What's Left of Lien Stripping in Bankruptcy- a Connecticut Perspective
| Pages | 474 |
| Publication year | 2021 |
69 CBJ 474. What's Left of Lien Stripping In Bankruptcy- A Connecticut Perspective
For those unfamiliar with bankruptcy practice, the term, "lien stripping," might be thought to refer to some new home improvement technique. While, in a broader sense, lien stripping in bankruptcy can, in some instances, be used to improve one's home or other property, scraping or sanding is not required. This article will attempt to define those instances in which lien stripping can still be utilized in bankruptcy, notwithstanding relatively recent United States Supreme Court authority restricting its use in certain settings. Particular emphasis will be focused on Connecticut bankruptcy court and Second Circuit Court of Appeals decisions.
A. Statutory
The term "lien stripping" refers to the procedure by which a creditor's lien is reduced or "stripped down" to the value of its collateral. (fn1) The statutory authority for this procedure is found in 11 U.S.C. §506(a). (fn2) This particular subsection "provides that a claim is secured only to the extent of the value of the property on which the lien is fixed." (fn3) Once a creditor's "secured claim" is determined in accordance with section 506(a), depending upon the particular chapter of the Bankruptcy Code in which the bankruptcy case is pending, and upon the characteristics of the claim, section 506(d) (fn4) may then operate to void the lien to the extent of the deficiency between the amount of the creditor's total claim and the value of its collateral. (fn5) Thus, the total claim of a secured creditor can be bifurcated into a secured component and an unsecured component.
B. United States Supreme Court Authority
The use of lien stripping in bankruptcy has been foreclosed by the United States Supreme Court in certain limited situations, but not entirely eliminated. Thus, its application in contexts that have not been addressed by the high Court remains open to interpretation. A review of the relevant Supreme Court authority is necessary before addressing the areas in which lien stripping may still be available.
In Dewsnup v. Timm, (fn6) a chapter 7 debtor, Aletha Dewsnup, sought to use section 506(a) and (d) to "strip down" the lien of a mortgage holder to the judicially determined value of its collateral, farmland in Utah. (fn7) The debtor claimed that under section 506(a), the creditor's allowed secured claim could be reduced to the value of its collateral, and that once reduced, section 506(d) would operate to void the creditor's lien to the extent its total claim exceeded that value. (fn8) The debtor reasoned that once the creditor's allowed secured claim is limited to the value of its collateral under section 506(a), subsection (d) of that section then operates to void the lien on the remaining unsecured portion of its claim because the remaining portion is not an "allowed secured claim, within the meaning of section 506(d). (fn9)
The Supreme Court held that lien stripping was not available to the debtor in Dewsnup because the phrase "allowed secured claim" in section 506(d) ("[t]o the extent that a lien secures a claim ... that is not an allowed secured claim. . .that is not an allowed secured claim, such lien is void. ...) (emphasis added), did not have the same meaning as "allowed secured claim" in section 506(a). Rather, the Court held that "allowed secured claim" as used in section 506(d) meant any claim that is first, secured, i.e., for which a lien exists, and second, that is not disallowed. (fn10) In other words, the Court read "secured claim" in section 506(d) to refer simply to whether security exists for the claim, not the extent to which the claim is secured based on the value of the creditor's collateral. (fn11) Accordingly, since there was no dispute that the mortgagee in Dewsnup held a valid lien and a claim that was not disallowed, its lien could not be voided.
In reaching its holding, the Court relied on the principle of statutory construction that when the language of the statute is ambiguous (fn12) it should not be construed in such a way as to effect a major change in pre-Code practice unless the change being advanced was the subject of some discussion in the legislative history. (fn13) Looking to pre-Code law, the Court observed that 'Ja]part from reorganization proceedings ... no provision of the pre-Code statute permitted involuntary reduction of the amount of a creditor's lien for any reason other than payment on the debt." (fn14) Finding no intent to depart from this principle either "in the Code itself or in the annals of Congress," the Court applied it in interpreting section 506 not to authorize lien stripping in chapter 7 cases. (fn15)
The Court was particularly careful in limiting its holding in two respects. First, as a preface to its ruling, the Court stated that it was focusing "upon the case before us," and that it would 11 allow other facts to await their legal resolution on another day." (fn16) Second, the Court hedged somewhat by stating that "we express no opinion as to whether the words 'allowed secured claim'have different meaning in other provisions of the Bankruptcy Code. " (fn17) These cautionary statements have left Dewsnup's applicability to other chapters of the Code open to question.
