Recently, several bankruptcy courts have reviewed the issue of whether a chapter 13 plan containing a provision requiring the release of a lien if the allowed secured claim has been paid in full prior to the completion of the chapter 13 plan may be confirmed. In re Smith, --- B.R. ---, 2002 WL 31954449 (Bankr. W.D. Tex. 2002) (decided December 20, 2002); In re Castro, 285 B.R. 703 (Bankr. D. Ariz. 2002)(decided November 17, 2002); In re Gray, 285 B.R. 379 (Bankr. N.D. Tex. 2002)(decided November 14, 2002); In re Parker, 285 B.R. 394 (Bankr. E.D. Tenn. 2002)(decided October 17, 2002); and In re Moore, 275 B.R. 390 (Bankr. D. Colo. 2002)(decided March 28, 2002). After evaluating the relevant Bankruptcy Code sections and case law, these courts reach differing conclusions. The Smith and Moore courts denied confirmation of debtors’ plans that included a provision that required the secured creditor to release its lien prior to completion of the chapter 13 plan and the entry of a discharge, while the courts in Castro and Gray decided that such a plan may be confirmed. As a sort of middle ground, the court in Parker held that, although it could not confirm the plan with the early release provision, the debtor could request the early release by motion after the allowed secured claim had been paid in full. The court found that early release is possible under the Bankruptcy Code, but the issue is not ripe for decision unless and until the allowed secured claim has been paid in full. These courts are not the only ones that have been required to decide this issue. See also, In re Townsend, 256 B.R. 881 (Bankr. N.D. Ill. 2001)(debtor’s plan confirmed with provision requiring secured creditor to release its lien upon payment in full of allowed secured claim that would occur prior to the completion of the plan); In re Woods, 257 B.R. 876 (Bankr. W.D. Tenn. 2000)(court would have allowed debtor to include an early release provision in plan, however, without provision and due to lender’s objection to early release, the debtor was required to pay the expected payment on the unsecured portion of the claim before lender could be forced to release lien); In re Shorter, 237 B.R. 443 (Bankr. N.D. Ill. 1999)(court confirmed plan with an early release provision); In re Johnson, 213 B.R. 552 (Bankr. N.D. Ill. 1997)(court confirmed plan with an early release provision); In re Scheierl, 176 B.R. 498 (Bankr. D. Minn. 1995)(court denied confirmation of plan that included an early release provision). Cf. In re Vivian James, 285 B.R. 114 (Bankr. W.D. N.Y. 2002) (finding that creditor could not repossess collateral after the debtors converted case from chapter 13 to chapter 7 since the debtor paid the secured value of the vehicle in the chapter 13). This recent spate of conflicting decisions, however, suggests it may be timely to re-examine the question.
Section 1322(b)(2) allows the debtor to modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor’s principal residence. This provision allows the debtor to bifurcate the lender’s claim into secured and unsecured claims and treat the two claims differently in the plan. Arguably, modification of the claim also allows the early release provision so long as the other requirements of §1325(a)(5) are met. Section 1325 (a)(5) provides that for a plan to be confirmable, if the holder of an allowed secured claim does not accept the plan, it must retain its lien and be paid the value of the lien, the allowed secured amount, through the plan – “cram down” or the debtor must surrender the property securing the claim. The plain language of the Code ties the lien retained by the secured creditor in a chapter 13 plan to the allowed secured claim only. Debtors’ counsel have argued that once the allowed secured claim is paid in full, the lien has been paid in full and release of the lien prior to the completion of the plan is appropriate. Nothing in the language of §1325 provides for the release of the lien prior to the completion of the plan and the entry of discharge. A number of the courts that have reviewed this issue have held, however, that this absence of authority does not imply that an early release is prohibited.
Courts that have denied confirmation of plans with early lien release provisions have focused in part on what the debtor might do after lien release and what rights might be denied to the secured creditor. If the case is dismissed after the early release of the lender’s lien, there is an argument that the lender’s lien should be reinstated under §349(b)(1)(C). This section provides that, “[u]nless the court, for cause, orders otherwise, a dismissal of a case . . . reinstates -- any lien voided under §506(d) of this title.” Section 506(d) provides, subject to certain exceptions, that, “[t]o the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void.” Thus, upon dismissal, arguably, the lender’s lien should be reinstated to the extent the lender still has an unsecured claim – the lender should be returned to its pre-bankruptcy status. Therefore, early release in the chapter 13 is premature as the debtor has not yet completed the plan and dismissal is still a possibility.
