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# U n ited S ta tes Co urt o f Ap p ea ls

F o rth eS e v e n th C ir cu it
N o. 12

- 3492 A L E J A ND R O P AL OMAR, S R ., an d R AF AE LA P AL OMAR, P laint if fs -App el lants , v.
F IR S T A MERI CAN B ANK, D efend a nt-A pp ellee

.

A pp eal from the United S t ates Di strictC our t fo r the N o rthernDi stricto f Illino is, Eas tern Div isi on. No . 12 C2418

— G aryS. Fein erm an, Judge .
A RG UE D M AY 21, 2013

— D ECI DE D J UL Y 11, 2013

Befo re P OSNER, M A NI ON, an d R OV NER, C ircu it Judges . P OSNER, Cir cu it Judg e . M r. and M rs . Pal om arfi l ed f or b a nk r up t c y un de r Ch a pt e r 7 o f the Ba nk r up t c y Co de i n J uly20 11, and a t rust ee w as appoint ed. A m onth aft er th e filin g t h e t ru st ee rep or te d th at th e e st at e in ba nk r upt cyc o nt ai ne d no th i ngtha t could be s o l d a nd yiel d m one y for th e Pal o m a rs’ uns ecu red cred itors. So a di sc ha r ge o fthe i r di sc ha r g eabl e deb ts was e nt er ed an d i n De c e mbe r the b a nk r up t c y c a s e wa s c l o s e d.2 N o. 12

- 3492 T he da y before the tru s tee issue d his no-asset report th e Pa l o m ar s ha d fi l ed i n the b an k r upt cyc o ur t ana d versa r y a ct i o n a g ai ns t F i r stAm er i ca n Ba nk, whi chhe l d ( an d hol ds) a s eco nd m or tga ge on thei r hom e. The o rig inal am ount o fthe l oan secur ed by th e m or tga ge w as $5 0, 00 0, b utthe c ur r en t ba l an ce i s unkno wn an d the b a nkh a s n o tb o the r e d t o fi l e a n a pp e a r a nc e in the a dver sar y a cti on. A notherl ender, LBP S ( I BM Lender Bu si ness Pro ces s S e r v i c e s , I nc . , r e c e ntl y r enam ed Se ter us) , had and has a fi rs t m or tga ge o n the Pal om ar s’ hom e on w hich the u n p aid ba lance w he n th e Palom ars fi l ed f orbank ruptcy w as $243 , 000

— y e tthe h o me w as va l ue d the n, a cc o r di ngt o a n a ppr ai sa l a tt ac he d t o the d ebtor s ’ c om p lai nt, at only $165,000. Th e Palom ars ar g ue tha t th e se co nd mortg ag e was wor th l es s an d sh ou ld th e r e fo re be “stripp ed off”

— that i s, di sso l ved by or der o fthe bankr up tc y c ou rt
. A s a uthor i ty they ci te 11 U
. S. C. § 50 6(a ). Th e a ccurac y o fthe apprai salhas not been questi one d , tho ugh the Pal om ar s had an i ncenti ve to o bt ai n a l o w appr ai sa l i n o r dert o b o l ster th ei r a r g um ent f orthe str i pp i ng o ffo fthe seco nd m or tga ge. By the ti m e the ad versar y a cti on was r eady t o be deci de d b y the bank ruptcy j ud ge, the bankr up tcy had been closed

. Th e j ud ge cou ld h a ve reop en ed i t “to acc ord r el i eft o the de bt o r, ” 11 U. S
. C. § 3 50 ( b) , a s bys tr i ppi ng offa l i en ( i fthatwo u ld be properr el i ef ) , pro vi ded that th e P alo m ar s h ad n ot be en res p on sib le for a d el a y in p ressing th eir su it that w ou ld h ave h arm e d t h e cred itors (th at i s, pro vi ded thatthe Pal om ar s had notbee n gui l ty of lac h es ). In re B ianucci, 4 F.3 d 5 2 6 , 528 (7th C ir. 1993);N o. 12

