Sacramento Area Bankruptcy Laws Unsettled With Regard to “Stripping-off” an Unsecured Second Mortgage by Filing Chapter 7

For those of you living in the Sacramento area that have a second mortgage on your real property which is essentially “unsecured” due to the fact that the value of your house has fallen below the amount secured by your first mortgage may be able to stop the bank from foreclosing and save your home by filing Chapter 7. In the case In Re Lavelle, 2009 Bankr., a bankruptcy judge for the Eastern District of New York allowed debtors to void the second mortgage lien held by the bank against their property by filing Chapter 7 when the value of their home fell below the amount secured by the first mortgage.

Since the case-law has not been settled in the Ninth Circuit, whose rules apply to those of us living in the Sacramento area, a debtor could conceivably prevent foreclosure and save their house so long as they can afford to continue making payments on the first mortgage after all other debts have been discharged in addition to the second mortgage. It makes sense that local judges could be inclined to interpret the bankruptcy code in a similar fashion as the court in the Eastern District of New York since a bank holding an unsecured second mortgage would not see a penny whether the house gets foreclosed on or the debt is stripped-off and voided under Chapter 7. Given the economic “fresh start” principles that Chapter 7 is designed to provide to a debtor, and the number of people that this interpretation of the law could help from losing their homes, I believe judges will become increasingly receptive to the argument. This view rests on a novel interpretation of the bankruptcy code, however, and would probably be an uphill legal battle. Nonetheless, In Re Lavelle shows at least one judge has become sensitive to the current economic situation and there is enough wiggle room in the law to provide a legal basis for making such a claim.

As a Sacramento bankruptcy attorney I have spoken with numerous clients with these types of questions. The only way to know for sure is by locating a debtor who finds himself in this situation to retain a lawyer who is willing to bring the case before a local court and present the argument. This would almost certainly become a drawn out legal process, but the courts would probably allow the debtor to at least remain in the property until all appeals have been exhausted and a final decision, perhaps by the United States Supreme Court, has been made. If you believe that you could benefit from this interpretation of the law it may be in your best interest to consult an attorney familiar on the subject.