Monroe v. Seaway Bank & Trust Co. (In re Monroe)

Citations: 509 B.R. 613; 2014 WL 1654562; 2014 Bankr. LEXIS 1898Docket: Bankruptcy No. 13-24570-GMH; Adversary No. 13-02747

Court: United States Bankruptcy Court, E.D. Wisconsin; April 25, 2014; Us Bankruptcy; United States Bankruptcy Court

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The United States Department of Housing and Urban Development (HUD) and Seaway Bank hold junior mortgage claims against Mark and Sharon Monroe's residence. The Monroes assert that they owe more to Wells Fargo Bank, which has a senior mortgage, than their home's value, and seek a court declaration that HUD's and Seaway's claims are unsecured under 11 U.S.C. § 506(a). They also argue that the junior mortgages are either void under 11 U.S.C. § 506(d) or can be eliminated through their Chapter 13 debt adjustment plan under 11 U.S.C. § 1322(b)(2). HUD responded, acknowledging its junior status and the Monroes' indebtedness exceeding their property’s worth, thus rendering Seaway's claim irrelevant for the dispute with HUD.

HUD contends that the Monroes cannot eliminate its junior mortgage because (i) § 506(d) does not allow lien invalidation merely due to an underwater status, and (ii) the Monroes are ineligible for discharge under 11 U.S.C. § 1328(f) due to a Chapter 7 discharge received three years prior. The court notes that controlling authority does not support the Monroes’ argument regarding § 506(d). However, conflicting district court decisions exist regarding the ability of Chapter 13 debtors ineligible for discharge under § 1328(f)(1) to strip underwater junior liens.

Bankruptcy court precedents in this district have consistently rejected such efforts by discharge-ineligible Chapter 13 debtors. The parties agreed to submit briefs on the issue of HUD's lien elimination and related factual disputes. Following the submission of briefs and oral arguments, the court concluded that there are no material factual disputes, allowing for a legal adjudication on the Monroes’ ability to eliminate HUD's lien based on the undisputed facts.

HUD's claim originated after Wells Fargo and Seaway recorded mortgages on the Monroes' home, with Wells Fargo's first-priority mortgage recorded in November 2002 and Seaway's second-priority mortgage in July 2008. In March 2009, the Monroes executed a note in favor of HUD, securing it with a third-priority mortgage recorded in April 2009. Following the Monroes' chapter 7 bankruptcy filing in February 2010, the bankruptcy court discharged their personal obligations to HUD, but HUD's lien remained intact. The Monroes initiated a chapter 13 case in April 2013, during which HUD filed a proof of claim for the debt secured by its lien, emphasizing that the lien passed through the prior bankruptcy unaffected. 

HUD's claim is nonrecourse, allowing it only to collect the debt through foreclosure on the Monroes' home. The value of the Monroes' residence was less than the amounts owed to senior lienholders, a point HUD acknowledged. The critical issue is whether the Monroes can eliminate HUD's right to wait for an increase in property value through their chapter 13 case. 

The Monroes argue they can void HUD's lien under 11 U.S.C. 506(d), claiming it secures a non-allowed secured claim, and also contend that 11 U.S.C. 1322(b)(2) permits modification of HUD’s rights in their chapter 13 plan. Their proposed plan seeks to strip off the unsecured second and third mortgages, declaring them fully paid upon completion. HUD objects to this plan, asserting that its lien can only be stripped if a chapter 13 discharge occurs. 

Ultimately, the court determined that the Monroes cannot avoid HUD's lien under 506(d) because the section stipulates that a lien is void only if it secures a claim that is not an allowed secured claim, and the exceptions to this rule do not apply in this case.

Under 11 U.S.C. § 506(a), a claim is classified as 'secured' only to the extent that a debtor's bankruptcy estate has an interest in the property. An allowed claim by a creditor secured by a lien is considered a secured claim to the extent of the value of that lien against the estate's interest in the property; otherwise, it is classified as unsecured. A junior lienholder's secured claim is limited to the value of the property exceeding senior liens. HUD acknowledges its claim is 'unsecured' under § 506(a) because the amounts owed on senior liens exceed the value of the Monroes' residence. The Monroes argue that since HUD's lien does not attach to any value, it is not a secured claim and is void under § 506(d). However, the Supreme Court's ruling in Dewsnup v. Timm clarifies that 'allowed secured claim' in § 506(d) refers to a claim allowed under § 502 and secured by a valid lien under state law, irrespective of its classification under § 506(a). Dewsnup separates the definitions in § 506(a) and § 506(d), asserting that valid liens remain effective in bankruptcy. The Monroes' assertion that Dewsnup’s interpretation is irrelevant in chapter 13 cases is countered by the Seventh Circuit, which maintains that § 506(d) applies uniformly across bankruptcy chapters. Additionally, the Monroes consider eliminating HUD's lien through their chapter 13 plan under § 1322(b)(2), which permits modification of secured claims. However, this section appears inapplicable since HUD's lien is a security interest in the Monroes' principal residence.

