District Court Gets it Wrong in Chapter 13 Lien Strip Case

Posted by NCBRC - August 12, 2016

A district court in Maryland mistakenly applied section 506(d) when it held that a debtor may not strip off a wholly unsecured lien in chapter 13 where the creditor failed to file a proof of claim. Burkhart v. Community Bank of Tri-County, No. 14-315 (D. Md. July 27, 2016).

Edwin Michael, and Teresa Stein Burkhart’s home was subject to several liens, two of which were held by Tri-County and were wholly unsecured. Tri-County did not file a proof of claim in the Burkharts’ bankruptcy. The Burkharts filed an adversary complaint seeking to strip off the wholly unsecured liens under section 1322(b). Tri-County did not respond and the Burkharts moved for default judgment.

The bankruptcy court relied on section 506(d)(2), which provides: “to the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void, unless . . . such claim is not an allowed secured claim due only to the failure of any entity to file a proof of such claim. . .” Because Tri-County had not filed a proof of claim, the court held its liens could not be stripped. (The court granted default judgment against PNC, the holder of another wholly unsecured junior lien, because PNC had filed a timely proof of claim).

On appeal, the district court agreed with the reasoning of the bankruptcy court. In so holding, it relied on the following points:

  1. Dewsnup v. Timm, 506 U.S. 410 (1992) holds that “lien avoidance depends upon the interplay between §§ 506(a) and 506(d) of the Bankruptcy Code.”
  2. A lien may be avoided under section 506(d) only if it is “not an allowed secured claim.”
  3. Relying solely on the interplay between section 506(a) and section 1322(b)(2) for strip-off in chapter 13 would render section 506(d) “mere surplusage.”

The court emphasized that mere failure to file a proof of claim is historically not sufficient cause to strip a lien. “For these reasons, the Court concludes that § 506(d), working in tandem with §§ 506(a) and 1322(b), constitutes the statutory mechanism for stripping off a wholly unsecured junior lien in a chapter 13 case.” Because the liens could not be stripped under section 506(d), the court found that they could not be stripped at all.

In the alternative, the court held that even if section 506(d) is not a necessary component of strip-off in chapter 13, the Burkharts are still out of luck under the requirements of section 506(a). Lien stripping of a wholly unsecured lien under section 1322(b) necessitates valuation under section 506(a) and under that latter provision, only an “allowed” claim is subject to valuation. Because no proof of claim was filed either by the creditor, or by the Burkharts or the trustee, the court concluded that there was no allowed claim to value.

With respect to the court’s finding that section 506(d) controlled the availability of strip-off in this case, it erred. In Dewsnup v. Timm, 506 U.S. 410 (1992), the Supreme Court held that to be deemed void under section 506(d), a lien must be both not allowed and unsecured. What the Burkhart court failed to understand is that, under Nobelman v. Am. Sav. Bank, 508 U.S. 324 (1993) and its extensive progeny, liens in chapter 13 are stripped by way of sections 506(a) and 1322(b), not section 506(d). Section 1322(b)’s anti-modification provision applies to secured liens. Unlike section 506(d) which inserts a requirement that to be void, an unsecured claim not be allowed, section 1322(b) is based solely on the distinction between secured and unsecured.

Post-Nobelman decisions have uniformly found that wholly unsecured liens are not subject to the anti-modification provision. The holding in Dewsnup and its interpretation of section 506(d) is entirely inapplicable in the chapter 13 context. The recent decision in Bank of America, N.A. v. Caulkett, — U.S. —-, 135 S. Ct. 1995, 192 L. Ed. 2d 52 (2015), reaffirms this distinction. Caulkett distinguished between Dewsnup’s lien stripping discussion in chapter 7, and Nobelman’s lien-stripping discussion in chapter 13, stating: “Nobelman said nothing about the meaning of the term ‘secured claim’ in §506(d). Instead, it addressed the interaction between the meaning of the term ‘secured claim’ in §506(a) and an entirely separate provision,§1322(b)(2).”

The Burkhart court’s reliance on In re Woolsey, 696 F.3d 1266, 1272-73 (10th Cir. 2012), further illustrates its failure to understand the distinction between lien-stripping in chapter 7 and lien-stripping in chapter 13. Woolsey, and other similar cases, held that a chapter 13 debtor may not rely on section 506(d) for lien-stripping. However, as the court in Woolsey stated in dictum, in pursuing section 506(d) as the mechanism for lien-stripping, the debtor failed to adopt “the only possible winning argument they may have had;” to wit, lien-stripping via section 1322(b).

The issue of “allowance” of the claim, as treated in this case, has two conflicting components. Section 506(d)(2) voids a lien that is not an allowed secured claim, but if the only reason it is not allowed is due to the creditor’s failure to file a proof of claim, it is treated as “allowed” for purposes of application of section 506(d)’s voidance provision. On the other hand, section 506(a) provides for valuation of an allowed claim. To reach its conclusion in this case, the Burkhart court reasoned that Tri-County’s claim cannot be valued under section 506(a) because it is not “allowed,” and cannot be voided under section 506(d) because it is “allowed.”

Burkhart D Md opinion July 2016





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