The United States Supreme Court’s decisions in Dewsnup v. Timm1 and Nobelman v. American Savs. Bank2 have had many effects on the treatment of secured claims in bankruptcy cases. Neither decision imposes limits on the power of Chapter 13 debtors to modify claims secured by personal property, and Nobleman does not cover all situations involving real estate secured liens in Chapter 13 cases. The purpose of this article is to briefly summarize the evolving case law since Dewsnup and Nobleman concerning lien stripping and modification of secured claims in Chapter 13. A brief recap of those two seminal Supreme Court opinions is helpful.
Dewsnup held that a Chapter 7 debtor cannot use 11 U.S.C. § 506(d) to avoid a lien to the extent that the creditor’s claim exceeds the value of its collateral. Although lien stripping is clearly prohibited under Dewsnup, that holding was confined to Chapter 7 cases, and then only where a Chapter 7 debtor seeks to use § 506(d) to avoid a lien on real property. Nobelman, in turn, held that the exception in 11 U.S.C. § 1322(b)(2) to the power to modify claims secured by real property that is the debtor’s principal residence, prohibits Chapter 13 debtors from splitting an under secured mortgage claim into secured and unsecured components. But, it establishes no limitation on the power of Chapter 13 debtors to modify claims secured by personal property and does not answer the question of what happens to junior mortgage liens that are virtually unsecured. The 1994 amendments to 11 U.S.C. § 1322(c)(2) alter Nobelman with respect to home mortgages in which the last payment "on the original payments schedule" is due before the final payment under the plan.
The unanswered questions arising in the wake of Dewsnup and Nobleman have created splits among the various courts and tend to focus on two issues: (1) the ability of a Chapter 13 debtor to strip a junior residential mortgage lien or security interest when the value of the home is less than the amount of the first mortgagee’s claim; and (2) to what extent can a Chapter 13 debtor modify the rights of a secured vehicle lender under a Chapter 13 plan by providing for a release of that lien prior to the consummation of the plan. These two issues are raised from time to time in test cases because Dewsnup nor Nobelman provides a definitive answer to these questions. The Seventh Circuit has not yet answered either of these questions and, not surprisingly, the lower courts that have decided the issues have reached conflicting results.
Debtors have not always faired so well in attempting lien strips on junior home mortgage liens. For example, in Barnes v. American Gen. Fin. (In re Barnes),3Judge Schmetterer held that the prohibitions on the modification of rights of creditors of secured claims, secured by an interest in real property that is the debtor’s principal residence, cannot be modified under § 1322(b)(2). Thus, that section prevents a debtor from using 11 U.S.C. § 506(a) to strip off a lien of a junior mortgagee that is wholly unsecured as a result of the value of the underlying property and the amount of the senior mortgage lien encumbering it. In applying the Nobelman holding, he noted that it rejected the debtor’s interpretation of § 1322(b)(2) as allowing modification of a creditor’s claim based on the claim’s valuation.4
The Barnes case followed the line of cases denying a debtor’s attempt to strip off a junior mortgagee’s security interest under a home mortgage for lack of equity in the debtor’s principal residence. Following In re Neverla5 and In re Jones,6 Barnes held that a creditor’s rights under § 1322(b)(2) may not be modified regardless of the presence or absence of underlying equity in the residence, and there is no recourse to look to § 506(a) on valuation. Thus, Barnes followed the Nobelman holding that § 1322(b)(2) prohibits a § 506(a) modification where the lender’s claim is secured only by a lien on the debtor’s principal residence.7 The Barnes court observed that the debtor’s views would make treatment of secured lenders on home mortgage loans, at the time of confirmation, wholly contingent on fluctuations of the collateral market value.8 Further, the court stated that if Congress intended prohibition against modification in § 1322(b)(2) to be limited only to certain mortgages, it could have drafted the section to reflect such limitation.9 The approach taken in Barnes has been utilized by a number of other courts.10
The debtors in Barnes cited a number of cases attempting to distinguish Nobelman on the basis of their effort being a "strip down" rather than a "strip off." Judge Schmetterer rejected the line of case law holding that a complete "strip off" of a mortgage is permissible under § 506(a), despite § 1322(b)(2), when the creditor’s security interest in the debtor’s principal residence is virtually wholly unsecured.11 Those cases, instead of first looking to § 1322(b)(2), focused on § 506(a) for valuation of the creditor’s claim. In re Purdue,12 for example, found Nobelman only applicable to partially secured security interests in the debtor’s principal residence.13 Purdue thus concluded that where a creditor’s claim lacks any secured component under § 506(a), it is actually completely unsecured and therefore can be modified under § 1322(b)(2).
