By Ryan C. Wood
Wait, there is no such thing as Chapter 20. You looked it up right? Chapter 20 bankruptcy is kind of like ordering a burger “Animal Style” at In and Out. Chapter 20 is not on the menu but it absolutely exists. Just ask the Free’s, Bankruptcy Case No. 14-41876, filed in the Bankruptcy Court for the Western District of Washington. They filed a Chapter 20 then ran into some legal problems raised by the Chapter 13 trustee assigned to their case. First though, what is and why file a Chapter 20 bankruptcy case?
What is a Chapter 20 bankruptcy case?
Chapter 20 refers to filing a Chapter 7 bankruptcy case and obtaining a discharge of all eligible debts. Now that the eligible unsecured debts are discharged in the Chapter 7 pursuant to Section 524 of the Bankruptcy Code a Chapter 13 bankruptcy case is filed to reorganize secured debts and priority debts. (Chapter 7 + Chapter 13 = Chapter 20) Why would anyone do this? It is because of the debt limitations to be eligible to file a Chapter 13 reorganization case. I have said this before and will say it again, “Hate the game not the player.” The Bankruptcy Code does not say you cannot file a Chapter 7 case then immediately file a new case under Chapter 13. Filing a Chapter 7 first and obtaining a discharge will get you around the unsecured debt limitations to be eligible to file a Chapter 13 reorganization bankruptcy case if you have a lot of unsecured debt. This might seem like a lot to go through just to qualify to reorganize under Chapter 13. The alternative is to reorganize under Chapter 11. According to most Bankruptcy Attorneys filing a Chapter 7 case, obtaining a discharge, then filing a Chapter 13 to reorganize your debts is still easier and more beneficial than filing a Chapter 11 reorganization case from the beginning. Reorganizing under Chapter 11 can be very expensive and time consuming.
What are chapter 13 debt limitations under section 109(e)?
I have to say, as a bankruptcy attorney that was formerly a staff attorney for a Chapter 13 trustee, the debt limitations under Section 109(e) are horribly out dated and should be significantly adjusted. These limitations need to be jurisdictional also. Which means, base the debt limitations on the median home cost in local housing market primarily. Two houses in the Bay Area equals around 7 houses where I grew up in Merced. Section 109(e) is applied to both areas the same when both areas economically are clearly not in the same world. I will take my own advice though and just accept that these are the rules of the game right now and not hate. So, at the time the Free’s filed for Chapter 13 to be eligible to reorganize your debts under Chapter 13 you could not have over $383,175 in unsecured debts or $1,149,525 in secured debts. So they first filed a Chapter 7 bankruptcy case to discharge unsecured debts to qualify to file a Chapter 13 reorganization and strip off under secured mortgages from their house.
Free’s Chapter 13 Bankruptcy By The Numbers
The whole point in filing the Chapter 7 then Chapter 13 for the Free’s was to be able to strip off their under secured or underwater mortgages from their house. So here are the numbers regarding their house when filing the Chapter 13 case:
Fair Market Value of house: $425,000.00
First Mortgage: $438,621.93
Second Mortgage: $348,481.01
Third Mortgage: $186,705.68
As you can see the second and third mortgages are completely underwater. Yes, it is horrible the value of their house has decreased so much in such a short time. If the house was sold at the time of filing the Chapter 13 case the second and third mortgage holders would get nothing, and that is how they are treated when reorganizing debts in bankruptcy. This is all assuming that the value of their house is actually $425,000, much less than the amount owed on the first mortgage. This is not the issue in the Chapter 13 case though. In Schedule D, secured debts, the Free’s listed $973,808.62, Schedule E unsecured debts, $3,204.76 and Schedule F, general unsecured debts, $4,000.00. The Free’s original filed schedules therefore list secured debts totaling $973,808.62 and unsecured debts totaling $7,204.76. Okay, great. The Frees’ debts are within the debt limitations to be eligible to file a Chapter 13 case . . . . right?
The standing Chapter 13 trustees said wait a minute here. Your personal liability was already discharged in the Chapter 7 bankruptcy case as to these mortgages. This is the big deal part. A discharge of a debt relieves the bankruptcy filer of the “in personam” or personal liability to repay the debt. The lien rights of a secured creditor or “in rem” rights continue on. So the mortgage holders still could enforce their properly recorded deeds of trust recorded against the Free’s house. That is what usually happens after a Chapter 7 case. The bankruptcy filer is either current on the mortgages and life goes on with the house or they are behind in their monthly payments and one or more of the mortgage holders try to foreclose on the home under state law.
The Chapter 13 trustee argued that the second and third mortgages should be scheduled as unsecured debts since the personal liability was already discharged in the Chapter 7 case. If this were true then the Free’s unsecured debt would be approximately $542,391.45, and therefore exceed the unsecured debt limitation of Chapter 13. The Chapter 13 trustee filed a motion to dismiss the case on this basis and the bankruptcy court agreed. So the Chapter 13 case was dismissed and the Free’s appealed.
How to schedule discharged secured liens in Chapter 20?
On December 17, 2015, the Ninth Circuit Bankruptcy Appellate Panel published an opinion discussing how to treat wholly unsecured mortgage claims when looking at the Chapter 13 debt eligibility limitations of Section 109(e). The 9th Circ. BAP, Case No. WW-14-1395-JuKiF, holds that if a the “in personam” liability of a secured mortgage is discharged in a prior Chapter 7 case under Section 524 the debts in a subsequent Chapter 13, a Chapter 20, should be counted as a secured debt for debt eligibility calculations and not an unsecured debt.
So the Ninth Circuit Bankruptcy Appellate Panel held the Chapter 13 trustee and bankruptcy court were wrong to dismiss the case. Debts secured by liens should still be listed as secured debts in Schedule D even though the personal liability in the prior Chapter 7 was discharged. I have to say this makes sense in looking at the big picture. The second and third mortgage holders still had their lien rights to enforce under state law even though the personal liability was discharged.
So does this mean the Free’s can be successful in their Chapter 20?
Possibly, now that their Chapter 20 case will not be dismissed for debt limitations they still need to obtain court approval or confirmation of their Chapter 13 plan of reorganization. From reading the Free’s petition and the objections to confirmation filed in the case it looks like an uphill battle. A little hint, see In Re Egebjerg, 574 F.3d 1045 (9th Cir. 2009), and remove the 401k loan from Schedule D. Time will tell whether the Free’s Chapter 13 is successful.
