Lien stripping could be in state’s future

Case could allow practice now barred in bankruptcy

The state’s bankruptcy attorneys are hoping that a case before the 8th Circuit Court of Appeals will allow debtors to get out from under second mortgages in Chapter 13 bankruptcies and bring Minnesota in line with the rest of the country when it comes to a practice called lien stripping.

Michael Fisette filed for Chapter 13 bankruptcy in 2010. Like many homeowners in today’s economy, Fisette owed more money on his home than it was worth. The fair market value of his home was $145,000. He had three mortgages, and the first had an outstanding balance of $176,312.

As part of his Chapter 13 plan submitted to the Minnesota Bankruptcy Court, Fisette proposed to strip or nullify the liens on his second and third mortgages. Neither the second nor the third mortgage holder objected to Fisette’s plan.

But at a confirmation hearing, the bankruptcy judge said that a debtor was not allowed to strip an unsecured second or third mortgage. Fisette appealed to the state’s Bankruptcy Appellate Panel. That panel reversed the decision of the bankruptcy court in August 2011. The bankruptcy trustee for the District of Minnesota then appealed the panel’s decision to the 8th Circuit.

Fisette’s attorney, Craig Andresen of Bloomington, said Minnesota is one of the only states in the 8th Circuit and the country that doesn’t allow for lien stripping of second mortgages when the homeowner is underwater. He said the Minnesota courts rely on the wrong case law to prohibit lien stripping and said this case could finally change that, and more importantly allow more homeowners in bankruptcy to stay in their homes. Some homeowners could save as much as $900 a month by stripping the second mortgage, and many more creditors could be paid, he said.

“In the 1990s into the 2000s bankruptcy courts said you couldn’t do lien stripping on unsecured second mortgages, but over the past few years every other circuit except for the 8th started to change its mind and say you can do lien stripping if there is no value on the home,” he said. “As real estate values have plummeted now you have lots of totally unsecured second mortgages, and Minnesota is still saying that you can’t strip those liens. I felt that if every other court was allowing it, why not Minnesota? It’s time to get lien stripping approved by an appeals court.”

Debtors can modify their loans on vacation or rental properties and even cars, Andresen continued, but not primary residences in Minnesota. He hopes the Fisette decision will finally change that. Fisette is still in his home and making payments on the first mortgage awaiting a decision.

“It may sound like he is getting away with something by not paying his second and third mortgages, but I don’t see it that way,” Andresen said. “The second mortgage is much riskier for the mortgage company. They know that if there is a foreclosure, they won’t get paid a penny.”

Anoka bankruptcy attorney Tim Theisen said he fully expects the 8th Circuit will uphold the appellate panel’s decision. He said that Minnesota judges have used outdated case law for too long in denying the lien stripping appeals. The U.S. Supreme Court has ruled that you can’t alter the terms of a mortgage when only part of the loan is unsecured, but in cases like Fisette, the entire loan is unsecured.

He said part of the reason it has taken so long to get to this point is that it’s hard to find the right case to be the precedent setter.

“I have had cases a few years ago where I would try to strip the liens, but we would get stuck when the creditor would object [to the lien stripping] and the judge wouldn’t allow it,” he said. “I would be trying to talk the homeowner into appealing the case so we could change the case law, but the client would be hesitant [to appeal] because they could lose.”

Lenders actually stand to benefit if the appeals court allows debtors to strip second and third mortgages, said Minneapolis bankruptcy attorney Ian Ball. He said if the Fisette decision stands, it will force lenders to be more flexible with homeowners in debt and negotiate a solution that works for both parties.

“Many mortgage lenders whose liens have been stripped haven’t bothered to respond,” Ball said. “They are looking at it and saying if we did foreclose on the loan, we would have to pay off the first mortgage holder and we wouldn’t get our money back, so the heck with it.

“I’ve had a few cases where the second or third mortgage lender has said, ‘We don’t want to spend money arguing with you. How about offering us something in the Chapter 13 — then we can settle the mortgage claim voluntarily?’ The lenders would rather get something on Chapter 13 than spend $5,000 fighting over it and then have the homeowner just walk away.”

Ball said that unfortunately it could be several months until the 8th Circuit rules, and “meanwhile you’ve lost a year to more foreclosures and people abandoning their homes, and there’s another house on the market adding to the inventory of unsold homes. It accomplishes nothing for the creditors, and the homeowner sees no financial advantage of continuing in a home in which they are acquiring no equity.”

Jasmine Keller, the Chapter 13 bankruptcy trustee for the District of Minnesota, agrees that second and third mortgages should be stripped because homeowners need help. She said some families have $200,000 mortgages on homes now worth $125,000. For them, lien stripping is no different than when corporations file for bankruptcy protection.

“If the banks agreed to be more realistic and reduce interest rates, they wouldn’t be losing all that money and the debtors would be able to stay in their homes,” she said. “We bailed out the banks with billions; why is it that we can’t help the debtors who have seen the value of their homes go down because of circumstances beyond their control?”

But her office appealed the panel’s decision. She said it did so because there needs to be “certainty” to the question of lien stripping.

“This is a case we need direction on,” she said. “There are going to be a lot of debtors who want to [strip second mortgages], and we want to make sure a decision comes down and the courts allow it first. We need a decision from the 8th Circuit one way or the other.”