What The Heck Is Chapter 20??

As a bankruptcy professional, I deal, obviously, with the U.S. Bankruptcy Code on a regular basis.  The Bankruptcy Code (or just “the Code” here) is more formally known as Title 11 of the United States Code, and it is comprised of a number of “chapters,” just like some books.  Some of these chapters address basic issues regarding bankruptcy, such as who may be a debtor, when one may file a petition in bankruptcy, the duties of trustees and debtors, and so on.  Some chapters are restricted to particular types of relief that a debtor might avail himself or herself of, such as Chapter 7 which is a liquidation type of bankruptcy (also known colloquially as a “fresh start” bankruptcy for individual debtors) and Chapter 13, which is known as an “Adjustment of Debts for Individuals With Regular Income.”  Notice it states “individuals.”  While individuals who operate a business as a sole proprietorship might be able to file Chapter 13, corporations, limited liability companies, partnerships and other such entities may not.  If they want to reorganize their businesses, they must do so in Chapter 11.

The chapters of the Code consist of all of the odd numbers from 1 through 15 with the exception of Chapter 12, which is sort of like a Chapter 13 with a little Chapter 11 sprinkled in and is reserved specifically for the family farmer or fisherman.

The two other specifically reserved chapters are 9 and 15.  Chapter 9 has been in the news quite a bit recently and it is reserved for municipalities such as counties or cities.  The most recent is, of course, the filing by the City of Detroit.  Chapter 15 is a relatively new chapter aimed at ancillary administration in aid of bankruptcies filed in other countries.

But one thing is certain.  Search as one might, the Code makes no reference to Chapter 20.  Still, “Chapter 20” can and is used by debtors in certain circumstances who cannot obtain complete relief in one chapter under the Code.

Essentially, Chapter 20 is the combination of two bankruptcies filed consecutively.  A debtor might file a Chapter 7 and obtain a discharge but finds that, despite obtaining a discharge for most if not all debts, the relief obtained was not complete.  A person may not file another Chapter 7 case in which he or she receives a discharge of their debts until eight years have passed since filing the first one.  The time limit in order to obtain a discharge in Chapter 13 after having filed Chapter 7 is four years.  Still, even though a discharge may not be issued until those time periods lapse, a person may still find that filing a Chapter 13 after having filed a Chapter 7 (hence, “Chapter 20”) could afford significant relief.

For instance, a Chapter 7 debtor may have significant debt owed to the IRS or other tax entity which was not discharged by the Chapter 7.  Once the Chapter 7 discharge is granted, the tax entity may usually begin collection action again.  If the debtor cannot come to an agreement with the tax entity (often they can), then they might seek relief in Chapter 13, putting the debt in a plan of up to five years without interest or penalties.  No discharge is necessary since the debt is being paid in full.

An issue that has arisen over the past few years is whether a debtor may strip off a wholly unsecured lien (such as a second mortgage) in Chapter 13 after having filed a Chapter 7.  Typically, a Chapter 13 debtor may do just that if the debtor can show that the value of the property is less than the amount owed to a senior lien holder (such as a first mortgage) which means that the second or third mortgage really have no equity.  In order to do this, the debtor must complete a Chapter 13 plan and receive a discharge.  With the discharge and the court’s order finding no equity reaching the junior lien, the junior lien is “stripped off” meaning it is void and of no effect.  The question is whether such a “strip off’ is permitted after a Chapter 7 has been filed and an earlier discharge granted to the debtor.

Some courts around the country allow this approach and some do not.  Some of those that do not allow lien stripping in Chapter 20s focus on the requirement of a Chapter 13 discharge and state that since no discharge can be granted in the subsequent Chapter 13, then no lien may be stripped either.

However, in a case of first impression in the District of New Hampshire and, apparently, the First Circuit, the Honorable J. Michael Deasy has found in the case of In re Dolinak, 2013 BNH 015, that lien stripping in a Chapter 20 may, in some circumstances, be permissible.

In Dolinak, Judge Deasy, in a carefully-reasoned opinion, addressed the three different approaches taken by other courts around the country and found nothing in the bankruptcy code which prevented an out-of-equity junior lien from being stripped in a Chapter 20.  He did emphasize the ubiquitous “good faith” requirement found in all Chapter 13 cases and determined that such efforts at lien-stripping must be assessed on a case-by-case basis.  He pointed out that some debtors might try to manipulate the bankruptcy code in an impermissible fashion in order to obtain such relief but he also found that just because someone might try to do that was no reason to not grant relief to the honest debtor who was acting in good faith.  After considering a number of factors, Judge Deasy found that the debtor in Dolinak had acted in “good faith.”

So, for the time being, Chapter 20s aimed at eliminating junior liens which are entirely out of equity may be successful in New Hampshire as long as the debtor is acting in good faith.  This undoubtedly is a lesson to be taken by both creditors and debtors.  Debtors should make every effort to come to a reasonable agreement with creditors after filing a Chapter 7 and receiving a discharge; creditors should do the same.  If the debtor makes a real effort to treat the creditor fairly but the creditor still attempts to conduct a meaningless foreclosure, such as occurred in Dolinak, then the debtor may be able to resolve the matter in “Chapter 20.”