously stated, since the debt has already been discharged in the previous chapter 7, the debtor no longer personally owes the new unsecured debt, even though there will be no discharge of this new unsecured debt in the subsequent chapter 13 case.
Finally, there is also no Code provision that requires that a lien may be stripped only upon Chapter 13 discharge. In fact, the Code provisions that are used, 11 USC 506(d) and 11 USC 1322, each provide that the lien stripping is immediate, even if no discharge and even prior to completion of all chapter 13 payments. Moreover, since the new Bankruptcy Laws under 11 USC 348 and 11 USC 349 provide remedies in the event of dismissal or conversion, new arguments can be made for immediate recording of the avoided lien.
In short, a prior chapter 7 should not be an obstacle for a subsequent chapter 13 that is filed to strip a junior mortgage, provided the requirements for lien stripping exists and there is no bad faith in that chapter 13 filing. Always check with an experienced Bankruptcy Attorney if you think you might qualify for this relief.
Written by Michael G. Doan