A recent Massachusetts Bankruptcy Court decision set forth the standard that the majority of Federal Circuits have adopted: a bankruptcy debtor may avoid a wholly unsecured lien on the home.

The case involved a debtor who claimed their home was worth $370,000. The balance of the first mortgage was approximately $ 376,000, and a second mortgage, held by American Home, had a balance of approximately $95,000. In the Chapter 13 plan, the debtor proposed to pay American Home as an unsecured creditor as a “result of ‘cram down of unsecured claim on second mortgagee on Debtor’s principal residence.” The debtor also field a Motion to Determine Secured Status under Section 506(a). (Despite adequate and proper notice, American Home did not challenge the debtor’s expressed intentions.)

Even though the Bankruptcy Code expressly prohibits modification of mortgages on a debtor’s primary residence under Section 1322(b)(2), the Court found that Chapter 13 plans may avoid liens on a debtor’s residence that are wholly unsecured. As this view appears to have been adopted in other districts, the Bankruptcy Court ruled in favor of the debtor, and allowed the debtor’s motion seeking a determination that American Home’s mortgage was unsecured.

For Massachusetts homeowners contemplating bankruptcy and looking at declining property values, this decision is welcome news.

In re Pelosi, Chapter 13 case no. 07-16820 (February 21, 2008).