Tuesday, November 5, 2013

FYI: 4th Cir Affirms Bankruptcy Court's Refusal to "Strip Off" a "Valueless Lien" on Property Owned by Debtor and Non-Debtor Spouse in Tenancy by the Entirety

In an issue of first impression in the federal appellate courts, the U.S. Court of Appeals for the Fourth Circuit recently ruled that the statutory provisions authorizing a "strip off" of a "valueless" lien under 11 U.S.C. § 506(a), and applicable Maryland property law, do not permit a bankruptcy court to alter a non-debtor's interest in property held in a tenancy by the entirety, and that the filing of a joint complaint against a lien holder in bankruptcy court is not sufficient to satisfy the Maryland law requirement that tenants by their entireties act together to alter their interests in their entireties property.


In so ruling, the Fourth Circuit upheld the district court's opinion that the bankruptcy court lacked authority to "strip off" the debtor's "valueless" lien because only the debtor's interest in the estate, rather than the complete entireties estate, was before the bankruptcy court.


A copy of the reported opinion is available at: http://www.ca4.uscourts.gov/Opinions/Published/121156.P.pdf


At the time the debtor filed his Chapter 13 petition, the value of the property he owned with his non-debtor spouse was allegedly less than the full amount owed on the first-priority lien.  The debtor and his non-debtor spouse jointly filed a complaint in the bankruptcy court to strip off the allegedly valueless second-priority lien, arguing that because the Second Lien Holder's lien was completely valueless -- and therefore unsecured under 11 U.S.C. § 506(a) -- they were entitled to strip off the lien. 


Denying the request, the bankruptcy court held that a lien on property held in a tenancy by the entirety cannot be stripped when only one tenant by the entirety had filed for bankruptcy.  The district court affirmed, and this appeal followed.


As you may recall, to effectuate a lien strip, a bankruptcy court first considers the valuation provision contained in § 506(a), which states:


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.


A bankruptcy court next applies § 1322(b)(2), which addresses the debtor's reorganization plan and permits debtors in such plans to modify the rights of holders of unsecured claims. "The end result is that section 506(a)… operates with section 1322(b)(2) to permit a bankruptcy court, in a Chapter 13 case, to strip off a lien against a primary residence with no value." Branigan, 716 F.3d at 335.  A lien strip becomes effective and permanently eliminates a lienholder's in rem rights against the collateral property upon completion of a debtor's reorganization plan. Branigan, 716 F.3d at 338.


In addition, in Maryland, "a tenancy by the entirety is a joint tenancy of spouses with rights of survivorship between the spouses."  See Slip Op. at 9.  The marital unit owns the property, "with each spouse having an undivided interest in the whole property."  See Slip Op. at 9.  In addition, until one spouse dies, "a tenancy by the entirety can be severed only by divorce or by the joint action of both spouses.  One spouse alone cannot alienate, convey, or encumber his or her interest in the entireties property."  See Slip Op. at 10 (internal citations omitted).


Identifying an issue of first impression among federal appellate courts, the Fourth Circuit, agreeing with the lower courts, held that while generally "a creditor's lien on real property passes through bankruptcy unaffected," a bankruptcy court in a typical Chapter 13 proceeding does have "the authority to strip off a completely valueless lien . . . ."  See Slip Op. at 4 (citing Branigan v. Davis, 716 F.3d 331 (4th Cir. 2013)).  However, such authority does not extend to liens on entireties property when only one spouse has filed for bankruptcy. 


In reaching this conclusion, the Fourth Circuit relied on Greenblatt v. Ford, 638 F.2d 14 (4th Cir. 1981), in which the Court held that a bankruptcy filing by only one spouse "'does not sever the estate of tenancy by the entirety' created under Maryland law."  See Slip Op. at 11 (quoting Greenblatt, 638 F.2d at 14-15).  The Court's prior decision also recognized that only a debtor's individual undivided interest in a tenancy by the entirety is transferred into the bankruptcy estate upon filing.  Because by statute confirmation of a Chapter 13 plan only binds the debtor and his creditors, "the bankruptcy court is without authority to modify a lienholder's rights with respect to a non-debtor's interest in a property held in a tenancy by the entirety."  See Slip Op. at 13.  Consequently, the Court held that only the debtor's interest in the entireties property, and not the whole of the entireties property, became part of his bankruptcy estate.


In addition to rejecting their argument that jointly filing a complaint brought the entireties property into the estate, the Fourth Circuit also rejected the debtor's and his spouse's argument that a bankruptcy court can remove the lien under 11 U.S.C. § 363(h), which permits the trustee in limited circumstances to dispose of a non-debtor spouse's interest in entireties property. 


Instead, the Court held that "the Bankruptcy Code does not authorize a bankruptcy court to eliminate a lienholder's rights with respect to a non-debtor's interest in property or to contravene state law regarding entireties property to eliminate an in rem component of a lien."  See Slip Op. at 15.   




Ralph T. Wutscher
McGinnis Wutscher Beiramee LLP
The Loop Center Building
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Chicago, Illinois 60602
Direct: (312) 551-9320
Fax: (312) 284-4751
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Email: RWutscher@mwbllp.com


Admitted to practice law in Illinois


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