The Supreme Court in Nobelman v. American Savings Bank established that the determination of whether a creditor’s claim is 'secured' for the purposes of 11 U.S.C. § 1322(b)(2) relies on 11 U.S.C. § 506(a). The case focused on whether a Chapter 13 debtor could 'cram down' a claim secured by a first-priority lien on their principal residence. The Court ruled that if the estate has any interest in the residence to which a lien can attach, the creditor holds a 'secured claim.' Consequently, if a claim is secured, the antimodification provision of § 1322(b)(2) prevents a debtor from altering the creditor's rights regarding full claim payment.

The Court agreed with the debtors that the status of a 'secured claim' should be evaluated under § 506(a), which assesses the property's value to determine lien attachment. If there is value, the claim is 'secured,' and the debtor cannot modify it. Conversely, if there is no value, the claim is 'unsecured,' and the antimodification provision does not apply. Courts of appeals have consistently held that a Chapter 13 plan can eliminate a fully underwater lien on a debtor’s principal residence. The Seventh Circuit acknowledged this prevailing view without suggesting a different stance. 

Most rulings permitting lien stripping under § 1322(b)(2) relate to recourse claims, where eliminating an underwater lien modifies the creditor's collection rights from the property to solely from the debtor personally. In contrast, when the creditor's claim comprises only an underwater lien, the plan's elimination of the lien does not clearly constitute a 'modification' of the creditor's rights, as it removes the only right the creditor possesses. Thus, the term 'modify' is applied in a nonstandard way in this context.

Eliminating a claimholder's sole right may not constitute a modification under 11 U.S.C. § 1322(b)(2), which raises questions about the elimination of nonrecourse liens, even if they are underwater. Courts have interpreted Chapter 13 plans as temporarily modifying lien rights, allowing creditors to retain liens until specified by the plan or confirmation order. Upon confirmation of a plan, property of the estate vests in the debtor free of creditor claims outlined in the plan, although creditors retain a contingent interest in the property. If a debtor's case is dismissed or converted before plan completion, the creditor's rights revert to their pre-filing state unless the debtor has fully paid the creditor’s claim. A Chapter 13 plan that strips a nonrecourse lien modifies the creditor's foreclosure rights, making them contingent on the debtor's successful plan completion. The Monroes' Chapter 13 plan stipulates that HUD's lien will lose legal effect only upon their successful plan completion, with HUD not challenging the plan or the Monroes’ claims. HUD acknowledges that lien stripping is permissible in Chapter 13 under certain conditions but contends that it is not appropriate if the debtor cannot obtain a discharge, citing In re Jarvis. However, Jarvis is considered unpersuasive as it lacks support from the Bankruptcy Code, which does not limit lien stripping based on discharge eligibility. The principles in Jarvis were derived from In re Lilly, which focused on allowed secured claims rather than unsecured claims, affirming that HUD's claim, deemed unsecured due to the senior lienholders' claims exceeding the collateral value, falls under this category.

A Chapter 13 debtor ineligible for discharge cannot permanently modify the interest rate on a '910 claim' through their repayment plan, as established in Lilly. A '910 claim' arises from debts incurred within 910 days of bankruptcy filing, secured by a motor vehicle for personal use. The unnumbered 'hanging paragraph' of Section 1325(a) indicates these claims are exempt from Section 506(a). While Lilly determined that a debtor's Chapter 13 plan may adjust the interest rate during the plan's duration, it cannot effect a permanent alteration, as 11 U.S.C. 1325(a)(5)(B)(i)(I) mandates that holders of allowed secured claims retain their liens until the debt is fully paid or the debtor receives a discharge.

Lilly's decision relies on the stipulation that only 'allowed secured claims' retain protections under Section 1325(a)(5). For this purpose, an allowed secured claim is defined under 506(a), except for those claims explicitly excluded by the hanging paragraph. HUD’s claim is not considered an allowed secured claim, as it acknowledges it may be treated as unsecured in the Monroes’ Chapter 13 plan. Consequently, the requirement for lien retention does not apply to HUD’s claim.

