Lien Rights: Does Discharge of a Debtor Preclude Enforcement of a Lien Against the Debtor’s Property?

Washington v. Green Tree Servicing, LLC (In re Washington), 529 B.R. 654 (Bankr. D. S.C. 2015) –

After filing a second chapter 13 bankruptcy, a debtor brought a proceeding to determine the creditor’s lien rights, if any, in her mobile home and to assert violations of the automatic stay, discharge injunction and provisions of the state unfair trade practices act. The debtor and creditor each moved for summary judgment.

In the initial bankruptcy the debtor scheduled a claim arising from a retail installment contract and security agreement that was secured by her mobile home, and the creditor filed a proof of claim asserting a partially secured and partially unsecured claim.

The debtor’s chapter 13 plan in the original proceeding valued the secured claim at $19,500 and provided for monthly payments at 7.25% interest. The plan also provided that (1) secured claims would retain their liens until the earlier of payment in full under non-bankruptcy law or discharge under the Bankruptcy Code; and (2) required the trustee to stop making payments to a secured creditor if it obtained relief from the automatic stay.

Under the plan, the debtor was still subject to the original financing documents. The creditor declared a default because the debtor failed to maintain insurance. There was an initial settlement, but the debtor once again failed to make required payments for insurance premiums. So based on the settlement agreement, the court in the initial bankruptcy proceeding entered an order lifting the automatic stay to permit the creditor to enforce the security agreement and other state law rights.

As provided in the plan, the trustee then stopped making payments. The debtor subsequently received a discharge in the original case. The trustee’s report on the amounts paid to the creditor showed that it did not receive the full amount of its allowed secured claim of $19,500.

A couple of years later the creditor filed a claim and delivery action in state court to repossess the mobile home. At that point the debtor filed a second chapter 13 bankruptcy. Initially the debtor filed schedules identifying the creditor as a secured creditor, but stating that the debt owed was discharged and extinguished in the first case. Subsequently the schedules were amended to remove the creditor from the list of secured creditors.

The creditor then filed a proof of claim listing “money loaned” and describing the collateral as the debtor’s mobile home. The creditor contended that its lien on the mobile home survived discharge of the debtor in the first case. It also amended the amount of its claim to assert a reduced amount that was apparently based on the $19,500 secured claim, reduced by subsequent payments, together with interest.

The initial question was whether debtor’s performance and resulting discharge in her first case extinguished the creditor’s lien so that it could not pursue a court action to recover the amount still owed from its allowed claim in the first case.

Quoting from Section 524 of the Bankruptcy Code, the court noted that the discharge operates as an injunction against any activity relating to the “debt as a personal liability of the debtor.” The parties agreed that the creditor could not sue the debtor for the claimed amount, but disagreed on whether it retained an in rem remedy. In response, the court quoted a number of cases to the effect that “the law is well settled that a lien passes through bankruptcy despite discharge unless voided by a plan or court order.”

In the first case, the plan gave the creditor an allowed secured claim and provided for monthly payments until the claim was satisfied. However, the trustee stopped making monthly payments after entry of the order granting relief from the stay so that the total amount was never paid. Under these circumstances, the discharge did not extinguish the lien. The Section 1328(a) discharge did not extinguish in rem rights, and in effect, the plan provided that if there was a default, the secured creditor could obtain an order granting relief from the automatic stay in order to enforce its lien as an alternative to the plan payments.

The debtor also argued that upon confirmation of a plan property vests in the debtor “free and clear of any claim or interest of any creditor provided for by the plan” under Section 1327(c) of the Bankruptcy Code. However, this is the case “[e]xcept as otherwise provided in the plan or the order confirming the plan.” Since the plan provided that secured creditors were to retain their liens until certain conditions were met, and these conditions were not met for this creditor, the court concluded that the plan provided otherwise.

On the other side, the secured creditor argued that once a default occurred, the plan was no longer applicable. The court disagreed. It concluded that the secured creditor was still limited to its in rem rights in connection with its secured claim, as opposed to being permitted to attempt to collect its full claim after the default.

The court further held that the creditor’s in rem rights constituted a claim that permitted it to file a proof of claim limited to the unpaid amounts of its total secured claim from the first case. Although the debtor argued that the failure to complete payments under the plan by the trustee was not her fault, the court pointed out that she knew plan payments would stop once the stay relief order issued. If she wanted the payments to continue she should have taken action in the bankruptcy court.

Since there was no indication that the secured creditor attempted to take any action to collect from the debtor, as opposed to realizing on its collateral, the court denied the debtor’s claims for violation of the automatic stay, the discharge injunction and the state unfair trade practices act.

It can be easy to overestimate the ability of a debtor to rid itself of a lien in a bankruptcy. There is a persistent theme in the case law that as a general matter liens pass through bankruptcy. Obviously this is not always the case, but it happens more often than many people might expect.

Vicki R. Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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