Chapter 13 debtors can generally strip liens secured by personal property collateral and real property, so long as it is not the debtor's principal residence. The concept of lien stripping is that you reduce an undersecured creditor's claim to its present value by valuing the collateral. This is also known as claim bifurcation because the effect is to reclassify the claim into secured and unsecured portions whereby the unsecured claim is stripped from the collateral and treated as a general unsecured claim.
After reducing the creditor's secured claim to the present value of its collateral through lienstripping, a debtor can generally pay (often for pennies on the dollar) and then discharge the remaining unsatisfied unsecured portion of the claim through a Chapter 11, 12, or 13 plan of reorganization.
Here is an example:
- Debtor has a first priority lien (Deed of Trust) secured by Wells Fargo for $500,000
- Debtor has a second priority lien (Deed of Trust) secured by Bank of America for $200,000
- Debtor's home is only worth $450,000.
Within the framework of Chapter 13, the Debtor would likely be able to strip the lien of Bank of America and classify the claim as a general unsecured claim that potentially gets paid only pennies on the dollar, depending on the reorganization plan. Within the context of Chapter 11 or 12, other options are available that allow the Debtor to treat the claim a little more favorably through the claim bifurcation and valuation process.