No Unsecured Claim against the Estate in Chapter 20 Lien Strip Case

Posted by NCBRC - September 9, 2019

Reversing the bankruptcy court, the BAP for the Ninth Circuit found that a wholly unsecured junior lienholder’s claim was not allowable as a general unsecured debt against the bankruptcy estate where the chapter 13 debtor had obtained a discharge on her personal liability in a prior chapter 7 bankruptcy. Washington v. Real Time Resolution, Inc., No. 18-1206 (B.A.P. 9th Cir. July 30, 2019).

Gwendolyn Washington obtained a chapter 7 discharge and, five years later, filed for chapter 13 bankruptcy proposing a 100% plan and seeking to strip off a wholly unsecured junior lien on her home. The servicer for the junior lienholder, RTR, filed a proof of claim listing Ms. Washington’s original debt as an unsecured claim under section 506(a), and the bankruptcy court allowed the claim over Ms. Washington’s objection.

In finding that RTR’s claim should be treated as unsecured, the bankruptcy court relied on cases such as In re Akram, 259 B.R. 371 (Bankr. C.D. Cal. 2001) and In re Gounder, 266 B.R. 879 (Bankr. E.D. Cal. 2001), aff’d, No. CIV.A. S-01-1707-WBS, 2001 WL 1688479 (E.D. Cal. Dec. 19, 2001), where the courts held that, when a lien is valued at zero under section 506(a) and the debtor has no personal liability on the debt, the creditor “retained its right to satisfy its claim against the debtor’s property, which had become property of the estate.”

On de novo review, the appellate panel noted that, notwithstanding the anti-modification provision of section 1322(b)(2), a wholly unsecured lien may be stripped off in chapter 13 and that strip-off typically results in the underlying debt being treated as unsecured. In a chapter 20 case, however, the fact of the earlier discharge changes the analysis. The panel found that, in allowing an unsecured claim for the underlying debt, the bankruptcy court and those cases it relied on, failed to give effect to section 524’s discharge injunction. Because of the injunction, once the debtor’s personal liability has been discharged, the creditor no longer has a right to payment on the debt. The panel cited In re Rosa, 521 B.R. 337 (Bankr. N.D. Cal. 2014), as stating the proper view that when a lien is valued at zero and the debtor’s personal liability has been discharged in a prior case, the creditor’s claim is not “allowed” under section 502(b), and there is nothing in the Code that resurrects that debt as a claim against the estate. The panel analogized the issue before it with its previous holding in Free v. Malaier (In re Free), 542 B.R. 492 (B.A.P. 9th Cir. 2015), where it held that debts for which the chapter 20 debtor had no personal liability should not be included in a section 109(e) debt limit calculation.

The panel rejected RTRs argument that the bankruptcy court’s form motion for valuation providing for treatment of a lien valued at zero as an unsecured debt, required the holding below. First, the panel noted that a court form must be read to comply with the Code, and second, the form had been changed to include language permitting different treatment upon order of the court.

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