In Dewnsup v. Timm, 502 U.S. 410, (1992), the Supreme Court addressed the question of whether Chapter 7 debtors could strip down a consensual lien against their real property. In that case, the property was encumbered by a first deed of trust securing payment of $120,000. The property had an approximate value of $39,000, leaving an unsecured deficiency of $81,000. The debtors then sought to have the secured lien “stripped down” to $39,000, the claimed fair market value of the property, pursuant to the provisions of Section 506(d). The relief sought by debtors was denied by the lower courts. The Supreme Court affirmed, and stated that:
The practical effect of [Appellant’s] argument is to freeze the creditor’s secured interest in the judicially determined valuation. By this approach, the creditor would lose the benefit of any increase in the value of the property by the time of the foreclosure sale. The increase would accrue to the benefit of the debtor * * * as a “windfall.” [T]he Creditor’s lien stays with the real property until the foreclosure. That is what was bargained for by the mortgagor and the mortgagee. The voidness language sensibly applies only to the security aspect of the lien and then only to the real deficiency in security. Any increase over the judicially determined valuation during bankruptcy rightly accrues to the benefit of the creditor * * * *.
* * * *
Under the Bankruptcy Act of 1898, a lien on real property passed through the bankruptcy unaffected…[T]o attribute to Congress the intention to grant a debtor the broad new remedy against allowed claims to the extent that they become “unsecured” for purposes of §506(a) without the new remedies being mentioned somewhere in the Code itself or in the annals of Congress is not plausible, in our view, and is contrary to basic bankruptcy principles.
Id. at 417-18 and 420.
In a second Supreme Court opinion, Nobelman v. American Savings Bank, 508 U.S. 324 (1993), the same issue arose in the context of a Chapter 13 case. The court addressed Section 1322(b)(2) of the Bankruptcy Code, which allows modification of the rights of both secured and unsecured creditors under a debtor’s repayment plan, subject to special protection for creditors whose claims are secured only by a lien on the debtor’s home. The court agreed with the debtors and found that a court must look first to Section 506(a) – the section which was distinguished and disregarded in Dewnsup – for a judicial valuation of the collateral to determine the status of the bank’s secured claim. In this case, there was some value that was underlying the claim. Consequently, the court found that “by virtue of its mortgage contract with petitioners, the bank is indisputably the holder of a claim secured by a lien on petitions’ home”, even if it was undersecured. Id. at 329.
Thus, the court found that even though the mortgage was undersecured, the bank’s rights pursuant to Section 1322 were “reflected in the relevant mortgage instruments . . . [including] the right to repayment of the principal in monthly installments over a fixed term at specified adjustable rates of interest, the right to retain the lien until the debt is paid off, the right to accelerate the loan upon default and to proceed against petitioners’ residence by foreclosure and public sale, and the right to bring an action to recover any deficiency, remaining after foreclosure.” Id.
To give effect to §506(a)’s valuation and bifurcation of secured claims through a Chapter 13 plan in the manner petitioners propose would require a modification of the rights of the holder of the security interest. Section 1322(b)(2) prohibits such a modification where, as here, the lender’s claim is secured only by a lien on the debtor’s principal residence.
Id. at 332. Both Dewnsup and Nobelman involved a “strip down”. The term “strip down” has been defined and used in those situations where the inferior mortgage is partially secured. The term “strip off” is used where the junior mortgage is totally unsecured. A conflict exists among the courts as to whether a debtor is able to use Section 506(d) to “strip off” a consensual mortgage.
