In the Matter of James A. Maddox, Debtors. Tower Loan of Mississippi, Inc. v. James A. Maddox, Jr., and Harold J. Barkley, Jr., Trustee

Citations: 15 F.3d 1347; 30 Collier Bankr. Cas. 2d 1510; 1994 U.S. App. LEXIS 4607; 1994 WL 59081Docket: 93-7266

Court: Court of Appeals for the Fifth Circuit; March 16, 1994; Federal Appellate Court

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The case involves Tower Loan of Mississippi, Inc. appealing a decision from the bankruptcy court regarding whether debtors can avoid nonpossessory, nonpurchase-money liens on exempt property under Section 522(f) of the Bankruptcy Code, following the Supreme Court's ruling in Owen v. Owen. The court affirmed that debtors in Mississippi can avoid such liens, even if they fall within state law exceptions to exemptions. Additionally, it confirmed that a Chapter 13 trustee has the standing to initiate motions to avoid these liens. The facts show that multiple debtors, who had granted Tower Loan security interests on personal property, filed for Chapter 13 protection, leading to a consolidated appeal involving various procedural contexts. In most cases, the trustee initiated lien-avoidance motions, with debtors either joining or being coerced to join the motions. The bankruptcy court's orders allowing for lien avoidance were affirmed by the district court, prompting Tower Loan's appeal to the Fifth Circuit.

The intersection of lien avoidance under Section 522(f) and state exemptions under Section 522(b) reveals that debtors can avoid liens on exempt property if they would have been entitled to an exemption under Section 522(b). Specifically, Section 522(f) allows avoidance of judicial liens and nonpossessory, nonpurchase-money security interests on exempt property that is primarily for personal, family, or household use, including household goods, tools of trade, and health aids. 

Debtors may choose between federal and state exemption lists, unless the state has opted out of the federal statute; Louisiana and Mississippi have opted out, while Texas has not. Despite this, state exemptions are still subject to certain exceptions concerning security interests or liens on exempt property. In *Matter of McManus*, the court ruled that debtors using the Louisiana exemption statute to avoid liens could not do so if those liens fell within state law exceptions. This decision has been applied to Texas and Mississippi exemption statutes as well.

The Supreme Court's ruling in *Owen v. Owen* reaffirmed that a judicial lien on exempt property can be avoided under Section 522(f), interpreting "would have been entitled" to mean what the debtor would have qualified for absent the lien. The court found no justification for differentiating between federal and state exemption treatments. The question remains whether *Owen* overrules the *McManus* precedents, but the distinction made by Tower Loan between judgment liens and nonpossessory liens was deemed irrelevant. Section 522(f) explicitly permits lien avoidance for both types of liens when they impair an exemption the debtor would otherwise qualify for.

The Court in Owen interpreted the phrase 'would have been entitled' in Section 522(f) to allow debtors to avoid liens that are exceptions to state law exemptions. This interpretation applies across all subsections of Section 522(f), including those concerning nonpossessory, nonpurchase-money security interests. The decision emphasizes that while states can determine exempt property, federal law governs lien avoidance under Section 522(f), overriding previous rulings, such as McManus, which limited avoidance based on state exceptions.

In the current case, Tower Loan argues that liens in Mississippi attach before property is eligible for exemption, claiming this means they do not attach to the debtor's interest as required by Section 522(f). Although Tower Loan correctly notes that property is not identified for exemption until selected by the debtor, it incorrectly concludes that a lien's attachment prior to this selection negates its attachment to the debtor's interest. The statute refers to 'an interest of the debtor in property' without stipulating it must be an exemptible interest; thus, the debtor's ownership interest suffices.

Tower Loan also contends that Section 522(f) does not apply in Chapter 13 bankruptcy because liens do not impair exemptions for debtors who retain property under a confirmed plan. However, Section 522(f) is applicable in Chapter 13 cases per the explicit language of the Bankruptcy Code, which includes Chapter 5 provisions. Tower Loan's argument has been dismissed by the relevant circuit court, reinforcing the applicability of Section 522(f) in this context.

Tower Loan's argument regarding the 'no practical impairment' claim is factually inaccurate, as a debtor must meet the 'best interests of the creditor' standard for a confirmable Chapter 13 plan. Under Section 1325, this requires that unsecured creditors receive at least as much as they would in a Chapter 7 liquidation, and secured creditors must receive the present value of their collateral. In certain circumstances, a debtor can file a Chapter 13 bankruptcy by avoiding a lien under Section 522(f), which changes a creditor's status from secured to unsecured, thereby facilitating the bankruptcy process and aligning with Congressional preferences for Chapter 13 repayment plans over Chapter 7 liquidations.

The Chapter 13 Trustee initiated 13 of the 16 motions to avoid liens under Section 522(f), but Tower Loan contests the Trustee's standing to assert these motions unilaterally. This issue remains unresolved for at least one motion where the Trustee acts without the Debtor's involvement, highlighting a lack of consensus in existing jurisprudence on whether a Chapter 13 trustee can seek lien avoidance independently. 

Understanding the debtor-creditor relationship in Chapter 13 reveals that, typically, debtors are indifferent to lien avoidance since a confirmable plan allows them to retain control of their property and receive a discharge of all debts after completing the plan. Lien avoidance primarily impacts the distribution of payments among creditors, converting secured creditors to unsecured status and benefiting original unsecured creditors.

