During the last several years, there has been a growing debate within the Chapter 13 bankruptcy community, over whether a Chapter 13 Plan can modify the rights of a secured creditor to the extent that the secured creditor’s status changes before the discharge. In other words, can a Chapter 13 plan which provides that upon payment in full of the secured portion of a claim, that the lender must release its lien and surrender title to the debtor be confirmed over the objection of the secured creditor? The Courts nationwide have considered this issue, but have not come to a uniform conclusion.
Typically, the issue arises when the Debtor has purchased a vehicle pursuant to a retail installment contract which remains due and owing when a Chapter 13 bankruptcy is filed. Also, the remaining balance on the vehicle is greater than the fair market value of the vehicle. The payment terms of the plan are irrelevant. That is to say, whether the Debtor proposes a 100% distribution to the unsecured creditors or merely 10% does not have an impact on this issue. The issue is only whether the plan requires that the secured lender must tender the title to the motor vehicle when the Debtor pays the secured portion of the claim, but prior to the discharge pursuant to 11 U.S.C. Sec. 1328.
The split of opinion does not necessarily rest on the concept of lien stripping, as most court read Section 1322 (b) to say that it is permissible to strip liens on personal property. Notably the prohibition of lien stripping of real property as proscribed by Noblemen v. American Savings Bank, 508 U.S. 324 (1993) does not apply here. Rather, the split of opinion centers on the point in time that a secured creditor loses its status as a secured creditor — whether it should be at discharge or at the time that the secured portion is paid in full, but some time prior to the completion of the plan. Courts holding the latter position includes In re Murry-Hudson, 147 B.R. 960 (Bankr. N.D. Cal. 1992); In re Lee, 156 B.R. 628 (Bankr. N.D. Ohio 1993); In re England, no. 96-90911-BHL-13, slip op (Bankr.S.D.Ind.Nov. 5, 1996); In re Flowers, 175 B.R. 698, 700 (Bankr.N.D.Il 1994); and Nicewonger, 192 B.R. 886, 889 (Bankr. N.D. Ohio 1996).
The Northern District of Illinois recently ruled on this issue in the case of In re Daniel M. and Linda M. Johnson, Bankruptcy Case number 97 B 9972. There the court considered the language and history of the statute to ultimately conclude that the legislative intent was to strip the secured creditor of its status prior to the time the Debtor completed all the payments under the plan. In doing so, the Court had to balance the decision with the Supreme Court in Dewsnup v. Timm, 502 U.S. 410 (1992). Noting note that Dewsnup specifically prohibited just this type of event in Chapter 7 cases, the Court reasoned that, "there is no voiding of the component of the Bank’s claim after which the Bank shall release the lien as paid. This is a distinction with a real difference. Because the Dewsnup case prohibits the use of § 506(d) to strip liens in Chapter 7 cases, the real issue here is whether the Debtors can compel the Bank to release the lien on the Vehicle’s title once the secured component has been paid in full [in a Chapter 13 case] via §§ 1322(b)(2) and 1325 (a)(5)," Johnson opinion at page 4, footnote 2.
The Johnson Court begins with Sections 1325(a)(5)(B)(i) and (ii) which state:
the plan provides that the holder of such claim retain the lien securing such claim; and the value, as of the effective date of the plan, of property to be distributed under the plan on account of such claim is not less than the allowed amount of such claim.
Johnson at page 6, citing 11 U.S.C. §1325(a)(5)(B)(i) and (ii).
The Court further considered the opinion of the Court in In re England, no. 96-90911-BHL-13, slip op (Bankr.S.D.Ind.Nov. 5, 1996) which held that §1322(b) permits lien stripping. The Court therefore felt that the rights to modify holder of secured claims pursuant to Section 1322(b)(2) "does not limit the power to modify the rights of secured creditors to "payment terms."" Johnson at 7, citing In re Flowers, 175 B.R. 698, 700 (Bankr.N.D.Il 1994).
