The Trouble With Lien Stripping Under Section 506(d)

Photo Credit: The Chicago Tribune.

But this much still is clear. Right or wrong, the Dewsnuppian departure from the statute’s plain language is the law. It may have warped the bankruptcy code’s seemingly straight path into a crooked one. It may not be infallible. But until and unless the Court chooses to revisit it, it is final. — Tenth Circuit Court of Appeals, Woolsey v. Citibank, September 4, 2012

A reason that some debtors choose to file bankruptcy is to be able modify or “strip” certain liens. As recent caselaw demonstrates, however, it is very important what chapter and section of the Bankruptcy Code the debtor chooses to be able to try to accomplish this result.

It is well-accepted that chapter 13 expressly permits lien stripping. For instance, Section 1322(b)(2) of the Bankruptcy Code provides that a chapter 13 plan can modify secured claims, and Section 1327 provides that a confirmed plan can vest property in the debtor free and clear of any creditor’s interest. [FN1]

In addition, Section 506 appears to provide favorable ammunition for debtors coming to Bankruptcy Court seeking to avoid a lien. Section 506(a) defines an allowed secured claim as one secured to the extent of the value of the underlying property. Section 506(d) then states, “[t]o the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void[.]” [FN2]

But the problem is that Section 506(d) was interpreted very differently by the U.S. Supreme Court, and that decision remains the law. [FN3] In Dewsnup, the Supreme Court held that in a chapter 7 case, Section 506(d) did not allow the strip down of a lien, but only voided liens that were not “allowed” and “secured.” [FN4] In other words, if a claim is (1) allowed (which it most likely will be if the creditor files a claim in the case and the debtor does not have a basis for an objection to it), and (2) secured (which it most likely will be if the creditor obtained a lien prior to filing bankruptcy), Section 506(d) is not going to apply.

Despite this longstanding precedent, this has not stopped debtors from invoking Section 506(d) in their efforts to have liens stripped from their property. In particular, debtors have made valiant attempts to try to persuade courts to distinguish the Dewsnup ruling in chapter 13 cases.

Recently in Nicks, the District Court for the Northern District of Illinois was so persuaded. In Nicks, the Bankruptcy Court dismissed a chapter 13 debtor’s adversary proceeding seeking to avoid a tax lien under Section 506(d) based on Dewsnup, since the tax lien was both allowed and secured. The District Court reversed, finding that Dewsnup’s reasoning was limited to the chapter 7 case before it, and that the purpose of chapter 13 militated against extending its reasoning. [FN5]

The Nicks ruling appears not yet to be final, as the IRS has filed a motion for reconsideration in the case which is currently pending, and it seems a likely case for appeal. But other courts considering its rationale have disagreed.*

In another case from the Northern District of Illinois, the Bankruptcy Court held that the Nicks court was mistaken in its conclusion that Section 506(d) could be used to strip down liens in chapter 13 cases notwithstanding Dewsnup. The Ryan court held that the Supreme Court’s ruling held with equal force in chapter 13 cases, rendering Section 506(d) unavailable as a lien-stripping device in a chapter 13 case. [FN6]**

In another recent opinion, the federal appeals court for the Tenth Circuit in Woolsey, using colorful and clear language, reached the same conclusion – that a lien may not be stripped under Section 506(d) in a chapter 13 case. [FN7] As NCBRC notes, this conclusion may seem unremarkable to many in the bankruptcy community, although the persistence of debtors in tilting at Dewsnuppian windmills may be.

All is not lost, as debtors can pursue lien modification through other provisions in bankruptcy. But what these cases mean practically is that unless Nicks is affirmed on appeal by the Seventh Circuit for Illinois debtors or Dewsnup is overruled, Section 506(d) is not very helpful. Debtors seeking to modify liens should look elsewhere in the Bankruptcy Code for support.

—————
[FN1] 11 U.S.C. §§ 1322(b)(2), 1327.

[FN2] 11 U.S.C. §§ 506(a), (d).

[FN3] Dewsnup v. Timm, 502 U.S. 410, 415 (1992).

[FN4] Id. at 417.

[FN5] Nicks v. United States of America (In re Nicks), 2012 WL 3133618, No. 12 C 1360, Bankr. No. 11-31930, Adv. No. 11-1671 (N.D. Ill. July 31, 2012).

*The District Court entered a minute order on 11/8/12 denying the motion for reconsideration on the grounds that the motion reiterated previously raised arguments that the Court rejected.

[FN6] Ryan v. United States of America (In re Ryan), 2012 WL 4959632, Bankr. No. 11-34346, Adv. No. 11-1793 (Bankr. N.D. Ill. October 17, 2012), aff’d 725 F.3d 623, 112 A.F.T.R.2d 2013-5190, 2013-2 USTC P 50,418, 69 Collier Bankr.Cas.2d 1604, Bankr. L. Rep. P 82,499 (7th Cir.(Ill.) Jul 08, 2013) (NO. 12-3398), cert. den. 134 S.Ct. 1540, 188 L.Ed.2d 556, 82 USLW 3319, 82 USLW 3548, 82 USLW 3550 (U.S. Mar 24, 2014) (NO. 13-581). [updated 11/26/14]

**The Seventh Circuit further affirmed the Bankruptcy Court’s rationale.

[FN7] Woolsey v. Citibank (In re Woolsey), 696 F.3d 1266, 2012 WL 3797696 (10th Cir. (Utah) September 4, 2012).

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