When Would Someone File For Chapter 20 Bankruptcy?

In “the good ol’ days” (before 2005) a bankruptcy debtor with a mortgage problem could file a Chapter 7 bankruptcy and discharge all of his unsecured debts, then immediately turn around and file a Chapter 13 to deal with real estate debt. Bankruptcy attorneys referred to this as a “Chapter 20” (Chapter 7 plus Chapter 13).

The 2005 amendments to the Bankruptcy Code sought to kill this practice; however recent cases have revived the Chapter 20 practice. See In re Davis (Branigan v. Davis), 716 F.3d 331 (4th Cir. 2013). Why would anyone want to file two bankruptcy cases? That is a good question – and there are some good answers for it!

Filing 2 bankruptcy cases

Imagine that you are self-employed and have a non-dischargeable $80,000 tax debt to the IRS, and $20,000 in credit card debt; money has been tight over the past year, and you haven’t been able to pay the IRS or keep up with your credit card payments. Then one day, surprise! The IRS freezes your bank account. What can be done about this? A Chapter 20 strategy can be used to rescue the money frozen by the IRS, discharge the $20,000 in credit cards through a Chapter 7 case, and then repay the $80,000 over five years with no interest or penalties (or threat of collection action) through a Chapter 13.

Chapter 20 can also be used to repay child support arrears without contempt of court hanging over your head, or cure a secured debt arrearage over three to five years, like a house or car payment. The primary benefit of discharging debt through a Chapter 7 initially is to free up money and eliminate creditors once and for all. If your circumstances improve during your Chapter 13 case, all you need do is pay the remaining balance in your Chapter 13 and walk away. The creditors discharged by your previous Chapter 7 case get nothing.

A ruling in favor of a debtor

The Bankruptcy Appellate Panel for the federal Eighth Circuit Court of Appeals has ruled in favor of a debtor who filed a Chapter 13 bankruptcy to strip away a wholly unsecured second mortgage, even though he was not eligible for a discharge in the Chapter 13 case.

In this case, In re Fisette, No. 11-6012 (8th Cir. BAP Aug. 29, 2011), the debtor filed his Chapter 13 case soon after receiving a discharge in a previous Chapter 7 case. The Bankruptcy Code requires that a debtor wait four years after a Chapter 7 case to be eligible for a Chapter 13 discharge, so the debtor was not eligible for a Chapter 13 discharge. After filing Chapter 7, Fisette continued to make payments on his home without formally reaffirming his personal obligation on any of his three mortgages. By 2010 he was behind on his mortgage payments.

Since the total amount owed on his first mortgage was more that his house was worth, Fisette decided to ask the bankruptcy court to strip away the second and third mortgages.

The Eighth Circuit BAP allowed Fisette to strip away the junior mortgages. Since Fisette had previously been discharged of his personal obligation on the junior mortgages during his Chapter 7 case, the bank had no recourse against Fisette or his property. This is the first time a federal appellate court has allowed lien stripping in a “Chapter 20” case since 2005. Since that time bankruptcy courts have both followed and rejected In re Fisette.

Is Chapter 20 is a viable option?

Likewise, the Fourth Circuit Court of Appeals recently concluded that Chapter 20 is a viable option in some circumstances. The Fourth Circuit reviews federal court cases from federal districts in Maryland, North Carolina, South Carolina, and Virginia. In the case at issue, In re Davis (Branigan v. Davis), In re Davis (Branigan v. Davis), 716 F.3d 331 (4th Cir. 2013), the debtors filed Chapter 7 bankruptcy and discharged all of their debts. They subsequently filed a Chapter 13 and asked the bankruptcy court to strip entirely unsecured second and third mortgage liens. The Chapter 13 trustee objected.

On appeal, the Fourth Circuit sided with the debtors. In a split opinion, the Fourth Circuit stated that while a debtor who receives a Chapter 7 discharge is ineligible for a subsequent Chapter 13 discharge for a period of four years, there is nothing that precludes that discharged debtor from taking advantage of other bankruptcy protections, like catching up on a mortgage arrears, or paying other debts under court protection and supervision.

In the Davis case, the debtors were allowed to strip off their entirely unsecured junior mortgages. Since their prior Chapter 7 bankruptcy had already discharged all of their personal obligations, the debtors were not obligated to pay the second or third mortgage at all. Once the Chapter 13 plan is completed, the junior liens are stripped away permanently.

Some courts and commentators (and creditors!) have complained that Chapter 20 is a bad faith attempt to get around the Bankruptcy Code. Under different circumstances, a court could find that the debtor has engaged in bad faith and refuse to provide relief. See In re Scotto-DiClemente, 459 B.R. 558 (Bankr. D.N.J. 2011) (finding evidence of bad faith after debtor “fabricated” arrears after a Chapter 7 discharge as part of a stratagem to sidestep the limitations of Dewsnup in a Chapter 13). But every case (and court) is different. If you are interested in Chapter 20, I suggest you speak to an experience bankruptcy attorney and learn how your district and circuit is treating these cases!

Chapter 20 is not right for every case, and is typically used only in rare circumstances. When it is proper and needed, there is usually a pressing need to file the second case quickly. In some cases a court may allow you to file your Chapter 13 case before your Chapter 7 case has been discharged (there is no prohibition against having two active bankruptcy cases), or even allow you to convert the case to a Chapter 13 after the Chapter 7 discharge is ordered.