Taking together Sections 1322(b), 1325(a)(5)(B) and Section 506(a) which allows for the bifurcation of claims, the Johnson Court agreed with the holding Nicewonger that "the holder of an undersecured claim has been accorded due process upon the receipt of the present value of its collateral through plan payments and can be required to release its lien prior to the payment of any dividend provided by the Chapter 13 plan on the unsecured portion of the amount owing to it." Nicewonger, 192 B.R. 886, 889 (Bankr. N.D. Ohio 1996). So long as the plan provides that the holder of the lien retains its lien while the secured portion of its claim is being paid, the Bankruptcy provisions are complied with and the plan should be confirmed. The other concerns of the Creditor, according the Johnson court, when weighed with the rights and concerns of the Debtor, are insufficient to warrant the denial of confirmation of a plan containing lien release language.
Of particular concern to the secured creditor is the effect of dismissal, either voluntary or involuntary vis à vis §349(b) of the Bankruptcy Code. It is this particular section which forms the basis of the secured creditor’s argument. Section 349(b) provides in pertinent part:
(b) Unless the court, for cause, orders otherwise, a dismissal of a case other than under section 742 of this title —reinstates —
B) any transfer avoided under section 522, 544, 545, 547, 548, 549, or 724(a) of this title, or preserved under section 510(c)(2), 522(i)(2) or or 551 of this title; and
C) any lien voided under section 506(d) of this title; vacates any order, judgment, or transfer ordered, under section 522(i)(1), 542, 550, or 553 of this title; and revests the property of the estate in the entity in which such property was vested immediately before the commencement of the case under this title.
11 U.S.C. § 349(b).
The Johnson court weighed the parties’ economic interests in light of the fact that Section 349(b) completely restores the status quo ante to the creditor. In an instance where the Debtor’s case would be dismissed, either voluntarily or involuntarily, the Debtors suffer their own hardship. The court reasoned that the benefit of the super discharge would evaporate and the Debtor would be, once again, obligated to pay 100% of the obligation to her unsecured creditors. Moreover, the Johnson court maintained that affording the Debtor with a fresh start trumped the creditors concern for the potential of abuse. The potential abuse, as the lender would argue, occurs after the Debtor obtains the motor vehicle title then encumbers the vehicle, or transfers it to a bona fide purchaser for value. At that point, the creditor loses its collateral and therefore its secured status. Sometime later, but prior to the time when all payments are made under the plan are completed, the case is dismissed. The creditor must attempt to collect an unsecured debt or attempt to re-lien the vehicle. Though both events are problematic at best, the Court in Johnson felt that, if the Debtor had paid so much as the full value of the vehicle then she deserved the title, as the devastating effects of a pre-discharge dismissal is difficult enough without the likelihood of a car repossession. See In re Johnson at page 10. Again, the Johnson court looked to the Nicewonger case for the proposition:
To graft into §1325 the idea that §349 might allow a holder of a secured claim to keep both a stream of payments received prior to dismissal of a case and the full economic value of collateral that a chapter 13 debtor seeks to "redeem" through his or her plan would be inappropriate statutory expansion. While no provision of the Code dealing with Chapter 13 plan formulation can be ignored in this analysis, a Code provision dealing with potential dismissal cannot to circumvent the rights specifically granted to chapter 13 debtors.
Id., citing Nicewonger, 192 B.R. at 890 (citing Murry-Hudson, 147 B.R. at 962-64).
Finally, the court in Johnson concluded that payment in full of the secured portion of the claim satisfies Sec. 1325(a)(5)(B) and therefore, if the case is subsequently converted or dismissed, or if the Debtor further encumbers this vehicle, it is of no consequence to the creditor as they have been paid the value of their collateral through the Chapter 13. See Johnson at page 12.
The competing line of cases suggest that the provision in a plan that requires the Creditor to prematurely surrender its security interests in a motor vehicle essentially circumvents the effects of Section 349(b) which necessarily results in a windfall to the Debtor. For reference, please see In re Scheierl, 176 B.R. 498 (Bankr. D. Minn. 1995); Matter of Pruitt, 203 B.R. 134 (Bankr. N.D. Ind. 1996); In re Jones, 152 B.R. 155 (Bankr. E.D. Mich. 1993); In re Holiday, 1993 WL 7333165 (Bankr. S.D. Ga. March 30, 1993); and In re Leverett, 145 B.R. 7009 (Bankr. W.D. Okl. 1992).
