Tenth Circuit Asks If § 1322(B)(2) Allows Or Prohibits The Stripping Of Undersecured Liens On A Debtor’s Principal Residence?

andersonBy Kevin Anderson, Chapter 13 Trustee for the District of Utah

This issue arose in a case where the debtor’s filed an adversary proceeding and obtained default judgment that the trust deed claim on their principal residence was wholly unsecured under § 506(a). Debtors then sought an order immediately removing the trust deed as an encumbrance of record, and included this as provision in their plan. The trustee objected to confirmation asserting under § 11 U.S.C. § 1325(a)(5)(B)(i)(I) that the creditor retained its trust deed lien as encumbrance of record until completion of the plan and entry of discharge.

Judge Thurman denied confirmation and issued the comprehensive opinion of In re Woolsey, 438 B.R. 432 (Bankr D. Utah 2010), that makes the following points:

  1. Section 506(a) allows bifurcation of undersecured trust deed on debtors’ principal residence for purposes of determining treatment under the plan (e.g., undersecured trust deed claim can be paid with other unsecured claims);
  2. However, § 506(a) does not operate to disallow an undersecured claim, as that can only be done under § 502; and § 506(d) only strips a lien associated with a claim that was not “allowed” under § 502.
  3. Because the trust deed gave the bank in rem rights in the real property, and because the bank’s claim had not been disallowed under § 502, it holds an “allowed secured claim” for purposes of §§ 506(d) and 1325(a)(5), despite being completely unsecured under §§ 506(a) and 1322(b)(2).
  4. BAPCPA amended § 1325(a)(5) to require that the holder of an “allowed secured claim” retains its lien until the debt is paid in full under state law or the debtor receives a § 1328 discharge.
  5. As a result, the undersecured trust deed could not be removed as an encumbrance of record until debtors completed the plan and received discharge, even though the claim itself could be paid through the plan as unsecured.

Debtors appealed and the District Court affirmed. Debtors then appealed to Tenth Circuit Court of Appeals raising the following issues:

  1. Is debt related to undersecured trust deed on a debtor’s principal residence an “allowed secured claim”?
  2. Is such a wholly unsecured lien null and void under § 506(d)?
  3. Must such a lien be immediately removed as an encumbrance of record of does the creditor retain such lien until the entry of discharge?

No party raised whether § 1322(b)(2) prohibited the modification of an undersecured trust deed on the debtor’s principal residence.

After oral argument in November 2011, the Tenth Circuit ordered supplemental briefing on the following issue:

Whether a debtor’s initiation of an adversary proceeding “to determine the validity, priority, or extent of a lien or other interest in property,” Fed. R. Bankr. P. 7001(2), constitutes an objection to a creditor’s claim under 11 U.S.C. § 502(a), and whether any action by the bankruptcy court in connection with such an adversary proceeding—including, but not limited to, granting relief to the debtor—causes or results in the claim being disallowed for purposes of 11 U.S.C. §§ 502 and 506.

After the filing the supplemental briefs in December 2011, the parties awaited a ruling.

On July 3, 2012, the Tenth Circuit issued a second order for supplemental briefs on the following issue:

Does 11 U.S.C. § 1322(b)(2) independently authorize a Chapter 13 debtor to remove a lien on his principal residence if the lien is wholly unsecured by value in the collateral? Compare, e.g., In re Lane, 280 F.3d 663 (6th Cir. 2002) with In re Barnes, 207 B.R. 588 (Bankr. N.D. Ill. 1997).

While this issue was neither raised nor addressed in the initial briefs, the debtor, bank and trustee filed supplemental briefs on this question. While NACBA filed an amicus brief as to the initial issues, it did not file a brief regarding the § 1322 issue. The matter remains pending before the Tenth Circuit Court of Appeals.

The majority of Circuits and cases clearly favor the stripping of undersecured liens on the principal residence of a Chapter 13 debtor. However, the Supreme Court has seriously considered the issues raised when a real property interest is removed by operation of bankruptcy law. The brief of the debtor and the trustee are attached hereto, and attempt to illuminate the pros and cons of allowing or prohibiting the striping of an undersecured trust deed on a debtor’s principal residence.

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Kevin R. Anderson was appointed as a Standing Chapter 13 Trustee for the District of Utah in 1998, and currently administers 12,000 Chapter 13 cases. Mr. Anderson is the past-President of the National Association of Chapter 13 Trustees (NACTT), and he is a Fellow of the American College of Bankruptcy. He is a frequent speaker and writer on Chapter 13 issues, including for The Norton Bankruptcy Law Advisor, the ABI Journal, and the NACTT Quarterly. He has served on a number of national committees regarding Chapter 13 legislation, rules, forms, and policy. Prior to his appointment as Chapter 13 trustee, Mr. Anderson practiced for thirteen years in the area of commercial litigation with an emphasis in civil fraud, real property, and representing Chapter 11 and Chapter 7 trustees. Mr. Anderson clerked for the Honorable David N. Naugle, United States Bankruptcy Judge, Central District of California.

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