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LIEN STRIPPING & VALUATION – SECTION 506
IMPORTANT: THIS FIRM MAKES NO REPRESENTATIONS AS TO THE ACCURACY OR CURRENT STATUS OF ANY LAW, CASE, ARTICLE OR PUBLICATION CITED HEREIN OR LINKED TO. WARNING – SOME OF THESE REFERENCES ARE PRE-BAPCPA.
ONLY CRAMDOWN LEFT? SECTION 506 LIEN STRIPPING & VALUATION
The following is an article by:
HON. THOMAS J. TUCKER – (MODERATOR), U.S. BANKRUPTCY COURT (E.D. MICH.); DETROIT, MICH.
CHARLES D. BULLOCK, STEVENSON & BULLOCK, PLC; SOUTHFIELD, MICH.
MARK E. BREDOW, POTESTIVO & ASSOCIATES, P.C., ROCHESTER HILLS, MICH.
published in American Bankruptcy Institute (offered solely for only education purposes)
11 U.S.C. § 1322 (b): Subject to subsections (a) and (c) of this section, the plan may- (2) modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor’s principal residence… 11 U.S.C. § 506 (a)(1): An allowed claim of a creditor secured by a lien on property in which the estate has an interest, … is a secured claim to the extent of the value of such creditor’s interest in the estate’s interest in such property, … and is an unsecured claim to the extent that the value of such creditor’s interest … is less than the amount of such allowed claim. Such value shall be determined in light of the purpose of the valuation and of the proposed disposition or use of such property, and in conjunction with any hearing on such disposition or use or on a plan affecting such creditor’s interest.
WHAT DOES IT MEAN TO STRIP THE LIEN?
11 U.S.C. § 506 describes how to determine whether a claim is secured. Section 506(a)(1) explains bifurcation (division) of an allowed claim into secured and unsecured parts—the secured part being “secured” by the collateral’s value, the unsecured part being the remaining amount of the claim in excess of the collateral’s value. For example, an allowed claim of $200,000 with collateral valued at $170,000 is bifurcated between a secured claim of $170,000 and an unsecured claim of $30,000, resulting in “lien stripping” of $30,000. If the $170,000 collateral is related to an allowed first claim of $200,000 and an allowed second claim of $10,000, the $10,000 claim can be “stripped” as well. The distinction may be identified as “stripping down” (or a “cramdown” of) the lien to the value of the collateral or “stripping off” the lien completely.
In re Grijalva, 4:11-bk-25386-EWH (Dis. AZ, 4/1/12) Marie Antoinette Grijalva (“Debtor”) proposes to modify the first-position lien on her principal residence in her Amended Chapter 13 Plan (“the Amended Plan”). For the reasons explained in the balance of this opinion, such treatment is permitted pursuant to 11 U.S.C. § 1322(c)(2) and § 1325(a). ISSUE: Does § 1322(c)(2) permit a chapter 13 debtor to bifurcate an under-secured short-term mortgage and “cram down” the unsecured portion of the mortgage pursuant to § 1325(a) (5)?
When avoiding a judgment lien under Section 522(f), the court applies the state exemption law in effect on the filing date of the bankruptcy petition, rather than on the creation date of the lien.
In re Boskoski 22-55098 (9th Cir. Nov. 14, 2022) The panel affirmed the bankruptcy court’s judgment in favor of Dejan Boskoski and against the Chapter 7 Trustee in a case in which Boskoski sought to avoid a judgment lien recorded in 2014 against his California home. The panel was called upon to decide how the Bankruptcy Code’s procedure for avoiding judgment liens that “impair[] an exemption to which the debtor would have been entitled,” 11 U.S.C. § 522(f)(1), interacts with California’s homestead exemption, which allows a debtor to claim a limited exemption in bankruptcy in connection with his primary residence. The issue gained complexity here because the amount of California’s homestead exemption increased significantly between the time the lien on Boskoski’s home was recorded in 2014 and the time he filed for bankruptcy in 2021. Under California law, the exemption Boskoski could claim would be fixed at the 2014 amount. Boskoski argued that the Bankruptcy Code requires looking to the exemption he could have claimed, but for the lien, at the time he filed his bankruptcy petition.
The panel agreed with Boskoski. The panel held that in deciding whether a judgment lien impairs a debtor’s California homestead exemption, the Bankruptcy
Code requires courts to determine the amount of the exemption to which the debtor would have been entitled in the absence of the lien at issue. In this case, that means the court applies the state exemption law in effect on the filing date of the bankruptcy petition, rather than on the creation date of the lien. Following this principle, the bankruptcy court correctly applied the $600,000 homestead exemption available in 2021, which, consequently, allowed Boskoski to avoid the entirety of the judgment lien placed on his home.
CHAPTER 7 CASES – STRIPPING OFF UNSECURED JUNIOR MORTGAGE.
Latest update (February 20, 2019) – Supreme Court refused cert on case to overturn Dewsnup.
Dewsnup v. Timm, 502 U.S. 410 (U.S. 1987) prohibited Chapter 7 debtors from using 11 U.S.C. § 506(d) to void an undersecured lien on real property. Case law has extended Dewsnup to prohibit lien stripping on wholly unsecured liens (in Chapter 7 cases), holding that unless and until there is a claims allowance process, there is no basis for the debtor to avoid a lien under 11 U.S.C. § 506. The legislative history of Section 506 also makes it clear that lien stripping is permissible in reorganization chapters, but not in Chapter 7. See In re Talbert, 344 F.3d 555 (6th Cir. 2003), Concannon v. Imperial Capital Bank (In re Concannon), 338 B.R. 90 (Bankr.Fed.App. 2006).
Christopher Barclay v. Dejan Boskoski, 22-55098, 9th Cir Ct of Appeals, 11/14/22 The panel affirmed the bankruptcy court’s judgment in favor of Dejan Boskoski and against the Chapter 7 Trustee in a case in which Boskoski sought to avoid a judgment lien recorded in 2014 against his California home. Holding that, when a judgment lien impairs a debtor’s state-law homestead exemption, the Bankruptcy Code requires courts to determine the exemption to which the debtor would have been entitled in the absence of the lien.
