In the January 2015 edition of the ABI Journal, Kathleen Furr and Brett Switzer (hereinafter “the authors”) lauded the decision in In re Rose.[1] In that decision, the court rejected the concept of providing for the vesting of property of a chapter 13 estate in an entity other than the debtor, based solely on state law.[2] The authors relegate the opposite view to a couple of footnotes. That is unfortunate because the opposite view — such as the one in In re Watt[3] — correctly analyzes the applicable law. Because Rose focused on state law, its analysis is profoundly flawed.
We begin with “bankruptcy bromides,” as the First Circuit calls them. The purpose of bankruptcy is to enable the honest-but-unfortunate debtor to shed oppressive debt and get a fresh start on his financial life. This has been true for at least a century.[4] Although the power of Congress to enact uniform laws on the subject of bankruptcy is enshrined in the Constitution, the first bankruptcy statute was not enacted until 1800. Since then, the purposes and methods of providing bankruptcy relief have changed dramatically as the economy has changed.[5]
In modern times, the most common reason for an individual to file a bankruptcy case is to avoid foreclosure of a home mortgage. In the present economy, however, property values have declined significantly while mortgage loan balances have skyrocketed. As a result, many debtors wish to rid themselves of “underwater” properties. The need for bankruptcy relief can stem from other sources, as well: poor financial management, job loss or unexpected medical expenses, for example. Regardless of the cause, helping debtors change the habits, or solve the problems, that created the need is a necessary element of effective bankruptcy representation. To paraphrase Santayana, debtors who cannot remember the past are condemned to repeat it.
Where the debtor does not want to keep the property, all of the pertinent chapters of the Code provide that a debtor may “surrender” the property to the creditor. While chapters 7 and 13 explicitly mention “surrender,” chapter 11 does not, but by reading several statutory provisions together, one can find a basis for “surrender” in chapter 11.
In the practical sense, “surrender” is useless because “surrender” only means that the debtor makes the collateral available, and the creditor can do with it — or not — whatever the creditor wants. More often than not, this means that the creditor does nothing, and the collateral just sits there.[6] This leaves the debtor and the bankruptcy estate potentially liable for property maintenance, taxes and insurance (as administrative expenses), and there may well be criminal penalties if the property has been abandoned in the literal sense, such as the debtor moving from the property. For a debtor that wants to divest himself of burdensome, unwanted property — not just debt — chapter 7 is a poor choice.
Fortunately, chapter 13 provides a solution to the problem. Under § 1322(b)(8) and (9), a debtor’s plan may provide for payment of any claim from property of the estate or property of the debtor, and may also provide for the vesting of property in the debtor or in any other entity, upon confirmation or at a later time. There is no ambiguity in those sections, and the language is as plain as it can be. These sections are how the debtor surrenders property.[7] It is common ground that absent some plan provision to the contrary, the debtor’s interest in property of the estate generally vests in the debtor upon confirmation.[8] This is a matter of local practice, but there is no reason why property cannot vest upon confirmation in an entity other than the debtor because the language of § 1322(b)(9) is plain and unambiguous.
For property that the debtor wishes to surrender, plans should provide for both surrender and vesting in the secured creditor upon confirmation; they are separate provisions of chapter 13, so they should both be explicitly and separately stated. There is no principled reason to delay vesting and every practical reason to vest effective with confirmation. It is the debtor’s choice, and if the debtor chooses vesting, the secured creditor has nothing to say about it, nor does the court, absent some statutory basis (i.e., the Bankruptcy Code).[9]
Under § 1322(b)(9), a plan effects surrender by vesting the property in the creditor (“or any other entity”) upon confirmation, unless a later time is stated in the plan. A plan using this method should explicitly state that the property vests and when it vests, and explicitly reference § 1322(b)(9). In Associates Commercial Corporation v. Rash,[10] the Supreme Court stated that “When a debtor surrenders the property, a creditor obtains it immediately, and is free to sell it and reinvest the proceeds,” and that “surrender and retention are not equivalent acts.”[11] Thus, a debtor who wishes to surrender property and vest it in the secured creditor should vacate the property or, in the case of an automobile, for example, possibly drive it to the nearest dealer and hand over the keys (i.e., cease retaining the property).[12] Providing for vesting in this manner should be uncontroversial with case law authority like this. All that Pratt and Canning — both chapter 7 cases — mean is that title remains in the debtor until the secured creditor does something with it; they say nothing about surrender under chapter 13.[13] Thus, vesting pursuant to § 1322(b)(9) puts teeth in a debtor’s right to surrender property to the secured creditor.
