In most courts, it was not possible to strip off unsecured liens from their homes for people filing for Chapter 7 bankruptcy. However, a three-judge panel of the Eleventh Circuit Court of Appeals made an unpublished decision in 2012 that offered hope for bankruptcy attorneys and their clients. They ruled that it was possible for a Chapter 7 debtor to strip off an unsecured loan in their bankruptcy.
The case of the Palomars
In July of 2011, the Palomars filed for Chapter 7 bankruptcy. However, their bankruptcy trustee reported that there were no assets amongst them only a month later. The debts were subsequently discharged and in December of 2011, the case was closed.
However, the family did file an adversary proceeding a day before the report came in. This proceeding was against First American Bank â€“ the holders of the second mortgage of their home for the sum of $50,000. The home was appraised at $165,000, and the first mortgage was worth $243,000. The complaint argued that the second mortgage should be stripped because it was worthless.
The judge refuses to open the case
However, once the adversary proceeding was ripe, the judge refused to reopen the bankruptcy case. The reason cited was that the claim brought by the Palomars was meritless. Instead, the judge dismissed the claim altogether.
There was no reaction from First American Bank and the Palomars filed an appeal to the district court and later to the Seventh Circuit. According to the Seventh Circuit, only Chapter 11 or Chapter 13 cases allow for lien stripping.
â€œNo improvement in the financial situationâ€
According to the court, from a practical standpoint, extinguishing the lien would not truly improve the financial situation for the Palomars. Instead, it may even deprive them of a chance to make more money later on, especially if the value of the home were to rebound beyond what the first mortgage was worth.
Because of their very low assets, the Palomars did not have the option to file for Chapter 13. Because of this, despite the worthlessness of the lien, the family will continue to owe the debt to First American. This established that lien stripping is unavailable if you live within the Seventh Circuit.