The Ninth Circuit held that the California exemption amount in effect at the time of the filing of the bankruptcy petition applied, even though the language of the California exemption for judgment liens would have required calculation of the amount of the exemption as of a different date.
FILING POC IN 13 AFTER DISCHARGED IN 7 “CHAPTER 20”
In re Washington, BAP NO. CC-18-1206-LKuF (July 30, 2019) Debtor Gwendolyn Washington obtained a chapter 7 discharge, which extinguished her personal liability on the debt secured by a junior lien on her residence. About five years later, she filed a chapter 13 case; she obtained an order valuing at zero the junior lien held by Option One Mortgage Corporation, serviced by Real Time Resolutions, Inc. (“RTR”). RTR filed an unsecured claim in the full amount of the debt it believed it was owed; Ms. Washington objected on the ground that her personal liability had been discharged. The bankruptcy court overruled the objection, concluding that the discharge did not fully eliminate the claim and that the plain language of § 506(a) required the allowance of RTR’s unsecured claim in the amount of $307,049.79. We REVERSE. BAP finds that a debtor may employ so-called chapter 20 to strip off an underwater subordinate mortgage while simultaneously avoiding personal liability for the debt.
In re Boukatch, Az-14-1483 (9th Cir BAP, 7/9/15) Chapter 13 debtors, Serge M. Boukatch and Lori J. Boukatch (“Debtors”), appeal an order denying their motion to avoid a lien on their principal residence. The bankruptcy court determined that, as a matter of law, a “chapter 20” debtor is not entitled to avoid a wholly unsecured junior lien under §§ 506(a) and 1322(b)(2) against the debtor’s principal residence when no discharge will be entered in the pending chapter 13 case. On this issue of first impression, we REVERSE and REMAND. (Good discussion on Nobelman and anti-modification provisions.)
We conclude that § 1328(f)(1) does not prevent Debtors’ ability to strip off MidFirst’s wholly unsecured junior lien in their chapter 13 plan, because nothing in the Bankruptcy Code prevents chapter 20 debtors from stripping such liens off their principal residence under §§ 506(a)(1) and 1322(b)(2). We further conclude that plan completion is the appropriate end to Debtors’ chapter 20 case. Unlike a typical chapter 13 case, the lien avoidance will become permanent not upon a discharge, but rather upon completion of all payments as required under the plan. In re Davis, 716 F.3d at 338; In re Frazier, 469 B.R. at 900; In re Blendheim, 2011 WL 6779709, at *6; In re Okosisi, 451 B.R. at 99-10 100; In re Frazier, 448 B.R. at 810; In re Tran, 431 B.R. at 235.
Chapter 20 debtors eligible to void liens permanently upon the completion of their Chapter 13 plans (after discharge in 7)
In re Blendheim, D.C. No. 2:11-cv-02004 (9th Cir. Court of Appeals 10/1/15). Affirming in part and vacating in part the district court’s judgment, the panel held that an amendment to the Bankruptcy Code¯barring debtors from receiving a discharge at the conclusion of their Chapter 13 reorganization if they received a Chapter 7 discharge within four years of filing for Chapter 13 relief¯does not render such “Chapter 20” debtors ineligible for Chapter 13’s lien-voidance mechanism, which allows a debtor to void or modify certain creditor liens on the debtor’s property, permanently barring the creditor from foreclosing on that property.
The panel held that the bankruptcy court properly voided a creditor’s lien under § 506(d) of the Bankruptcy Code. The panel held that under § 506(d), if a creditor’s claim has not been “allowed” in the bankruptcy proceeding, then a lien securing the claim is void.
The panel held that the voiding of the creditor’s lien was permanent such that the lien would not be resurrected upon the completion of the debtors’ Chapter 13 plan. Agreeing with the Fourth and Eleventh Circuits, the panel held that 11 U.S.C. § 1328(f), enacted as part of the Bankruptcy Abuse Prevention and Consumer Protection Act in 2005, did not render Chapter 20 debtors ineligible to void liens permanently upon the completion of their Chapter 13 plans. The panel concluded that a discharge is not necessary to close a Chapter 13 case, and lien voidance does not subvert Congress’s intent in enacting BAPCPA.
The panel held that the voiding of the lien comported with due process because the creditor received notice that its rights might be affected when the debtors objected to its proof of claim.
The panel held that under the totality of the circumstances, the bankruptcy court did not clearly err in concluding that the Chapter 13 petition was filed in good faith. Agreeing with the Eleventh Circuit, the panel rejected a per se rule prohibiting a debtor from seeking the benefits of Chapter 13 reorganization during the post-discharge period when his Chapter 7 case remains open and pending. The panel affirmed the bankruptcy court’s lien-voidance order, plan confirmation order, and plan implementation order.
CHAPTER 13 CASES – UNSECURED JUNIOR MORTGAGE MAY BE STRIPPED OFF
a. Nobelman v. American Savings Bank, 508 U.S. 324 (U.S. 1993). A “strip down” or “cramdown” of claim that is secured by real property that is the debtor’s primary residence is prohibited. The United States Supreme Court held that after applying 11 U.S.C. § 1322(b)(2) and 11 U.S.C. § 506, a lien “strip down” of an undersecured home mortgage lien is impermissible in a chapter 13 case for a claim secured by the debtor’s principal residence, because it modifies the total package of rights for which such a claim holder bargained.
b. 11 U.S.C. § 1322(b), commonly known as the anti-modification clause, prevents debtors from changing the rights of creditors whose claims are secured only by a security interest in real property that is the debtor’s principal residence. Under various Circuit Court decisions interpreting Nobelman in Chapter 13 cases, §1322(b)(2) protections are no longer available to a creditor whose lien is a junior lien, and where the amount due to the senior lienholder(s) is greater than the value of the property pledged as security to that loan. Such creditor’s claims may be treated as an unsecured claim in the plan and paid consistent with other unsecured claimholders.
c. Majority view: While the anti-modification clause in § 1322(b) uses the term “claim” rather than “secured claim” and, therefore, applies to both the secured and unsecured part of a mortgage, the anti-modification clause still states that the claim must be “secured only by a security interest in … the debtor’s principal residence.” 11 U.S.C. § 1322(b)(2) (emphasis added). If valuation of the property under §506(a) determines that a junior mortgage holder’s claim is wholly unsecured, then the bank is not in any respect a “holder of a claim secured by the debtor’s residence” under §1322(b). Accordingly, the junior mortgage holder simply has an unsecured claim and the anti-modification clause does not apply. On the other hand, if any part of the mortgagee’s claim is secured, then, under Nobleman’s interpretation of the term “claim,” the entire claim, both secured and unsecured parts, cannot be modified.
