August 3, 2012

Ninth Circuit BAP Holds that a Solvent Debtor May Use Chapter 13 to Strip a Fully Unsecured Second Lien Against the Debtor’s Home

The Ninth Circuit BAP has ruled that a chapter 13 plan proposed by a solvent debtor whose purpose in filing the plan is to strip a fully unsecured second lien against the debtor’s home may, if other elements of confirmation are met, be confirmed.  Meyer v. Lepe (In re Lepe), 470 B.R. 851.  The debtor in Lepe filed bankruptcy, scheduling assets of $363,900 and debts of $581,380, of which only $549 consisted of general unsecured claims.  The debtor was capable of paying his living expenses, including the payment on the second mortgage.  None of the debtor’s creditors, including the holder of the second mortgage lien, objected to confirmation.  However, the chapter 13 trustee objected,
contending that, since the debtor had only $549 in general unsecured debt and was able to pay both that and the payments on the second mortgage, the debtor’s sole purpose in filing bankruptcy was to strip the second lien from the home and pay it less than in full.  The trustee contended that this intent was an abuse of the bankruptcy process and in bad faith.

In ruling against the trustee in this particular case, the BAP held that well-established Ninth Circuit precedent of Goeb v. Heid (In re Goeb), 675 F.2d 1386 (9th Cir. 1982) requires a bankruptcy court to analyze a debtor’s good faith, or lack of it, in filing a chapter 13 plan by viewing the plan in a broad “totality of the circumstances” test, where no one factor will completely outweigh the others.  The BAP described the various factors to include the following: (a) the amount of proposed payments and the amount of the debtor’s surplus income after expenses, (b) the debtor’s income, employment
history and likelihood of future increases in income, (c) the expected duration of the plan, (d) the level of accuracy in the plan, (e) the extent of preferential treatment between classes of creditors, (f) the extent to which secured claims are modified, (g) whether debts to be discharged in the plan
would be excepted from discharge in a chapter 7 proceeding, (h) the existence of special circumstances, such as medical debt, (i) the frequency with which the debtor has sought bankruptcy relief, (j) the debtor’s motivations and sincerity, (k) the burden which the plan’s administration will place on the trustee, (l) whether the debtor manipulated the bankruptcy process in an inequitable manner, (m) whether the debtor filed bankruptcy only to defeat state court litigation, and (n) whether egregious behavior is present.  The BAP stated that no one factor, even if indicative of bad faith, cannot outweigh the other factors in the analysis.

The trustee argued for a bright line test that would hold any plan to be filed in bad faith if the debtor was otherwise able to pay debts, whose sole purpose for filing chapter 13 is to strip a totally unsecured lien on the debtor’s home, and proposes to pay unsecured creditors (including the stripped-down lien) only a percentage of their debt.  The BAP declined to do so, ruling that established case law clearly holds that there is no per se bad faith rule, and instead a failure by a bankruptcy court
to examine all factors in determining whether the debtor filed his plan in good faith would itself be improper.

Because good faith must be measured by a totality of factors, the fact that the debtor was able to pay his debts in the ordinary course was not per se indicative of bad faith.  In fact, the BAP noted that the debtor was insolvent on a balance sheet basis, although his cash flow was sufficient to enable him to pay his debts as they came due.  Citing the Ninth Circuit BAP’s decision in In re Stolrow’s, Inc., 84 B.R. 167 (9th Cir. BAP 1988), the BAP reiterated that neither balance sheet insolvency nor inability to pay debts as they came due is a prerequisite for filing a voluntary
petition.  In addition, the BAP held that the debtor’s intent to strip the second lien was not per se improper in light of the Ninth Circuit’s opinion in In re Zimmer, 313 F.3d 1220 (9th Cir. 2002), where the Ninth Circuit held that a debtor’s chapter 13 plan may strip the lien of a creditor holding a claim secured by the debtor’s house where there is no value to support the lien.

Finally, the BAP noted that, had Mr. Lepe filed a chapter 7 petition, the second mortgage holder and the other unsecured creditors would like have received nothing.  The chapter 13 plan proposed to
pay them a significant portion of their claims, which the court found to be a benefit to unsecured creditors.  Viewing all applicable factors, the BAP affirmed the bankruptcy court’s confirmation of
the debtor’s plan.