Tag Archives: 506(d)

March 15, 2016

Secured Creditors Beware: Ninth Circuit Holds a Chapter 13 Debtor may Avoid Liens Even if not Entitled to a Discharge

Congress enacted § 1328(f) of the Bankruptcy Code when its passed BAPCPA. This section prohibits the granting of a chapter 13 discharge if the debtor received a chapter 7 discharge within four years prior to the commencement of his chapter 13 case. The Ninth Circuit in In the Matter of Blendheim, 803 F.3d 477 (9th Cir. 2015) held a chapter 20 debtor may in his chapter 13 case avoid a lien under § 506(d) even if § 1328(f) precludes him from receiving a discharge.

The creditor in Blendheim was HSBC Bank, which held a deed of trust lien on the debtors’ home. The debtors filed a chapter 7 case and received a discharge. Soon thereafter, they filed a chapter 13 case, mainly to restructure debts relating to their primary residence. HSBC timely filed a secured proof of claim based on its deed of trust against the debtors’ residence. The debtors objected to the claim, substantively objecting on the grounds that the note which formed the basis for the claim bore a forged signature. For some unknown reason, HSBC never responded to the debtors’ objection, and the bankruptcy court entered an order disallowing HSBC’s secured claim. In fact, after receiving notice that its secured claim had been disallowed, HSBC withdrew its proof of claim and requested the court to no longer send it electronic notifications in the case.

Thereafter, the debtors filed an adversary proceeding against HSBC seeking to void HSBC’s lien under § 506(d) which provides “to the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void.” The debtors contended they were entitled to avoid the lien because the plain language of the statute says a lien securing a debt which is not an allowed secured claim is void. HSBC defended, asserting the debtors were not entitled to avoid the bank’s lien because the debtors were precluded from receiving a discharge by § 1328(f), which provides that a debtor may not receive chapter 13 discharge if he has received a chapter 7 discharge within four years prior to the commencement of his chapter 13 case.

The Ninth Circuit agreed the debtors could avoid HSBC’s liens even though they could not receive a chapter 13 discharge. First, the court concluded the plain language of § 506(d) entitled the debtors to avoid HSBC’s lien. Because this section provides that a lien is void if it secured a debt which is not an allowed secured claim, the court concluded that Congress’ intent was manifest, and held the purpose of § 506(d) was to nullify a creditor’s legal rights in a debtor’s property if the creditor’s claim is disallowed. The court stated its belief that the Supreme Court’s decision in Dewsnup v. Timm, 502 U.S. 410 (1992) confirmed its interpretation. In Dewsnup, the debtors argued that the creditor’s claim was not an allowed secured claim because it was undersecured, and therefore they could avoid it under § 506(d). The Supreme Court rejected this argument, holding “§ 506(d) did not void the lien on his property because the creditor’s claim has been fully ‘allowed.’”

HSBC argued that such a conclusion would be inconsistent with decisions from the Eighth,[1] Fourth[2] and Seventh[3] Circuits, all of which held that avoiding liens for claims which were disallowed because they were untimely filed violated the long-standing principle that valid liens pass through bankruptcy unaffected. Viewing these decisions as holding that filing an untimely claim is akin to not filing a claim at all, the court determined the reasoning of these cases to be inapplicable since HSBC’s claim was disallowed on the merits. The court also noted that the Eleventh[4] and Fourth[5] Circuits have held that a chapter 13 debtor who cannot receive a discharge because of § 1328(f) may still void liens under § 506(d).

Finally, the court rejected HSBC’s argument that allowing avoidance of its lien in these circumstances would effectively grant the debtors on a de facto basis, the discharge to which they were not entitled. The court stated this argument ignored the difference between in personam and in rem liability. By enacting § 1328(f), Congress affected only the debtor’s in personam liability: “We take Congress at its word when it said in § 1328(f) that Chapter 20 debtors are ineligible for a discharge, and only a discharge.” The court further noted there is no language in the Bankruptcy Code which prevents Chapter 20 debtors from receiving the other benefits chapter 13 has to offer, and had Congress intended to prevent these debtors from avoiding liens, it would have included specific language when it enacted BAPCPA.

 

[1] In re Shelton, 735 F.3d 747 (8th Cir. 2013)

[2] In re Hamlett, 322 F.3d 342 (4th Cir. 2003)

[3] In re Tarnow, 749 F.2d 464 (7th Cir. 1984)

[4] In re Scantling, 754 F.3d 1323 (11th Cir. 2014)

[5] In re Davis, 716 F.3d 331 (4th Cir. 2013)

October 6, 2015

File a Proof of Claim, Lose Your Lien? Ninth Circuit Holds That Lien Associated With Disallowed Claim is Void

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. 

Conclusion

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.

August 18, 2015

Supreme Court, Citing Dewsnup v. Timm, Refuses to Allow a Debtor to Strip Off a Fully Undersecured Second Lien Against Debtor’s Home

In its opinion in Dewsnup v. Timm, 502 U.S. 410 (1992) the Supreme Court held that a debtor may not under § 506(d) of the Bankruptcy Code, strip down a partially undersecured mortgage lien against his home to the value of the lender’s collateral.  In its recent opinion in Bank of America, N.A. v. Caulkett, 135 S. Ct. 1995 (2015), the Court has extended that reasoning to prohibit a debtor from stripping off a fully undersecured mortgage lien under § 506(d).  In Caulkett, the debtor argued that the Court’s reasoning in Dewsnup applied only to partially secured liens and did not apply to fully secured lines.  The Court rejected that argument and held that its reasoning in Dewsnup applies equally to fully undersecured liens.

Interestingly, the Court noted early in its opinion in Caulkett that a straightforward reading of § 506 supported the debtor’s contention.  Section 506(a)(1) provides that “an allowed claim of a creditor secured by a lien on property . . . is a secured claim to the extent of the value of such creditor’s interest in . . . such property,” and further provides that such claim “is an unsecured claim to the extent that the value of such creditor’s interest . . . is less than the amount of such allowed claim.”  Section 506(d) provides that “to the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void.”  Although acknowledging that the debtor’s contention was reasonably in light of the statutory language, the Court held that its reasoning in Dewsnup precluded a ruling in favor of the debtor.

The Court referred to its opinion in Dewsnup in the following words:  “Relying on policy considerations and its understanding of pre-Code practice, the Court concluded that if a claim ‘has been allowed’ pursuant to § 502 of the Code and is secured by a lien with recourse to the underlying collateral, it does not come within the scope of § 506(d). . . In other words, Dewsnup defined the term ‘secured claim’ in § 506(d) to mean a claim supported by a security interest in property, regardless of whether the value of that property would be sufficient to cover the claim.”  The court reiterated that § 506(d) comes into play to strip down or strip off a lien only if the claim itself has not been allowed.  The debtor argued that Dewsnup should be limited to its facts and should not be extended to fully undersecured claims.  However, the Court stated that such a holding would require it to read the same words in the statute differently depending on situational context, and would lead to arbitrary results in light of the shifting nature of real estate value.  As a result, the Court extended its reasoning in Dewsnup to fully undersecured liens, and concluded that a claim that is fully allowed and secured by a lien cannot be stripped down or stripped off under § 506(d).