Hey, the Sun Is Hot and the Water's Fine: Why Not Strip Off That Lien?

JurisdictionUnited States,Federal
Publication year2013
CitationVol. 30 No. 1

Hey, the Sun is Hot and the Water's Fine: Why Not Strip Off That Lien?

Lawrence Ponoroff

HEY, THE SUN IS HOT AND THE WATER'S FINE: WHY NOT STRIP OFF THAT LIEN?


Lawrence Ponoroff*


Abstract

In this article, the author maintains that avoidance of wholly unsecured liens ("strip off") in chapter 7 is permissible and desirable notwithstanding the Supreme Court's controversial 1992 decision in Dewsnup v. Timm, which refused to permit avoidance of the unsecured portion of a partially secured lien ("strip down"). The argument flows from a broader analysis of the proper characterization of secured claims in bankruptcy. Specifically, contrary to the state law ideation of "secured" that focuses on the identity of the claimant, the author urges that in bankruptcy the concept of "secured" should focus on that creditor's claim or claims as defined by the Bankruptcy Code. He argues not only that bankruptcy courts have the authority to develop a uniform federal rule in this area, but that to do so would limit Dewsnup to its narrowest possible construction, and perhaps provide the impetus for reexamination of a decision that is out-of-step with core bankruptcy policy and the Court's own bankruptcy jurisprudence.

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Introduction

The 1990's witnessed a vigorous debate over the efficiency of secured credit1 and the distributive impact of the "full priority" rule for secured creditors enshrined, following some debate,2 in the revision of Article 9 of the Uniform Commercial Code ("UCC").3 The new century saw an ebbing of the controversy; most likely a consequence of the dramatic shift in commercial financing patterns from conventional asset-based lending to various forms of securitization4 The squabble, however, over the potential moral hazard created

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by the effective judgment proofing of debtors through all-encompassing security interests5 continues unresolved to date.6

The issue is exacerbated in the context of a bankruptcy case where the unique rehabilitative fresh start and equality policies of the federal bankruptcy law enter into the fray, policies that find doctrinal instantiation in certain key provisions of the Bankruptcy Code ("Code").7 Chief among these is § 506(a) of the Code, which calls for the bifurcation of partially secured ("undersecured") claims into two parts: (1) a secured claim equal to the value of the collateral, and (2) an unsecured claim for the balance of the debt supporting the claim.8 This distinction, which ties the concept of "secured claim" to specific economic value, has no corollary under state law.9 Largely, it derives from the necessity in bankruptcy to cleave a wide chasm between the debtor's pre- and postpetition lives.10 Whether in liquidation or reorganization

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mode, bankruptcy at its core entails a fundamental and mandatory realignment of existing contractual and property relationships and obligations so as to achieve the debtor's fresh start or rehabilitation, as the case may be.11 On the face of it, then, it would seem that being "secured" for bankruptcy purposes means simply the right to a priority claim in the present value (net of prior liens) of the creditor's collateral as of the date of filing—no more and no less.12 The controversy and disagreement, however, over how to properly conceptualize security interests in bankruptcy demonstrates that, in fact, understanding the ontological meaning of and entailments associated with a "secured claim" has been anything but simple.

In 1992 the Supreme Court of the United States set the stage for the current debacle with its controversial decision in Dewsnup v. Timm.13 The narrow holding of the case was that "strip down"14 of an undersecured claim is not permitted under § 506(d) in a chapter 7 case.15 The broader implications of the holding were that, in ways yet unarticulated, being secured in bankruptcy might entail rights beyond simply the right to the property pledged to secure the claim, or its value. In 1997, Professor Knippenberg and I published a law review article rather critical of the Court's decision in Dewsnup16 based primarily on our view of a security interest as representing a claim to property,

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but not an indefeasible right in property.17 In attempting to demonstrate the futility of the holding in Dewsnup, we stated that by resorting to a device known as "chapter 20"18 a debtor could do in two steps what Dewsnup now forbids doing in one; namely, strip down an undersecured lien, at least as against nonresidential real property.19

