In an elegant opinion employing judicial tools of plain text reading, simple logic, and historical context, the Ninth Circuit joined the “Fourth and Eleventh Circuits in concluding that Chapter 20 debtors may permanently void liens upon the successful completion of their confirmed Chapter 13 plan irrespective of their eligibility to obtain a discharge.” HSBC Bank v. Blendheim (In re Blendheim), No. 13-35412 (Oct. 1, 2015).
The Blendheims filed for chapter 13 bankruptcy within four years of their chapter 7 discharge thereby rendering them ineligible for discharge under section 1328(f). HSBC filed a proof of claim based on its first position mortgage on the debtors’ residence. The Blendheims filed an objection to the POC asserting that HSBC failed to attach a copy of the promissory note evidencing the debt (the Blendheims also challenged the validity of the note). HSBC did not respond to the objection, did not respond to the court’s disallowance of the claim, did not respond to the court’s suggestion that it take steps to protect its interests, and did not appear at the hearing on the debtors’ adversary proceeding to avoid the lien. In fact, HSBC did not lift a finger on its own behalf until over one year after the adversary proceeding ended in a default judgment against it. At that time HSBC sought reinstatement and defended against the Blendheim’s motion for summary judgment seeking an order voiding the lien.
Having disallowed the claim and noting HSBC’s lack of participation, the bankruptcy court denied the motion for reinstatement and found that the lien was void pursuant to section 506(d) which provides that “[t]o the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void.” The district court affirmed.
On appeal, the Ninth Circuit found that a reading of section 506(d), taken in conjunction with the holding in Dewsnup v. Timm, 502 U.S. 410 (1992) as recently reaffirmed in Bank of America, N.A. v. Caulkett, 135 S. Ct. 1995 (2015), makes plain that a claim that is not “allowed” is void. In this case, HSBC’s claim was expressly disallowed by the bankruptcy court after the Blendheims objected to it and HSBC did not respond. The court distinguished cases in which courts declined to void liens when the claims based on them were disallowed solely because the proofs of claim were filed late. Those courts equated late proofs of claim with not filing a proof of claim at all and therefore found that the exception set forth in section 506(d)(2) applied. In contrast, this case involved a timely proof of claim to which the debtors objected. Therefore the exception did not apply.
The court turned to the issue of whether lien voidance becomes permanent upon completion of the debtors’ plan regardless of the fact that the debtors were not entitled to discharge. The court noted that “[t]wo other courts of appeals and bankruptcy appellate panels from three circuits, including our own, have also addressed the question, all concluding that Chapter 20 debtors may void liens irrespective of their eligibility for a discharge. See In re Scantling, 754 F.3d 1323, 1329–30 (11th Cir. 2014); In re Davis, 716 F.3d 331, 338 (4th Cir. 2013); In re Boukatch, 533 B.R. 292, 300–01 (B.A.P. 9th Cir. 2015); In re Cain, 513B.R. 316, 322 (B.A.P. 6th Cir. 2014); In re Fisette, 455 B.R. 177, 185 (B.A.P. 8th Cir. 2011)” (noting that those cases all involved liens that were wholly unsecured under section 506(a) and stripped under section 1322(b) rather than voided under section 506(d) as is the case here).
In arguing that its lien should rebound after the Blendheims complete their plan, HSBC, relied on In re Leavitt, 171 F.3d 1219 (9th Cir. 1999), as outlining only three ways to end a chapter 13 case: conversion, dismissal, or discharge. Under sections 348 and 349, both conversion and dismissal reinstate liens which were otherwise voided or stripped. Only discharge results in permanent lien-stripping. The Ninth Circuit found HSBC’s reliance on Leavitt to be erroneous, explaining that the Leavitt court did not state a “rule” but merely delineated in dictum some of the methods of ending a chapter 13 case in the context of the facts before it. “Our statement in Leavitt should not be read to describe an exhaustive list of ways in which a Chapter 13 case may conclude.” In fact, the Code offers a fourth way of ending a chapter 13 case: closure under section 350(a).
That ineligibility for discharge does not affect liens is in perfect harmony with the rule that discharge affects only in personam liability and, in the absence of lien stripping or avoidance, liens pass through bankruptcy unaffected under section 524(a)(2). “It follows logically that there is no reason to make the Bankruptcy Code’s in rem modification or voidance provisions contingent upon a debtor’s eligibility for a discharge, when discharges do not affect in rem rights.” From a historical standpoint, the court noted that “[n]o discharge is, or ever has been, necessary to accomplish the outcome that the Blendheims seek.” Cases finding that discharge is necessary to permanent lien stripping have erroneously relied on precedents involving post-bankruptcy continuation of in personam liability where the debtor has been unable under the Code to discharge a particular debt.
Addressing the concern, either express or implied, that underlies many courts’ finding that discharge is essential to permanent lien avoidance, the court rejected the argument that debtors somehow make an end run around Congress’s intent to limit their rights in the event of subsequent bankruptcy filings when they strip a lien in chapter 20. Rather, the court stated: “We take Congress at its word when it said in § 1328(f) that Chapter 20 debtors are ineligible for a discharge, and only a discharge.” Congress could have, and has in other circumstances, limited debtors’ lien-voidance rights but did not do so in section 1328(f). Simply put: “Nothing in the Code conditions Chapter 13’s other benefits or remedies on discharge eligibility.” The court reasoned that Congress’s decision to deny discharge to debtors who seek bankruptcy too soon after a previous chapter 7 discharge fosters the goal of preventing debtors from engaging in post-bankruptcy profligate spending and relying on bankruptcy to extricate them from their new debts. Contrary to HSBC’s argument, permitting permanent lien stripping does not give the debtor any advantage over discharge-eligible debtors because failure to successfully complete the plan will still result in reinstatement of liens.
The court rejected HSBC’s complaint that it was denied due process by reason of the lien voidance decision. Essentially, HSBC was provided with the necessary notice of the potential loss of its lien when it received the Blendheim’s objection to its proof of claim. It was HSBC’s subsequent inaction that resulted in default judgment against them. Thus, “the record shows that HSBC’s inexplicable failure to assert its rights, and not any defect in process, led to its predicament here.”
Finally, the court found that successive and even simultaneous bankruptcy filings (here, the Blendheims filed their chapter 13 while their chapter 7 was still technically open though almost 2 years after they obtained their chapter 7 discharge) does not inexorably lead to the conclusion that the later bankruptcy was filed in bad faith. “Because nothing in the Bankruptcy Code prohibits debtors from seeking the benefits of Chapter 13 reorganization in the wake of a Chapter 7 discharge, we see no reason to force debtors to wait until the Chapter 7 case has administratively closed before filing for relief under Chapter 13.” The court agreed with the bankruptcy court’s finding that, under the totality of circumstances, the Blendheims did not act in bad faith. They had reasons for filing chapter 13 other than avoiding foreclosure and in any case averting an imminent foreclosure does not equate with bad faith.Lien Stripping