Written by Craig D. Robins, Esq.
Judge Rules That Debtor Engaged in Unfair Manipulation of Bankruptcy Code
Judge Alan S.Trust, sitting in the Long Island Bankruptcy Court in Central Islip, New York, just issued an interesting decision in a case which the Judge stated “tests the outer limits of how debtors may seek to utilize the Bankruptcy Code and Rules to obtain the maximum advantages of the process known as ‘Chapter 20′.” In re: Adam John Renz, No. 11-73471-ast, (Bankr. E.D.N.Y., Aug. 1, 2012).
What is a Chapter 20 Bankruptcy?
First, let’s discuss the concept of “Chapter 20.” There is no actual Chapter 20 of the Bankruptcy Code. Instead, this refers to the situation in which a consumer debtor files a Chapter 7 case and receives a discharge, and shortly thereafter files a Chapter 13 case.
There are several reasons why debtors may try to use a Chapter 20 strategy. The objective is to obtain more relief than filing for Chapter 7 or Chapter 13 alone.
One common reason why debtors will do so is to discharge their unsecured debts through the Chapter 7 filing and then cure mortgage arrears over an extended period of time with a Chapter 13 plan.
Chapter 20 also enables consumers who need Chapter 13 relief, but don’t qualify because they owe more unsecured debt than Chapter 13 jurisdictional requirements permit, to become eligible for Chapter 13 filing.
In the past several years, some savvy bankruptcy practitioners have utilized Chapter 20 in a more creative way – to cram down a second mortgage that they could not have done if the debtor only filed for Chapter 7 relief, as most judges do not permit debtors to strip off second mortgages in Chapter 7 cases.
This has become a controversial maneuver as some jurisdictions do not permit this, having concluded that a debtor cannot strip off a second mortgage that has already been discharged, or that the second filing was not done to further the purpose of Chapter 13 relief, which is to pay debts through a plan, but instead to seek cram-down relief.
It should be noted that once a debtor files for Chapter 7 relief and obtains a discharge, the debtor is not entitled to receive a Chapter 13 discharge unless more than four years have passed from the date of the first filing to the date of the second filing. Code section 1328(f)(1).
Thus, the objective in most Chapter 20 scenarios is not to discharge any debt, but instead, to use the payment plan features of Chapter 13 to cure mortgage arrears over a period of time.
Many debtors successfully cram down their second mortgages in Chapter 13 cases in this district and that has become a large part of consumer bankruptcy practice here during the past few years. To do so, the debtor brings an adversary proceeding against the mortgagee seeking to strip off the second mortgage.
The Renz Case – An unsuccessful Chapter 20 Bankruptcy
In the Renz case, the debtors filed for Chapter 7 relief in 2009 and received a discharge. Sixteen months later, they filed a Chapter 13 case.
Since less than four years passed from the date of the prior filing, they would not be entitled to a Chapter 13 discharge.
The debtor had a second mortgage on his home with with JPMorgan Chase for $100,000 that was clearly underwater. Chase did not file a proof of claim, so debtor’s counsel, before the bar date, filed one for them. (Bankruptcy Rule 3004 permits a debtor to file a proof of claim on behalf of a creditor). As it turned out, Chase failed to file any papers whatsoever in the entire case.
Bankruptcy counsel also filed a cram-down adversary proceeding against Chase seeking a determination that the second mortgage was wholly unsecured. Since Chase never responded to the adversary proceeding, the debtor obtained a default judgment.
The judgment specifically provided that “the claim held by Chase, secured by a mortgage lien on the Debtors’ real property . . . [shall] be deemed a wholly unsecured claim, and that the entire subordinate mortgage lien be declared null and void upon the filing by the Chapter 13 Trustee of a Certification of Completed Chapter 13 Plan.”
Here’s the kicker: two weeks later, debtor’s counsel filed a letter with the Court withdrawing the Chase claim. He also amended the Chapter 13 plan calling for a one hundred percent distribution to unsecured creditors. However, since the proof of claim had been withdrawn, Chase stood to receive no distribution whatsoever.
Chapter 13 Trustee Marianne DeRosa thereafter filed an objection to confirmation, arguing that the plan was not proposed in good faith, that the debtor did not have statutory authority to withdraw the proof of claim, and the debtor had sufficient income to satisfy the Chase claim in full.
Debtor’s counsel argued that the plan was proposed in good faith and that Chase’s failure to participate or file papers in any part of the proceedings was a tacit acceptance of debtor’s withdrawal of the Chase claim.
Judge Trust determined that the debtor’s actions here went too far and that the case “exemplifies an unfair manipulation of the Bankruptcy Code.”
The judge noted that while the debtor appeared to have sought bankruptcy protection in good faith, the circumstances concerning the Chase claim demonstrate an attempt to abuse the purpose and provisions of Chapter 13. As such, the Judge sustained the trustee’s objections to the plan.
Judge Trust held that the debtor did not have any cognizable basis for withdrawing the proof of claim and that it should be treated as an allowed unsecured claim. He also held that the debtor had the ability to pay the Chase claim in full.
Although debtor’s counsel argued that the Chase mortgage debt had been discharged by the prior Chapter 7 case, the Court held that the debtor was required to satisfy the terms of a proposed plan before the mortgage lien could be stripped off. Since the debtor’s gambit did not work, the case will likely be dismissed.
Here’s what I gleaned from this decision. In a Chapter 20 case before Judge Trust, the debtor must file it in good faith and for the purposes that Chapter 13 is intended for. In addition, the debtor can cram down the second mortgage, but should expect to pay it as an unsecured debt through the plan.
Creative lawyering and using novel theories to test the bounds of the law and to achieve extraordinary results is the mark of a smart attorney. Many great results have been obtained this way. After all, you don’t know where the limits are until you’ve exceeded them. However, counsel must be careful not to tread too far over the line, which may have been the case here.