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Fourth Circuit Permits Lien Stripping in Chapter 13 Cases Regardless of Whether a Proof of Claim is Filed

Posted By USFN, Tuesday, April 17, 2018
Updated: Monday, April 16, 2018

April 17, 2018

by Nathan Greyard
Rosenberg and Associates, LLC – USFN Member (District of Columbia)

In Burkhart v. Grigsby, 2018 U.S. App. LEXIS 7928 (4th Cir. Mar. 29, 2018), the Fourth Circuit held that the bankruptcy court can strip an unsecured claim from the debtor’s principal residence in a Chapter 13 case regardless of whether the claimant filed a proof of claim. This result may require secured creditors to be extra vigilant about filing proofs of claim (and, when necessary, objecting to plan confirmation in Chapter 13 bankruptcies) in order to protect their liens.

In 2012, the Burkharts filed a Chapter 13 bankruptcy, at which time four liens encumbered their principal residence, which was worth $435,000. Chase Bank’s first-priority lien was over $600,000 — making it the only secured creditor. Tri-County Bank held unsecured second- and third-priority liens. PNC Bank was unsecured in fourth position. Only Chase and PNC filed proofs of claim with the bankruptcy court.

The debtors initiated an adversary proceeding to strip the unsecured liens, which the trustee opposed. The bankruptcy court stripped PNC’s lien but denied to strip the Tri-County liens, holding that Bankruptcy Code § 506(d)(2) prohibits lien avoidance where no proofs of claim are filed. On appeal, the district court agreed that § 506(d)(2) barred the Tri-County liens from being voided due, simply, to the failure to file a proof of claim.

Appellate Analysis
The Fourth Circuit Court of Appeals disagreed with the lower courts, noting that the trustee’s focus on claim allowance created a system where the secured creditor has no incentive to file a proof of claim if the property is underwater. PNC filed a proof of claim and had its lien stripped, but Tri-County did nothing and its liens survived. This made no sense.

The Fourth Circuit did not adopt a hardline view of § 506. It determined that authority for a Chapter 13 debtor to strip underwater liens actually stems from § 1322(b)(2), where a plan may modify the rights of holders’ secured claims, other than a claim secured only by a security interest in real property that is the debtor’s principal residence. A creditor’s rights thus turns on whether there is any value in the collateral. The junior liens had no value because Chase’s lien swallowed the value of the property. As a result, the junior lienholders are unsecured and their liens may be stripped under § 1322(b), regardless of whether or not they filed proofs of claim.

Moving forward, creditors must be cognizant concerning whether to file proofs of claim and ensure that they are filed timely. A debtor can now strip a lien on his or her principal residence through the plan without filing anything else. If the debtor fails to complete his or her plan, then the lien will remain. However, if a creditor does not file a proof of claim on an unsecured lien, and the debtor does receive a discharge, that creditor could walk away with nothing. Moreover, valuation of the property is important.

If a creditor is in a junior position and there may be any value left after the senior lien, that junior lien is secured and cannot be stripped in Chapter 13. Even if it just a dollar, the lien will survive the bankruptcy. In these close calls, a creditor will need to object to plan confirmation to protect its lien. Consult with local counsel as to how the Burkhart v. Grigsby opinion may affect specific liens on properties in bankruptcy.

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April e-Update

Note for consideration of the USFN Award of Excellence: This article is not a "Feature."


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