The immovable object versus the irresistible force: rethinking the relationship between secured credit and bankruptcy policy.

• Author: Ponoroff, Lawrence

And then, with the coming of the night the north wind was again loosed, while the rain still beat against the windows and pattered down from the low Dutch eaves.

When it was light enough Johnsy, the merciless, commanded that the shade be raised.

The ivy leaf was still there.

O. Henry(1)

INTRODUCTION

The last leaf in O. Henry's classic short story was hanging by a delicate thread, but it never fell. It never fell, of course, because it wasn't real; Old Behrman had painted it (and caught pneumonia for his trouble) in order to give Johnsy the will to live. The Supreme Court's decision in Dewsnup v. Timm(2) is also hanging by a thread, following a barrage of scholarly criticism and more than four years of limiting case law and legislative incursions on the case's core conceptual rationale. But the holding in Dewsnup, unlike the last leaf, is very real. It has had, and continues to have, a deleterious effect on the ability of many individual debtors to obtain meaningful relief and a truly "fresh start" in bankruptcy.

This article urges Congress, as it considers the recommendations of the National Bankruptcy Review Commission,(3) to sever the last thread and consign the Supreme Court's 1992 decision to its rightful role as a historical anomaly. In taking this action, Congress could clarify once and for all the nature and status of security and secured claims in bankruptcy.(4) The advantages to be attained from doing so are considerable, not the least of which includes establishing the contours of the fresh start for individual debtors in chapter 7 in a manner that raises fresh-start policy to a level of dignity commensurate with the policy of efficient debt collection(5)

The treatment of secured claims in bankruptcy, and, in particular, partially secured claims, has been a controversial subject(6) since the enactment of the current Bankruptcy Code in 1979.(7) For example, a fundamental tension has always existed between the state-law rules -- which facilitate a single creditor's ability to fence off all of the debtor's existing and after-acquired property -- and bankruptcy's fresh-start and rehabilitative policies.(8) Nevertheless, the combination of contemporary scholarship examining the purposes of secured credit(9) and nearly ten years of case law devoted to working through the Code's approach to secured and unsecured claims(10) demonstrate that Dewsnup was more than just another manifestation of that traditional tension. As we argue in this article, Dewsnup was not only a historical anomaly in terms of the Supreme Court's established methodology in its approach to bankruptcy cases,(11) but also an untenable exception in the ever-more-clearly emerging course of bankruptcy jurisprudence under the Code.(12)

We begin in Part I by examining the Dewsnup holding in the context of contemporaneous legislative and judicial developments relating to the treatment of undersecured claims in bankruptcy. In Part II, we evaluate, and find unconvincing, the most recent apologia for the outcome in Dewsnup. We conclude from this that Dewsnup must to a considerable degree be understood as the product of certain imaginative conceptions about the nature of secured credit. This leads us in Part III to review the most recent positions advanced in the now nearly twenty-year-old debate over the efficiency of secured financing. Our examination reveals that scholars, whether writing from an economics-driven perspective on the law or not, are increasingly reaching the conclusion that secured credit as an institution, and its derivative rule of full priority for secured claims upon insolvency, does not in fact promote systemic efficiency. Nevertheless, the law in this area continues to be guided by the precepts of freedom of contract and free alienability of property rights.(13) It is that normative justification for secured credit -- premised on the same principles of party autonomy that form the philosophical underpinnings of both contract and property law -- that presents the most serious challenge for the position we advance in this paper.

In Part IV, therefore, we examine this "conveyance model" of the security interest in the bankruptcy setting and find that it fails to account adequately for certain unique but fundamental bankruptcy policies, including, in consumer cases, the fresh-start policy. This leads us to the conclusion that, notwithstanding the utility of a property-based understanding of security interests in a variety of other contexts, what is called for in the bankruptcy context is an alternative to the conceptualization of the secured claim as "property." Part V examines recent work in the cognitive sciences on which such an alternative conceptualization might be built. That work has revealed that abstract concepts, such as legal concepts, are understood metaphorically. The principal insight of that learning, that concepts are not direct reflections of some external reality independent of the reasoner, has important ramifications for legal analysis and legal reform. The significance of that insight is nowhere better demonstrated than in the context of the topic at hand, the way in which we have come to conceptualize secured credit.

