Lien stripping of personal property through chapter 13 plans has received considerable review by the bankruptcy courts over the last few years. The dispute centers on whether a chapter 13 debtor may require a creditor who has a lien on personal property to release the lien once the secured value of the claim is paid, or whether the creditor can require the debtor to complete the plan and obtain a discharge before the lien is released. The issue involves consideration of the interplay between §§349, 506(a) and (d), 1325 and 1327. Courts have adopted two distinct paths in reaching a conclusion as to whether the debtor can compel a creditor to release a lien on personal property (usually a vehicle whose value is less than the outstanding debt) prior to discharge. Notwithstanding the correctness of either view, §1325(a)(5)(B)(i) is ripe for Congressional review, should Congress opt to do so.

The National Bankruptcy Review Commission (NBRC) did not make a recommendation on either view, but focused on the appropriate method of valuation and rate of interest under §1325. The NBRC has recommended that personal property in chapter 13 cases should be valued at the wholesale price, and that a secured claim should be paid over the life of the chapter 13 plan.² Also, the NBRC recommended that the Code should employ a nationally recognized rate of interest to promote equal treatment of similarly situated debtors and creditors. The proposal appears to indirectly address the release of lien issue by requiring that secured claims be paid over the life of the plan. This approach suggests that the creditor would retain its lien if the debtor does not complete the plan and the secured claim remains unpaid. The undecided issue would be for what amount: the remaining secured claim or the outstanding balance on the collateral.

Sens. Charles Grassley (R-IA) and Richard Durbin (D-IL) in S.1301 (§302 in the proposed legislation) are more direct, calling for the Code to provide that a lien is not released until the debtor receives a discharge. Rep. George Gekas (R-PA) in H.R. 3150 (§125 in the proposed legislation) suggests that §1325(a)(5)(B)(i) provide that a secured creditor retain its lien until the earlier of payment of the underlying debt as determined under non-bankruptcy law or discharge under §1328. The Gekas proposal has a further provision that if the chapter 13 case is either dismissed or converted, then the lien is retained to the extent recognized by applicable non-bankruptcy law. Finally, Reps. Jerrold Nadler (D-NY) and John Conyers (D-MI), in their proposed legislation, H.R. 3146, follow the other view and suggest that §1325(a)(5)(B)(i) make clear that a lien is extinguished upon payment of the allowed secured claim. All the positions offered are arguably subject to further clarification except for the Nadler-Conyers proposal.

Absent legislative redress, as discussed below, each case law construction presents a credible analysis of whether the debtor can provide for the release of a lien upon payment of the allowed secured claim.

Lien Stripping and Subsequent Release Prior to Discharge

Cases holding that a debtor can force a creditor to release its lien on personal property once the secured claim is paid (which is almost always before discharge) employ a literal reading of §1325(a)(5)(B)(i) and whether §349 and §506 limit its application. The most recent reported decision is In re Johnson, 213 B.R. 552 (Bankr. N.D. Ill. 1997), where the creditor had a lien on a vehicle. The debt was partially secured. The debtors proposed a 20 percent distribution to unsecured creditors, and their chapter 13 plan required that the creditor’s lien on the vehicle be released when the underlying secured claim was paid in full with interest. The creditor’s secured claim would be paid prior to the debtors receiving their §1328 discharge.

The Johnson court began its analysis by noting that a majority of courts have found that lien stripping is permissible in chapter 13. These courts reason that the Supreme Court’s ruling in Dewsnup v. Timm, 502 U.S. 410, 112 S.Ct. 773, 116 L.Ed. 2d 903 (1992), is limited to chapter 7, focusing on the court’s comment in footnote three of the opinion, which stated that "we express no opinion as to whether the words ‘allowed secured claim’ [in §506(a) and (d)] have a different meaning in other provisions of the Bankruptcy Code." Dewsnup, 502 U.S. at 417, n.3. See, also, Bank One, Chicago, NA v. Flowers, 183 B.R. 509, 513 (N.D. Ill. 1995).³ Further, these courts construct the phrase "such claim"⁴ in §1325(a)(5)(B)(I) and (ii) to refer only to the secured component of a creditor’s claim. Johnson, 213 B.R. at 557-58.