- 3492 3 In re B eaty, 3 06 F
. 3d 91 4, 9 23 ( 9th Ci r . 2 00 2)
. Butde ci di ng that the ad versar y a cti on was m er i tl ess , the j ud ge r efus ed to r eo penthe b an k r upt cypr o ce edi nga nd instea d dism issed the ad versary ac tio n. Th e d istri ct cou rt affi rm ed and the Pal om ar s have appeal ed to us. Fi rs t Am e r i c a n Ba nkh a s n o ta pp e a r e d. S o f ara s r el at es t o the a ppea l, s ec ti o n 50 6( a) o fthe B an krup tcy C od e states that “an allo w e d clai m of a c re d ito r se c u re d b y a lien on p ro p er ty
. . . is a s ec u re d cla im to t h e e x t en t o f th e v alu e o f su c h cr ed ito r’s int er es t in the e sta te’ s i nter esti n such pro perty
. . . a n d is an unsecured cl ai m to the extent that the v al ue o fsuch cre dit or ’ s i nter est
. . . i s l ess than the am ou n t o f such al l o w ed c lai m . ” S ec ti o n 5 06 ( d) s ta te s th at“ to the e xt en t that a l i en se cures a cl ai m ag ai nst the debto r that i s no t an all owed secured cla i m , such l i en is vo i d.” In reTar now , 74 9 F.2 d 464, 46 5- 66 ( 7th Ci r. 19 84) , expl ai ns that th es e pr o vi si o ns a r e best i nt er pr et ed as c o nfi r m i ngthe v e ne rable princ iple of Lo ng v. B ulla rd, 1 1 7U. S
. 6 1 7, 6 2 0- 21 ( 1886 ) , thatbank ruptcy l aw per m i ts a l i en to pass thro ugh ba n kr up tcy unaffecte d, provi ded thati t’ s a val i d l i en and s ecu re s a val i d cl ai m ( “an a l l owed se cured cl ai m ”)
. The h ol der o fsuch a cl ai m can i fhe wants ign or e t h e b an kr u p tc y p ro c ee d in g a n d en for c e h is cl ai m by f or ecl osi ng the l i en. But al ter nati vely he can file th e c laim in t h e b an kr u p tc y p ro c ee d in g, w h ich w ill be a n un se cur ed cl ai m t o the ex ten t t ha t i t ex ce eds the va l ue o f the c o l l a t e r a l

. Th e up s i de o f thi s wa y o fpro ce edi ng is tha t i fthe c l ai m e xc ee ds th atv al ue , y etthe debtorhas ass ets suffi ci ent t o enabl e the exce ss at le as t o r a por ti on o fi t t o be pai d i n sat i sfa c ti on o fan unsec ured4 N o. 12

- 3492

c laim , th e c re d ito r w ill be b et te r off t h an b y for ec los in g h is l i e n. T he do wns i de i s tha tthe c l a i m m a y b e di s al l o we d, in w h ich ev en t t h e li e n w i l l b e a vo id ed ; for all a lien is is s ec u rit y, so if th er e is n ot h in g t o s e c u re , th e lien is d own the drai n. The bank ruptcy cour t’ s i nval i dati on o f a l ien , i fnotr eve rs ed, wil l o perat e a s co l l ate ra l es toppel sh ou ld th e cred itor later t r y t o for eclose, th at is, try to e nf o r ce the l i en . No t e ho we v e r that par t i al d isa llow an c e o f a lien cr ed ito r ’ s se cur ed cl ai m do es n’ t i nv al i dat e th e lie n, b ut m er el y s hr i nk s i t. “ I fa pa r tyi n i nt er es t r eque st s th e [ bankr up tcy] cour t t o deter m i ne and al l ow or disa l l ow th e cl ai m s ec ur ed bythe l i enunders ec ti o n 5 02 a nd the c l a i m i s n o ta l l o we d, the n the l i e n i s v o i d”

—but o nl y “ to the e xtent that the cl ai m i s not al l owed

. ” H
. R. Rep. N o. 95

- 595, 95 th Cong. , 1s t S ess . 35 7 ( 1977 ) , r epri nted i n 197 8 U
. S. C.C. A
. N
. 59 63, 63 13. I f, however, as Tarn ow t e ac he s wh e n r e a d a l o ng s i de such l ate r decisio n s a s In re Ta lbert, 34 4 F
. 3d 555, 56 0- 61 ( 6 th Ci r . 2 0 0 3 ) , a nd R ya n v. H o m eco m ing s Fin a nc ia l Netw o rk, 253 F. 3d 778, 78 1-8 2 (4th Ci r. 20 01) , the onl y l i en vo i ded b y s ec tio n 50 6(d ) in w h ole o r p ar t is on e s ec u rin g a cla im r ej ec te d i n who l e o r pa r t bythe b an k r upt cyc o ur t, the statu te ha s no ap p li cation to this case. F irst A m erican’s cl ai m was no t r ej ec te d b y the b an k r upt cyc ou rt

— i t fi l ed no cl ai m . N o one did; thi s was a no- ass et bankr up tcy. And s o the b a nkwa s fr e e t o f o re cl ose i t s l i e n o ut s i de o fb an k r upt cy . Nori s th er e an y s ug g es ti o n tha t h ad the b a n k fil ed a clai m i t w ou ld h ave be en rej ecte d

. I t has n’t f o r ec l o se d, y eto nl y (w e su ppo se ) b ec au se a t pr es en t th eN o. 12

