Minnesota Court Prevents Stripping Off Second Mortgage in Chapter 13 Bankruptcy

Minnesota has long had a history of marching to the beat of its own drummer.  For example, in politics, Minnesota was the only state in the U.S. in 1984 to vote for Walter Mondale for President over Ronald Reagan (granted, Mondale was a Minnesota native).  In music, folks like Bob Dylan and Prince have stubbornly charted their own course and broken new ground in the face of critical opposition. 

In law, Minnesota occasionally goes its own way also.  Case in point:  an April 2010 Bankruptcy Court decision in the case of In Re Loban, 426 B.R. 805 (2010).  The case involved a very common issue these days:  a Chapter 13 debtor sought to have a second mortgage holder declared an unsecured creditor due to the fact that the equity in his home was less than the balance owed on the first mortgage, thus leaving no equity to satisfy the second mortgage.  The mortgage holder, BAC Home Loans Servicing, L.P. did not even object to the treatment of its claim as unsecured.

Seems pretty straightforward, right?  Not a chance here in Minnesota.  Flying in the face of decisions of other jurisdictions under similar circumstances, the Court held that Section 506(a) of the Bankruptcy Code was inapplicable to claims secured only by a lien on a debtor’s principal residence.  What’s disappointing about the decision is that the Court gives no foundation for its conclusion that Section 506(a) does not apply; it’s as if to say “it doesn’t apply because we say it doesn’t apply.”

This decision has profound implications as, if the second mortgage was deemed to be an unsecured claim by virtue of the lack of sufficient equity with which to pay the mortgage, the claim could be subject to avoidance.  Instead, the Minnesota Court surprised almost everyone, overruled the debtor’s objection to the claim and denied confirmation of the debtor’s Chapter 13 plan.  Whether this decision will carry over to the more common Chapter 7 case where the debtor seeks to discharge the second mortgage after the home has been lost in foreclosure remains to be seen (although, applying the Loban Court’s logic, given that the claim is no longer secured by the debtor’s primary residence post-foreclosure when the second mortgage lien has been extinguished, a debtor should still be able to discharge the second mortgage in that instance). 

What impact the In Re Loban decision will have on other jurisdictions in the future remains to be seen.  For now, the decision seems to be just another example of Minnesota being “different” than everywhere else.