There is a pending Ninth Circuit case to decide whether a wholly unsecured claim should count toward a debtor’s chapter 13 eligibility following a chapter 7. On April 26, 2010, Aleli A. Hernandez (the debtor) filed a chapter 7 bankruptcy case in the U.S. Bankruptcy Court for the Central District of California[1] identifying Chase Home Mortgage and Cadles of Grassy Meadows II, LLC as holding secured claims pursuant to first and second trust deeds, respectively, on real property identified as 22851 Maiden Lane, Mission Viejo, California 92692 (the property). On Aug. 17, 2010, the debtor received a discharge enjoining recovery against her personal liability, but not against her property.[2] Therefore, by extinguishing the in personam but not in rem liability, Chase and Cadles were now foreclosed from pursing collections against the debtor, but not against her property.[3]
On Feb. 5, 2015, the debtor filed a subsequent chapter 13 bankruptcy case[4] again identifying Chase and SW Linear Investment Group, LLC (SWL), successor in interest to Cadles, as holding secured claims pursuant to first and second trust deeds, respectively, on the property. On May 22, 2015, the debtor filed a Motion to Avoid Junior Lien on Principal Residence (the “Avoidance Motion”).[5] The Avoidance Motion asserted that the value of the property is $950,000 and the value of Chase’s claim is $1,035,513.37. The Avoidance Motion further asserted that the value of SWL’s claim is $459,221.60. The debtor asserts that since there is no equity in the property, SWL’s claim should be avoided.
On June 3, 2015, SWL filed its Motion to Dismiss.[6] The dismiss motion argues that if the avoidance motion is denied, the resulting secured claims exceed the statutory debt limits; alternatively, if the avoidance motion is granted, the resulting unsecured claims exceed the statutory debt limits.[7] On July 31, 2015, the bankruptcy court entered an Order Granting the Avoidance Motion (the “avoidance order”). Specifically, the avoidance order held that upon receipt of a discharge, SWL’s lien will be avoided, and until then, “[a]ny filed proof of claim of the junior lienholder is to be treated as an unsecured claim and is to be paid through the plan pro rata with all other unsecured claims.”[8]
On July 5, 2016, the bankruptcy court entered an Order Denying the Dismiss Motion (the “dismiss order”). On July 25, 2016, the bankruptcy court entered an Order Confirming the Chapter 13 Plan (the “confirmation order”). On July 25, 2016, and Aug. 8, 2016, Asset Management Holdings, LLC (AMH), successor in interest to SWL, filed Notices of Appeal and a Statement of Election with respect to the dismiss and confirmation orders (together, the “orders”) with the Ninth Circuit Bankruptcy Appellate Panel (BAP).[9] On April 11, 2017, the BAP entered a Judgment Affirming the Orders. On May 10, 2017, AMH filed its Notice of Appeal of Judgment Entered April 11, 2017. That appeal is now pending before the Ninth Circuit Court of Appeals as Case Number 17-60044.[10]
Standard
Both AMH and the debtor concur that the standard for chapter 13 eligibility is:
Only an individual with regular income that owes, on the date of the filing of the petition, noncontingent, liquidated, unsecured debts of less than $250,000 and noncontingent, liquidated, secured debts of less than $750,000, or an individual with regular income and such individual’s spouse, except a stockbroker or a commodity broker, that owe, on the date of the filing of the petition, noncontingent, liquidated, unsecured debts that aggregate less than $250,000 and noncontingent, liquidated, secured debts of less than $750,000 may be a debtor under chapter 13 of this title.[11]
Thus, Congress has imposed eligibility ceilings on the amount of secured and unsecured debts of an individual in chapter 13. Because § 109(e) states “on the date of the filing of the petition,” most courts determine eligibility by the debtor’s originally filed schedules, checking only to see whether the schedules were made in good faith.[12] However, courts may also consider other evidence in determining the amount of a debt, but should not engage in an extensive evidentiary hearing.[13]
Debtor’s Position
The debtor’s argument is straightforward: The chapter 7 discharge relieved in personam liability, and the Avoidance Order relieved in rem liability; therefore, AMH’s claim should not count toward § 109(e) eligibility. The debtor relies heavily on In re Free, in which the debtors similarly obtained a chapter 7 discharge.[14] The Free debtors then filed a chapter 13 case, and that court explicitly held that “debts for which the in personam liability was discharged in a prior chapter 7 should not be counted toward the unsecured debt limit for eligibility under § 109(e).”[15]
In response, AMH distinguishes the debtor’s reliance on Free because that case did not analyze whether an undersecured (or wholly unsecured) in rem claim counts as a secured debt, since the claims in that case rendered the analysis irrelevant. Thus, AMH asserts that Free did not definitively hold that a claim could be disregarded entirely. AMH further distinguishes Free on the basis that the avoidance order contains language specifically treating its claim as unsecured.
