In an opinion building on the Supreme Court’s infamous Dewsnup v. Timm decision from 1992, Bankruptcy Judge Diane Davis of Utica, N.Y., disagreed with the Ninth Circuit by holding that disallowance of a secured claim resulting from the lender’s default does not preclude the bank from enforcing the lien after bankruptcy, at least when the lien is otherwise incontestably valid.
Debtors in chapter 13 owed about $105,000 on a home mortgage. They confirmed a plan providing for them to pay the mortgage directly.
The debtors objected to the claim filed by the mortgage lender because the creditor failed to attach supporting documents required by Bankruptcy Rule 3001(d). The lender did not oppose the objection, presumably on the assumption that the lien nonetheless would ride through bankruptcy in line with Dewsnup, Judge Davis said.
Given the lender’s default on the claim objection, the court entered an order sustaining the objection. Significantly, the order provided only that the claim would not “share in any dividends paid to creditors” under the plan.
After the debtors received their discharges, they initiated an adversary proceeding asking the court to declare the mortgage void under Section 506(d). That section provides that a lien is “void” to the extent the lender’s secured claim was disallowed.
On cross motions for summary judgment, Judge Davis ruled in favor of the lender, upholding enforceability of the mortgage on the authority of Dewsnup and its progeny. In Dewsnup, the high court arguably disregarded the language of the Bankruptcy Code and held that liens pass through chapter 7 unaffected.
In deciding to uphold the enforceability of the mortgage despite disallowance of the lender’s secured claim, Judge Davis’s first obstacle was the language of the statute itself, which she said “appears to support the debtors’ argument when read literally and in isolation.”
Judge Davis’s second obstacle was the 2015 decision in HSBC Bank USA v. Blendheim (In re Blendheim), where the Ninth Circuit, in a secondary holding, ruled that a mortgage lien became invalid once the chapter 13 plan was confirmed and the debtors completed payments, because the lender defaulted on an objection to the secured claim. To read ABI’s discussion of Blendheim, click here.
As other courts have done, Judge Davis read Dewsnup for the proposition that a secured creditor can decline to participate in a bankruptcy “without jeopardizing its underlying lien” and that “lien rights are generally preserved rather than forfeited in bankruptcy.”
She therefore adopted the approach of three circuit courts that interpret the “longstanding principle that valid liens pass through bankruptcy unaffected” to mean that Section 506(d) cannot be used to void a lien when the underlying claim was disallowed because it was not filed before the deadline.
Judge Davis distinguished Blendheim, because forgery allegations in that case meant the lien could have been defeated on the merits had the lender not defaulted on the claim objection. She also noted that chapter 13 has protections for secured lenders that “Section 506(d) does not afford” in chapter 7, such as the inability to modify the mortgage on a principal residence.
If the prior claim objection did not rule on “the substance of a creditor’s claim or make a merits-based determination,” Judge Davis said it “would be illogical and contrary to longstanding bankruptcy jurisprudence to deprive such creditor of its contractual in rem rights.”
Judge Davis’s conclusion is in line with the 2011 Advisory Committee Notes to Rule 3001, which say that failure to provide information in itself does not justify disallowing a claim.
Her conclusion is also fair because the mortgage holder may have defaulted on the claim objection in reliance on Dewsnup, especially since the plan provided for paying the mortgage directly. That does mean, however, that the result would necessarily be the same were the case taken to the Supreme Court.
Especially if Justice Antonin Scalia were alive, the debtors in this case could mount a frontal attack on Dewsnup in the Supreme Court. At oral argument in 2015 in Bank of America v. Caulkett, Justice Scalia said that the majority in Dewsnup had disregarded the plain meaning of the statute to implement a policy without support in the law.
In the unanimous Caulkett decision in June 2015, Justice Clarence Thomas said that a “straightforward reading” of Section 506(d) would produce the result that Justice Scalia advocated 23 years earlier in his Dewsnup dissent. Because the debtor in Caulkett was not asking to overrule Dewsnup, the Court continued to follow its 1992 precedent.
At oral argument in Caulkett, other justices seemed to believe that Dewsnup may have been wrongly decided. Whether the Supreme Court today would overturn Dewsnup could depend on how much the justices follow the principle of stare decisis.
In any event, questions about Dewsnup might lead some lower courts to read that case more narrowly.