In S. White Transportation, by remaining silent until after confirmation, a mortgagee managed to retain its lien notwithstanding the debtor’s attempt to discharge it through a plan of reorganization.
Acceptance Loan Company, Inc. claimed that it had a lien on an office building owned by S. White Transportation, Inc. (SWT) to secure its loan to SWT. The parties ended up in state court litigating the validity of the lien. When SWT filed bankruptcy, it identified Acceptance’s claim as a secured claim in its schedules but designated the claim as disputed. When SWT filed a plan of reorganization, it discussed the Acceptance claim in the disputed claims section, noting that no proof of claim was filed and that the time to file had expired. (The significance being that the claim should be disallowed since there was no timely proof of claim, and the fact that the claim was scheduled did not make any difference since it was identified as disputed.)
After the plan was confirmed, Acceptance asked the bankruptcy court to determine that it retained a first priority lien and that its lien was not affected by the plan confirmation. Alternatively it asked the bankruptcy court to amend its order to provide for resolution of the lien claim and to modify the automatic stay to allow the state court to determine the issue.
Section 1141(c) of the Bankruptcy Code provides:
Except as provided in subsections (d)(2) and (d)(3) of this section [dealing with exceptions from discharge] and except as otherwise provided in the plan, after confirmation of a plan, the property dealt with by the plan is free and clear of all claims and interests of creditors, equity security holders, and the general partners in the debtor.
Consequently the bankruptcy court denied Acceptance’s motion, finding that its lien was void as a result of confirmation of the Chapter 11 plan of reorganization.
On appeal, the district court began with the assertion that “the general rule has been that liens pass through bankruptcy unaffected.” (However, recognize that this concept is not free from controversy. As noted in a prior blog, “Lien Stripping” Lives, many courts view this principle as limited to Chapter 7 liquidation cases and not applicable in Chapter 11 reorganization cases.) After noting Section 1141(c), the district court stated that the 5th Circuit has held that four conditions must be met in order for a plan to void a lien:
(1) the plan must be confirmed;
(2) the property that is subject to the lien must be dealt with by the plan;
(3) the lien holder must participate in the reorganization; and
(4) the plan must not preserve the lien.
The only item in dispute was whether Acceptance “participated.” In determining whether there has been participation, some courts have required that the creditor file a proof of claim, while at least one other court found that it was sufficient if the creditor had notice and an opportunity to object to the plan.
After analyzing various cases, the district court concluded that “a weight of persuasive authority supports the conclusion that more than the mere receipt of notice is necessary to satisfy [the 5th Circuit’s] participation requirement.” It found support for this conclusion in the definition of “participation” in Black’s Law Dictionary, as well as the broader principle that liens generally pass through bankruptcy unaffected.
The district court further determined that it would be inequitable to void the lien since Acceptance would receive nothing while junior lien holders would be paid in full. The court noted that SWT could have filed a proof of claim on behalf of Acceptance and then challenged the claim in an adversary proceeding. However, it did not do so.
Reiterating that notice alone is insufficient, the court concluded that Acceptance’s lien survived confirmation of the chapter 11 plan.
This is by no means a universally held view. However, it raises the specter that the only way to be sure that a lien is actually discharged is to challenge it in a separate adversary proceeding, as opposed to relying on treatment under the plan of reorganization.
Recognize that this goes far beyond saying that any actual dispute with a lien holder must be resolved in an adversary proceeding as opposed to a plan hearing. Rather, in this case the lender did not file a proof of claim, did not raise any objections to the treatment of its lien under the plan, and generally was not heard from until after the plan had been confirmed. There was no indication that the mortgage might not be discharged under Section 1141(c) until after the plan was confirmed, when the mortgagee was allowed to retain its mortgage lien notwithstanding the fact that it had received a copy of the plan and notice of the confirmation hearing (among other notices), but failed to object to confirmation of the plan.
Vicki R. Harding, Esq.