Ninth Circuit Narrowly Reads Section 506(d) on Voiding Liens After Claim Disallowance

Affirming the Bankruptcy Appellate Panel, the Ninth Circuit held that Section 506(d) does not void a lien if disallowance of the associated secured claim was based on a lack of standing to file the claim.

The opinion distinguished and limited the Ninth Circuit’s pivotal Blendheim decision, which validated the use of so-called chapter 20 cases. HSBC Bank USA v. Blendheim (In re Blendheim), 803 F.3d 477 (9th Cir. Oct. 1, 2015).

How (Almost) to Own a Home for Free

Until the BAP and the circuit court intervened, a default by the bank’s lawyer was on the cusp of letting the debtor own his $420,000 home free and clear, even though he owed the bank $675,000.

The chapter 13 debtor had scheduled his home as encumbered by a $625,000 mortgage. The bank filed a secured claim for about $675,000. The debtor filed an objection to the claim, contending that the bank did not have standing.

Whether intentionally or not (it’s unclear), the bank did not respond to the claim objection, and the bankruptcy court entered an order disallowing the claim on default. The bankruptcy court confirmed a plan that paid nothing to the lender. The debtor completed plan payments and received a discharge.

During the five years of the plan, the bank did not move to modify the stay to permit foreclosure for nonpayment.

After the debtor’s discharge and after retaining new counsel, the bank sought to set aside the order on default, expunging the claim for lack of standing. For whatever it’s worth, documents in the record suggest that the bank in fact did have standing.

The debtor operated under the theory that the lien was void because the claim had been disallowed. He therefore countered the bank’s motion to set aside the default with an adversary proceeding to void the bank’s lien under Section 506(d), which provides: “To the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void . . . .”

The bankruptcy court bought the theory and voided the bank’s mortgage lien. The bank appealed, and the BAP reversed. Bank of New York Mellon v. Lane (In re Lane), 589 B.R. 399 (B.A.P. 9th Cir. 2018). To read ABI’s report on the BAP opinion, click here.

The debtor appealed but lost again in a June 1 opinion by District Judge Lynn S. Adelman of Milwaukee, sitting by designation.

The Circuit Upholds the BAP

Judge Adelman began by laying out a secured creditor’s options in chapter 13, made somewhat bizarre by the Supreme Court’s decision in Dewsnup v. Timm, 502 U.S. 410 (1992). As the late Justice Antonin Scalia said, Dewsnup arguably ignored the plain language of the statute by allowing a lien to pass through bankruptcy unaffected when the secured creditor fails to file a claim. Even though several sitting justices have criticized Dewsnup, the Court has not granted certiorari to consider setting it aside.

Back to the story: In view of Dewsnup, Judge Adelman said that a secured creditor in chapter 13 has the option of filing a proof of claim or not. If the creditor does not file a claim, the creditor will not be paid under the chapter 13 plan but retains the mortgage that may be enforced when the automatic stay ends. If there was no claim on file, the lender cannot pursue the debtor for a deficiency.

However, the case on appeal wasn’t a simple instance of failure to file a claim. If it were, as Judge Adelman said, the “lien would pass through bankruptcy unaffected.” Rather, the bankruptcy court had expunged the secured claim on default, later invoking Section 506(d) to void the underlying mortgage lien.

To void a lien, does the basis for claim disallowance matter? Indeed it does, and it makes all the difference in the world.

The claim was disallowed for lack of standing, meaning that the claimant was not entitled to enforce the mortgage note under the Uniform Commercial Code, Article 3. Disallowance for lack of standing, Judge Adelman said, means that “someone other than the claim filer may be the person entitled to payment under the note.”

“Importantly,” Judge Adelman said, the finding of a lack of standing “does not imply that either the note or the lien securing the note is invalid.” He went on to say that expunging the claim for lack of standing did not mean “that the note or any lien securing it was invalid or otherwise unenforceable.”

“In a nutshell,” Judge Adelman said, “a bankruptcy court cannot destroy the property rights of the person who is the real party in interest based on the actions of a person who is not the real party in interest.”

Judge Adelman concluded the opinion by explaining how Blendheim did not control, although he said it was “superficially like this one.” The claim in Blendheim was not disallowed for lack of standing. Instead, the bankruptcy court had disallowed the claim on default based on an allegation that the claim was invalid.

Judge Adelman affirmed the BAP, ruling that the mortgage was “not void under Section 506(d).”