Courts have also predicated refusal to approve the early release provision on the grounds that the debtor has other options that would allow the court to release the lien. For example, §349(b)(1)(C) provides that the court may order the lien released for cause. Thus, at dismissal, the debtor could argue in the motion to dismiss that the lender’s lien should not be reinstated as the allowed secured claim had been paid. In that event, the court could enter the dismissal and release the lien, leaving the lender in the same position it would have been in if it had repossessed and sold the collateral outside of bankruptcy. Further,
§1328(b) allows the court to grant the debtor a discharge without completing the plan if circumstances beyond the debtor’s control prevent the debtor from making additional payments, the debtor has paid the unsecured claimants what they would have received in a chapter 7 and modification of the plan is not feasible. Thus, if the debtor cannot complete the plan, there are options other than early lien release that would protect the debtor’s ability to keep the collateral free of the secured creditor’s lien.
Other courts have held, however, that because the lien was paid in full in the chapter 13 plan, there is no lien to reinstate under §349(b)(1)(C) upon dismissal of the bankruptcy. The Castro court held that the early release is not a windfall to the debtor who later dismisses the case as the debtor retains personal liability for any claims that remain unpaid. The risk of dismissal after early release of the lien seemed minimal to the Castro court given the fact that the debtor has substantial incentive to continue to make plan payments to discharge personal liability on the remaining unsecured debts. While the lender may argue that it is not being returned to its pre-bankruptcy position, it arguably is in no worse condition than if it had repossessed and sold the vehicle. Any deficiency claim after the sale of the vehicle is an unsecured claim against the borrower.
Additionally, some lenders look to the Supreme Court decision in Dewsnup v. Timm, 502 U.S. 410 (1992) to further support their position that the early release provision should not be allowed. In Dewsnup, the Court held that, in a chapter 7 case, the debtor is prevented from stripping the creditor’s lien to its secured value. Thus, arguably, Dewsnup prevents a chapter 7 debtor from bifurcating an undersecured claim on property the debtor intends to keep. The argument is also made that as the Dewsnup court interpreted “allowed secured claim” under §506(d) to mean the full claim, both secured and unsecured, that meaning should apply to the cram-down provision of §1325(a)(5)(B) and the creditor should be allowed to keep its lien until the plan is completed and discharge is entered.
Courts that allow the early release provision counter by arguing that Dewsnup does not apply to chapter 13 cases and that the Dewsnup decision was limited to claims secured by real property. These courts point out that §1322(b)(2) specifically provides that the rights of a secured creditor may be modified unless the claim is secured only by an interest in real property that is the debtor’s principal residence. Thus, under chapter 13, the lien is avoided under §506(d) as to the portion of the claim that is greater than the value of the collateral. Additionally, the chapter 13 plan may be viewed as a form of redemption over time with interest. See Castro at 710. Because the debtor may retain the collateral by paying its fair market value through a chapter 7 redemption, the debtor should be entitled to have the lien released in the chapter 13 when the fair market value has been paid in full. Dewsnup did not address the debtor’s right to redeem under §722 as the property at issue was real property. Section 722 specifically provides for bifurcation in the chapter 7 context as the debtor is allowed to redeem personal property by paying the holder of the lien the amount of its allowed secured claim. Arguably, if the case is converted to a chapter 7 after the early lien release, the creditor has already received what it would have received if the debtor redeemed. Furthermore, §348(f)(1)(b) provides that upon conversion from a chapter 13 case to a chapter 7 case, valuations of property and of allowed secured claims in the chapter 13 case apply in the converted case, with the allowed secured claims reduced to the extent they have been paid in accordance with the chapter 13 plan. Thus, if the allowed secured claim has been paid in full in the chapter 13, conversion to a chapter 7 would appear to allow the debtor to redeem the property and have the lien released for $0.
Additionally, even though the debtor has a right to convert to a chapter 7 from a chapter 13, there is the possibility that if the debtor does so after obtaining an early release of the lien, either the court or the U.S. Trustee, or the lender may challenge the debtor’s ability to receive a discharge. For example, the court or the U.S. Trustee may file a §707(b) motion to dismiss the chapter 7 case if the granting of a discharge would be a substantial abuse of the chapter 7 provisions.
The lender’s underlying concern appears to be that the debtor is somehow abusing the chapter 13 process by seeking to have the lien released prior to discharge and that the creditor risks not receiving its fair share due to the early release. The Parker court attempted to address this concern by evaluating equitable considerations at the time the debtor requests the lien release. As stated earlier, the Parker court held that a decision did not need to be made on the early release issue unless and until the debtor actually paid the allowed secured claim in full. At that time, the debtor could pursue release and the creditor could object. The court could then evaluate any equitable considerations weighing against allowing the release. This approach may prove to be the most pragmatic way of dealing with this otherwise difficult problem.