The conclusion that the Courts in these cases came to was that the Creditor was unduly harmed by the release of their lien and the Debtor received a windfall. This conclusion is drawn from both Section 349(b) and from the concept that the confirmation of a plan is a contract that binds both the Debtor and the Creditor. The "new contract" contains bilateral covenants and considerations. Both the Pruitt and the Scheierl Courts considered that only upon completion of the terms of the plan should the Debtor enjoy the full benefits of the super discharge. Courts which allow a Debtor to receive the full benefit of a lien free automobile without completion of a plan do not consider the return to full pre-petition status quo afforded creditors by §349(b) and the absolute right of a Debtor under §1307(b) to obtain dismissal of her case without a showing of cause.
The Courts in both Scheierl and Pruitt held that §§349(b) and 1307(b) indicate that a Chapter 13 case cannot bring any permanent reordering of property and contract rights, partial or comprehensive, until the Debtor meets a threshold requirement: entitlement to a discharge by completing all payments under the plan, pursuant to 11 U.S.C. §1328(a). Scheierl at 505. The court in Pruitt wrote. ". . . Congress intended for Chapter 13 to be a comprehensive solution to a Debtor’s problems, rather than a piecemeal strategy to obtain a fresh start." Pruitt at 137. Further, the Court in Pruitt concluded:
That to permit an undersecured creditor to retain its lien pending the completion of a Debtor’s plan appropriately protects the creditor’s interests in the event of a subsequent dismissal of the Debtor’s case. The Court determines that releasing the lien prior to completion of the plan and discharge would thwart the underlying purpose of Section 349(b) which is restore the parties’ property rights in the event of a dismissal.
Pruitt at 137.
The argument here is that those Courts which advocate pre-discharge lien release ignore the fact that a permanent reordering off property and lien rights brought forth without Debtors’ completion of his plan gives Debtors either the semblance or the actuality of remedies to which they are not statutorily entitled. This is true, since Sec. 349(b) restores a secured creditor to its rightful status quo ante, — both legally and contractually, by operation of law. In re Scheierl, 176 B.R. at 504.
The Scheierl and Pruitt further discuss the nature of the vesting of the property upon confirmation. Though the property revests in the Debtor, in effect, the property remains property of the estate. The Debtors are limited in what they can do with property of the estate without Court approval. Section 1303 clearly gives the Debtor the identical rights and powers, and subjects the Debtors to the same limitations, as those of a liquidating trustee with respect to the sale, use, or lease of property of the estate under Sec. 363(b), (d), (e), and (f) and (h). The Debtor must comply with the notice and hearing requirement imposed under Sec. 363(b) and any entity having an interest in the property is entitled to adequate protection under Sec. 363(e).
By giving the statutory concepts of "vesting" and "property of the estate" a decisive import insofar as the extent of lien rights are concerned, the Scheierl Court concluded that the Lee and Murry-Hudson Courts elevated those concepts to a plane far beyond the one they actually hold. That is to say, according the Scheierl Court, where the plain language approach is applied, as it was in the Murry-Hudson, Lee and the Johnson Courts, it must be used in context. Moreover, the Scheierl Court urged that code sections which provide remedies of "secured-creditor cramdown and lien-stripping — §§ 1322(b), 1325(a)(5)(B), 5006(a) and 506(d) — serve the purpose of allowing a debtor to retain possession of assets through and after the term of the plan, with the benefit of a reduced financial burden." Scheierl at 506. That court further stated that pre-discharge lien release drastically alters the pre-petition contractual rights of secured creditors and "cut(s) so powerfully against creditors’ rights under state law,’’ that §1325(a)(5)(B) should not be applied by the courts as an isolated remedy during the pendency of the case. Scheierl at 506. The court held that this denies the "global" nature of the process of debt adjustment in Chapter 13. Scheierl at 506.
Until the 7th Circuit speaks to this issue, the debate will continue.
Amy A. Aronson is a Principal of Aronson & Walsh, PC, Glenview. Her practice is concentrated in Creditors Rights and Bankruptcy. She received her Undergraduate Degree in 1987 from Lawrence University and her Law Degree in 1991 from Drake University. She may be reached at email@example.com.
Terri M. Long is a Sole Practitioner in Homewood. Her practice is concentrated in Creditors Rights and Bankruptcy. She received her Undergraduate Degree in 1980 from Bradley University and her Law Degree in 1987 from IIT/Chicago-Kent. She may be reached at firstname.lastname@example.org.