- 3492 5 P alo m ar s’ h om e is w or th l e s s (u n les s t h e a p p ra isa l is g r o ss l y i n a c c u r a t e ) th a n th e s u m o fth e fi r s ta n d s ec o nd li en s on it, the ba nk ’s l ien b e in g the sec ond

. I n fact it’s wor thl es s th anthe fi r stl i en, th at ofLBPS a l o ne . But som eday the house m ay be “ abov e w ate r, ” a t which poi nt Fi rs t Am er i can m ay deci de to f or ecl ose . The ho l di ng s i n Tarn ow , Ta lbert, a nd Ryan a r e s up po r te d ( as no te d i n Ta lbert, 3 4 4 F
. 3 d a t5 6 0 , a nd Ryan , 253 F. 3d at 781- 82) by the Suprem e C ou rt ’ s pos t- Tarn ow dec i si o n i n De w s n u p v . Ti mm , 50 2 U.S
. 410 ( 1992 ) , wh i ch hold s that s ecti on 5 06( d) doe s no t a l l ow the bank ruptcy co ur t to s que ez e do wn a fu ll y v al i d l i ent o the c ur r en t val ue of the proper ty to w hi ch i t’ s a tta ched. S ee id

. at41 7- 18. That’ s th e re li efthe debtori n thi s ca se i s s eek i ng. Th e o nl y di ff e r e nc e betwe e n thi s c a s e a nd D e wsn up is that our debtor s want to r educe the val ue o fthe l i en to ze ro . Th ey p oin t t o s ec tio n 50 6(a ) , w h i c h m ak es a “c laim ofa cre dit orse cured bya l ien o n proper ty” a “se cured c la im ” only “to the exte nt of th e value of suc h cred itor’ s i nter esti n [ the] pro perty
. ” That val ue, t h e Pal om ar s no te, curr entl y i s z er o. But D e wsn up trea ted the undersec ured l o ani n tha t case as a “ se cur ed cl ai m ” wi th i n the m eani ng o fs ec tio n 506 ( d), and i n so doi ng deni ed that

“ th e w o r d s ‘ a l l o we d s e c u r e d c l a i m’ m us t t a k e th e s a me m eani ng i n § 506( d) as i n § 50 6( a)
. ” Id

. a t 41 7. The po i nt ofs e c t i o n 5 0 6 ( a ) i s n o tt o wi pe o utl i e ns b utt o r eco gni ze that i fa cre dit ori s o w ed m or e than the cu rre nt va l ue o f h is lien, he can by fi l i ng a cl ai m i n bankr up tcy ( ra ther th anb y pas singb an k r upt cya nd f orecl o singhi s l i en ) o bt ai n, i fhe ’ s l ucky , s o m e o fthe d ebt ow ed hi m tha t he coul d not o btai n by f or ecl osur e be cause hi s l ien is worth l ess than the debt

.6 N o. 12

- 3492 Th e P a l o mar s p o i nto uttha tl i e ns o n r e s i denti al proper ty c an be str i pp ed offi n bankr up tci es und er C ha p ter 13 of th e B an krup tcy C od e, th e cou nt erp art f o r i ndi vi dualde bt o r s o fCha pte r 1 1, whi chg o ve r ns corp orate reorgan izations. A Ch ap ter 13 p lan can “m od ify th e r i g ht s o fho l der s o fs ec ur ed claims, o th ertha n a cl ai m se cured o nl y b y s ecu rity i nter esti n re alpro perty that i s the debto r’ s princi p al re sidence, o r ofhol ders of unsecured cl ai m s. ” 1 1 U.S
. C. § 1322(b) ( 2)
. A nd despi te the e xcepti on, co urts al l ow a Chap ter13 pl an to el i m i nate a s ecure d j u n ior cl ai m ( such as a cl ai m se cured b y a se c on d m or tg ag e) a ga in st res id en tia l p ro p er ty if the s ecu rit y i nter estno l onge r has v al ue bec ause w hat th e d ebtors ow e hold ers of li en s sen ior to th is creditor’s l i e n ( the h o l de r o fa fi rs t mo r t g a g e f o r e xa mpl e ) e xc e e ds the v al ue o fthe proper ty. S ee In re B a rtee, 21 2 F
. 3d 277, 29 2- 95 ( 5t h C ir. 20 00 ); In re M cD ona ld, 20 5 F
. 3d 606, 61 5 ( 3d Cir
. 2000)
. T hat i s what the Pal om ar s want now, but to ge t i t th ey w ou ld have had t o fi l e f orbank ruptcy und er Cha pte r 1 3 r athe r tha n Cha pte r 7
. The s trip-offr i g ht i n Chap ter13 i s a part i alo ff setto the ad vantages that Ch apter13 , r el ati ve to C h apter7, gr ants cre dit or s, such as acces s to a lar gerpoolo fas set s be cause the debt or m us t com m it all d isposa ble incom e for th ree to fi v e ye a rs to rep aying his un secu red d ebts

