Chicago bankruptcy judge rules that receipt of discharge is necessary to strip off a wholly unsecured second mortgage from a residence.

As homeowners struggle to keep up with their financial obligations in the current economy, many have turned to Chapter 13 Bankruptcy.  Chapter 13 cases, like all bankruptcy cases, are handled by the federal court system.  The Northern District of Illinois includes all of Cook County and it's collar counties, including Will, DuPage, Lake, Kane, LaSalle, Grundy and Kendall.  Each bankruptcy district may interpret sections of the Bankruptcy Code differently, which means that what a person can do with a bankruptcy in their district may differ from what can be done in another district.

In the past few years, it has become a fairly common practice in Chicago and the surrounding counties to use the mechanics of a Chapter 13 bankruptcy to "strip" a second or junior mortgage from a bankruptcy filers' home.  Stripping a junior mortgage is the process by which a junior mortgage lien is paid the same as an unsecured creditor, like a credit card, through the Chapter 13 plan payment.  The junior mortgage lien is then satisfied by the completion of the Chapter 13 plan and removed from the property. 

In order to qualify for this process, the Debtor must live in the property and have a first mortgage that exceeds the current market value of the property.  In his decision in Erdmann v Charter One Bank, 2011 Bankr. LEXIS 845 (Bankr. N.D.Ill. Mar. 10, 2011), Judge Bruce W. Black ruled that another qualification for this process is the receipt of a bankruptcy discharged at the end of the Chapter 13 case.  This decision was reached by considering the requirements under sections 11 U.S.C. 1325 and 11 U.S.C. 502 of the U.S. Bankruptcy Code.

The discharge is usually, but not always, the purpose of filing for bankruptcy protection, as it is the court order that in effect wipes out any remaining unpaid unsecured debts (with restrictions).  In a Chapter 13 case, this would be debts to creditors who failed to file claims in the Chapter 13 case before the bar date and claims that were not paid in full during the plan.  There are number of reasons that a person may not be entitled to a discharge in a Chapter 13 case.  The most common reason is the receipt of a discharge in a prior bankruptcy case where the current Chapter 13 case was filed too closely to the discharge of the prior case. 

The common scenario that this ruling addressed is where a Chapter 7 bankruptcy was filed to eliminate the filer's unsecured debt.  The filer(s) then attempted to file for Chapter 13 bankruptcy protection in order to remove the junior mortgage from their residence.  Since there was a recent Chapter 7 discharge, no discharge would be granted in the Chapter 13 case, but this would be irrelevant because, with the lien removed, the liability on the second mortgage would have been already discharged in the Chapter 7.  Judge Black interpreted the code in Erdmann to mean that the discharge in Chapter 13 is required to remove the lien, and therefore lien stripping is not available if there is no Chapter 13 discharge.

This is one of many reasons that the representation of an experienced Chicago bankruptcy attorney is vital from the very beginning of the process.  A good bankruptcy lawyer will explain to you the options available, including lien stripping, and recommend which chapter of bankruptcy is your better option.  The experienced bankruptcy lawyers at Ledford & Wu are happy to offer you a free consultation to discuss your options.

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