The other line of cases holds that debtors can "strip off" junior home mortgage liens that are wholly unsecured due to the senior lien holder’s claim equaling or exceeding the value of the residence. Johnson v. Asset Management Group, LLC14 is typical of this approach. The court in Johnson distinguished between a "strip off" occurring when an entire lien is removed from a "strip down" occurring where a lien is bifurcated into unsecured and secured claims with only the unsecured component being removed as a lien from the home. Acknowledging that the contrary line of cases tends to focus on what it found to be the plain language of § 1322(b)(2), the Johnson court noted that the role of a § 506(a) valuation could not be too easily dismissed because § 506(a) valuations occur in bankruptcy proceedings under all chapters.15 Notwithstanding § 1322(b)(2), junior lien holders have "no right" to be treated more favorably in bankruptcy than in foreclosure.16 The court also concluded that, outside of bankruptcy, had the debtor defaulted on the senior lien and was at risk of foreclosure, a completely unsecured junior lien holder would receive nothing in a foreclosure proceeding because of all the proceeds would go to the senior lien holder.17 Thus, Johnson concluded that Nobelman did not prohibit the stripping of such a lien, determining that §§ 1322(b)(2) and 506(a) provide that a lien may be stripped, and the rights of the unsecured creditor can be accordingly modified.18
Another recent opinion following the line of cases allowing the "strip down" or "strip off" of junior mortgages, despite the language in § 1322(b)(2), is Flowers v. FirstPlus Fin., Inc. (In re Flowers).19 Flowers observed that under the facts in Nobelman, the objecting secured creditor’s claim would have been at least partially secured even in the absence of the anti-modification language of § 1322(b)(2).20 Thus, the question left unanswered by Nobelman was whether a different result would be reached if there was no equity to which the junior mortgage could attach.21 According to the Flowers decision, the majority position taken by courts after Nobelman is that a Chapter 13 plan may treat such creditors as unsecured.22
Because it was undisputed in the Flowers case that the first deed of trust or mortgage substantially exceeded the fair market value of the property, there was no equity to which the creditor’s second deed of trust or mortgage could attach, and thus the lien was void under § 506(d). Interestingly enough, Flowers noted that the concern about a Chapter 13 debtor later converting to Chapter 7 would not necessarily violate the prohibition of § 506(d) "strip down" under Dewsnup. The Flowers case followed In re Yi23 which concluded that Dewsnup prohibits only a "strip down" of a partially secured claim and not a "strip off" of a wholly unsecured claim.24 The result in Flowers, adverse to the junior lien holder, was temporarily ameliorated because the avoidance was conditioned on the debtor’s receipt of a discharge, since dismissal, whether voluntary or involuntary, prior to discharge would have the legal effect of restoring the lien under 11 U.S.C. § 349(b). The court concluded that entry of an order immediately avoiding the junior mortgagee’s lien could at least in theory prejudice its position if an intervening lien were to attach to the property and the case was then dismissed. Accordingly, the Flowers court found that the avoidance of that lien would not occur until the debtor received a discharge under 11 U.S.C. § 1328 or the case was converted to Chapter 7 under 11 U.S.C. § 727.