In In re Rosa,[14] the secured creditor did not object to the plan,[15] although the chapter 13 trustee did. Since the creditor did not object, it was deemed to have accepted the plan pursuant to § 1322(b)(5)(A), so the trustee’s objection was overruled. The court suggested that if the creditor had objected, the result might have been different. However, § 1322(b)(9) is abundantly clear and gives the debtor discretion to include such a provision in a plan; nothing in the Bankruptcy Code permits a secured creditor to refuse surrender and vesting. Thus, the creditor’s view on this issue should have no impact on confirmation.
Some creditors have argued that notwithstanding the unambiguous statutory language, a creditor’s consent to surrender is required for a plan to be confirmed, and based on state law, they can refuse surrender and vesting. There is no merit to this position; creditor’s consent is not required for surrender pursuant to § 1325(a)(5)(C).[16] Prior to confirmation, only the debtor may propose a plan — not the trustee, not the court and certainly not a creditor.[17] The provisions of § 1322(a) are mandatory, but the provisions of § 1322(b) are permissive.[18] It is the debtor who has permission to use those provisions, and a creditor’s consent is not required by the Code.
Likewise, the provisions of § 1325(a) are mandatory, and the court must confirm a plan that conforms to § 1325(a).[19] “Surrender” is an explicit, Congressionally approved manner of paying a secured claim.[20] A plan that complies with § 1325 — including a provision for surrender of the collateral — must be confirmed, assuming there are no other statutory barriers to confirmation.[21]
Part of creditors’ argument — and what the court in In re Rose[22] held — is that because state law (usually) requires “acceptance” of a deed for a conveyance to be effective, creditors must “accept” the plan. It is true that state law generally controls how the bankruptcy court resolves disputes over property issues.[23] In Butner, the Supreme Court stated:
Property interests are created and defined by state law. Unless some federal interest requires a different result, there is no reason why such interests should be analyzed differently simply because an interested party is involved in a bankruptcy proceeding.[24]
The Rose court did not mention Butner. Had it done so, it would have realized that the first part of the second sentence is widely and conveniently overlooked, as courts tend to focus on the second part. For present purposes, it is the first part (“Unless some federal interest requires a different result,…”) that should have controlled the court’s decision and, for the reasons given below, would have required that the court confirm the debtor’s plan.
This is because under the federal Constitution, federal law is the supreme law of the land, and to the extent that a state law conflicts with federal law, the state law must give way.[25] The court noted in that case that where a federal statutory scheme is “so pervasive … that Congress left no room for the States to supplement it or where there is a federal interest … so dominant that the federal system will be assumed to preclude enforcement of state laws on the same subject,” the court infers an intent to displace state law altogether.
The Bankruptcy Code is such a statutory scheme.[26] It is true that in some respects, the Bankruptcy Code incorporates state law, as Butner stated. For example, Congress gave states the right to determine what property may be exempted from a bankruptcy estate, and whether federal or state law, or either, will control.[27] Absent an explicit statutory provision to the contrary by Congress, however, it is the Bankruptcy Code that determines the rights of debtors and creditors in bankruptcy cases. This federal interest overwhelms any interest a state may have in the subject, and any state law (statutory or common) conflicting with the Bankruptcy Code cannot stand.
The obvious result is that if a debtor chooses to exercise the option under § 1322(b)(8) to pay a mortgage claim (or at least the secured portion of it) by providing that the property will be surrendered pursuant to § 1325(a)(5)(C) and vest in the creditor pursuant to § 1322(b)(9), any otherwise-applicable state law is preempted. Butner is not to the contrary; in fact, it supports that position.
