Opinion ID: 3006507
Heading Depth: 3
Heading Rank: 1

Heading: Claim Disallowance and Lien Voidance

Text: In 2007, Robert and Darlene Blendheim filed for bankruptcy under Chapter 7 of the Bankruptcy Code. The Blendheims eventually received a discharge of their unsecured debts in 2009. The day after receiving the discharge in their Chapter 7 case, the Blendheims filed a second bankruptcy petition under Chapter 13 to restructure debts relating to their primary residence, a condominium in West Seattle. In their schedule, the Blendheims listed their condo at a value of $450,000, subject to two liens: a firstposition lien securing a debt of $347,900 owed to HSBC Bank USA, N.A., and a second-position lien securing a debt of $90,474 owed to HSBC Mortgage Services. The firstposition lien is the only interest at issue in this appeal. The first-position lien holder (“HSBC”), represented in bankruptcy proceedings by its servicing agent, filed a proof of claim in the Chapter 13 proceeding seeking allowance of its claim, which authorizes a creditor to participate in the bankruptcy process and receive distribution payments from the estate. The Blendheims filed an objection to the claim on the basis that, although HSBC properly attached a copy of the relevant deed of trust to its proof of claim, HSBC failed to 6 IN THE MATTER OF: BLENDHEIM attach a copy of the promissory note.1 The Blendheims also alleged that a copy of the promissory note they had previously received appeared to bear a forged signature. For reasons unknown, HSBC never responded to the Blendheims’ objection to its proof of claim. The deadline for responding passed, and in November 2009, hearing no objection from HSBC, the bankruptcy judge entered an order disallowing HSBC’s claim. Even after the Blendheims served HSBC and its counsel with a copy of the disallowance order, HSBC took no action in response. Instead, it withdrew its pending motion and requested no future electronic notifications from the court. In April 2010, the Blendheims filed an adversary proceeding complaint seeking, among other things, to void HSBC’s first-position lien pursuant to 11 U.S.C. § 506(d), which states 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.” The Blendheims contended that because HSBC’s claim had been disallowed, its lien secured a claim that is “not an allowed secured claim” and thus the lien could be voided. The bankruptcy court held a hearing the following month, specifically advising HSBC to take action to address the disallowance order. Voidance of the lien posed a more drastic consequence than simple disallowance of HSBC’s claim in the bankruptcy proceeding: voiding the lien would eliminate HSBC’s state-law right of foreclosure. 1 The Blendheims objected pursuant to Rule 3001 of the Federal Rules of Bankruptcy Procedure, which requires that “[w]hen a claim, or an interest in property of the debtor securing the claim, is based on a writing, a copy of the writing shall be filed with the proof of claim.” Fed. R. Bankr. P. 3001(c)(1). IN THE MATTER OF: BLENDHEIM 7 Even though the threat of voidance loomed, a year passed, and still HSBC took no action to set aside the order. Once more, the court advised HSBC to file a motion to set aside the disallowance order. This time, almost a year and a half after the disallowance order was entered, HSBC responded. In April 2011, HSBC filed a motion for reconsideration of the disallowance order, alleging grounds of mistake, inadvertence, surprise, excusable neglect, due process violations, and inadequate service. Following a hearing, the bankruptcy court denied the motion. The court explained that HSBC presented “no argument or evidence as to why its failure to respond was due to mistake, inadvertence, surprise, or excusable neglect,” and “[HSBC] has not provided any rationale for waiting nearly 18 months after entry of the [disallowance] order to request reconsideration.” It therefore declined to set aside the disallowance order. The Blendheims subsequently moved for summary judgment, once again seeking lien voidance. HSBC filed a response, arguing that it would be improper and inequitable to void the lien after the claim was disallowed for mere failure to respond. In support of its argument, HSBC pointed to a Seventh Circuit case called In re Tarnow, 749 F.2d 464 (7th Cir. 1984), which had similarly dealt with the voidance of liens under § 506(d). As HSBC explained, there, the Seventh Circuit declined to permit a court to void a lien under § 506(d) where the creditor’s claim had been disallowed for untimely filing. The court concluded that because a secured creditor is not required to file a proof of claim at all, and may instead look to its lien for satisfaction of the debt, destruction of a lien under § 506(d) is a “disproportionately severe sanction” for an untimely filed claim. HSBC argued that destruction is equally inappropriate in the case of simple default. 