In re Phillips25 interpreted Nobelman as instructing that a mortgagee must first qualify under § 506(a) as a holder of a secured claim in order to obtain the protection of § 1322(b)(2) and followed In re Hornes.26 Under Hornes and Phillips, a creditor must hold a secured claim in both the "literal" sense, that is secured by lien on collateral, as well as in the "Code" sense in order to come within the anti-modification provision of § 1322(b)(2). The creditor in Phillips, while meeting the "literal" criteria of a secured claim because it held a claim secured by lien on collateral, failed in the "Code" sense because there was no equity in the property to secure its junior lien claim. The Phillips court cited additional cases for the point that a wholly unsecured creditor is not protected by the anti-modification provision in § 1322(b)(2).27 The court further cited Lam v. Investors Thrift (In re Lam)28 for the policy point that protecting holders of completely unsecured claims might encourage junior mortgagees to intentionally obtain a mortgage on property that is already overburdened with a senior mortgage for the sole purpose of avoiding modification of those pre-petition contractual rights. The Lam court also concluded that the congressional intent of encouraging home lending by residential mortgagees does not apply to second mortgagees because they are not in the business of lending money for home purchases. Therefore, the same reasons for protection of first mortgagees under § 1322(b)(2) do not exist for second mortgagees.29
The split of authority and different rationales advanced carries over into the second issue regarding modification of the rights of a secured vehicle lender when drafting a plan. Typically, the modification occurs in the context of a plan provision requiring the lender to release the lien on the vehicle at the time the secured component of the claim is paid under the plan in full, plus the appropriate interest or discount factor.
Many courts follow the approach taken by Judge Barliant in In re Flowers30 where he held that a debtor can strip down an under secured automobile lender’s claim. He noted that § 1322(b)(2) allows a plan to "modify" the rights of holders of secured claims and does not by its own words limit the power to modify the rights of secured creditor only to "payment terms."32 A secured creditor has the right to enforce its lien to the full extent of the contract debt. Nothing in the Bankruptcy Code or any Supreme Court decision excludes that right from those subject to modification in a Chapter 13 plan as to personal property. The allowed secured claim in 11 U.S.C. § 1325(a) has the § 506(a) meaning, namely that portion of the total claim equal to the value of the collateral. Under § 1325(a)(5)(B), the only lien retained is the lien securing the secured claim; that is the claim to the extent of the value of the collateral. In Flowers, Judge Barliant disagreed with Judge Schmetterer’s view as enunciated in In re Hernandez.33 The District Court reversed Hernandez, expressing agreement with Judge Barliant’s approach.
The author has followed the line of cases which have held that such a plan provision is permissible.34 In Johnson, the debtor’s plan was objected to by the secured lender with the lien on the vehicle. The secured lender contended that the plan provision violated § 1325(a)(5)(i)and (ii), and the effect of § 349(b) would be improperly circumvented if the case was dismissed after confirmation of the plan or any time subsequent to the release of its lien. The court in Johnson found that the majority of courts agree that the concept of lien stripping is permissible in Chapter 13 cases because the narrow holding in Dewsnup is inapplicable in Chapter 13. Moreover, this situation does not involve a prohibited lien strip of residential realty proscribed by Nobelman. Prior to Dewsnup, the Seventh Circuit had not rejected the concept of lien stripping per se in the Chapter 7 context.35 The Johnson court was persuaded by the line of cases allowing the vehicle to be free of the lien once the payment of the secured component of the creditor’s claim occurred.36 In addition to the modification provisions of § 1322(b)(2), the Johnson court focused on § 1325(a)(5)(B)(i) which provides that confirmation of a Chapter 13 plan over the objection of a holder of a secured claim can occur if a plan provides that the holder of such claim retains the lien securing "such claim," and that 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."
In the final analysis, a motor vehicle title should not be properly held "hostage" to secure the creditor’s remaining unsecured claim after bifurcation under § 506(a) has occurred, and the secured component of the claim has been paid in full. Thus, the Johnson court concluded that to require a lien release only when the remainder of the plan payments to the unsecured claims have been paid and the debtor receives a discharge makes the bifurcation process of § 506(a) of no consequence and virtually relegates the effect of the modification provisions of § 1333(b)(2) to occur at the end of a successful case.