The several Circuit Courts that have ruled on the issue, including the Sixth Circuit, support the majority position allowing lien stripping of wholly unsecured junior mortgage liens. See Pond v. Farm Specialist Realty (In re Pond), 252 F.3d 122 (2nd Cir. 2001); McDonald v. Master Fin., Inc.(In re McDonald), 205 F.3d 606 (3d Cir. 2000), cert. denied, 531 U.S. 822, 121 S.Ct. 66, 148 L.Ed.2d 31 (2000); Bartee v. Tara Colony Homeowners Ass’n (In re Bartee), 212 F.3d 277 (5th Cir.2000); Lane v. W. Interstate Bancorp (In re Lane), 280 F.3d 663 (6th Cir.2002); Zimmer v. PSB Lending Corp. (In re Zimmer), 313 F.3d 1220, (9th Cir. 2002); Tanner v. FirstPlus Fin., Inc. (In re Tanner), 217 F.3d 1357 (11th Cir. 2000). The only variance in this uniformity among the circuits is an Eleventh Circuit opinion, which disagrees with the In re Tanner panel that originally decided the issue, but which followed the Tanner decision as established precedent in that circuit. See In re Dickerson, 222 F.3d 924 (11th Cir.2000). See also Domestic Bank v. Mann (In re Mann), 249 B.R. 831, 833 (B.A.P. 1st Cir. 2000); Griffy v. U.S. Bank (In re Griffey), 335 B.R. 166 (B.A.P. 10th Cir. 2005); Waters v. The Money Store (In re Waters), 276 B.R. 879 (Bankr.N.D.Ill. 2002); In re King, 290 B.R. 641 (Bankr.C.D.Ill. 2003).
d. Minority view: While the Circuit Courts are nearly uniform in support of the majority view, some Bankruptcy Courts take a minority view. They hold that a properly perfected mortgage claim is literally “secured only by a security interest in real property that is the debtor’s principal residence” within the meaning of §1322(b), irrespective of whether the claim is wholly or partially secured, or totally unsecured after the application of §506(a). They reason that this view is consistent with the emphasis in the Nobelman decision on the state law contractual rights bargained for by the mortgagor and mortgagee, and with the legislative history which indicates that §1322(b) was intended to encourage the flow of capital into the home lending market and to exempt such Mortgages from valuations and bifurcations as the result of an application of § 506(a). Cases following minority view include Barnes v. American Gen. Fin. (In re Barnes), 207 B.R. 588 (Bankr.N.D.Ill.1997).
e. The Hon. Keith Lundin has expressed support for the minority view, that Nobleman was concerned about protecting the state law rights of the residential mortgagee and did not consider the issue to be a question of valuation. Lundin’s view and the minority view is there is no justification, following the Nobelman decision, for courts to focus on the value, at the date of the petition, of the real property securing a debt as the threshold of whether the rights of the mortgagee may be modified. In the majority view, a mortgagee with $1.00 in equity receives the anti-modification protection of §1322(b), while the mortgagee with no equity does not. Keith M. Lundin, Chapter 13 Bankruptcy, 3d. Ed. §14.1, p. 221 (2000 & Supp. 2004)
f. Lien stripping in the Seventh Circuit:
i. Although every circuit court of appeals that has considered the question has followed the majority view, the Seventh Circuit Court of Appeals has not directly ruled on the issue; thus, lower courts in the Seventh Circuit may follow either the majority or the minority view.
ii. In the Northern District of Illinois, the cases go both ways. Barnes v. American Gen. Fin. (In re Barnes), 207 B.R. 588 (Bankr. N.D. Ill. 1997) (follows the minority view that 11 U.S.C. §1322(b)(2) prohibits stripping off wholly unsecured mortgages.) Waters v. Money Store (In re Waters), 276 B.R. 879 (Bankr. N.D. Ill. 2002) follows the majority position after a thorough analysis of both views. Also in the Northern District of Illinois, the district court in In re Holloway v. United States, 2001 U.S. Dist. LEXIS 16898 (N.D. Ill. Oct. 16, 2001) follows the majority view.
iii. In the Central District of Illinois, In re King, 290 B.R. 641 (Bankr. C.D. Ill. 2003) adopted Waters, supra.
iv. In In re Black, 2002 Bankr. LEXIS 1752 (Bankr. N.D. Ind. 2002), the Northern District of Indiana provides a comprehensive review of cases following the majority and minority views, and decides that stripping off a wholly unsecured mortgage from the debtor’s residence “represents the most appropriate reading of both [11 U.S.C.] § 1322(b)(2) and Nobelman.”