AMH’s Position
AMH argues that its claim should be counted as secured because the § 109(e) standard is as of the petition date, and the avoidance order is only effective upon the debtor’s chapter 13 discharge. Therefore, the debtor had impermissibly looked at hypothetical future events rather as of the petition date, at which time AMH had a secured claim.[16] Alternatively, should the avoidance order prohibit a secured claim, AMH relies on a string of chapter 12 cases for the proposition that its claim must be counted somewhere as an unsecured claim.[17]
In response, the debtor distinguishes AMH’s avoidance order argument as putting form over substance in light of Slack.[18] Specifically, because the avoidance order has determined that AMH’s lien will be avoided, it would be unjust to the debtor to ignore the avoidance of the in rem liability created by the lien. The debtor distinguishes AMH’s chapter 12 argument by claiming a different standard applies because chapter 12 requires a debtor’s “aggregate debts” (without distinguishing between secured and unsecured) to fall under statutory eligibility ceilings without any explanation as to how the debt could constitute part of an “aggregate debt” but simultaneously fail to constitute a secured debt or unsecured debt for chapter 13 eligibility purposes.[19]
Conclusion
The issues raised by AMH and the debtor reinforce a number of longstanding bankruptcy principles. First, proofs of claim should be crafted with great care. Creditors need to be precise with their assertions, supporting documents and values. Second, valuation of the collateral drives a number of key bankruptcy decisions and should not be overlooked. All parties should take heed anytime a value is asserted by a party and how credible their source is. Third, and perhaps most importantly, parties must take heed anytime a bankruptcy is filed and evaluate how it impacts both their present and future positions. In this article’s illustrative case, the parties are now into their fourth year of contesting these issues. Based on the precise language of the avoidance order and uniformity of applying the § 109(e) analysis as of the petition date, it is the author’s belief that AMH will prevail at the appellate stage. However, that victory would most likely involve a remand to the bankruptcy court, necessitating further work and underscoring the principles found in this conclusion.
[1] Case Number 8:10-bk-15427-TA in the U.S. Bankruptcy Court for the Central District of California.
[2] 11 U.S.C. §§ 524(a)(2) and (e).
[3] The property was abandoned back to the debtor.
[4] Case Number 8:15-bk-10563-TA in the U.S. Bankruptcy Court for the Central District of California.
[5] 11 U.S.C. §§ 506(a)(1) and (d).
[6] The dismiss motion requests that the chapter 13 bankruptcy case be dismissed outright (as opposed to conversion).
[7] 11 U.S.C. § 109(e).
[8] Docket Number 48 at 4b(4).
[9] The appeals — Case Numbers CC-16-1228 and CC-16-1244 — were subsequently consolidated under Case Number 16-1228.
[10] The appeal has been fully briefed, and the parties are coordinating the oral argument schedule possibly as early as December of 2018.
[11] 11 U.S.C. § 109(e).
[12] Scovis v. Henrichsen, 249 F.3d 975, 982 (9th Cir. 2001).
[13] Slack v. Wilshire Ins. Co. (In re Slack), 187 F.3d 1070, 1073-74 (9th Cir. 1999).
[14] 542 B.R. 492, 494-95 (B.A.P. 9th Cir. 2015). It is worth noting Free is a Ninth Circuit BAP decision and therefore not binding on the presiding Ninth Circuit.
[15] Id. at 497.
[16] See HSBC Bank USA N.A. v. Blendheim, 803 F.3d 477, 487 (9th Cir. 2015).
[17] See Quintana v. Internal Revenue Serv., 107 B.R. 234 (B.A.P. 9th Cir. 1989), aff’d Quintana v. Comm’r, 915 F.2d 513 (9th Cir. 1990); Davis v. Bank of Am. N.A., No. BAP CC-11-1692-MKSKI, 2012 WL 3205431 (B.A.P. 9th Cir. 2012), aff’d Davis v. U.S. Bank, N.A. (Davis II), 778 F.3d 809 (9th Cir. 2015). In this chapter 13 context, the Davis II court held:
A creditor retains a right to payment, enforceable in rem, on the unsecured portion of a loan for which in personam liability may have been discharged. We therefore agree with the BAP that [the debtor’s] “aggregate debts” include the unsecured portions of the undersecured mortgage loans that remain enforceable against [the debtor’s] property, even though the loans are not enforceable against [the debtor] personally.
[18] 187 F.3d 1070 (evaluating whether tentative state court decision that arguably determined amount of claim but not liability can form basis of liquidated claim for chapter 13 eligibility purposes. The Slack court held that “a debt is liquidated if the amount is readily ascertainable, notwithstanding the fact that the question of liability has not been finally decided”).
[19] 11 U.S.C. § 101(18)(A) (“The term ‘family farmer’ means — individual or individual and spouse engaged in a farming operation whose aggregate debts do not exceed $3,237,000....”).