I. Strip Off Permissible.
Several courts permit a debtor to avoid a totally unsecured lien under Section 506(d). See, Yi v. Citibank, 219 B.R. 394, 397 (E.D.Va.1998); In re Smith, 247 B.R. 191 (W.D.Va.2000); Zempel v. Household Finance Corp., 244 B.R. 625 (Bankr.W.D.Ky.1999); Farha v. First American Title Ins., 246 B.R. 547, 549 (Bankr.E.D.Mich.2000); and In re Malone, 489 B.R. 275 (Bankr.N.D.Ga.2013)(Debtor could use Code provision purporting to void any lien that secures a claim against debtor that is not an allowed secured claim in order to “strip off” junior security interest.). In the Eleventh Circuit, In re Williams, 488 B.R. 492 (Bankr.M.D.Ga.2013) held debtors may avoid totally unsecured leans citing to Folendore v. U.S. Small Business Administration (In re Folendore), 862 F.2d 1537 (11th Cir.1989) and McNeal v. GMAC Mortg., LLC, 477 Fed.Appx. 562 (11th Cir.2012). Folendore provided the logic for lien stripping stating as follows:
While it is true that the Folendores might in the future pay off the mortgages on the property, at this moment the banks could foreclose on the property and cut out the SBA and the Folendores completely. The SBA admits the banks’ power to foreclose and annihilate the SBA lien. The SBA presumably hopes that sometime in the future the Folendores will have equity in the property which could be attached by the SBA. The SBA’s position is self-defeating. It simply provides an incentive for the Folendores to abandon the property. There is no reason the Folendores should remain on a piece of property on which the SBA can attach any equity they manage to generate. They, and any other post-discharge possessors of real property, would be far better off finding unencumbered property upon which to start their financial life afresh. This, of course, would leave a creditor like the SBA with nothing, which is exactly what section 506(d) on its face says it has.
In re Folendore, 862 F.2d at 1540.
However, even within this group of cases that allow “strip offs” a dispute exists as to how to determine whether a strip off is occurring. In Williams, the Internal Revenue Service filed a notice of federal tax lien against debtor–plaintiffs on May 21, 2012. Debtors filed a Chapter 7 petition on August 13, 2012. The debtors listed their only real property as their residence, worth $150,000 and subject to debts of $300,000. They listed personal property worth $46,500. The complaint alleges the residence is worth $210,000 and is encumbered by a first priority lien in favor of Wells Fargo in the amount of $237,564 and a second priority lien in favor of the IRS in the amount of $77,588.51 plus interest. So the IRS’ lien was completely ‘out of the money’ with respect to the real estate, but still encumbered the personal property.
The court held that under these facts, stripping off the IRS lien from the real estate was not possible. It stated that under §506(d) the question was whether the IRS’s lien “secures a claim against the debtor that is not an allowed secured claim.” A “claim” is defined not by the existence and extent of collateral but by the existence and extent of debt. The debtors’ schedules listed the IRS as the holder of a single priority claim. That claim was either an allowed secured claim for purposes of Section 506(d), or it is not. “There is no basis to divide the claim into separate claims for each type of collateral – i.e., one claim secured by the real property and a second claim secured by the personal property – which would then be independently analyzed to determine whether they are allowed secured claims.” Id. at 498.
The IRS holds one claim. As long as the claim can attach to some value, it is “secured” for purposes of §506(d). Here the IRS’s claim does attach to value in the personal property. Therefore the IRS’s single claim is an “allowed secured claim” under §506(d). As a result, Dewsnup rather than McNeal applies to these facts, and no portion of the IRS lien can be avoided.
Id. at 499. See also, Hoekstra v. U.S. (In re Hoekstra), 255 B.R. 285 (E.D.Va.2000); but see, Johnson v. IRS (In re Johnson), 386 B.R. 171, 181 (Bankr.W.D.Pa.2008), aff’d, 415 B.R. 159 (W.D.Pa.2009) (“[I]t would make no sense to deny the Debtor relief in this case based solely on a fiction the IRS itself does not consistently follow, that is, that the IRS lien is so indivisible in nature that a Bankruptcy Court cannot strip it off real property that has no equity value while allowing it to remain on personalty that does have value.”)