EXCEPTIONS TO ANTI-MODIFICATION: – NOBELMAN EXCEPTIONS (Nobelman v. American Sav. Bank (92-641), 508 U.S. 324 (1993) (see below)
– § 1322(b)(2) provides that the Chapter 13 plan may modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor’s principal residence. §1123(b)(5) says the same thing for Chapter 11 cases.
a. Debtor’s Principal Residence –
Principal Residence defined U.S.C. 101(13A) The term “debtor’s principal residence”–(A) means a residential structure, including incidental property, without regard to whether that structure is attached to real property; and (B) includes an individual condominium or cooperative unit, a mobile or manufactured home, or trailer.
b. Liens on attached property or curtilage?
c. When is the Principal Use determined?
i. Origination date or petition date?
ii. Is pre-petition “use planning allowed?”
d. “Secured Only By” – Effect of lien on residence as well as upon other assets.
i. Additional security interests in mortgage escrow accounts. A majority of courts have ruled that the grant of a security interest in an escrow fund for insurance and taxes by a Chapter 13 debtor’s second mortgage did not convey additional collateral. The anti-modification provision continues to apply. The debtor retained no interest in the funds once placed in escrow and so any grant of a security interest in such funds was meaningless and conveyed essentially no interest at all. 1st 2nd Mortgage Co. of NJ., Inc. v. Ferandos (In re Ferandos), 402 F.3d 147 (3d Cir. 2005). See also Boehmer v. Essex (In re Boehmer), 240 B.R. 837(Bankr. E.D.Pa. 1999); Rodriguez v. Mellon Bank, N.A. (In re Rodriguez), 218 B.R. 764 (Bankr. E.D. Pa. 1998); In re Abruzzo, 245 B.R. 201 (Bankr. E.D. Pa. 1999), vacated In re Abruzzo, 245 B.R. 2000 U.S. Dist. LEXIS 4936 (E.D. Pa. Apr. 7, 2000), on remand In re Abruzzo, 249 B.R. 78 (Bankr. E.D. Pa. 2000)
ii. Other view: Residential mortgage debt was not one secured “only by a security interest in real property” that was debtor’s principal home, within meaning of anti-modification provision of Chapter 13, where mortgagee had also been granted security interest in escrow for taxes and insurance premiums; mortgagee had additional security interest in escrowed funds, notwithstanding that, on petition date, that interest had not been perfected by delivery. Stewart v. U.S. Bank, 263 B.R. 728 (Bankr.W.D. Pa. 2001).
iii. Secured by additional assets other than the residence; cross collateralization clauses, overly broad security agreement?
1. Fixtures: will a security interest in fixtures destroy §1322 antimodification protection?
2. Mortgage extending mortgagee’s security interest to non-fixture appliances, as well as other personalty, removed mortgagee’s claim from category of claims secured only by residential realty, for purpose of preventing Chapter 13 debtor from modifying mortgagee’s rights. In re Caster, 77 B.R. 8 (Bankr. E.D. Pa. 1987).
iv. Valuation- Under § 506 (a)(1), “value shall be determined in light of the purpose of the valuation and of the proposed disposition or use of such property, and in conjunction with any hearing on such disposition or use or on a plan affecting such creditor’s interest”(emphasis added). If a valuation of the property under §506(a) determines that a junior mortgage holder’s claim is wholly unsecured, then the mortgagee is not in any respect a “holder of a claim secured by the debtor’s residence” and the jr. mortgage holder’s claim may be modified and treated as an unsecured claim.
1. Date of Valuation –
a. Loan Origination Date or Date of Bankruptcy Petition?
2. Methodology of Valuation. Market value or liquidation value? When a Chapter 11 debtor or a Chapter 13 debtor intends to retain property subject to a lien, the purpose of a valuation under section 506(a) is not to determine the amount the creditor would receive if it hypothetically had to foreclose and sell the collateral. Neither the foreclosure value nor the costs of repossession are to be considered because no foreclosure is intended. . . . The fair market value is not ‘replacement value’ because the house is not being replaced. The fair market value is the price which a willing seller under no compulsion to sell and a willing buyer under no compulsion to buy would agree upon after the property has been exposed to the market for a reasonable time. Taffi v. United States (In re Taffi), 68 F.3d 306, 309 (9th Cir. 1995)
3. Current use or highest-best use? Should not calculate the value of the property on the value such property could demand if it were converted to some other use. The purpose of the valuation is to determine how much the creditor will receive for the debtor’s continued possession . . .. The foreclosure value is not relevant because no foreclosure is intended by the Plan. . . . Consequently, the value has to be the fair market value of what the debtors are using. Taffi v. United States (In re Taffi), 68 F.3d 306, 309 (9th Cir. 1995) Cannot deduct for hypothetical costs of sale – Huntington Nat’l Bank v. Pees (In re McClurkin), 31 F.3d 401 (6th Cir. 1994)
Nobelman v. American Sav. Bank (92-641), 508 U.S. 324 (1993)
Held: Section 1322(b)(2) prohibits a Chapter 13 debtor from relying on §506(a) to reduce an undersecured homestead mortgage to the fair market value of the mortgaged residence. Although petitioners were correct in looking to §506(a) for a judicial valuation of their residence to determine the status of the lender’s secured claim, that valuation does not necessarily limit the lender’s “rights [as a claim] holde[r],” which are the focus of §1322(b)(2)’s protection. In the absence of a controlling Bankruptcy Code definition, it must be presumed that Congress left the determination of property “rights” in estate assets to state law. Butner v. United States, 440 U.S. 48, 54-55. The mortgagee’s “rights,” therefore, are reflected in the relevant mortgageinstruments, which are enforceable under Texas law. Those rights include, among others, the right to repayment of the principal in monthly installments over a fixed term at specified adjustable interest rates, and they are protected from modification by §1322(b)(2). That section’s “other than” exception cannot be read to protect only that subset of allowed “secured claims,” determined by application of §506(a), that are secured by a lien on the debtor’s home. Rather, the more reasonable interpretation is to read “a claim secured only by a [homestead lien]” as referring to the lienholder’s entire claim, including both its secured and unsecured components, since it would be impossible to reduce petitioners’ outstanding mortgage principal to $23,500 without modifying the mortgagee’s contractual rights as to interest rates, monthly payment amounts, or repayment term. Pp. 2-8.