Tower Loan argues that the language of Section 522(f) implies that only the debtor has standing to avoid liens, as it specifies the debtor's ability to do so despite any waiver of exemptions. They contend that allowing the Trustee to act independently would undermine the debtor's choice regarding lien avoidance. However, this interpretation is disputed.

A chapter 13 trustee's standing to assert lien avoidance is the primary issue being addressed, while the question of overriding a debtor's preference is not considered. Tower Loan's argument, although compelling, overlooks the multiple sections of the Bankruptcy Code that confer authority upon a chapter 13 trustee, specifically Section 1302, which outlines the trustee's powers and duties. The language of Section 1302 does not provide a clear resolution to the matter at hand, necessitating a review of the historical context of Chapter 13, which was enacted in response to deficiencies in the earlier Chapter XIII. These deficiencies included the uncertain status of secured creditors and the chapter trustee's role, prompting Congress to establish a more defined and broad role for trustees. Section 522(f) was enacted to mitigate issues arising from consumer credit practices, while Section 1302 designates the chapter 13 trustee as the principal administrator, tasked with a wide range of responsibilities beyond mere disbursement. This trustee operates similarly to a chapter 7 trustee, with the key difference being the nature of the 'asset'—future income in Chapter 13 versus property in Chapter 7. Section 1302 empowers the trustee to ensure equitable collections and disbursements, allowing the trustee to examine claims and object to improper ones, as well as to participate in hearings to confirm Chapter 13 plans.

A chapter 13 trustee has standing to avoid liens under Section 522(f) of the Bankruptcy Code, as supported by the historical development of Chapter 13 and the intended role of the trustee. Subsection (b)(2) grants the trustee the authority to participate in the confirmation of plans, which would be undermined if they lacked standing to challenge improper secured claims. The trustee's ability to avoid liens is akin to objecting to a secured claim that should be reclassified as unsecured, aligning with the powers outlined in Section 1302(b)(1). This position is further backed by the antidiscrimination principle in Section 1322(a)(3), which mandates equal treatment for claims within the same class, indicating that misclassified secured claims are improper and subject to objection by the trustee.

The ruling establishes that the chapter 13 trustee is the primary party interested in lien avoidance to ensure equitable distribution among creditors. It confirms that Congress intended for trustees to hold such authority and that states can define exempt property, while the avoidance of specific liens is governed by federal law, specifically Section 522(f). Consequently, the bankruptcy court's orders are affirmed, validating the trustee's objection to the debtor's plan due to the failure to avoid a lien under Section 522(f).

The bankruptcy court upheld an objection that required the Debtor to join the Trustee's motion or risk dismissal of his Chapter 13 case, leading the Debtor to comply. The court referenced the rationale from *In re Kennedy*, which is under appeal. The court refrained from expressing an opinion on whether a Chapter 13 trustee can compel a debtor's decisions regarding lien avoidance under 11 U.S.C. § 522(f). It noted that various state laws affect exemptions and that Louisiana, Texas, and Mississippi have specific rules regarding encumbrances on property. The document cites several legal precedents, including *Owen* and *Farrey*, which clarify that a debtor must have an interest in the property to avoid a lien under § 522(f). It also indicates that while the 11th Circuit has ruled on this issue, other circuits have assumed the applicability of § 522(f) in Chapter 13 cases without direct ruling. The interplay between § 522 and § 1325 may significantly alter the amount owed to secured creditors based on the classification of claims in bankruptcy proceedings.

Under FED.R.BANKR.P. 3001-08 and 11 U.S.C. Sec. 1325(a)(5), a creditor entitled to collateral's present value risks losing that status if their lien is avoided, resulting in unsecured creditor status. This change limits recovery to what would be available in a Chapter 7 liquidation, which can lead to receiving nothing if the property is exempt under Sec. 522(b). Despite this, the unsecured creditor may still receive a pro-rata share of payments from the debtor. This shift in status can significantly affect the confirmability of a Chapter 13 plan. The House report for the Bankruptcy Reform Act of 1978 emphasizes that bankruptcy should be a last resort, promoting repayment under Chapter 13 to lessen creditor losses. The Trustee does not claim that joinder issues moot the standing for remaining motions, and while one case supports standing for a trustee to avoid liens, others suggest limitations on that authority. Tower Loan's argument hinges on the compelled joinder of the Debtor in a motion, but since the Debtor has not appealed, Tower Loan cannot assert the Debtor's rights, as courts typically do not allow third-party claims to standing.

Debtors generally have the right to avoid compelled joinder in bankruptcy proceedings, especially given the adversarial nature of creditor-debtor relationships, as established in precedent such as Friedman v. Harold. Third-party standing is typically not recognized unless the third party cannot assert their own rights or has a close relationship with the rights advocate. The interpretation of the Bankruptcy Code should be consistent across its provisions, as illustrated by cases like In re Howard. The 1978 Bankruptcy Reform Act highlighted concerns about creditors acquiring excessive security interests in debtors' property, which hindered debtors from achieving a fresh start post-bankruptcy. Relevant statutory sections, such as 11 U.S.C. Sec. 704 and Sec. 1302, further outline the powers and responsibilities within bankruptcy proceedings.