Later that same year, Judge Robert D. Martin, in a case titled In re Kirchner,20 faced with a chapter 20 scenario similar, but by no means identical, to the one Professor Knippenberg and I hypothesized,21 opined: "How the chapter 7 discharge affects what can be done in a subsequent chapter 13 case is not as obvious to me as it was to Professors Ponoroff and Knippenberg."22 Sixteen years after that, in Branigan v. Davis,23 the U.S. Fourth Circuit faced an attempt by debtors to "strip off" wholly underwater liens against their personal residences in a chapter 20 case. In a two-to-one decision, the court held that lien stripping in chapter 20 is permissible notwithstanding: (1) the fact that it created an "end run" around Dewsnup, and (2) the amendments to chapter 13 accomplished under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA")24 intended to tip "the bankruptcy scales back in the direction of creditors."25

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In short, notwithstanding the passage of more than 16 years, the spilling of much ink on the subject, and a comprehensive overhaul of the federal bankruptcy law, we have gone exactly nowhere in advancing our collective understanding of what it means to be "secured" in bankruptcy. So, it seems timely to tilt yet once more at that windmill where divergent state and federal law schema have uncomfortably co-existed for so long. I begin this redux with a brief overview of the relevant Supreme Court jurisprudence relating to this topic, and then consider some of the questions that remained unanswered after those cases, including the dilemma faced by Judge Martin in Kirchner and the differing treatment to be accorded to strip off as opposed to strip down.26 Next, I turn to a detailed discussion of the Branigan case and its implications. Following that, I attempt to pull together some of the disparate threads by focusing, ironically, on the technique employed by Congress under BAPCPA to expand the scope of non-modifiable claims in chapter 13. I then propose what I submit represents a way to conceive of security in bankruptcy, as distinct from state law, that fairly balances the contractual entitlements of secured creditors with the specific equality and rehabilitation objectives implicated in any bankruptcy proceeding. Lastly, relying on recent scholarship analyzing the role of the bankruptcy courts in the development of the law, I conclude that the courts inherently possess the means to allow strip off in chapter 7, and, in so doing, to confine the Court's definition of "secured claim" in Dewsnup to its narrowest (and least damaging) possible sphere of operation.

I. The Supreme Court Trilogy (or How We Got to Where We Are TODAY)

A. Dewsnup

In Dewsnup, the chapter 7 debtors owed $120,000 on land worth only $39,000.27 The debtors sought to keep the land by bifurcating the undersecured claim under § 506(a) and then relying on what appeared to be the plain

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language of § 506(d)28 to void ("strip down") the portion of the lien ($81,000) unsupported by the land's value.29 The Court, in Justice Blackmun's majority decision, found that the relationship between subsections (a) and (d) of § 506, as well as their relationship with other parts of the Code, was sufficiently ambiguous30 to allow the Court to overlook its own rules of statutory construction regarding the meaning to be attached to identical terms as used in different parts of a statute.31 Thus freed to make its own interpretation of § 506, the Court concluded that the better reading of the phrase "allowed secured claim," as used in § 506(d), was to assign it a different meaning from the defined meaning of the identical phrase in § 506(a); i.e., that portion of the total claim that is supported by value in the collateral.32 Specifically, Justice Blackmun concluded that the phrase "allowed secured claim" in § 506(d) "should be read term-by-term" so as to refer only to a claim that is both "not allowed" and "not secured."33 In this case, because the creditors' claim had been allowed under § 502, and was secured,34 this construction of § 506(d) meant that the lien could not be stripped down.

It becomes important later to pay some attention to the rationales that the majority opinion offered in support of its holding that strip down of an undersecured claim is not permitted in chapter 7. First, the Court opined that a different conclusion would, of necessity, "freeze the creditor's security interest at the judicial valuation," and, thus, deprive the creditor of the any later appreciation in the property.35 Second, noting the doctrine that holds the Code

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should be read not to change pre-Code practices without some indication in the legislative history,36 the Court pointed to the pre-Code principles that liens passed through bankruptcy unaffected, and that debtors were only permitted to reduce an unwilling creditor's lien by either paying it in full or filing for reorganization.37 Ironically, the majority missed the one obvious opportunity to mitigate its butchery of the usual canons of statutory interpretation in construing the language of § 506(d).38 That is, the debtors' interpretation of § 506(d) could be seen as rendering the redemption provision in § 722 largely superfluous,39 in contravention of the general judicial reluctance to avoid construing a statute in a manner that produces that result.40

The majority opinion drew a splenetic dissent from Justice...

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