Moreover, the Johnson court found that because §506(a) allows for a claim to be broken down into its secured and unsecured components, a reading of §506(a) in conjunction with §1322(b)(2)⁵ supports the conclusion that "the holder of an undersecured claim has been accorded due process upon receipt of the present value of its collateral through plan payments and can be required to release its lien prior to the payment of any dividend..." Id., citing In re Nicewonger, 192 B.R. 886, 889 (Bankr. N.D. Ohio 1996). Therefore, when a secured claim is established under §506(a), the plan proponent is only required to provide for payment of the secured claim under §1325(a)(5)(B)(i). To require otherwise would require a debtor to retain a lien after the underlying secured claim is paid in full, a result not supported by §506(a).⁶ Id. See, also, Flowers, 183 B.R. at 701.

Releasing Liens Only Upon Discharge

Cases holding that a lien on personal property should not be released until the debtor receives a discharge focus on the realities and equities of the early release of liens. These courts cite the high number of chapter 13 cases that fail or convert to chapter 7. They further point out that chapter 13 is a process that contemplates receiving a discharge after completion of a plan. These courts question the release of a lien prior to receipt of a discharge.

For example, the court in In re Pruitt, 203 B.R. 134, 136-37 (Bankr. S.D. Ind. 1996), maintained that a chapter 13 plan is a collective proceeding, in which debtors must propose and effect a comprehensive solution to their financial difficulties. Accordingly, a chapter 13 plan is in truth a new contract between a debtor and all of his/her creditors. Id. (citations omitted). As with any contract, there are covenants and considerations. As such, before a debtor can receive adjustment of its pre-petition obligations, the debtor should be required to make all plan payments. Id.

Similarly, other courts conclude that a lien floats through bankruptcy unaffected, unless the debtor earns the right to avoid the lien through discharge. In re Zakowski, 213 B.R. 1003, 1006 (Bankr. E.D. Wis. 1997). As in Pruitt, these courts hold that chapter 13 is a new contract, and before the contract is binding, that all conditions and covenants must be fulfilled. Therefore, the lien remains until all payments are made. Id.

Finally, other courts focus on §1307, which allows the debtor the unfettered right to dismiss a chapter 13 case at any point during the pendency of the case. Arguably, after a lien is released after payment of an allowed secured claim, there is nothing a court or creditor could do to avert dismissal. These courts question a debtor’s motives who could simply dismiss a case after the lien is avoided. These courts find that the only way that a creditor’s rights could be maintained (retention of the lien) is to apply §349(b)7 to dismissed or converted chapter 13 cases, which would result in the lien being retained. Id. Feher v. Ford Motor Credit Co. (In re Feher), 202 B.R. 966, 972 (Bankr. S.D. Ill. 1996); In re Murray-Hudson, 147 B.R. 960, 962-63 (Bankr. N.D. Cal. 1992).8

Conclusion

Both viewpoints have merit, although requiring the release of lien upon discharge arguably marries with the Congressional goal of completing a chapter 13 plan before obtaining the benefits of the most sweeping discharge in the Code. If the "pulse" of Congress is to level the playing field, and to fill the supposed void between debt relief and equity for creditors, then Congress should amend §1325(a)(5)(B)(i) to provide that a lien on personal property is released only upon discharge. Such a proposal would provide a further incentive for debtors to complete their chapter 13 plans.

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Footnotes

¹ The views expressed in this article are those of Mr. Gargotta,and do not necessarily reflect the views of the Department ofJustice. Return to Text

² Many jurisdictions allow for a chapter 13 debtor to pay claimsout of disposable income in terms of priority. As such,monthly chapter 13 trustee disbursements would first beapplied to administrative claims (attorney’s fees), secured claims, priority claims and then unsecured claims. This type of payment scheme would entail secured claims being paid sometimes many months before the debtor completes his/her plan and receives a discharge. Return to Text

³ The Flowers court concluded that while §506(d) is to be applied with "equal force" in both chapters 7 and 13, it has a different effect in the two chapters. Id. at 514.(Emphasis added). A HREF="#note3">Return to Text

⁴ A court may confirm a plan over a creditor’s objection if under (I) "the plan provides that the holder of such claim retain the lien securing such claim"; and (ii) "the value,..., of property to be distributed under the plan on account of such claim is not less than the allowed amount of such claim." Return to Text

⁵ A plan may "modify the rights of holders of secured claims..." Return to Text

⁶ Section 506(d) states that "[t]o the extent that a lien secures a claim against the debtor that is not a secured claim, such lien is void." Return to Text