8 IN THE MATTER OF: BLENDHEIM The bankruptcy court held a hearing and offered an oral ruling at the conclusion of argument. The bankruptcy court acknowledged that voiding HSBC’s lien under § 506(d) “based on a default gives the Court pause.” However, the court explained, the text of § 506(d) seemed clearly to contradict HSBC’s contentions: “[T]he trouble with the lender’s arguments here [is] they would just blue pencil 506(d) right out of the equation. 506(d) very clearly says if the secured debt . . . is purporting to secure a disallowed claim, then the lien can be avoided.” The court acknowledged that “there’s plenty of case law that says, even in a [Chapter] 13 . . . the secured creditor can just take a pass on the whole proceeding” without imperiling his lien. But it distinguished Tarnow, explaining that while that case involved a late-filed claim, here HSBC had filed a timely claim in the bankruptcy proceeding: The claim [in Tarnow] was only disallowed because it was late in a situation where they didn’t need to file a claim at all. . . . So it’s as if the secured creditor in Tarnow didn’t file the claim at all. That’s substantially different than what we have here where the claim was filed. There was a[n] objection to it that went to the substance, did not have anything to do with the form of the claim or the lateness of the claim. And regardless of arguments now as to whether that would have been a meritorious objection if it had been responded to, [HSBC] just slept on its rights . . . . IN THE MATTER OF: BLENDHEIM 9 Because HSBC’s claim had been disallowed and the court had found no legitimate basis for setting aside the disallowance, the disallowance was “clearly a predicate under 506(d) for disallowance of the lien . . . and therefore the lien should be set aside.” The court ordered that “upon Debtors’ completion of a Bankruptcy, this order shall be self-executing and the subject Deed of Trust . . . is void pursuant to 11 U.S.C. § 506(d), and hereby cancelled.” B. Plan Confirmation and Permanent Lien-Voidance The parties then proceeded to the plan confirmation process. The bankruptcy court rejected several proposed plans, ultimately confirming the Blendheims’ eleventh amended plan. The bankruptcy court’s discussion of its reasons for rejecting the Blendheims’ ninth amended plan, however, is relevant here. After the Blendheims filed their proposed ninth amended plan, HSBC objected on two grounds. First, HSBC argued that the Blendheims “improperly seek to cancel and void [HSBC’s] lien upon completion of the . . . Plan.” According to HSBC, even if a lien is properly voided under § 506(d), that lien must be reinstated upon the completion of a Chapter 13 plan. This is because the Blendheims could only obtain permanent voidance of the lien through a discharge, and the Blendheims were statutorily ineligible for such a discharge because they had already received a Chapter 7 discharge within the previous four years. See 11 U.S.C. § 1328(f) (“[T]he court shall not grant a discharge of all debts provided for in the plan or disallowed under section 502, if the debtor has received a discharge in a case filed under Chapter 7 . . . during the 4-year period preceding the date of the order for 10 IN THE MATTER OF: BLENDHEIM relief . . . .”). Second, HSBC objected that the plan was not filed in good faith. The bankruptcy court rejected HSBC’s argument that a lien may not be voided upon plan completion. Recognizing a split of authority among lower courts, the court observed that a Chapter 13 debtor’s ability to void a lien does not depend on the debtor’s eligibility for a discharge. It concluded that “it is not per se prohibited for Debtors to propose a Chapter 13 plan stripping the First or Second Position Lien on their Residence, notwithstanding their lack of eligibility for a Chapter 13 discharge.” The court went on to address good faith. It concluded that the Chapter 13 petition had been filed in good faith, as the Blendheims had valid reorganization goals and did not appear to be “serial repeat filers” who were “systematically and regularly abusing the bankruptcy system.” However, the court ultimately concluded that the plan had not been proposed in good faith; the plan would authorize the Blendheims to void both the first- and second-position liens, even though the secondposition lien would become fully secured (and thus legally enforceable) at the moment HSBC’s first-position lien was deemed void. Accordingly, the court rejected the ninth amended plan, but permitted the Blendheims to amend. In April 2012, the bankruptcy court confirmed the Blendheims’ eleventh amended Chapter 13 plan. This plan reinstated the second-position lien, the voidance of which had caused the previous plan to fail. The court concluded that the reinstatement of the second-position lien “cure[s] what [the court] found was in bad faith before,” and thus confirmed the plan. Importantly, the confirmed plan replicated the ninth amended plan in permitting the Blendheims to permanently void HSBC’s first-position lien upon the completion of the IN THE MATTER OF: BLENDHEIM 11 plan. The court subsequently issued an order implementing the plan.