In re Grijalva, 4:11-bk-25386-EWH (D. AZ 4-2-12) Marie Antoinette Grijalva (“Debtor”) proposes to modify the first-position lien on her principal residence in her Amended Chapter 13 Plan (“the Amended Plan”). For the reasons explained in the balance of this opinion, such treatment is permitted pursuant to 11 U.S.C. § 1322(c)(2) and § 1325(a).
When is the Lien Stripped Off ?
The unsecured junior lien is not stripped off at confirmation. To allow lien strip at confirmation would encourage “mischief” such as the debtor’s post-confirmation sale of the property to an unsuspecting purchaser. Under BAPCPA section 1325(a)(5)(B)(i)(I)(bb), the plan must provide that the claim holder “retain[s] the lien securing such claim until … discharge under section 1328….”
1. Christopher Barclay v. Dejan Boskoski, 22-55098, 9th Cir Ct of Appeals, 11/14/22 The panel affirmed the bankruptcy court’s judgment in favor of Dejan Boskoski and against the Chapter 7 Trustee in a case in which Boskoski sought to avoid a judgment lien recorded in 2014 against his California home. Holding that, when a judgment lien impairs a debtor’s state-law homestead exemption, the Bankruptcy Code requires courts to determine the exemption to which the debtor would have been entitled in the absence of the lien.
The Ninth Circuit held that the California exemption amount in effect at the time of the filing of the bankruptcy petition applied, even though the language of the California exemption for judgment liens would have required calculation of the amount of the exemption as of a different date.
2.The junior lien is deemed satisfied and lien should be discharged or released only upon conclusion of the bankruptcy case. In re Jones, 152 B.R. 155 (Bankr. E.D. Mich. 1993).
3. The right to avoid a lien has not fully matured in a Chapter 13 context until a discharge is granted upon successful completion of the Chapter 13 Plan. Accordingly, the order confirming the Debtors’ plan will specifically provide that the Debtors’ house shall remain property of the estate, and shall not re-vest in the Debtors, until the Debtors are granted a discharge. Castle v. Parrish, 29 B.R. 869, 874 (Bankr. S.D. Ohio 1983)
4. A plan is inconsistent with the provisions of Chapter 13 when it purports to effectuate irrevocable lien avoidance on plan confirmation. In re McMillan 251 B.R. 484, 490 (Bankr.. E.D. Mich.2000)
5. If the Debtor is ineligible to receive a discharge due to prior discharge under 11 U.S.C. 1328(f) then the Debtor may not benefit from the lien stripoff. See In re Akram, 259 B.R. 371, 378-79 (Bankr.C.D.Cal.2001); In re King, 290 B.R. 641, 651(Bankr. C.D. Ill.2003)
Hardship discharge?
If the Debtor receives only a “hardship discharge” under 11 U.S.C. 1328(b) is the debtor entitled to the benefit of the lien strip and a discharge of the junior mortgage lien?
1. One line of cases holds that a creditor’s lien may be extinguished pursuant to the debtor’s plan. These cases use the following two lines of reasoning: First, the creditor’s lien is void upon the payment of the allowed secured claim pursuant to 11 U.S.C. § 506(d); and second, where §1322(b)(2) does not prevent a modification to the creditor’s lien rights, any concern about the debtor dismissing his case after the creditor’s lien is released, but prior to full payment under the plan, is outweighed by the policy of affording the debtor a fresh start. See, e.g., Bank One, NA v. Flowers, 183 B.R. 509 (N.D. Ill. 1995); In re Nicewonger, 192 B.R. 886 (Bankr.N.D.Ohio 1996); In re Hernandez, 175 B.R. 962 (N.D. Ill. 1994); In re Wilson, 174 B.R. 215 (Bankr. S.D. Miss. 1994); McDonough v. Plaistow Coop. Bank (In re McDonough), 166 B.R. 9 (Bankr. D. Mass. 1994); In re Cooke, 169 B.R. 662 (Bankr. W.D. Mo.1994); In re Schultz, 153 B.R. 170 (Bankr. S.D. Miss.1993); In re Lee, 156 B.R. 628 (Bankr. D. Minn.1993).
2. Another line of cases holds that a debtor may not obtain a release of a secured creditor’s lien until he successfully completes the confirmed plan and receives a §1328(a) discharge. See, e.g., In re Zakowski, 213 B.R. 1003 (Bankr. E.D. Wis.1997); In re Pruitt, 203 B.R. 134 (Bankr. N.D. Ind. 1996); In re Scheierl, 176 B.R. 498 (Bankr. D. Minn.1995);In re Jordan, 164 B.R.. 89 (Bankr. E.D. Mo.1994); In re Jones, 152 B.R. 155 (Bankr. E.D. Mich.1993); Gibbons v. Opechee Distribs. (In re Gibbons), 164 B.R. 207 (Bankr. D.N.H. 1993).
IS AN ADVERSARY PROCEEDING REQUIRED
Chapter 13 debtors may not need to file an adversary proceeding to strip the mortgagee’s lien. One court summarized the cases:[I]t appears that no adversary proceeding is needed simply to value and declare void a totally unsecured claim. The majority of courts therefore hold that “the appropriate procedure for lien avoidance under Section 506 is by motion because lien avoidance is the inevitable byproduct of valuing a claim, which is accomplished by motion pursuant to Bankruptcy Rule 3012.” In re Sadala, 294 B.R. 180, 183 (Bankr. M.D. Fla. 2003) (collecting cases); see also, In re Millspaugh, 302 B.R. 90 (Bankr. D. Idaho 2003); In re Fisher, 289 B.R. 544 (Bankr. W.D.N.Y. 2003) (court allows proceedings to be prosecuted by motion in the absence of a specific objection by the mortgage holder that the proceeding be converted to an adversary proceeding); but see, e.g., In re Kressler, 252 B.R. 632 (Bankr. E.D. Pa. 2000) (espousing the minority view that an adversary proceeding is required); …Once the value of the secured claim is determined, the attendant lien is stripped off automatically under Section 506(d).” In re Sadala, 294 B.R. 180, 183 (Bankr. M.D. Fla. 2003) In re Robert, 313 B.R. 545, 549 (Bankr. N.D. N.Y. 2004).