Despite recognizing the inapplicability of Section 1325(a)(5)(B)(i)(D) to its situation, HUD cites Jarvis's ruling that a no-discharge Chapter 13 case cannot lead to a permanent modification of a creditor's rights, typically achieved through a discharge. However, neither HUD nor Jarvis convincingly supports the argument that modifying a creditor's lien rights is traditionally linked to discharge or that a debtor’s lack of discharge necessitates case conversion or dismissal. The ability to discharge personal liability does not inherently affect a debtor's capacity to adjust lien rights in their debt-adjustment plan. In bankruptcy, a discharge eliminates the debtor's personal liability for claims, effectively acting as an injunction against collection efforts for discharged debts.

A bankruptcy discharge allows for actions against a debtor in rem, meaning creditors can enforce their secured claims through property rather than personal liability. HUD's claim, classified as unsecured under section 506(a), pertains solely to its mortgage lien on the Monroes' property, as they previously discharged their personal liability in a Chapter 7 case. Chapter 13 does not allow nonrecourse claims to be treated as recourse claims, so HUD retains the right to pursue the property despite the Monroes’ discharge. The Monroes' desired modification of HUD’s rights cannot be achieved through discharge, as HUD lacks an allowed secured claim, which impacts the applicability of section 1325(a)(5)(B)(i)(I)(bb) in confirming their Chapter 13 plan.

Additionally, sections 348 and 349 indicate that liens remain attached to claims that are not fully repaid upon the conversion or dismissal of a Chapter 13 case. This means a Chapter 13 plan must be completely fulfilled to permanently alter creditor liens. The completion of a no-discharge Chapter 13 plan does not necessitate case conversion or dismissal, as per section 1307, which allows courts discretion in this regard. Thus, even without a discharge, a Chapter 13 plan can extinguish liens. The Code does not prohibit confirming a Chapter 13 plan that modifies the rights of holders of unsecured claims, regardless of the debtors' discharge eligibility.

A Chapter 13 plan can permanently modify the rights of unsecured claim holders, including the state-law lien rights of those whose claims are deemed 'unsecured' under Section 506(a). Upon confirmation of a Chapter 13 plan, its terms are binding on the debtor and all creditors, regardless of whether their claims are addressed in the plan or if they have objected to it. Confirmation vests all property of the estate in the debtor, free and clear of any creditor claims provided for by the plan. While there is no definitive authority interpreting 'free and clear' under Section 1327, the Seventh Circuit has interpreted similar language in Section 1141(e) to imply that a plan that addresses a lienholder’s claim without preserving the lien effectively eliminates the lien. The default rule in the Bankruptcy Code is that such claims are extinguished if provided for in the plan. When a creditor participates in the bankruptcy process, the confirmation of a reorganization or debt-adjustment plan can result in the permanent extinguishment of liens on estate property.

A confirmed Chapter 13 plan is treated as a final judgment and is generally immune to attacks by creditors with adequate notice, subject only to modification through appeal, revocation, or specific collateral attacks under Federal Rule of Civil Procedure 60(b). The notion that liens pass through bankruptcy unaffected does not preclude a no-discharge Chapter 13 plan from extinguishing liens; this principle cannot be interpreted literally. The case of Penrod illustrates that a lien survives only as allowed in the plan or confirmation order. There is no significant difference between Chapter 11 and Chapter 13 regarding the treatment of liens under their respective plan confirmation provisions. Courts opposing lien stripping in no-discharge Chapter 13 cases have not justified why the pass-through principle would not apply to discharge-eligible cases, where lien stripping is generally accepted. Finally, HUD argues that permitting discharge-ineligible Chapter 13 debtors to confirm plans that strip underwater liens effectively grants them a de facto discharge, countering Congress's intent to prevent exploitation of the bankruptcy system.

Some legal decisions argue that the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 prohibits no-discharge Chapter 13 plans from eliminating underwater liens, citing legislative history as evidence of this intent. Specifically, Section 306 of the 2005 Amendments, titled "Giving Secured Creditors Fair Treatment in Chapter 13," and a House Report indicate that Chapter 13 plans must allow secured creditors to retain their liens until the underlying debt is paid or the debtor is discharged. However, the structure of 11 U.S.C. § 1325(a)(5) and relevant precedents suggest that "allowed secured claim" should not be interpreted as any claim secured under state law but rather in accordance with 11 U.S.C. § 506(a). 

Even if allowing no-discharge debtors to eliminate underwater liens contradicts the congressional intent to protect liens from repeat filers, the text and structure of the statute imply that § 1325(a)(5)(B)(i)(I) does not fully align with this intent. A debtor could have modified their underwater lien in a Chapter 13 case had they filed in 2010, and no appellate court has ruled against this principle. Furthermore, the four-year discharge prohibition under § 1328(f) does not impose additional constraints on a Chapter 13 plan's capacity to modify rights of claims treated as unsecured under § 506(a). 

