Tag Archives: lien stripping

January 12, 2016

Ninth Circuit BAP Holds That a Wholly Unsecured Junior Lien, Discharged in Chapter 7, is not Included in Calculating Chapter 13 Eligibility Under Sec. 109(e)

Section 109(e) of the Bankruptcy Code limits eligibility for chapter 13 relief to those individual debtors whose noncontingent, liquidated unsecured debts do not exceed statutory limits. In calculating eligibility to file chapter 13, should a court consider debts which have been discharged in a prior chapter 7 case and which are “out of the money” because, while secured by a trust deed against the debtor’s residence, the value of the debtor’s residence is insufficient to cover the debt relating to the first trust deed? The Ninth Circuit Bankruptcy Appellate Panel answered this question in the negative, holding in Free v. Malaier (In re Free), 2015 WL 9252592 (9th Cir. BAP 2015) that such debts are not to be included in determining eligibility for chapter 13 relief.

In Free the debtors owned a home which they valued in their chapter 7 schedules at $425,000. The home secured three debts totaling over $900,000, with the first lien holder owed more than the value of the home. The debtors received a chapter 7 discharge and shortly thereafter commenced a chapter 13 case in which they sought to strip off the two subordinate liens. The chapter 13 trustee filed a motion to dismiss the case, arguing that these two wholly unsecured subordinate liens should be included in determining eligibility, and doing so rendered the debtors ineligible for chapter 13 relief. While noting that there was no Ninth Circuit controlling case directly on point, the bankruptcy court relied on several opinions in the Ninth Circuit in chapter 12 cases to conclude the subordinate liens should be included in the calculation and finding the debtors were not eligible for chapter 13 relief.

The BAP reversed, concluding that the discharged debts reflected by the wholly unsecured subordinate liens, should not be considered in determining chapter 13 eligibility. The court began its analysis with the definitions of “debt” and “claim” in section 101 of the Code. Because “claim” is defined as a right to payment and “debt” is defined as liability on a claim, the court held “there is no ‘unsecured debt’ unless the creditor has a ‘right to payment’ on an unsecured basis.” The court next concluded that the result of the debtors’ chapter 7 discharge resulted in their having no personal liability to pay the debts relating to the subordinate liens.

Because the bankruptcy court based its ruling in part on the U.S. Supreme Court’s decision in Johnson v. Home State Bank, 501 U.S. 78 (1991), the BAP addressed its perceived distinctions between the facts in Johnson and the facts in the present case.   In Johnson, the debtor obtained a chapter 7 discharge of a judgment in a foreclosure action and then filed a chapter 13 case with the intent to pay the in rem judgment through his chapter 13 plan. In addressing the question of whether an in rem claim for which personal liability has been discharged can properly be included in a chapter 13 plan, the Supreme Court held that such a claim can be treated in a chapter 13 plan because the claim was enforceable against the debtor’s property even though it was not enforceable against the debtor himself.

The BAP also distinguished the decision of the Ninth Circuit in Quintana v. Commissioner, 915 F.2d 513 (9th Cir. 1990) and the Ninth Circuit BAP in Davis v. Bank of America (In re Davis), 2012 WL 3205431 (9th Cir. BAP 2012), both of which involved chapter 12 proceedings. In Quintana, a judgment creditor agreed to waive any deficiency judgment following the sale of the debtor’s real property securing the judgment. Because the real property had not yet been sold, making a determination of the relative amounts of the secured and unsecured debts uncertain, the Ninth Circuit held it appropriate to include the full amount of the judgment debt in determining the debtor’s eligibility for chapter 12 relief. The BAP also noted the differences between § 109(e), which segregates secured and unsecured debts in determining eligibility, and § 101(18), which determines who is a family farmer by looking to the individual’s aggregate debts. The BAP distinguished its prior decision in Davis on similar grounds.

The BAP then distinguished the Ninth Circuit’s decision in Scovis v. Henrichsen (In re Scovis), 249 F.3d 975 (9th Cir. 2001) and the Ninth Circuit BAP’s decision in Smith v. Rojas (In re Smith), 435 B.R. 637 (9th Cir. BAP 2010) both of which held that the unsecured portion of partially secured debts are to be included in determining chapter 13 eligibility on the grounds that both Scovis and Smith dealt with cases where the chapter 13 proceeding was not preceded by a chapter 7 discharge of the debtor’s personal liability on the debt in question.

Finally, the BAP addressed the U.S. Supreme Courts’ decisions in Dewsnup v. Timm, 502 U.S. 410 (1992) and Bank of America v. Caulkett, 135 S. Ct. 1995 (2015) in connection with lien stripping efforts by chapter 13 debtors. The Court in Dewsnup held that a chapter 7 debtor cannot strip down a partially unsecured lien under § 506(d) to the value of the collateral. Subsequently in Caulkett the Court extended its holding in Dewsnup to situations involving wholly unsecured junior liens. The BAP noted that, following Dewsnup and Caulkett, litigants have argued that debtors who first file a chapter 7 case and obtain a personal discharge and then file a chapter 13 case seeking to strip the remaining in rem claim are acting in bad faith. The BAP refused to reach this issue as it had not been brought forward in the appeal but did state that this argument must be raised by filing a motion to dismiss the chapter 13 case as a bad faith filing and not in the context of whether the debtor is eligible under § 109(e) to file a chapter 13 case.

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.