Finally, having unpacked the metaphors by which our thinking about security has been both advanced and constrained, in Part VI we critique the metaphor that implicitly dictated the result in Dewsnup. We then offer, and consider the practical applications of, an alternative characterization of security interests in bankruptcy that conceptualizes the security interest as a claim to property, rather than as an indefeasible right in the property itself.

1. AVOIDANCE OF UNDERSECURED CLAIMS IN BANKRUPTCY

   Consider as a starting point for discussion a chapter 7 debtor with a homestead exemption of $15,000 and a residence valued at $120,000. Assume this property is subject to, in order of priority, a $100,000 nonavoidable first mortgage, a $15,000 judicial lien, and a $20,000 nonavoidable second mortgage. Section 522(f)(1)(A) of the Bankruptcy Code authorizes the debtor to avoid the fixing of the lien on the debtor's property to the extent that such lien impairs an exemption to which the debtor would otherwise have been entitled.(14) Section 522(f)(2)(A), added to the Code by the 1994 Amendments, now defines impairment(15) to make it clear that the entire judicial lien impairs the exemption and, therefore, may be set aside in toto.(16) By focusing on the dollar amount of liens against the property and the value of the exemption, the new statutory formula for measuring impairment effectively overrules those cases that refused to permit avoidance unless there was an execution pending on the lien at the time the bankruptcy was filed.(17) It also negates the continuing viability of those decisions holding that there can be no impairment where state law requires a minimum bid equal to the amount of the homestead exemption in order for a forced sale to be valid.(18)

   Because of the existence of the unavoidable second mortgage, however, the above scenario presents another interpretational issue that is not resolved by the text of the 1994 Amendments to the Code.(19) Unless the benefit of the avoidance is preserved for the debtor, it inures entirely to the junior mortgagee.(20) This raises the question of whether the junior unavoidable lien simply fills the vacuum created by the avoidance of the judicial lien or whether the concept of preservation of avoided liens for the benefit of the estate under 11 U.S.C. [sections] 551 can be imported into 11 U.S.C. [sections] 522(f) in order to allow the debtor to rely on section 522(i)(2) to claim an exemption out of the avoided lien. Permitting the junior lien to claim the priority formerly occupied by the avoided judicial lien might be defended as corresponding more or less with the result under state law.(21) Furthermore, there is an arguable theoretical benefit to the debtor attendant to the avoidance of the judicial lien, even if the nonavoidable junior lien is not subordinated to the exemption.(22) In the final analysis, however, it is a result that serves rather poorly the humanitarian impulses that accounted for the adoption of the debtor avoiding power in the first instance.(23) The other, and candidly, more logical, alternative would be to permit the debtor to use 11 U.S.C. section 506(d) in tandem with section 522(f)(1)(A) to set aside the second consensual mortgage in the bankruptcy proceeding to the extent of that creditor's unsecured deficiency.(24) The problem, of course, is that Dewsnup foils this neat solution, forcing debtors to resort to far more costly and convoluted schemes for accomplishing the same result.(25)

   How did we arrive at this curious state of affairs? As always, through the most circuitous of routes. Our story begins not at the beginning but at what we gather (and hope) is nearly the end. Prior to the 1994 Amendments, several courts, including at least four circuit court of appeals panels,(26) had ruled that in order to be subject to the debtor's avoiding power in 11 U.S.C. section 522(f)(1),(27) the debtor had to have equity in the property over at least the amount of senior nonavoidable liens.(28) Accordingly, if the judicial lien were completely unsecured (in the bankruptcy sense of the word), it was nonavoidable because it did not, to use the language of the statute, impair an exemption to which the debtor would otherwise be entitled.(29) Thus, on the facts of the hypothetical posed earlier, the entire judicial lien might have survived because the debtor had no equity in the property over and above the sum of the nonavoidable liens.(30) This line of authorities, which in part was seen as offering a preferred construction of the statute because of its consistency with the Supreme Court's holding in Dewsnup,(31) has now also been overruled by the statutory formula for determining "impairment" that was added to the Code by...