While Congress has limited relief for some repeat filers, it has not restricted those who discharged debts in a Chapter 7 case from utilizing Chapter 13 for debt adjustment. The limitations on discharge do not impede a Chapter 13 plan’s ability to modify the rights of unsecured claimholders. Ultimately, the ability to eliminate underwater liens in a Chapter 13 plan remains intact following the 2005 Amendments, as the Code's provisions do not convincingly indicate that a debtor's ineligibility for discharge affects their capacity to modify rights associated with underwater liens. The Supreme Court has historically recognized that reorganization plans can extinguish junior lien-holders' security interests when the property value is less than the senior lienholder's claim.

The lien-stripping principle allows chapter 13 debtors eligible for a discharge to modify junior mortgage lien rights on their principal residence if the property value is less than the senior lien. This principle applies equally to ineligible debtors, as the modification of creditors' rights under a confirmed chapter 13 plan, rather than the debtor's discharge, eliminates liens contingent on the debtor's full performance of the plan. Under section 1325(a)(5), no-discharge chapter 13 plans must pay the full amount owed on allowed secured claims; however, this does not apply to wholly underwater liens, which lack allowed secured claims. Therefore, a chapter 13 debtor can strip an underwater junior mortgage lien regardless of discharge eligibility. 

The court concludes that the Monroes' chapter 13 plan can treat HUD's claim as unsecured, allowing for the permanent extinguishment of HUD's mortgage lien upon plan completion. The court will deny HUD's objection to the plan confirmation and schedule a status conference for any remaining issues. Jurisdiction is established under 28 U.S.C. 1334 and the Eastern District of Wisconsin’s order of reference. Although the Monroes did not schedule their debt to HUD in their chapter 7 case, the discharge applies to all pre-relief debts except those specified in 11 U.S.C. 523. HUD does not claim the debt arose from fraud or willful injury, and in no-asset chapter 7 cases, the discharge is effective for all debts not excepted under section 523(a)(2), (4), or (6).

HUD has acknowledged that the Monroes' personal liability to it was discharged in their Chapter 7 bankruptcy case, meaning HUD's claim in the current context is nonrecourse. A Chapter 13 plan may not necessarily provide the same benefits as a Chapter 7 discharge. Although a Chapter 13 plan can classify unsecured claims separately, it must not unfairly discriminate against any designated class and must ensure that the value of property distributed on account of unsecured claims is at least equal to what would be paid in a Chapter 7 liquidation. Specific provisions under Section 1325(a) clarify that certain secured claims, particularly those with purchase money security interests incurred within specified timeframes, are treated differently.

The Dewsnup case interpreted "allowed secured claim" under section 506(d) to mean any claim that is allowed and secured. This interpretation diverges from the standard rule of statutory construction whereby similar terms in a statute should have the same meaning. The Dewsnup court noted that the language of section 506(d) did not clearly indicate a change in the treatment of liens during liquidation bankruptcies, leaving open the possibility that "allowed secured claim" might have different meanings in other sections of the Bankruptcy Code. The ruling in Dewsnup raises complexities regarding the interaction of these definitions with provisions in Section 1325, particularly concerning the implications for cramdown scenarios.

Under 11 U.S.C. 1325(a)(5), a debtor's plan must provide that a non-consenting holder of an "allowed secured claim" receives property equal to at least the allowed amount of that claim. The allowed amount is determined by nonbankruptcy law, and "allowed secured claim" is interpreted similarly to its meaning in Dewsnup v. Timm, which prohibits lien stripping when a claim is fully allowed. Additionally, reading 1325(a)(5) to prevent cram down would contradict numerous judicial decisions affirming its application in Chapter 13 cases.

HUD references Colbourne v. Ocwen, asserting that a Chapter 13 plan cannot permanently modify creditor rights without a discharge. In Colbourne, the debtor attempted to cram down claims secured by first-priority mortgage liens, which required the creditor to retain its liens until discharge or repayment per nonbankruptcy law. This case differs because it involved claims governed by 1325(a)(5). 

Other code sections, such as 1325(a)(3), may restrict some discharge-ineligible debtors from eliminating underwater liens via their Chapter 13 plans, particularly if the plan solely aims to eliminate a lien post-Chapter 7 discharge. However, the Monroes, having filed their Chapter 13 case nearly three years after their Chapter 7 discharge, proposed a 60-month plan intending to pay over $20,000 to creditors and modify claims, including curing a $15,000 arrearage owed to Wells Fargo. HUD acknowledged that the Monroes' proposal was made in good faith.