. 1 1 U
. S. C
. § 1325(b)(1)( B ). The di ff er en ce be twe en Cha pte r 1 3 ( al so Cha pte r 1 1) a nd Ch apter7 i s the di ff er ence between reorga ni zati on an d l i qui d ati o n. I n the l at te r ty pe o fb an k r upt cythe de b t o r s ur re nd e r s h i s a s s e t s ( s ubj e c tt o c e r t a i n e xe mpti ons) and i n exchange i s r el i eve d ofhi s debt s ( w i th c er ta in ex c ep tio n s), th u s g ivin g h im a “fr es h st ar t.” B u t inN o. 12

- 3492 7

a re or ga n iza tio n th e a ss et s a re n ot so ld

— the e nter pri se c o nt i nu es

— th o ug h o wner sh i p i s tr an sfer r ed f r o m the debtorto hi s c re d itors
. Chapter 13 i s o nl y a nal ogo us to a r eor gani zati on; the debtordoes notbecom e a sl ave. B u t u n like w h at h ap p en s in a C h ap te r 7 b an kr u p tc y, h is as s e t s a r e not sold ; i ns tead he p ays h is creditors, over a thre e- o r fi ve- yea r peri od , a s m u ch as he can aff or d. 11 U
. S. C
. § 1325(b). Often t h is m akes th e cred itors better off than the y would be i n a l i quidati on, f orthe ass ets , tho ugh i m port ant t o the debt or, m ay have l i ttl e m ar ketval ue. The Pal om ar s poi nt out thatl i ens c an so m eti m es be s t r i pp e d o ffe v e n i n Ch a pt e r 7 b a nk r up t c i e s . S e e 1 1 U. S
. C. §§ 522( f ), 7 22. The ci ted pro vi si ons re l ate , however, to l i ens o n proper ty that i s e x em pt fro m cr edi tor s’ cl ai m s. Se cti on 52 2(f) al l ows the debt orto r educe a l i en o n ex empt pr o perty so f ara s i s ne ce ss ar y t o pr es er ve the exem pti on, wh i l e s ecti on 7 22 al l ow s a d ebto r to re deem “tan gible p erson a l p rop erty inten d ed prim aril y for p ersonal, f am i l y, o r househol d use, from a li en se curi ng a di sc ha r g eabl e co ns um erde bt ” bypa y i ngthe c ur r en t value ofthe l i en. Both pro vi si ons supp or t the “fre sh sta rt ” pol i cy ofChapter 7, con sis te nt with the a i m o f bank r up t c y l a w o fb a l a nc i ngthe b a nk r up t ’ s int e r e s ts agains t his cred itors’ interest s. I n an y even t, sect ions 522(f) a n d 7 22 are not available to the Palom ars

— a nd “ f re sh sta rt ” i s not an am bul ato rypol i cy i nvokabl e whenever a debto r m ake s a n appeal to j ud i ci alsy m pathy. And ifthe r e we r e s uc h a p r i nc i pl e i two ul dn ’ tb e a ppli cabl e t o thi s ca se. Giv en the gr oss di spari ty bet w een th e cur r en t m ar k etv al ue o fthe P alom ar s’ ho m e an d the8 N o. 12

- 3492 cl ai m s s ecure d by i t, Fi rs t A m er i can Bank i s unl i kel y, to s a y the l e a s t, t o f o r e c l o s e i n the i mm e di a t e o r near fut ur e. F o r tha t woul d e nt ai l the b ank ’ s i nc ur r i ng l ega l expenses to o btai n the ow n er shi p ofpro pertyworth less tha n the fi r stmor tg ag e o n the pr o per ty ; the b an k w oul d be co m pound i ng i ts l oss . So a l l thatf ai l i ng to exti ngui sh Fi rs t A m er i can’ s l i en does f ro m a p ra cti cal sta nd po i nti s de pr i v e the de b t o r s o fthe c ha nc e t o m ake som e m oney sho uld the va l ue o fthei r hom e e verexce ed the b al ance o n LB PS’ s fi rs t m or tga ge. I t i s har d to see how the d ep rivation of so sp ecu lative a fu t u re opp ortuni ty coul d be thought t o i m pai r the debtor s’ abi l i ty to m ak e a f r es h start . T h e e x tin c tio n of th e lien w ou ld not enabl e them to o btai n a ne w se cond m or tga ge ( unle ss f ro m a predato ryl end er ) oro ther w i se i m prove th ei r fi na nc i als i tu at i o n. A FFI RMED .

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