Two New Decisions Appear to Support Lien-Stripping (Under Certain Conditions)

Contributed by Katherine Doorley
Lien stripping is a topic that has frequently been in the bankruptcy news this summer in light of the Supreme Court’s recent decision in Bank of America v. Caulkett.  Post-Caulkett, we here at the Weil Bankruptcy Blog queried whether the Dewsnup rule that liens could ride through a bankruptcy was ripe to be overruled. Last week we discussed the Second Circuit’s decision to embrace that principle.  This week, we bring you two other additions to the lien-stripping landscape, Boukatch v. Midfirst (In re Boukatch) and In re John Paul Smith. These decisions either found or implied that the debtor in question could avoid a lien on real property assuming the debtor satisfied its obligations under its plan. 
One year after obtaining a discharge in a chapter 7 case, the individual debtors in Boukatch filed a chapter 13 case.  In each case, the debtors identified two liens against their residence—a first lien held by Wells Fargo and a second lien held by MidFirst Bank.  In the subsequent chapter 13 bankruptcy, the debtors identified MidFirst’s second and wholly underwater lien and asserted that MidFirst held an “empty lien” because the debtors’ personal liability had been discharged in the debtors’ previous chapter 7 case.  Accordingly, the debtors filed a motion seeking to avoid MidFirst’s lien.  Although no one (including MidFirst) objected to the motion, the United States Bankruptcy Court for the District of Arizona denied the lien stripping motion, on the grounds that a “chapter 20” debtor who is not receiving a discharge is not permitted to strip off liens.
On the debtors’ appeal from that order, the Bankruptcy Appellate Panel for the Ninth Circuit held that a “chapter 20” debtor can strip off a wholly underwater junior lien even though the debtor is not receiving a discharge.  The Boukatch panel discussed three different approaches used by courts considering this issue:

  1. Stripping off a wholly underwater lien in a “chapter 20” case is impermissible because lien stripping is tantamount to a de facto discharge, which is not permitted in a chapter 20 case.
  2. Chapter 20 lien stripping is permissible in theory, but the parties’ prepetition rights are reinstated by operation of law after the chapter 13 plan has been consummated unless the claim is discharged or paid in full. Therefore, the lien avoidance can never be permanent.  These courts have reasoned that chapter 13 cases end either through conversion, dismissal, or discharge, and if a chapter 13 case is dismissed or converted prior to the successful completion of all plan payments, any avoided liens are reinstated.
  3. Chapter 20 lien stripping is permissible because nothing in the Bankruptcy Code prevents it. This group of courts has held that the specific Bankruptcy Code mechanism that voids the lien is plan completion, rather than the discharge of the debtor, and that a successful chapter 20 case would not be dismissed or converted, but rather would end in an administrative closing.  Accordingly, these courts have found that, because the Bankruptcy Code sections that reverse any lien avoidance are only implicated if a chapter 13 case is converted or dismissed, those provisions do not apply so long as debtors make all payments under their chapter 13 plans.  In other words, the lien-stripping is not dependent upon the debtor receiving a discharge, but rather is dependent on the debtor successfully making all plan payments.

The Boukatch panel “join[ed] the growing consensus of courts” that follow the third approach.  The panel held that nothing in the Bankruptcy Code prevented the debtors from stripping off a wholly underwater lien against their principal residence, notwithstanding that the debtors were not eligible for a discharge.  The panel made a distinction between discharge—which would have enjoined the creditor from enforcing the debt against the debtor personally, but would not have released the lien from the debtor’s property—from avoiding the lien.  The panel concluded that the Bankruptcy Code does not prevent individual debtors from stripping off a wholly underwater lien in their chapter 13 plan.  The only way the lien would not be avoided would be if the debtors failed to complete all of the payments required under their chapter 13 plan and the case was subsequently converted or dismissed.  Accordingly, the panel reversed the bankruptcy court’s decision to deny the lien stripping motion.
In Smith the United States Bankruptcy Court for the Eastern District of North Carolina entered a confirmation order on an individual debtor’s chapter 11 plan.  The confirmation order provided that the debtor was released from all dischargeable debts with the express condition that confirmation was contingent upon the debtor “providing for the payment of all allowed claims assertable against the debtor’s estate” as specified in the plan.  The debtor was unable to meet his payment obligations under the plan and dismissed his chapter 11 case.  After dismissal, a prepetition secured creditor commenced a foreclosure action seeking to foreclose on its lien against the debtor’s real property.  After squabbling in state court about the effect of the debtor’s bankruptcy on the secured creditor’s lien, the creditor sought to reopen the bankruptcy case so the bankruptcy court could determine the meaning and impact of the plan and the confirmation order on its lien.
At issue was whether—notwithstanding the “confirmation order” entered by the bankruptcy court—the debtor’s plan ever had been confirmed in light of the order’s contingency that the debtor “provide for the payment” of allowed claims.  The debtor argued that the contingency had been satisfied because it only required the debtor to provide in the plan for how each creditor would be paid.  The court, however, thought that the more logical reading of the confirmation order was that the debtor was required to actually make the payments before the plan would be confirmed.  (Although section 1141(d)(5) of the Bankruptcy Code provides that confirmation does not discharge a debt provided for in the plan until an individual debtor completes its payments under the plan, it seems odd to condition confirmation of a plan upon completion of payments under the plan).
The debtor asserted that his property revested free and clear of the creditor’s lien as a result of section 1141(c) of the Bankruptcy Code.  Because the court found that the debtor’s plan was never confirmed, and the debtor dismissed his case prior to making all of the payments required by the confirmation order, the court determined that it did not need to address the effect of section 1141(c).  Although it did not decide the issue, the court implied that had the debtor satisfied the conditions inherent in the plan and confirmation order, and made the required payments, then the secured creditor’s lien could have been stripped off.
While each decision dealt with a different chapter of the Bankruptcy Code, both Boukatch and Smith provide some support that liens can be stripped in a bankruptcy case, although in each case it was with the prerequisite that the debtor satisfy the necessary conditions in its plan.  In light of these decisions it continues to appear as if chapter 7 debtors are the only debtors entirely unable to avoid liens in their bankruptcy cases due to the operation of Dewsnup v. Timm and Caulkett.  Whether Dewsnup and Caulkett will eventually be overturned remains to be seen, but the Bankruptcy Blog will continue to monitor the dockets and bring you further updates.