No Lien Strip Permitted in Chapter 7 under Section 506

Posted by NCBRC - July 29, 2013

In In re Palomar the chapter 7 debtors filed an adversary proceeding seeking to strip off a wholly unsecured junior lien on their residence. The bank had not filed a claim in the bankruptcy. The court found that the debtors could not strip the lien and the district court affirmed. The Seventh Circuit found that neither section 506(a) standing alone, nor in conjunction with section 506(d), permits such lien stripping. Palomar v. First American Bank (In re Palomar), No. 12-3492 (7th Cir. July 11, 2013).

The Seventh Circuit began with the finding that, under the reasoning set forth in Dewsnup v. Timm, 502 U.S. 410 (1992), 506(d) does not permit strip-off of a lien that is allowed even though that lien may be valueless under section 506(a). Because, in Palomar, the bank had not filed a claim, there was no issue as to whether the claim was “allowed” for purposes of application of section 506(d), therefore, the lien could not be stripped pursuant to that section. See also Ryan v. Homecomings Financial Network, 253 F.3d 778, 781-82 (4th Cir. 2001) (chapter 7 debtor may not strip-off wholly unsecured lien pursuant to section 506(d)); Talbert v. City Mortg. Serv., 344 F.3d 555 (6th Cir. 2003) (same); Laskin v. First Nat’l Bank of Keystone, 222 B.R. 872 (B.A.P. 9th Cir. 1998) (same). But see In re McNeal, 477 Fed. Appx. 562 (11th Cir. 2012) (under Eleventh Circuit precedent chapter 7 debtor may strip wholly unsecured lien pursuant to section 506(d)).

The court turned to whether section 506(a) would serve the purpose sought by the debtors and  found that it would did not. “The point of section 506(a) is not to wipe out liens but to recognize that if a creditor is owed more than the current value of his lien, he can by filing a claim in bankruptcy (rather than bypassing bankruptcy and foreclosing his lien) obtain, if he’s lucky, some of the debt owed him that he could not obtain by foreclosure because his lien is worth less than the debt.” Citing In re Tarnow, 749 F.3d 464, 465-66 (7th Cir. 1984).

Though, as was found by the Palomar court, the trend is toward interpreting Dewsnup as prohibiting strip-offs of wholly unsecured liens in chapter 7, the Eleventh Circuit rejected that finding in its unpublished opinion in In re McNeal, 477 Fed. Appx. 562 (11th Cir. 2012). There, the court found that Dewsnup should be confined to its factual borders which dealt only with a partially secured lien. When the issue involves a wholly unsecured lien, albeit one that is allowed under section 502, Dewsnup does not control. Rather, the court in McNeal relied on Folendore v. United States Small Bus. Admin., 862 F.2d 1537 (11th Cir. 1989), which held that the plain meaning of sections 506(a) and (d) rendered a wholly unsecured lien in chapter 7 void.

Palomar opinion

McNeal opinion


Post a Comment

You must be logged in to post a comment.