In Nobelman v. Am. Sav. Bank, (fn18) The Supreme Court addressed the limited issue of "whether §1322(b)(2) prohibits a chapter 13 debtor from relying on §506(a) to reduce an undersecured homestead mortgage to the fair market value of the mortgaged residence." (fn19) Section 1322(b)(2) provides that a chapter 13 plan may:
modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor's principal residence, or of holders of unsecured claims, or leave unaffected the rights of holders of any class of claims. (fn20)
Prior to Nobelman, there had been a division among the Circuits as to whether the prohibition against modifying the rights of a residential mortgage holder applied only to the "secured" portion of the mortgagee's claim as determined by section 506(a), or whether it applied to prevent any alteration of the mortgage contract, and in particular, lien stripping, notwithstanding that the claim might be only partially secured. (fn21) The former approach is fairly represented by the Second Circuit's decision in Bellamy v. Federal Home Loan Mortgage Corporation (In re Bellamy). (fn22)
There, the Second Circuit held that the "claim" referred to in the so-called "other than" clause ("other than a claim secured only by a security interest in real property that is the debtor's principal residence" ) (fn23) is really a subset of "secured claims " the term immediately preceding the "other than" clause. (fn24) Bellamy then held that the term "secured claims," in section 1322(b) had to be determined according to section 506(a), Le, according to the value of the collateral. (fn25) Thus, under Bellamy, a chapter 13 debtor, without running afoul of the "other than" clause in section 1322, could strip down the claim of a residential mortgage holder to the value of the residence - producing a "secured claim" - and "make scheduled mortgage payments only until the secured claim is fully paid." (fn26) The balance of the claim would be unsecured.
The second approach to construing section 1322(b)(2) was the one ultimately adopted by the Supreme Court in Nobleman. Nobelman held that the term "claim" in the "other than" clause, given that it is broadly defined under the Code to include a right to payment that is secured or unsecured, refers to the mortgagee's entire claim, including both its secured and unsecured components. (fn27) Since section 1322(b)(2) also refers to "rights," stating that a plan may "modify the tights of holders of secured claims, other than a claim secured only by a" (fn28) home mortgage, the Court examined what the rights were of a "claim" secured only by a home mortgage. Observing that the term "rights" is not defined in the Bankruptcy Code, the Court applied the general rule that property rights in bankruptcy are determined by state law. (fn29) As to a home mortgage lender, the Court instructed that its rights under state law are defined by the relevant loan documents and include "the right to repayment of the principal in monthly installments over a fixed term ... [and] the right to retain the lien until the debt is paid off...." (fn30) Since those rights are embodied in a note that applies to the lender's entire claim, both secured and unsecured components, the Court held that stripping down the lender's lien to the value of the residence worked a "modifica tion" of its rights within the meaning of section 1322(b)(2)31 and thus was prohibited.
While the decisions in Dewsnup and Nobelnwn provided certainty in two important areas of bankruptcy law, (fn32) they also created new issues for practitioners and the courts. Among the most provocative of those issues are whether Dewsnup applies to chapters 13 and 11 of the Bankruptcy Code, particularly since the Code sections the Court was construing - sections 506(a) and (d) - apply to all chapters under Code, (fn33) and whether Nobelman applies to a junior home mortgage for which there is no equity in the residence. As a related issue, if NobelTwn bars lien stripping in chapter 13 only with respect to a claim secured solely by a home mortgage, what will qualify as additional collateral such as to take a mortgagee's claim outside of the anti-modification provision of section 1322(b)(2), thereby permitting lien stripping? Fortunately, a body of case law has developed that has helped define the contours of lien stripping in light of the decisions in...
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