Written By: Alan S. Wolf
With the decimation of property values from 2008 through 2012, servicers almost invariably punted on any type of objection to stripoffs of junior liens. Even where there were possible defenses, it made little economic sense to fight for a lien on a property that was already over-encumbered by the senior liens and where property values were depreciating. Today, with rising property values in many locales (e.g., Northern California), this analysis should be revisited.
As servicers are aware, just $1 of equity above the senior lien acts as an absolute defense to stripoffs. An older appraisal may not show any equity but in rapidly appreciating areas, the change in value within just a couple of months between appraisals can make all the difference. Accordingly, servicers must ensure that they obtain an appraisal as of the bankruptcy petition date and not rely on an earlier appraisal.
Even if there is currently no equity to support the junior lien, over the course of a 5 year Chapter 13 Plan in an appreciating market, there is often a good chance that there will be equity. Accordingly, servicers should weigh the possibility of future recovery against the costs of objection.
There are a variety of objections that can be made to stripoffs. In high value areas such as California, New York, Massachusetts and Connecticut, the debtor may have inadvertently exceeded the Chapter 13 unsecured limits of $383,175 by the proposed stripoff. For example, if the first is owed $500,000 and the second is owed $300,000, a stripdown to $400,000 of the senior lien, and stripoff of the junior lien, would result in unsecured debt of $400,000, an amount clearly over the Chapter 13 limits. This would not only preclude the Chapter 13 stripdown of the senior lien and stripoff of the junior lien, but would also cause the dismissal of the Chapter 13 case. In short, by virtue of the unsecured debt, the debtor does not qualify for Chapter 13. Any combination of unsecured debt over the $383,175 limits ensures the same result. For example, if the above debtor owed $100,000 in credit card debt and the value of the property were $450,000 instead of $400,000 the stripdown/stripoff, when combined with other unsecured debt, would still result in unsecured debt over $383,175 and a dismissal of the Chapter 13 case.
Another equally effective defense to stripoff is where the property is not solely owned by the debtor. For example, if the property is owned by the husband and wife and only the wife files or where two or more people own the property and not all the owners file bankruptcy, a bankruptcy court cannot stripoff the loan. This is because the Court only has power over property of the estate and therefore cannot affect the nondebtor’s property interest, even if that nondebtor agrees to that treatment. A recent 4th Circuit Court of Appeal decision decided on October 23, 2013 makes this very clear (Alvarez v. HSBC Bank USA, N.A. (In re Alvarez), 2013 U.S. App. LEXIS 21516 (4th Cir. Md. Oct. 23, 2013)).
In addition, some jurisdictions preclude stripoff if the Debtor previously received a Chapter 7 discharge. In still other jurisdictions, it may be possible to amend the plan where property values have risen and thus prevent the stripoff.
Changing market conditions should cause servicers to take a second look at their stripoff procedures. In areas of appreciation, objection to stripoff may be appropriate.