These Courts have determined that lien stripping is a valuation issue, not a challenge to the “validity, priority, or extent of a lien” of F.R.B.P. 7001, requiring an adversary proceeding.
a. Courts have considered the “lien-stripping” effect of § 506 in the context of:
i. an adversary proceeding. See, e.g., Gaglia v. First Federal Sav. & Loan Asso., 889 F.2d 1304, 1305 (3d Cir. Pa.1989), overruled by Dewsnup v. Timm, 502 U.S. 410 (U.S. 1992); In re Lindsey, 823 F.2d 189, 191 (7th Cir. Ill. 1987); In re Cobb, 122 B.R. 22, 24(Bankr.E.D. Pa.1990); Bellamy v. Federal Home Loan Mortg. Corp., 122 B.R. 856, 857 (Bankr. D. Conn. 1991), aff’d In re Bellamy, 132 B.R. 810 (D.Conn.1991), aff’d In re Bellamy, 962 F.2d 176 (2d Cir. Conn. 1992); Goins v. Diamond Morttg. Corp., 119 B.R. 156, 157 (Bankr. N.D. Ill.1990); In re Garnett, 88 B.R. 123, 124 (Bankr. W.D. Ky.1988), aff’d United States on behalf of Farmers Home Admin. v. Garnett, 99 B.R. 757 (W.D. Ky. 1989); In re Crouch, 80 B.R. 364, 365 (Bankr. W.D. Va.1987); In re O’Leary, 75 B.R. 881, 882(Bankr. D. Or. 1987);
ii. a motion to avoid a lien. See, e.g., In re Jablonski, 88 B.R. 652, 653 (E.D. Pa. 1988); In re Chavez, 117 B.R. 733, 734 (Bankr. S.D. Fla. 1990); In re Marshall, 111 B.R. 325, 326 (Bankr. D. Mont. 1990); In re Demoff, 109 B.R. 902, 903 (Bankr. N.D. Ind.1989); In re Anderson, 88 B.R. 877, 878 (Bankr. N.D. Ind. 1988), In re Robert, 313 B.R. 545 (Bankr. N.D.N.Y. 2004) and,
iii. in an objection to a proof of claim. See, e.g., In re Jablonski, 88 B.R. 652, 653 (E.D. Pa. 1988); In re Chavez, 117 B.R .733, 734 (Bankr. S.D. Fla. 1990); In re Marshall, 111 B.R. 325, 326 (Bankr. D. Mont. 1990); In re Demoff, 109 B.R. 902, 903 (Bankr. N.D. Ind. 1989); In re Anderson, 88 B.R. 877, 878 (Bankr. N.D. Ind.1988).
b. Eastern District Court of Michigan- The Court has not to date required an adversary proceeding in any published opinion. In the case, In re Jones 152 B.R. 155 (Bankr. E.D. Mich. 1993); the Hon. Arthur Spector held that F.R.Bankr.P. 3012 permits § 506 valuations to be requested by motion, and noted that the advisory committee note relating to that rule distinguishes valuation proceedings from those subject to F.R.Bankr.P. 7001, and ruled that the debtor need not file an adversary proceeding to avoid a creditor’s lien under § 506. In re Hoskins, 262 B.R. 693(Bankr. E.D. Mich. 2001)
c. Western District of Michigan- a junior lien which is totally unsupported by any equity in property may be extinguished through Chapter 13 plan confirmation process, without need for adversary proceeding, as long as language in plan is sufficiently clear to put lienholder on notice of debtor’s intentions) (See also, In re Hoskins, 262 B.R. 693(Bankr. E.D. Mich. 2001)(Judge Spector), In re Fuller 255 B.R. 300, 306 (Bankr. W.D. Mich. 2000); In re Hudson, 260 B.R. 421 (Bankr. W.D. Mich. 2001); see also, In re Calvert, 907 F.2d 1069, 1072 (11th Cir. Ala. 1990);
i. Best Practice- Circuits have not specifically ruled. Debtors may wish to be cautious when deciding whether an adversary proceeding is required. If future appellate court decisions decide that an adversary proceeding is required, the lien strip-off may be subject to collateral attack. Cf. Ruehle v. Educ. Mgmt. Corp. (In re Ruehle), 412 F. 3d 679, 680 (6th Cir. 2005) (student loan discharge in plan void because adversary proceeding required).
EFFECT OF DISMISSAL
– A dismissal acts to undo bankruptcy and to restore property rights to the position in which they were found at commencement of case, as far as practicable, given facts of each case. Bankr.Code, 11 U.S.C. § 349(b).
i. Unless the court indicates otherwise, the general effect of an order of dismissal is to “restore the status quo ante; “it is as if the bankruptcy petition had never been filed. France v. Lewis & Coulter, Inc. (In re Lewis & Coulter, Inc.), 159 B.R. 188, 190 (Bankr. W.D. Pa. 1993); Lawson v. Tilem (In re Lawson), 156 B.R. 43, 45 (B.A..P. 9th Cir. Cal. 1993)).
ii. The legislative history of 11 U.S.C. § 349 states: The basic purpose of the subsection is to undo the bankruptcy case, as far as practicable, and to restore all property rights to the position in which they were found at the commencement of the case…. Where there is a question over the scope of the subsection, the court will make the appropriate orders to protect rights acquired in reliance on the bankruptcy case. H.R.Rep. No. 595, 95th Cong., 1st Sess., 338 (1977); 1978 U.S.Code Cong. & Admin.News, 5963, 6294.
iii. 11 U.S.C. § 1325(a)(5)(B)(i)(II) requires a plan to provide that if a Chapter 13 case is “dismissed or converted without completion of the plan,” the lien is retained by the lien holder “to the extent recognized by applicable nonbankruptcy law.”
