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In Re Cook

2011 WL 2221178 (U.S. Dist. Ct. D. N.J. 2011) (Unpublished)

BANKRUPTCY; MORTGAGES — Just because an otherwise valid second mortgage is behind a first mortgage that wouldn’t even be covered by the value of the property, does not mean that the second mortgage can be invalidated as a claim in a bankruptcy proceeding.

At the time a homeowner filed a Chapter 7 bankruptcy petition, his home was encumbered by a first and second mortgage held by the same bank. It was pretty much acknowledged that the amount of the first mortgage lien, alone, exceeded the value of the secured property. Based on that assumption, the borrower-debtor sought to have the second mortgage voided because sale of the property at its presumed current value would not even have satisfied the entirety of the first mortgage. To get rid of a mortgage lien is commonly called a “strip off.” Generally speaking, if a mortgage is otherwise a valid lien on a debtor’s property, but the value of the collateral is less than the amount owed under the mortgage, the claim is split into two pieces. The amount equal to the value of the property is treated as a secured claim, and the balance of the mortgage is treated as an unsecured claim. That process is often called a “strip down.”

The debtor tried to distinguish this situation from a United States Supreme Court case. The United States Supreme Court, in Dewsnup v. Timm, 502 U.S. 410 (1992), held that if a mortgage lien was otherwise valid, just because a portion of its is recategorized as an unsecured lien does not permit a court to invalid the unsecured portion of the claim. The debtor argued that the United States Supreme Court only applied to a “strip down” and did not apply to a “strip off,” as would be the case here because no portion of the second mortgage would be treated as a secured claim given that there was no remaining value in the property after the first lien had been satisfied, in part or in whole.

The debtor lost this argument in the Bankruptcy Court and also in its appeal to the United States District Court. Two other Circuit Courts of Appeals had already held that the Supreme Court’s ruling applied to both strip downs and strip offs, and not just to strip downs. Other case law also had held that the debtor’s argument was doomed. Basically, according to the Court, the only question was whether the second mortgage lien was valid in the first place and it held that it was a valid lien. The Court believed that if, after a sale of the property, there was in fact a surplus after paying the first mortgage, it should go to the second mortgage lien holder. If the second mortgage lien were voided, then any possible surplus would go to the debtor and that would be contrary to the intent of the Bankruptcy Code.

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