At least in the Seventh Circuit, a chapter 11 plan must explicitly provide for the preservation of a lien, or a formerly secured creditor with end up having only the rights of an unsecured creditor to sue for breach of contract.
District Judge Charles R. Norgle of Chicago called the case a “shemozzle,” a word derived from Yiddish meaning a mess, an uproar, a muddle or a quarrel. The debtors, a couple who owned commercial property operating as a restaurant, neglected to pay about $40,000 in real estate taxes. Before the chapter 11 filing, someone bought tax certificates at a county tax sale and became a secured creditor.
The holder of the tax certificates was in a class by itself under the chapter 11 plan. The plan called for selling the restaurant and paying off the $40,000 in real estate tax arrears. The holder of the tax lien negotiated an amendment to the plan requiring the debtor to sell the property and pay “the entire balance owed” within six months of confirmation.
When six months passed without payment, the tax lien holder filed a motion to modify the stay so it could obtain title to the property in state court.
The debtors and the holder of a $1 million mortgage on the property responded to the lift-stay motion by tendering $50,000 in cashier’s checks and moving to modify the plan by extending the six-month payment deadline by another six months.
The bankruptcy judge refused to modify the plan and modified the stay to permit recording a tax deed, but Judge Norgle granted a stay pending appeal.
In his Jan. 23 opinion on the merits of the appeal, Judge Norgle reversed the bankruptcy court, saying it was an abuse of discretion to modify the stay because the ruling below was based on an erroneous interpretation of the law.
Like the Seventh Circuit’s Penrod decision from 1995, Judge Norgle said the holder of the tax lien “gave up its pre-petition lien” in return for a promise under the plan to be paid in six months. He said that the “tax lien secured on the restaurant property was replaced with a new right – a contractual right defined by the terms of the plan.”
Like Penrod, Judge Norgle said the holder of the tax certificate lost its lien because the plan was “silent regarding whether [the secured creditor] maintained a secured claim on the restaurant property. [The secured creditor] never negotiated a clause preserving its pre-petition lien; instead [the secured creditor] opted for a payment deadline.”
The holder of the tax certificate was not without remedy. Judge Norgle said the creditor “had a breach of contract claim against the debtors, not a right to a tax deed.”