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In Re Alvarez, No. 12-1156

Decided:  October 23, 2013

The Fourth Circuit held that the bankruptcy court correctly determined that it lacked the authority to “strip off” the debtor’s valueless lien because only the debtor’s interest in the estate was before the bankruptcy court.  The Fourth Circuit rejected the debtor’s argument that the bankruptcy court should have stripped off the lien on the ground that his spouse’s property interest was not part of the bankruptcy estate.

Jose Alvarez filed a Chapter 13 petition in the U.S. Bankruptcy Court for the District of Maryland.  In that petition, Mr. Alvarez identified his property, which was owned by Mr. Alvarez and his wife as tenants by the entireties.  Importantly, Mrs. Alvarez was not a party to the bankruptcy petition, nor did she file a separate petition of her own.  At the time the petition was filed, the property was encumbered by two mortgage liens.  Chase Home Finance held the first-priority mortgage lien and HSBC Mortgage Service (HSBC) held the second-priority mortgage lien.  At the time of the petition, the value of Mr. Alvarez’s property was less than the full amount owned on the first-priority lien, thus rendering HSBC’s second-priority lien valueless.  As required by the Federal Rules of Bankruptcy Procedure, Mr. and Mrs. Alvarez jointly filed a complaint in the bankruptcy court against HSBC.  In the complaint, they maintained that because the HSBC lien was valueless and, thus, was unsecured under 11 U.S.C. § 506(a), they were entitled to strip off the lien from the property.  The bankruptcy judge held that the lien could not be stripped off because both “tenants by the entireties” had not filed a petition for bankruptcy.  The district court affirmed the decision and Mr. and Mrs. Alvarez filed this appeal.

The Court began its opinion by explaining the statutory framework for stripping off a valueless lien in a bankruptcy proceeding.  The Court provided that the main issue in the case was “whether a bankruptcy court, in a Chapter 13 case filed by only one spouse, can strip off a valueless lien on property that the debtor and his non-debtor spouse own as tenants by the entireties.”  The Fourth Circuit noted that this was an issue of first impression among the federal appellate courts and the bankruptcy courts had reached different conclusions on the issue.  The Court then discussed Maryland property law as it related to tenancy by the entirety.  According to the Court, a property held in a tenancy by the entirety, under Maryland law, is property not owned by either spouse individually, but rather by the marital unit where each spouse has an undivided interest in the whole property.  The Court provided that a tenancy by the entirety could only be severed, when both spouses are alive, by divorce or by the joint action of both spouses.  The Court then explained that when an individual files a bankruptcy petition, 11 U.S.C. § 541 mandates that a debtor’s bankruptcy estate contain “all legal or equitable interest of the debtor in property as of the commencement of the case.”  The Court agreed with the bankruptcy court that it lacked the authority to strip off the valueless lien on the property because where one spouse has filed for bankruptcy, then only that spouse’s interest in the entireties property, rather than the whole of the property, was before the bankruptcy court.  Therefore, the Court held that the bankruptcy court was without authority to modify a lienholder’s rights with respect to a non-debtor’s interest in property held in a tenancy by the entirety.

Full Opinion

– John G. Tamasitis