The U.S. Court of Appeals for the Fourth Circuit recently ruled that BAPCPA permitted so-called "Chapter 20" debtors to "strip off" completely valueless liens, reasoning that, notwithstanding BAPCPA's four-year bar on discharges in a Chapter 13 bankruptcy following a Chapter 7 filing, debtors may still take advantage of other protections under Chapter 13 that do not involve a discharge.
In so ruling, the Court concluded that the Bankruptcy Code did not create a per se rule against lien-stripping in Chapter 20 cases, as mechanisms existed for preventing abuse of the bankruptcy process, including a good faith requirement and a court's ability to dismiss Chapter 20 cases filed solely to strip off liens.
A copy of the opinion is available at: http://www.ca4.uscourts.gov/Opinions/Published/121184.P.pdf.
Debtors filed for bankruptcy protection under Chapter 7 of the Bankruptcy Code ("Code"), which discharged the personal liability on their unsecured debt but left their secured mortgage debt intact. Almost a year later, Debtors filed a petition under Chapter 13 of the Code to reorganize their debts, repay mortgage arrearages and consumer debt, and to "strip off," i.e., remove, junior liens against their residence and rental property. Their residence was valued at $270,000, and was encumbered by a first-priority lien with a balance of over $275,000, and second and third priority liens, the balances of which exceeded $230,000.
In this so-called "Chapter 20" bankruptcy, in which debtors file a Chapter 13 bankruptcy within four years of a Chapter 7 bankruptcy that resulted in a discharge, the Bankruptcy Court granted Debtors' motion seeking to strip off the third-priority lien on Debtors' residence. In so doing, the court found that Debtors had acted in good faith and reasoned that the Bankruptcy Abuse Prevention and Consumer Protection Act ("BAPCPA") did not create a "per se" rule against lien-stripping in the Chapter 20 context. The bankruptcy court also entered orders stripping off the second and third liens on Debtors' rental property and confirming their bankruptcy plan. The bankruptcy trustee ("Trustee") and the holder of the third-priority lien against Debtors' residence appealed to the district court.
In a separate Chapter 20 bankruptcy, consolidated with Debtors' case, an individual debtor filed a Chapter 13 petition just a week after having received a Chapter 7 discharge, seeking to pay a federal tax claim and strip off a valueless second lien against her home. After the bankruptcy court granted the individual's motion to strip off the second lien, the bankruptcy court confirmed the bankruptcy plan. Trustee appealed to the district court.
The district court affirmed the bankruptcy court's rulings. Trustee appealed. The Fourth Circuit affirmed.
As you may recall, Chapter 7 of the Code generally results in a discharge of debt, eliminating personal liability for certain debts, but leaves intact in rem claims against secured collateral. A Chapter 13 bankruptcy, on the other hand, permits the debtor to reorganize both unsecured and secured debt and to pay creditors primarily out of income.
In addition, a lien in bankruptcy is either secured or unsecured depending on the value of the collateral. See 11 U.S.C. § 506(a)(an allowed claim secured by a lien is a secured claim "to the extent of the value of such creditor's interest in the estate's interest . . ." 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.")
Moreover, a Chapter 13 bankruptcy 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, or of holders of unsecured claims, or leave unaffected the rights of holders of any class of claims[.]" 11 U.S.C. § 1322(b)(2).
Under BAPCPA's amendments to the Bankruptcy Code, lien creditors retain "allowed secured claims" until either payment of the underlying debt pursuant to nonbankruptcy law or discharge, and, in the event a Chapter 13 case is dismissed or converted without the plan being completed, the holder of an allowed secured claim retains the lien to the extent recognized by applicable nonbankruptcy law. See 11 U.S.C. § 1325(a)(5)(B). BAPCPA further provides that a debtor may not receive a Chapter 13 discharge within four years of filing a Chapter 7 that results in a discharge. 11 U.S.C. § 1328(f)(1).
While noting that Section 506(a) operates in conjunction with Section 1322(b)(2) to permit the bankruptcy court to strip off a completely valueless lien against a primary residence in a Chapter 13 case, the Fourth Circuit also observed that section 1322(b)(2) precludes a so-called "strip down" of a partially secured lien against a principal residence in the Chapter 13 context, because partially secured lienholders are considered "holders of secured claims" that are protected by lien modification. See Nobelman v. American Sav. Bank, 508 U.S. 324, 331-32 (1993); Zimmer v. PSB Lending Corp. (In re Zimmer), 313 F.3d 1220 (9th Cir. 2002); Lane v. W. Interstate Bancorp (In re Lane), 280 F.3d 663 (6th Cir. 2002).
Next, the Fourth Circuit addressed whether BAPCPA specifically precludes "Chapter 20" debtors from stripping off valueless liens. In so doing, the Court concluded that, notwithstanding BAPCPA's prohibition on debtors obtaining discharges in a Chapter 13 bankruptcy for four years following a Chapter 7 filing, debtors may still take advantage of other protections under Chapter 13 that do not involve a discharge. See Branigan v. Bateman (In re Bateman), 515 F.3d 272, 283 (4th Cir. 2008).
Thus, rejecting Trustee's various assertions, including the contention that lien-stripping depends on a debtor's ability to receive a Chapter 13 discharge, and that the liens in this case survived until paid because Debtors were not eligible for a discharge, the Fourth Circuit reasoned that BAPCPA did not alter the ability of bankruptcy courts to allow lien stripping in Chapter 13 proceedings. In reaching this conclusion, the Court rejected Trustee's argument that Debtors were trying an end run around the prohibition of Chapter 7 lien-stripping on "allowed secured claims," even where there was no equity in the collateral. See Dewsnup v. Timm, 502 U.S. 410 (1992)(considering whether a Chapter 7 debtor may strip down a lien to the value of the collateral). Observing that only claims with value may be "allowed secured claims," and that the liens in this case were completely valueless and thus wholly unsecured, the Fourth Circuit specifically pointed out that BAPCPA did not amend Section 506 or Section 1322(b), concluding that the lien-stripping analysis in a Chapter 13 bankruptcy similarly applied in the context of a Chapter 20 bankruptcy.
Finally, stressing that in allowing courts to scrutinize bankruptcy filings for bad faith, and to dismiss Chapter 20 cases aimed solely at stripping off liens, the Fourth Circuit also emphasized that a bankruptcy discharge only eliminates personal liability, and that lien-stripping orders only change a debtor's in rem liability where the lien has no value. The Fourth Circuit thus emphasized that its holding was limited to a bankruptcy court's ability to strip the in rem portion of a valueless lien, and that all in personam claims survive a Chapter 20 proceeding, thereby treating creditors equally in this regard.
Ralph T. Wutscher
McGinnis Wutscher Beiramee LLP
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Accordingly, the Fourth Circuit affirmed the lower court's judgment.