A secured creditor holding a mortgage on the residence of two chapter 13 debtors filed a proof of claim almost seven months after the claims bar date. The debtors objected on the basis that the claim was untimely, and the parties agreed to entry of an order disallowing the claim. The debtors then sought to avoid the mortgagee’s lien. The lower courts dismissed the debtors’ claims, and they appealed to the 8th Circuit.
This is another case that deals with the effect of Section 506(d) of the Bankruptcy Code:
(d) To the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void, unless –
(1) such claim is disallowed only under section 502(b)(5) [unmatured debt not subject to discharge] or 502(e) [reimbursement or contribution claims] of this title; or
(2) such claim is not an allowed secured claim due only to the failure of any entity to file a proof of such claim under section 501 of this title.
The debtors argued that (1) the mortgagee’s lien secured a claim that was “not an allowed secured claim” and (2) the exceptions did not apply because (a) the sections referenced in 506(d)(1) were not applicable and (b) the mortgagee filed a proof of claim. The mortgagee’s response was based on the argument that a lien generally survives bankruptcy even if a claim is not filed, and lien avoidance was not justified where the sole basis of disallowance was the untimeliness of the claim.
In finding for the mortgagee, the bankruptcy court relied in part on Dewsnup v. Timm, 502 U.S. 410, 112 Sup. Ct. 773, 116 L.Ed.2d 903 (1992), which noted that “a bankruptcy discharge extinguishes only one mode of enforcing a claim – namely, an action against the debtor in personam – while leaving intact another – namely, an action against the debtor in rem.” It also looked to decisions of the 4th and 7th Circuits to the effect that “the plain language of §506(d) did not void liens where an associated claim was rejected solely due to its untimeliness.”
On appeal, the 8th Circuit joined the 4th and 7th Circuits in rejecting a plain language interpretation of Section 506(d) in favor of the “longstanding principle that valid liens pass through bankruptcy unaffected.”
The 7th Circuit decision, which was prior to the Supreme Court’s decision in Dewsnup, concluded that lien avoidance was too significant a departure from pre-Bankruptcy Code law to have been intended by Congress. It emphasized that it would be absurd to heavily penalize a secured creditor who filed an untimely claim as opposed to a secured creditor who simply did not participate in the bankruptcy (and thus retained its lien under the exception in Section 506(d)(2)).
The 4th Circuit decision relied on the exception in Section 506(d)(2) as clarification that “Congress did not intend for a perfectly valid lien to be extinguished any time a creditor’s claim on the bankruptcy estate is disallowed.” Although the section did not explicitly refer to disallowed claims, a contrary result would be inequitable.
The 8th Circuit also considered Dewsnup to be relevant because it found ambiguity in Section 506 and because it included consideration of pre-Code practices and the interaction of different Code provisions. The court summarized by concluding: “We therefore align ourselves with the Fourth and Seventh Circuits and reject the Debtor’s superficially appealing, but ultimately inequitable and isolated, reading of §506(d).”
Courts truly struggle with the tension between the plain meaning of Section 506(d) and the pre-Bankruptcy Code concept articulated in Dewsnup that a lien passes through bankruptcy. (See also Underwater Liens: Can A Federal Tax Lien Be Stripped Off In A Chapter 13?.) In this case, the scales tipped to the Dewsnup side and the mortgagee won.
Vicki R. Harding, Esq.