This post assumes familiarity with my last post (part 1) of this multi-part series.  Thus, while you can certainly read this post without reading that previous one, you’ll get more out of it if you read that post first.

III.  Avoidance Of A Partially Or Wholly Unsecured Lien In Chapters 11 And 13

11 U.S.C. § 506 is used to determine the extent to which a claim is secured.  Rather than delving into the wording of the statute, let’s informally say that if the value of the collateral is less than the sum of the liens against it, then at least some of the liens are not fully secured, and some may even be wholly unsecured.

For example, suppose the collateral is a piece of real estate worth $500,000.  And suppose there are three liens against it.  The first recorded has a balance of $475,000, the second recorded has a balance of $50,000, and the third recorded has a balance of $50,000.  Then the first is fully secured because the property is greater in value than the balance of the first.  The second is partially secured:  $25,000 is secured by the house, and $25,000 is unsecured.  And the third is wholly unsecured.

I realize that in today’s real estate market, this scenario is unlikely.  However, some years ago it was fairly common.  And given the cyclic nature of things, we may see a repeat of the past —plus ça change, plus c’est la même chose.

   A.  Avoiding A Wholly Unsecured Lien

In Zimmer v. PBS Lending Corp. (In re Zimmer), 313 F.3d 1220 (9th Cir. 2002) the Ninth Circuit held that a Chapter 13 debtor can avoid a wholly unsecured lien against the debtor’s principal residence.

How does Zimmer square with § 1322(b)(2), which provides:  “the plan may … modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor’s principal residence, or of holders of unsecured claims, or leave unaffected the rights of holders of any class of claims.”  The answer lies in the fact that a wholly unsecured lien against the debtor’s residence is not actually secured by the debtor’s residence.  In that situation the debtor can strip off the wholly unsecured junior lien and treat it as a general unsecured debt for plan purposes.  You can use Form F 4003-2.5.

Note:  Two of our judges, Judge Zurzolo and Judge Johnson, require you to do the avoidance in an adversary proceeding because of Fed. R. Bankr. P. 7001(2).

Although the lien avoidance is done at the beginning of the case, it doesn’t take effect until plan completion because the now unsecured junior lien must be paid at the same rate as the other general unsecured claims.[1]  Thus, at plan completion you may need to move for an order finally avoiding the lien.

By the way, if your debtor gets a hardship discharge under § 1328(b) you can still get the final order because a requirement for a hardship discharge is that the unsecured creditors have already been paid the amount they would have received in a Chapter 7 liquidation.

Since the wording of § 1123(b)(5) is the same as that of § 1322(b)(2), Zimmer applies, mutatis mutandis, in a Chapter 11 plan.

Although we have been focused on a wholly unsecured lien on the debtor’s principal residence — primarily because of the exception in §§ 1322(b)(2) and 1123(b)(5) — this sort of lien stripping can be done on wholly unsecured liens against other assets.

   B.  Avoiding A Partially Secured Lien

But suppose the lien is partially secured and partially unsecured.  Can the claim be bifurcated into secured and unsecured portions?  The Supremes have answered that question in a couple of decisions.

  1. The Collateral Is The Debtor’s Principal Residence
          a. The Collateral Is Only The Debtor’s Principal Residence

In Nobelman v. American Savings Bank, 508 U.S. 324 (1993) the Court held that because of § 1322(b)(2) a lien that is only partially secured by the debtor’s principal residence cannot be bifurcated into secured and unsecured portions.  And since § 1123(b)(5) is the same as § 1322(b)(2), the same holds in a Chapter 11.  See also Dewsnup v. Timm, 502 U.S. 410 (1992).

          b. Special Subchapter V Exception

A Subchapter V plan may modify the rights of the holder of a claim secured only by the debtor’s principal residence, if the debt was incurred not primarily to purchase the property, and was used primarily in connection with the small business of the debtor.  11 U.S.C. § 1190(3).

  1. There Is Other Collateral In Addition To The Debtor’s Principal Residence

Sections 1322(b)(2) and 1123(b)(5) each contain the adverb, “only,” to wit:  “… other than a claim secured only by a security interest in real property that is the debtor’s principal residence …”  Therefore, if the lien was recorded against both the debtor’s principal residence and another piece of collateral — say another piece of real estate — the limitation doesn’t apply.

  1. The Collateral Is Not The Debtor’s Principal Residence

If the collateral is not the debtor’s principal residence, then the aforementioned limitation doesn’t apply.  Instead, the debtor may “modify the rights of holders of secured claims” per §§ 1322(b)(2) and 1123(b)(5).  The process involves a motion to value under § 506 and Fed. R. Bankr. P. 3012.  The big dispute will be over the value of the collateral — typically done at the time of valuation, not the petition date, because § 522 is not implicated.

IV.  The Chapter 7 Context

Can a Chapter 7 debtor avoid a lien?  In the case of a lien covered by § 522(f), the answer is an unequivocal yes.  Section 522(f) can be used in all chapters.

However, in the other contexts the answer is no.  Bifurcation is unavailable because of Dewsnup, and stripping a wholly unsecured lien is unavailable in Chapter 7 because of Bank of America, NA v. Caulkett, 135 S. Ct. 1995 (2015).

[1] Otherwise, if the case is dismissed prior to plan completion, the lien will be reinstated.