II. Strip Off Not Permissible.
Other courts have concluded that Section 506(d) is not available to the debtor to “strip off” a totally unsecured consensual mortgage on real estate. In Ryan v. Homecomings Financial Network, 253 F.3d 778 (4th Cir. 2001), the court dealt with the Dewnsup issue, but this time in the context of a request to “strip off” a lien that was fully unsecured. The appellants in this case argued that a junior lien which is unsecured may be “stripped off” pursuant to Section 506(d). The Fourth Circuit disagreed, discerning no principal distinction between the concept of “stripping down” a lien and “stripping off” a lien.
Dewsnup teaches that, unless and until there is a claims allowance process, there is no predicate for avoiding a lien under Section 506(d). Absent either a disposition of a putative collateral or valuation of the secured claim for plan confirmation in Chapter 11, 12 or 13, there is simply no basis on which to avoid a lien under Section 506(d). Section 506(d) standing alone does nothing. This section is efficacious only upon combination with a lien-voiding provision of the Bankruptcy Code.
Ryan, 253 F.3d at 782. This position was also adopted in In re Davenport, 266 B.R. 787 (Bankr.W.D.Ky.2001).
A similar conclusion was reached in In re Cunningham, 246 B.R. 241 (Bankr.D.Md.2000) where the court stated that Section 506(d) did not confer additional avoiding power. Further, the court noted that the right to redeem already exists with Section 722 of the Bankruptcy Code, which can be accomplished by paying the holder of the lien the cash value of the property sought to be redeemed. While this right is limited to tangible personal property, the court noted that “[h]ad Congress intended to provide for the redemption of real property as well, it would have provided for that form of relief in the Bankruptcy Code. Moreover, Section 722 would be redundant if Section 506(d) were interpreted so as to allow for lien stripping in chapter 7.” Id. at 247.
The same conclusion was reached in Wachovia Mortg. v. Smoot, 478 B.R. 555 (E.D.N.Y.2012). Quoting Laskin v. First National Bank of Keystone (In re Laskin), 222 B.R. 872, 876 (9th Cir.BAP 1998), the court noted: “[W]hether the lien is wholly unsecured or merely undersecured, the reasons articulated by the Supreme Court for its holding in Dewsnup . . . – that liens pass through bankruptcy unaffected, the mortgagee and mortgagor bargained for a consensual lien which would stay with real property until foreclosure, and that any increase in value of the real property should accrue to the benefit of the creditor, not the debtor or other unsecured creditors – are equally pertinent.”
Smoot stated that it plainly appeared that the Supreme Court intended the concept of “secured” to have a specific definition in the Chapter 7 context, so that valuation of the underlying collateral is irrelevant. The court stated:
Although the lien at issue in Dewsnup was secured by at least some equity in the debtor’s property, in light of the binding precedent, the Court disagrees that this distinction is dispositive. Rather, what is controlling is the Supreme Court’s construction of §506(d). An “allowed secured claim” in §506(d) does not denote a claim that is allowed and fully secured, but instead a “claim [that] is secured by a lien and has been fully allowed.” In other words, under the Supreme Court’s guidance, “if a claim is secured in the nonbankruptcy sense, without regard to §506(a)’s bifurcation of claims into secured and unsecured claims, and it is allowed in the bankruptcy case, it cannot be voided or stripped down by §506(d).
Id. at 568-69. Other Circuit Courts have allow judges to approve the reduction of the wholly unsecured junior lien through the process of “lien stripping” pursuant to Section 506(d) notwithstanding the anti-modification protection afforded holders of home mortgages in Section 1322(b)(2) as implied by Nobelman. See e.g., Pond v. Farm Specialst Realty (In re Pond), 252 F.3d 122 (2nd Cir.2001); McDonald v. Master Fin., Inc. (In re McDonald), 205 F.3d 606 (3rd Cir.2000); In re Bartee, 212 F.3d 277 (5th Cir.2000); In re Lane, 280 F.3d 663 (6th Cir.2002); Zimmer v. PSB Lending Corp., 313 F.3d 1220 (9th Cir.2002); and In re Tanner, 217 F.3d 1357 (11th Cir.2000).
Matthew T. Gensburg