CREDITOR DEFENSES:
a. Mortgage is not a “Junior Lien”
i. Failure to record or properly record a senior mortgage. If junior lienholder lacked notice of the prior lien, consider action to determine whether a “junior lien” has priority.
ii. Defective/invalid liens. If a senior lien has defects that render the security instrument void, consider action to determine lien priority (e.g., acknowledgment, signatures, witnesses, description of the property).
iii. Can junior lienholder compel Ch. 13 Trustee or Debtor to avoid a senior lien, thus preserving Jr. lien? No, because any such senior lien avoided would be preserved to the bankruptcy estate to prevent a junior lienholder from improving his position. 11 U.S.C. § 551
b. Valuation of property supports Junior Lien- Appraisals of property may establish that the property actually is worth more than the amount of the senior lienholder’s secured claim.
1. Claims of senior lienholder may be overstated. In a close case, it may be useful to examine the claim of the senior lienholder for components that may improperly inflate the amount of the claim.
Consider objections to the claim for:
a. Fees and costs incurred after the petition was filed;
b. Property taxes, insurance premiums, or property preservation expenses that were incurred after the petition was filed;
c. Fees and costs that are not authorized to be charged to the borrower under the note and mortgage, unless or until notice to the debtor is given;
d. Unlawful fees and costs;
e. Whether funds in escrow account should be credited.
c. Motions to convert case to chapter 7.
i. See note above, regarding §1325(a)(5)(B)(i)(II) (effect of dismissal or conversion)
ii. General grounds to convert case. Strategic reasons to convert to Chapter 7?
The borrower cannot strip lien in Ch. 7 case. Nobelman v. American Savings Bank, 508 U.S. 324 (U.S. 1993); In re Talbert, 344 F.3d 555 (6th Cir. 2003).
SETTLEMENT CONSIDERATIONS /CREDITOR CONCEDES THAT LIEN STRIP IS AUTHORIZED- WHAT NEXT?
a. Seek a judgment, plan provision, or order that protect junior lienholder until conclusion of the case.
i. Order should confirm lien is preserved until successful completion of all payments and issuance of § 1328(a) Order of Discharge.
ii. The judgment and the order confirming the plan should state that any property encumbered by liens securing an allowed secured claim shall remain property of the estate until the plan is fully performed.
iii. Seek favorable judgment provisions that protect the junior lienholder until the case is concluded, such as “Future Default” provisions , and provisions requiring maintenance of adequate hazard insurance coverage, and prompt payment of property taxes.
b. Make a close examination of Debtor’s Income and Expenses and file timely objections to under reported income, and unsubstantiated, unreasonable and luxury expenditures, to maximize dividends to unsecured creditors.
c. Consider valid objections to untimely or defective claims of other unsecured creditors to maximize junior lienholder’s pro rata share.
d. Monitor plan payments, prompt payment of property taxes, and maintenance of adequate hazard insurance and seek dismissal in appropriate circumstances.
OTHER EXCEPTIONS:
a. Short Term Mortgages – First Union Mortg. Corp. v. Eubanks (In re Eubanks), 219 B.R. 468 (B.A.P. 6th Cir. 1998) (Section 1322(c)(2) creates a statutory exception to the protection from modification for “short term” home mortgages in Chapter 13 cases; debtor can bifurcate undersecured second mortgage and pay allowable secured portion in full with interest consistent with § 1325(a)(5), while paying unsecured portion with other unsecured claims.)
Client filed Chapter 13. No confirmed plan yet. Did the MMM Program and got approved. Now want to try a lien strip on 2nd mortgage.
- Do I use value of property as of filing date or value as of now?
- Do I use 1st mortgage payoff as of filing date or now the new payoff that is part of the Mortgage Modification Agreement?
- BAC Home Loans Serv., LP v. Abdelgadir (In re Abdelgadir), 455 B.R. 896, 898 (9th Cir. BAP 2011) The Abdelgadir court found that the proper date to be considered was not the date of confirmation, but the date the debtor filed the petition for relief. The court reasoned that “ . . . the bankruptcy court’s approach improperly shifted the time for fixing a creditor’s claim from the petition date to some future valuation date and conflated the analysis of whether a creditor held a claim secured by the debtor’s principal residence with a determination of the value of that claim.” Followed by Benafel v. One West Bank, FSB (In re Benafel), 461 B.R. 581 at 587 (9th Cir. BAP 2011). 455 B.R. 896, 898 (9th Cir. BAP 2011) implied, in dicta, that the value of a claim does not necessarily have to be determined as of the petition date. That implication, however, does not mean that the petition date should not be used. The Abdelgadir court found that the lower court’s determination of whether a claim is protected from modification should be determined as of the date of confirmation, pursuant to §1123(b)(5), was flawed, as it conflates the analysis of whether a creditor holds a claim with the determination of the value of the claim. Thus, we are left with the query of whether or not equity exists in collateral to support the Defendant’s lien to avoid a lien strip. To determine this, the value of the Defendant’s claim must involve the value of the collateral. The Plaintiff posits that it would be inequitable, if not nonsensical, to fix the amount of the Defendant’s claim on one date, the confirmation date, and the value of the collateral supporting that claim on another date.
- Giebel v. Styron (In re Giebel) (Bankr. W.D.Wash., 2014), the court found that “. . . [t]he petition is the appropriate date for both valuing the mortgage property and for determining the amount of the senior mortgage debt.” In re Geibel at page 12; citing In re Gutierrez, 503 B.R. 458 (Bankr. C.D. Cal. 2013); and TD Bank, N.A. v. Landry, 479 B.R. 1 (Bankr. D. Mass. 2012) (the proper time for valuing residential property that secured junior mortgagee’s claim, for purposes of deciding whether junior mortgagee was undersecured or held a claim that was wholly unsupported by any equity in property and not protected from “strip off” by anti-modification provision of Chapter 13 was the petition date).
- Michael Eric Mccune vs Orangewood Village Homeowners Association, Arizona Bankruptcy Court, Adv. No.2-13-01160, Judge Nielsen
- A thorough analysis: Robert J. Hegeduis and Kerri M. Hegeduis vs. Harris, N.A., Adv.No.: 12-2203, Northern District of Indiana (January 23, 2015).