The Johnson court observed that the language of § 349(b) neither mentions nor attempts to undo what modifications to a creditor’s claim may have previously occurred in a bankruptcy case under §§ 506(a), 1322(b)(2) or 1325(a)(5)(B). Section 349(b) could have easily contained references to those sections had Congress intended to undo a debtor’s ability to modify an under secured creditor’s rights in a motor vehicle. Moreover, if a case was converted rather than dismissed, unlike § 349(b)(1)(C), 11 U.S.C. § 348 does not revive liens that have been avoided pursuant to § 506(d). Indeed, if the case and plan fail after a debtor paid the creditor’s secured motor vehicle claim component in full with the lien unreleased, the debtor would then face the less than equitable prospect of having to reaffirm with the lender in order to keep the vehicle, surrender it, or redeem it for cash pursuant to 11 U.S.C. § 722.37 That result is not particularly fair if, at that point, the debtor has paid the full amount of the replacement value of the vehicle, under Associates Commercial Corp. v. Rash.38 Such a result would subvert the effect of § 348(f)(1)(B).39 Accordingly, Johnson rejected the argument that the lien release in rem must wait until the debtor has received an in personam discharge at the conclusion of a successfully consummated and completed Chapter13 plan.
The result in Johnson was recently followed in In re Shorter.40 Judge Lefkow noted that nothing in § 1325 mandates how long a secured creditor must retain its lien to fulfill the purpose of having holders of allowed secured claims protected from loss of their secured interest if a debtor fails to complete its plan.41 Additionally, she stated that to require a lien to be retained after payment in full of the secured component of the debt effectively secures the remaining unsecured portion of the claim, which is an expansion of secured creditor’s rights not found in the Code. The Shorter court further opined that § 1322 allows modification and that the creditor’s rights are not terminated once it is required to release its lien on the title upon payment of the secured component of the claim, because it is not precluded from obtaining further recovery along with the other unsecured creditors on the unsecured component of its claim. Shorter is consistent with Johnson and the line of cases finding that the interest in affording debtors a fresh start outweighs the potential abuse of the system, and that debtors who are proposing to pay less than one hundred percent of their unsecured claims have a significant incentive to complete the plan even after obtaining a title release of lien in order to obtain a Chapter 13 discharge.42
The Shorter court agreed there is no provision in § 349 that would undo any modification of creditors’ rights under § 1322(b). A contrary result would provide a potential windfall to the detriment of unsecured creditors, in the event of dismissal, if the lien holder would retain the full economic value of the collateral to secure the remaining unsecured portion of its claim.
Several cases take the contrary view and do not allow release of the lien prior to completion of all payments under the Chapter 13 plan.43 Those opinions tend to focus on the underlying purpose of § 349 to effectively restore property rights in the event of a dismissal. Because Congress did not specifically provide in § 1325(a)(5)(B) for early lien release prior to the consummation of the plan and entry of a discharge, the court in Pruitt concluded that the retention of the creditor’s lien, pending completion of a Chapter 13 plan, was appropriate, unless the creditor agrees to other treatment.44 The Schierl court opined that viewed as a whole, Congress’ intent was that the fruition of a Chapter 13 cramdown on a secured creditor is all of a piece with the discharge, which is the debtor’s central remedy.45 Because lien stripping that effectuates the § 1325(a)(5)(B) cramdown cut so powerfully against creditors’ rights under state law, it should not be applied by the courts as an isolated remedy during the pendency of the case. The court in Schierl was also concerned about the possibility of an early lien release followed by a attempted regaining of lien rights that might find the lien vulnerable to avoidance in a subsequent conversion by the Chapter 7 trustee’s exercise of strong-arm powers under 11 U.S.C. § 544(a).46 The court observed that though the case was dismissed, the creditor’s full lien was restored by operation of § 349(b)(1)(C), but it would remain an unperfected lien.47 Thus, the only way a secured party can be adequately protected against such possible harms would be retention of the lien until the debtor completes payments and receives a discharge.
The lack of definitive binding precedents from the Seventh Circuit makes these issues of lien stripping of wholly unsecured junior mortgages, and modification of secured creditors’ liens on motor vehicles unresolved at the present time. Dewsnup and Nobleman leave these questions unanswered. Moreover, the courts that have discussed these issues have reached conflicting results, and hence have left the waters murky in this area. Only time will tell how clear it may become.
1 502 U.S. 410 (1992).
2 508 U.S. 324 (1993).
3 207 B.R. 588 (Bankr. N.D. Ill. 1997).
4 Id. at 593.
5 194 B.R. 547 (Bankr. W.D. NY 1996).
6 201 B.R. 371 (Bankr. D. N.J. 1996).
