The U.S. Supreme Court Stops Practice of Stripping Secured Liens in Chapter 7 Bankruptcy

On June 1, 2015, the United States Supreme Court ruled in a unanimous decision that a Chapter 7 bankruptcy debtor may not strip a junior lien putting an end to a practice decimating community associations’ finances in Florida.  As new foreclosure cases continued to rise in Florida homeowners sought refuge in bankruptcy court.  Bankruptcy filings and motions to avoid (“strip”) liens proliferated.

“Lien stripping” occurs when a bankruptcy debtor “strips” (removes) a secured junior lien from a property.  A community association lien can be stripped when the first mortgage exceeds the value of the property and there is no equity to which a junior lien can attach.

So prolific were the filings in Florida that the Middle District of Florida Bankruptcy Court’s Mortgage Modification Mediation program became the model for the country, with attorneys, judges, clerks of courts, and bank representatives from all over the county coming to Orlando to discuss and analyze the success of the Middle District’s program.  However, until only a few years ago, the stripping of junior liens was isolated to Chapter 13 and Chapter 11 filings.

In 2012, the Eleventh Circuit Court of Appeals ruled a debtor could strip junior lien in a Chapter 7 bankruptcy deviating from Supreme Court precedent. The result was a tsunami of Chapter 7 filings where debtors sought to remove association liens, eliminate the entire delinquency, and keep the property.  Countless community associations were unable to recover maintenance assessments, late fees, interest, or attorney fees and costs secured by the lien, causing the other homeowners to absorb the entire delinquency. Obviously, this led to much frustration and resentment among paying homeowners.

Adding insult to injury, many debtors filed motions to strip association liens citing property appraiser valuations, which are knowingly and purposely, undervalued.  If the association failed to object, debtors were able to remove liens where they otherwise would not have been entitled.

Earlier this month, the Supreme Court of the United States finally put a stop to this practice.  Overturning the Eleventh Circuit ruling, Justice Clarence Thomas said the debtors’ interpretation of the code would leave “an odd statutory framework” as it relates to so-called lien stripping.  Justice Thomas added that constant changing property values would lead to arbitrary results.

The ruling gives community associations much needed reprieve as now their liens will survive a Chapter 7 bankruptcy.  In some instances, associations may even be able to set aside previous orders stripping their lien. That said, a word of caution, the Supreme Court decision hints that the court may eventually authorize lien-stripping in Chapter 7 bankruptcies.  A footnote in the decision suggests if only the debtors had asked the court to overrule its previous precedent the court would have obliged.

The footnote and the fact that debtors can still strip liens in Chapter 13 or 11 bankruptcies serves as another reminder that community associations should not sit on their rights.  If an association has delinquent accounts, it should immediately begin the collection process.  Failure to do so could result in losing those funds forever.