In re Blendheim, ___ F.3d ___ (9th Cir. 2015) 2015 WL 5730015
CHAPTER 20 LIEN STRIPS NOW ALLOWED UNDER 9TH CIRCUIT LAW.
In a case of first impression, the 9th Circuit has now resolved a division in its lower courts that discharge ineligibility of a debtor who received a prior Chapter 7 discharge does not prohibit that debtor from obtaining a permanent lien strip of an underwater junior lien in a later filed Chapter 13 case.
THE BANKRUPTCY COURT CHAPTER 20 CASES
Debtors filed a Chapter 7 case and received their discharge. The day after the discharge was received, Debtors filed a Chapter 13 case. In the Chapter 13 case, a Secured Creditor holding a first deed of trust on Debtors’ home filed a proof of claim, subjecting itself to jurisdiction of the Bankruptcy Court.
Debtors objected to the Claim and Secured Creditor failed to respond to the objection. The Bankruptcy Court granted a default Order disallowing the claim.
Debtors then filed an Adversary Complaint declaring their intent to permanently void the Secured Creditor’s lien based on the disallowance of that claim by way of that default Order. (Compare this to the more common evidentiary judicial determination that the value of the real property allowed debtor to “lien-strip” off the junior deed of trust).
Secured Creditor failed to respond to the Adversary Complaint. Finally a year and a half later, Secured Creditor sought to set aside the default Order disallowing its claim. That motion was denied.
Debtors obtained Summary Judgment in the Adversary action that upon completion of its Chapter 13 plan, the Secured Creditor’s deed of trust would be void and cancelled.
Debtors’ 11th Amended Plan in the bankruptcy case was confirmed, over Secured Creditor’s objection that its lien should be reinstated at the end of the bankruptcy because only a discharged debtor may receive a permanent lien avoidance (lien-strip). As a result of confirmation of that 11th Amended Plan, the Secured Creditor’s lien was to be permanently voided upon completion of the plan.
THE APPELLATE DECISIONS
Secured Creditor appealed to the District Court, arguing that its lien could not be permanently removed since Debtors’ could not obtain a discharge in the Chapter 13 case. Secured Creditor also appealed on due process grounds, claiming a lack of knowledge that the granting of the claim objection would permanently affect its lien rights. The District Court affirmed the Bankruptcy Court’s decision. Secured Creditor appealed to the 9th Circuit Court of Appeals.
The 9th Circuit Court first set forth the statutory framework of the Bankruptcy Code sections involved in the case. In that regard, the 9th Circuit Court reiterated that in order for a creditor to collect a debt, it must hold a “claim” or right to payment, which has been “allowed” by the Bankruptcy Court.
That Court then explained all of the provisions set forth in the Bankruptcy Code that were required to confirm a Chapter 13 plan and explained all of the “tools” in the Chapter 13 reorganization “tool-box”, including the right of a debtor to lien strip completely under-water liens on their home under 11 U.S.C. § 1322(b)(2).
The 9th Circuit Court then held that the Bankruptcy Court had properly voided Secured Creditor’s lien under 11 U.S.C. § 506(d) because once the Bankruptcy Court granted the default Order denying the proof of claim, Secured Creditor no longer held an “allowed claim”, and thus held no right to payment on its claim for money owed.
The 9th Circuit Court decided that even though lien avoidance in this circumstance was a harsh result, that under the circumstances of Secured Creditor’s failure to respond multiple times to various motions, it was more like a concession by Secured Creditor to forfeit its claim.
The 9th Circuit Court then held that a lien strip can be permanent even if there is no discharge in a case as long as the plan is completed. It discussed at length the meaning of a discharge of “personal liability” in a Chapter 7 case versus the remaining post-discharge right to “in-rem” recovery by a lender. The 9th Circuit Court found no requirement that a discharge in the later 13 case is a requirement to permanently eliminate “in-rem” rights of a lender. It concluded that a debtor may permanently lien-strip a lien upon successful completion of its Chapter 13 plan even if debtor cannot obtain a discharge in the Chapter 13 case.
The final holding of the 9th Circuit Court was that the voiding of Secured Creditor’s lien in the fashion it was done did not violate the due process rights of that Secured Creditor. Following United Student Aid Funds, Inc. v. Espinosa, 559 U.S. 260 (2010), the 9th Circuit determined that Secured Creditor had received notice “reasonably calculated, under all circumstances, to apprise interested parties of the pendency of the action and afford them an opportunity to present their objections”. Secured Creditor had a responsibility to investigate the potential consequences of its lien under the plans proposed by debtors and failed to do so.
Finally, the 9th Circuit Court considered the good faith nature of the Chapter 20 bankruptcy in this instance. The 9th Circuit Court opined that this Chapter 13 petition and confirmed plan were filed in good faith under a totality of circumstances, even though the Chapter 13 case was filed while the Chapter 7 was still pending, but subsequent to Debtors’ discharge.
In light of this recent decision, we are likely to see an increase in Chapter 20 bankruptcies in the 9th Circuit. Debtors will file a Chapter 7 in order to discharge all of their unsecured debts (they cannot lien strip an “under-water” junior lien in Chapter 7 under the recent case of Bank of America v. Caulkett, 135 S. Ct. 1995 (2015)) and then file a Chapter 13 in order to try and lien strip an “under-water” junior lien secured by Debtors’ residence.
A junior lender needs to make sure it files a valid and complete proof of claim in the Chapter 13 case, including use of the new form and following the new rules that apply after December 1, 2015. This will avoid the result in Blendheim where the Court granted an objection to claim, eliminating the right of the secured creditor to payment regardless of the value of the residence.
A junior lender then has to obtain an appraisal and follow the evidentiary requirements to get that appraisal into evidence and then convince the Bankruptcy Court that there is at least a dollar of equity in Debtor’s residence so that the lien may not be stripped off upon completion of the Chapter 13 plan. Although some Courts allow the use of a Broker’s Price Opinion in lieu of an appraisal, it is not recommended by this author.
If the lender can show equity in the residence over and above senior liens including delinquent property taxes, it should prevail in the lien strip motion brought in the later Chapter 13 case and its lien would remain in place in the bankruptcy and would have to be paid in full at the end of the Chapter 13 plan.
Remember, only fully “under-water” liens may be stripped off the property. A partially secured lien on a Debtors’ residence may not be “stripped-down” to the value of the property under Nobelman v. American Savings Bank, 508 U.S. 324, (1993) under 11 U.S.C. § 1322(b)(2). The lien remains in place for the entire amount owed.