7 508 U.S. at 332.
8 207 B.R. at 593.
10 See American Gen. Fin., Inc. v. Dickerson, 229 B.R. 539 (M.D. Ga. 1999); In re Perkins, 237 B.R 658 (Bankr. S.D. Ohio 1999); In re Diggs, 228 B.R. 611 (Bankr. W.D. La. 1999); Lewandowski v. U.S. Dept. of HUD (In re Lewandowski), 219 B.R. 99 (Bankr. W.D. Pa. 1998); In re Barnes, 199 B.R. 256 (Bankr. W.D. N.Y. 1996).
11 See, e.g., Associates Fin. Servs. Corp. v. Purdue (In re Purdue), 187 B.R. 188 (S.D. Ohio 1995); Wright v. Commercial Credit Corp., 178 B.R. 703 (E.D. Va. 1995), appeal dismissed, 77 F.3d 472 (4th Cir. 1996).
12 187 B.R. 188.
13 Id. at 190.
14 226 B.R. 364 (Bankr. D. Md. 1998).
15 Id. at 369.
19 No. 98-11492-SSM, 98-1249, 1999 WL 118022 (Bankr. E.D. Va. Jan. 14, 1999).
20 Id. at *4.
21 Id. at *3.
22 Citing Wright v. Commercial Credit Corp. (In re Wright), 178 B.R. 703 (E.D. Va. 1995), appeal dismissed, 77 F.3d 472 (4th Cir 1996); Johnson v. Asset Management Group, LLC, 226 B.R. 364 (Bankr. D. Md. 1998); Lam v. Investors Thrift (In re Lam), 211 B.R. 36 (B.A.P. 9th Cir. 1997); In re Geyer, 203 B.R. 726 (Bankr. S.D. Cal. 1996); In re Lee, 177 B.R. 715 (Bankr N.D. Ala. 1995); In re Kidd, 161 B.R. 769 (Bankr. E.D. N.C. 1993).
23 219 B.R. 394 (E.D. Va. 1998).
24 Id. at 400.
25 224 B.R. 871 (Bankr. W.D. Mich. 1998).
26 160 B.R. 709 (Bankr. D. Conn. 1993).
27 See In re Cerminaro, 220 B.R. 518 (Bankr. N.D. N.Y. 1998); In re Cervelli, 213 B.R. 900 (Bankr D. N. J. 1997); Scheuer v. Marine Midland Bank (In re Scheuer), 213 B.R. 415 (Bankr. N.D. N.Y. 1997); In re Sanders, 202 B.R. 986 (Bankr. D. Neb. 1996); In re Geyer, 203 B.R. 726 (Bankr. S.D. Cal. 1996); Wright v. Commercial Credit Corp., 178 B.R. 703 (E.D. Va. 1995); Norwest Fin. Georgia, Inc. v. Thomas (In re Thomas), 177 B. R. 750 (Bankr. S.D. Ga. 1995); In re Lee, 177 B.R. 715, 716 (Bankr. N.D. Ala. 1995); Castellanos v. PNC Bank Nat. Ass’n (In re Castellanos), 178 B. R. 393 (Bankr. M.D. Pa. 1994); In re Woodhouse, 172 B.R. 1 (Bankr. D. R. I. 1994); In re Mitchell, 177 B.R. 900 (Bankr. E.D. Mo. 1994); Sette v. Bello (In re Sette), 164 B.R. 453 (Bankr. E.D. N.Y. 1994); In re Lee, 161 B.R. 271 (Bankr. W.D. Okla. 1993); In re Kidd, 161 B.R. 769 (Bankr. E.D. N.C. 1993); In re Plouffe, 157 B.R. 198 (Bankr. D. Conn. 1993); In re Moncrief, 163 B.R. 492 (Bankr. E.D. Ky. 1993).
28 211 B.R. 36 (B.A.P. 9th Cir. 1997).
29 Id. at 41.
30 175 B.R. 698 (Bankr. N.D. Ill. 1994), aff’d,183 B.R. 509 (N.D. Ill. 1995).
Honorable John H. Squires is the Presiding U.S. Bankruptcy Judge for the Northern District of Illinois in DuPage.