Chapter 20 and Who May Be a Debtor

Posted by NCBRC - May 9, 2017

In a chapter 20 case, a wholly unsecured junior lien for which the debtor has no personal liability, does not enter into the calculation in the subsequent chapter 13 case, of either secured or unsecured debt under section 109(e). Asset Management Holdings v. Hernandez, No. 16-1228, 1244 (B.A.P. 9th Cir. April 11, 2017) (unpublished).

Aleli Hernandez filed for chapter 7 bankruptcy and included in her schedules two debts secured by deeds of trust on her residence. More than four years after she obtained a discharge in that case, she filed for chapter 13 bankruptcy and sought to avoid the junior lien on the basis that the senior lien exceeded the value of the property. AMH moved to dismiss on the bases that Ms. Hernandez was ineligible for chapter 13 relief under section 109(e) and, in the alternative, that she filed her petition in bad faith. The bankruptcy court denied the motion and confirmed Ms. Hernandez’s plan.

Affirming on appeal, the BAP began with AMH’s argument that Ms. Hernandez’s debts exceeded the eligibility limits for unsecured debts under section 109(e). It cited its decision in Free v. Malaier (In re Free), 542 B.R. 492 (9th Cir. BAP 2015), for the rule that “debtors who had previously obtained a chapter 7 discharge of their personal liability for wholly unsecured junior liens against their residence were not required to include that debt as an unsecured debt for purposes of the chapter 13 eligibility.” The Free court reasoned that because the debtor’s personal liability on the debt had been discharged there was no allowable unsecured claim that could be made by that creditor in the subsequent chapter 13 case and, therefore, nothing to include in the 109(e) unsecured debt calculation.

In the face of the decision in Free, AMH argued that the panel should either decline to follow its precedent, or, in the alternative, treat the debt as secured and Ms. Hernandez as ineligible due to exceeding the secured debt limit under section 109(e).

The panel declined AMH’s invitation to reject Free in favor of the bankruptcy courts which held that, under Johnson v. Home State Bank, 501 U.S. 78 (1991), “the unsecured portion of an in rem claim must be included in the chapter 13 eligibility calculation despite a prior chapter 7 discharge.” In re Scotto-DiClemente, 463 B.R. 308 (Bankr. D.N.J. 2012), aff’d sub nom., In re DiClemente, 2012 WL 3314840 (D.N.J. Aug. 13, 2012); and In re Wimmer, 512 B.R. 498 (Bankr. S.D. N.Y. 2014). Rather, the BAP found that Johnson went to the issue of whether the creditor retained an in rem claim in bankruptcy and that the Court did not address the effect of chapter 7 discharge on eligibility under section 109(e). The BAP agreed with the reasoning in Free that it made no sense for an unsecured debt that had been discharged in a previous bankruptcy to be included in the debt limit calculation.

Turning to whether the debt should be considered in the secured debt calculation, the panel rejected AMH’s reliance on chapter 12 cases finding that those cases dealt with “aggregate debt” as applied to “family farmers.” It then addressed AMH’s argument that on the date of the petition, its loan had not yet been subject to avoidance under section 506(a) and should therefore have been included in the secured debt calculation. Under  Henrichsen v. Scovis (In re Scovis), 249 F.3d 975, 982 (9th Cir. 2001), however, the Ninth Circuit held that, notwithstanding its status at the time of the petition, “the bankruptcy court need not take a mechanical approach to determining eligibility by ignoring readily ascertainable circumstances, such as where a lien is clearly undersecured.” Because the debt was unsecured under section 506(a), the bankruptcy court did not err in refusing to include it in the secured debt calculation.

The panel was likewise unpersuaded by AMH’s “nonsensical” policy argument. Specifically, AMH argued that a holding in favor of Ms. Hernandez would result in increased litigation in chapter 7 cases by creditors seeking avoid potential loss of rights in the chapter 20 scenario. The court stated: “A secured creditor could not prevail on an objection to discharge or a motion to dismiss for bad faith in a chapter 7 case on grounds that a debtor intended to file a subsequent chapter 13 to eliminate the creditor’s lien.”

Finally, the panel addressed the issue of whether Ms. Hernandez filed her chapter 13 case merely in an attempt to avoid foreclosure and, if so, whether that constitutes bad faith. Under Leavitt v. Soto (In re Leavitt), 171 F.3d 1219, 1224 (9th Cir. 1999), a court looking at whether a petition was filed in good faith may consider: 1) whether the debtor misrepresented fact, 2) the debtor’s history of bankruptcy filings and dismissals, 3) whether the bankruptcy filing is an attempt to defeat state court litigation, and 4) whether there is egregious behavior. The court emphasized that filing a chapter 20 bankruptcy is not per se bad faith. In the absence of any evidence that any of the other Leavitt factors applied, the bankruptcy correctly determined that Ms. Hernandez did not act in bad faith.

Hernandez 9th BAP opinion April 2017


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