The Rose court then posits a “parade of horribles” about what might happen to the creditor if vesting is permitted. This solicitude for creditors is somewhat startling because it fails to recognize that the same “horribles” would devolve on the debtor and the bankruptcy estate if they came to pass and vesting had not been allowed — including the possibility of criminal penalties if, for example, the property is abandoned and becomes a danger to the health and/or safety of the community. It is also mystifying because there is no principled reason to saddle a debtor or the bankruptcy estate with property that is infected with any of these “horribles.” Above all, it is contrary to the well-settled principle that “[t]he principal purpose of the Bankruptcy Code is to grant a ‘fresh start’ to the ‘honest but unfortunate debtor.’”[28] The “principal purpose” is not to protect the interests of creditors, but to balance those interests with the “fresh start.”[29]
In fact, the secured creditor bargained for the right to have the property vest in it, albeit through foreclosure, so the resistance to vesting is puzzling. Security interests, such as mortgages, are defined in § 101(51) as liens created by an agreement. Thus vesting through a chapter 13 plan ought to be a highly desirable provision for secured creditors since it gives them the benefit of the bargain and saves them time and money since they do not need to go through the foreclosure process; it is the bankruptcy equivalent of a deed-in-lieu of foreclosure.
The Rose decision gives entirely too much weight to inapplicable state law and is entirely too solicitous of the interests of creditors as over debtors and the bankruptcy estate. By contrast, the court in In re Watt[30] got it right, and should be followed by other courts.
[1] 512 B.R. 790 (Bankr. W.D.N.C. 2014).
[2] The issue in Rose did not arise in the context of confirmation; instead, the debtors filed a motion to quitclaim the property to the creditor. It is conceivable that the result might have been different had the issue arisen in the context of confirmation of a plan with a provision employing § 1322(b)(9).
[3] 2014 WL 5304703 (Bankr. D. Or. 2014).
[4] See Williams v. United States Fidelity and Guaranty Co., 236 U.S. 549 (1915).
[5] See Central Va. Community College v. Katz, 546 U.S. 356 (2006).
[6] See, e.g., In re Pratt, 462 F.3d 14 (1st Cir. 2006) (automobile), and In re Canning, 706 F.3d 64 (1st Cir. 2013) (real estate).
[7] In re Bryant, 323 B.R. 635, 645 (Bankr. E.D. Pa. 2005) (in dicta).
[8] In some circuits, such as the First Circuit, property usually does not vest in the debtor until the discharge enters. A vesting provision would change that result.
[9] Cf. Law v. Siegel, 134 S. Ct. 1188 (2014).
[10] 520 U.S. 953 (1997).
[11] Id. at 962.
[12] See also In re White, 487 F.3d 199 (4th Cir. 2007).
[13] It may be that in Pratt and Canning, the First Circuit had in mind the provision of § 554(c), which states that property not administered during the case is abandoned to the debtor upon closing of the case. Again, there is no other “vesting”-like provision in chapter 7 relating to property of the estate post-petition. As a side note, one wonders if it would be possible to abandon the property to the secured creditor; that is beyond the scope of this article.
[14] 495 B.R. 522 (Bankr. D. Haw. 2013).
[15] Thus, the “silence” to which the authors were referring. Such silence was, indeed, “golden” for the debtors.
[16] In re White, 282 B.R. 418 (Bankr. N.D. Ohio 2002), and In re Harris, 244 B.R. 556 (Bankr. D. Conn. 2000).
[17] In re Muessel, 292 B.R. 712 (B.A.P. 1st Cir. 2003). Post-confirmation, the debtor, the trustee or an unsecured creditor may propose a plan amendment, but not a secured creditor. They must comply with the feasibility and best-interests tests, however. See In re Trumbas, 245 B.R. 764 (Bankr. D. Mass. 2000).
[18] In re Nosek, 544 F.3d 34 (1st Cir. 2008).
[19] In re Hamilton, 401 B.R. 539 (B.A.P. 1st Cir. 2009).
[20] See § 1325(a)(5)(C).
[21] Cf. Law v. Siegel, supra.
[22] 512 B.R. 790 (Bankr. W.D.N.C. 2014)
[23] See Butner v. United States, 440 U.S. 48 (1979).
[24] Id. at 55 (emphasis added).
[25] See, e.g., Arizona v. U.S., 132 S. Ct. 2492, 2500 (2012).
[26] See generally Central Va. Community College v. Katz, 546 U.S. 356 (2006).
[27] See Law v. Siegel, 134 S. Ct. 1188 (2014).
[28] Citizens Bank v. Marrama, 549 U.S. 365 (2007), quoting Grogan v. Garner, 498 U.S. 279 (1991).
[29] Cf. id.
[30] 2014 WL 5304703 (Bankr. D. Or. 2014).