With its Ahern decision in 2007, the Fifth Circuit created doubt about the ability of a plan to bind a secured creditor who sits on the sideline and never participates in a chapter 11 case.
Relying on Chesnut, a later nonprecedential authority from the Fifth Circuit, Bankruptcy Judge Eduardo V. Rodriguez of McAllen, Texas held that a chapter 13 debtor can modify and pay off a secured claim if the lender is given constitutionally sufficient notice, even if the lender never participates in the bankruptcy. Judge Rodriguez’s opinion also seems applicable to chapter 11 plans.
The Plan Modified and Paid a Secured Loan in Full
The debtor owned a home worth about $80,000, encumbered by a 14% mortgage with an outstanding balance of some $23,000. The chapter 13 plan called for reducing the interest rate to 5.25% and paying the mortgage loan in full through payments by the trustee.
When the lender failed to file a claim, the debtor filed a $23,000 claim on the lender’s behalf. Although it received multiple mailed notices — including notice of the plan, the claim filed by the debtor, and the confirmation hearing — the lender never appeared and never participated in the chapter 13 process.
However, the lender did accept plan payments from the trustee.
After the trustee certified that the debtor had made all plan payments, the debtor filed a motion for entry of a discharge. For the first time, the lender appeared and claimed that $30,000 was still owing on the mortgage, by applying plan payments first to interest at the higher rate.
The debtor responded with a motion to deem the mortgage paid in full and to require the lender to release the lien on the entry of discharge.
Is Ahern or Chesnut the Better Authority?
The lender relied on Elixir Industries Inc. v. City Bank & Trust Co. (In re Ahern Enterprises Inc.), 507 F.3d 817 (5th Cir. 2007), where the Fifth Circuit held that a plan could not void a mortgage unless the lender had participated in the chapter 11 case. Although courts in the Fifth Circuit continue following Ahern, its validity is subject to doubt in view of United Student Aid Funds Inc. v. Espinosa, 559 U.S. 260 (2010), where the Supreme Court held three years after Ahern that a chapter 13 plan could discharge a student loan even though the debtor had not followed required procedures, as long as the lender had sufficient notice.
Judge Rodriguez held in his June 30 opinion that the loan had been repaid and required the lender to release the mortgage lien. He relied in significant part on a Fifth Circuit opinion two years after Ahern, Brown v. Chesnut (In re Chesnut), 356 Fed. Appx. 732 (5th Cir. 2009), a nonprecedential, per curiam opinion by a panel that included Circuit Judge Carolyn King.
In Chesnut, the debtor had filed a claim on behalf of the secured lender, who did not object to the chapter 13 plan. After the debtor made all plan payments, the lender refused to release the lien, claiming the payments did not satisfy the debt.
The Fifth Circuit in Chesnut held that res judicata enabled the bankruptcy court to enforce the plan and ordered the lien released.
Saying that Chesnut was “similar to the case at bar,” Judge Rodriguez ruled there was no participation requirement in determining whether a plan and confirmation order are res judicata because neither the plan nor the confirmation order voided the lien. In other words, he limited Ahern to cases where the plan purported to void a lien as opposed to paying off a lien.
Judge Rodriguez therefore held that the lender’s “participation was not required in order for [the lender] to be bound by the debtor’s plan and this court’s confirmation order under the res judicata doctrine.”
In Chesnut, the lender did not raise the participation issue in the Fifth Circuit. Therefore, Chesnut is arguably not inconsistent with Ahern.
The case decided by Judge Rodriguez would be an excellent vehicle for the Fifth Circuit to rule on whether a secured creditor can sit on the sidelines throughout a chapter 11 or 13 case and claim not to have been affected by a confirmed plan. If the Court of Appeals were to disagree with Judge Rodriguez, it is not clear how plans in chapters 11 or 13 could affect secured creditors in the Fifth Circuit without compelling them to participate.
An appeal would also allow the Fifth Circuit to sit en banc and reconsider Ahern in light of Espinosa, while deciding whether Chesnut is good law.