A recent decision by the Ninth Circuit Court of Appeals (found here) changes the strategic calculus for a secured creditor deciding whether to file a proof of claim in a bankruptcy case in the Ninth Circuit. It has long been true that a secured creditor does not necessarily imperil his lien if he ignores a bankruptcy proceeding and declines to file a claim in connection with his lien. See U.S. Nat’l Bank in Johnstown v. Chase Nat’l Bank of N.Y.C., 331 U.S. 28, 33 (1947). But the Ninth Circuit’s decision in In re Blendheim, 2015 WL 5730015 (Oct. 1, 2015) holds that a creditor who actually files a claim, and has that claim disallowed, may have its lien voided under Bankruptcy Code § 506(d). Thus, filing a proof of claim, at least in a chapter 13 case, may expose a secured creditor to greater risk than simply observing the case from the sidelines. This contradicts the conventional wisdom that (issues of jurisdiction aside) it is often advisable to file a “protective” proof of claim to preserve your rights.
In re Blendheim was a “chapter 20” case—a chapter 13 case that followed a chapter 7 case by the same debtors. HSBC Bank (“HSBC”) filed a proof of claim reflecting its first position lien on the Blendheims’ home. The Blendheims objected to the claim on the basis that HSBC had not produced a copy of the promissory note upon which the claim was based, and that a previously provided promissory note appeared to bear a forged signature. HSBC never responded to the claim objection and HSBC's claim was disallowed. In the words of the bankruptcy court, HSBC “slept on its rights.” Id. at *3. In a subsequent adversary proceeding, the bankruptcy court held that HSBC’s lien would be void and cancelled “upon Debtors’ completion of a Bankruptcy.” Id.
The Ninth Circuit, on appeal, was asked to consider whether the bankruptcy court properly voided HSBC’s lien. The Blendheims argued that, because HSBC’s claim had been disallowed, the lien associated with that claim was void under the plain language of Bankruptcy Code § 506(d). That section provides:
To the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void, unless—
(1) such claim was disallowed only under section 502(b)(5) or 502(e) of this title; or
(2) such claim is not an allowed secured claim due only to the failure of any entity to file a proof of such claim under section 501 of this title.
The Ninth Circuit held that the bankruptcy court properly voided the lien. Under the plain language of the introductory clause of § 506(d), HSBC’s lien was void because it secured a claim that was disallowed. Although a creditor may decline to participate in a bankruptcy case, and its lien may ride through the bankruptcy unaffected, “where a claim is timely filed and objected to,” and ultimately disallowed, the lien becomes void. The Ninth Circuit recognized an exception, reflected in the decisions of other circuits, where a claim is disallowed solely because it was not timely filed. In that situation, the lien is not void. But, under the Ninth Circuit’s Blendheim decision, if a secured creditor’s claim is disallowed for any reason other than (1) untimeliness, or (2) the exceptions listed in section 502(d), the lien associated with the disallowed claim is void.
Secured creditors should consider carefully the advantages and disadvantages of filing a proof of claim in a chapter 13 case. Depending on the facts of the case, a better strategy may be to play a passive monitoring role and allow liens to ride through the bankruptcy. If the decision is made to file a claim, secured creditors should be vigilant in defense of their claims. If the creditor’s claim is disallowed, the creditor will lose its lien, and with it the right to seek foreclosure in the future.