Notes from a friend (Larry Karandreas – a great bankruptcy attorney): With respect to Section 506, Defendant’s argument that the property must be valued as of the time of confirmation falls flat and is unsupported by that statute. If Section 506 provided such a clear mandate, there would not be such a split between the courts regarding this very issue. In reading Section 506, it appears that the Defendant is bolstering its argument that confirmation is the rational point for the purposed of valuation by looking at the last sentence of that statute, adding emphasis to “… or on a plan affecting such a creditor’s interest.” Ignoring the conjunctive nature of that sentence, which, on its own, weakens the Defendant’s argument, the whole purpose of the valuation in this matter is to determine if the Defendant’s lien should be treated as entirely unsecured. To determine that value, the date of filing of the petition should be used based on the proposed disposition and use of the property sought to be valued, in conjunction with the confirmation of the Plaintiff’s chapter 13 plan.
Two cases: In re Elleni & Randy Berger and Charles & Sharon Yeomans v Commonwealth of Pennsylvania, 18-20778-GLT (3/29/19 US BK Court, WD PA)
Two sets of chapter 13 debtors commenced adversary proceedings to determine the nature and extent of various liens asserted against their real property. Revenue is a defendant in both cases because it holds tax liens on the affected properties.
- 1 Through separate motions, Revenue seeks dismissal of both adversary cases and each debtor has filed a response in opposition.
- 2 As both cases present the question of whether sovereign immunity prohibits the debtors from removing unsecured or undersecured tax liens from their property, the Court will decide them simultaneously.
Cases have discussion about sovereign immunity in bankruptcy.
Lien stripping is nothing more than a determination of the rights in a debtor’s res, in exactly the same way as the discharge of student loan debt in Hood and the avoidance of a preferential transfer in Katz. Indeed, the assessment and modification of liens against estate assets is the quintessential in rem proceeding, much more so than the actions evaluated by the Supreme Court in those two cases.86 Revenue’s assertion that lien-stripping is an “affirmative act” is also unavailing, because it wholly ignores the language in Katz authorizing ancillary proceedings to in rem adjudications. The act is “affirmative” in the same sense that clawing back a preferential transfer from a transferee is affirmative, and implicates the affected party’s rights to the same extent.
Characterizing the removal of the lien through a chapter 13 plan as an in personam proceeding is simply another attempt by Revenue to dress up simple facts in deceptive garb. Beneath the costume, the truth remains: determining rights in a piece of property is properly an in rem proceeding. Revenue therefore has no sovereign immunity to raise in these proceedings.
ADDITIONAL DISCUSSION: COURT REFERS TO MYTHOLOGY IN REJECTING A STATE’S ATTEMPT TO PREVENT TAX LIEN STRIP DOWN
Berger v. Pennsylvania (In re Berger) (Bankr. W.D. Pa., 2019)
In two Chapter 13 cases involving the Pennsylvania Department of Revenue, in which the state attempted use sovereign immunity to prevent several debtors from stripping down state tax liens, Judge Gregory L. Taddonio commenced his opinion in apropos reference to mythology:
“In mythological lore, the Greek hero Achilles thought himself to be invincible, impervious to the swords and arrows of his enemies.
“So too, is the mindset of the Pennsylvania Department of Revenue in the cases presently before the Court. Revenue requests dismissal of separate adversary proceedings brought by chapter 13 debtors seeking to reduce or eliminate Revenue’s secured claims.
“Revenue believes itself to be cloaked with sovereign immunity of such magnitude that its tax liens are invulnerable to modification by the bankruptcy court. But just as Achilles fatefully discovered his mortality, the Court finds that Revenue’s liens are similarly susceptible to a well-heeled attack.”
The court begins by making clear the distinction between strip-down and strip-off:
“As Judge Agresti explained in In re Johnson, lien-stripping encompasses both “strip-downs,” where a lien is “reduced to the equity value held by the debtor,” and “strip-offs,” where “a wholly-unsecured creditor’s lien is removed from collateral in which there is no equity value.
Then dispenses with Dewsnup:
“The rationale which compelled the Supreme Court to prohibit lien stripping in chapter 7 cases simply does not apply to the very different circumstances of a reorganization case under chapter 11 or 13.”
And rejects any theory of sovereign immunity:
“The proofs of claim and the adversary complaints arise out of the same “transaction or occurrence,” and Revenue has therefore waived its sovereign immunity with respect to the debtors’ complaints.
“Third Circuit law is clear that lien stripping in chapter 13 cases is not accomplished through § 506(d), but by a combination of § 506(a) and § 1322(b)(2).76
“Characterizing the removal of the lien through a chapter 13 plan as an in personam proceeding is simply another attempt by Revenue to dress up simple facts in deceptive garb. Beneath the costume, the truth remains: determining rights in a piece of property is properly an in rem proceeding. Revenue therefore has no sovereign immunity to raise in these proceedings.
CREDITOR FILED TO PRESERVE JUDGMENT LIEN (STATUTE OF LIMITATIONS RUNS) DURING BANKRUPTCY
In re Dobos, 9th Cir BAP, 8/2/19 A creditor seeking to enforce an avoided lien needs to ensure that the lien does not otherwise expire during the course of the litigation or appeal. In this case, a judgment creditor whose lien had been avoided filed a motion to reopen the debtor’s bankruptcy case but then failed to take further action for two years. In the meantime, the judgment lien expired under state law. As a result, the bankruptcy court’s dismissal of the nondischargability action was affirmed. Further, a motion to dismiss filed after an answer has been filed is still proper under Rule 12(c) or 12(h)(2).
The bankruptcy court granted a debtor’s motion to dismiss judgment creditors’ adversary proceeding seeking to have a judgment lien deemed nondischargable. The bankruptcy court ruled that the judgment creditors’ failure to act to preserve their judgment liens during the pendency of the bankruptcy case and the subsequent motion to reopen the bankruptcy case made it proper for the court to dismiss the case on the pleadings alone.
