Wednesday, January 22, 2014

Can a Mortgage Prevent you from Filing for Bankruptcy?

Individual bankruptcies, typically Chapter 7 or Chapter 13, are limited in certain ways.  For instance, Chapter 7 bankruptcy has income limitations, while Chapter 13 bankruptcy has debt limitations.   Below we will explain how your mortgage could disqualify you from filing Chapter 13 bankruptcy under the debt limitations.

A mortgage is a legal instrument typically securing a debt against real property, such as your residence. In our current real estate market, many homes are underwater. Not in the literal sense.  Figuratively, when a home is described as "underwater" it refers to the mortgages on said home having a value greater than the current fair market value of the home.

When filing a Chapter 13 bankruptcy, a wholly unsecured second mortgage or even the unsecured portion of an under-secured first mortgage should be listed as unsecured debt. Depending on other circumstances you may or not be able to discharge this "unsecured" debt, however that doesn't change the fact that the Court will consider it unsecured.

Why does this matter?

When filing a Chapter 13 bankruptcy, there are debt limits defined by 11 U.S.C. §§ 109(e). Said debt limits were recently raised, effective April 1, 2010. Under the current limits, a Chapter 13 bankruptcy will be dismissed if the debtor has unsecured debt greater than $336,900 and/or secured debt greater than $1,010,650. As of April 1, 2010, those figures rose to $360,475 and $1,081,400 respectively.

Consider the following scenario:
A debtor owns a $600,000 home but has $900,000 in mortgages. The debtor has a car with a lien of $20,000 (secured debt) and credit card (unsecured debt) of $100,000.

If the entire mortgage debt was considered secured then the debtor would be under the debt limits with a total secured debt of $920,000 and a total unsecured debt of $100,000. Unfortunately, because the Court considers the $300,000 of "underwater" mortgages unsecured, the debtor has a total unsecured debt of $400,000, which is above the debt limits. This debtor would, therefore, be ineligible to file for relief under Chapter 13 and be forced to seek other relief (possibly filing for bankruptcy under Chapter 7 or Chapter 11).

This is the exact scenario articulated by a California Court in an unpublished decision: In re Estrada.

Estrada refers to a Ninth Circuit decision: In re Scovis, 249 F.3d 975, 982 (9 th Cir. 2001). In Scovis, the Court stated that a "vast majority of courts, and all circuit courts that have considered the issue, have held that the unsecured portion of undersecured debt is counted as unsecured for 13 § 109(e) eligibility purposes."

It appears that this is also the law in Massachusetts. In re Marrama, 345 B.R. 458, 472 n.23 (Bkrtcy.D.Mass. 2006) In Marrama the court referenced Scovis and noted that the debtors failed to list the unseured portion of an undersecured mortgage as unsecured debt, which would have resulted in a greater unsecured debt.

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