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

Heading: The Life of a Bankruptcy Case

Text: A bankruptcy case begins with the filing of a petition and the creation of an estate, which comprises the debtors’ legal and equitable interests in property. 11 U.S.C. § 541; Fed. R. Bankr. P. 1002(a). The filing of the petition triggers an automatic stay, prohibiting all entities from making collection efforts against the debtor or the property of the debtor’s estate. 11 U.S.C. § 362. To collect on a debt, a creditor must hold a “claim,” or a right to payment, id. § 101(5), which has been “allowed” by the bankruptcy court, id. § 502. Every claim must go through the allowance process set forth in 11 U.S.C. § 502 before the claim holder is entitled to participate in the distribution of estate assets. The bankruptcy court may decline to allow—or “disallow”—a claim for a variety of reasons. See, e.g., id. § 502(b)(1) (disallowing claims “unenforceable against the debtor”); id. § 502(b)(9) (disallowing tardily filed proof of claim). But importantly, for creditors holding liens secured by property, filing a proof of claim and participating in the allowance process—indeed, participating in the bankruptcy process as a whole—is completely voluntary. A creditor with a lien on a debtor’s property may generally ignore the bankruptcy proceedings and decline to file a claim without imperiling his lien, secure in the in rem right that the lien guarantees him under nonbankruptcy law: the right of foreclosure. See U.S. Nat’l Bank in Johnstown v. Chase Nat’l Bank of N.Y.C., 331 U.S. 28, 33 (1947) (a secured creditor “may disregard the bankruptcy proceeding, decline to file a claim and rely solely upon his security if that security is properly and solely in his possession”). The Bankruptcy Code contains two chapters designed to give relief exclusively to individual debtors: Chapters 7 and 14 IN THE MATTER OF: BLENDHEIM 13. To decide which chapter to file under, a debtor must compare his means and goals against the purposes of each chapter. In a Chapter 7 bankruptcy proceeding, also called a “liquidation,” a bankruptcy trustee immediately gathers up and sells all of a debtor’s nonexempt assets in the estate, using the proceeds to repay creditors in the order of the priority of their claims. 11 U.S.C. §§ 704(a)(1), 726. The bankruptcy estate does not, however, include any wages or assets that a debtor acquires after the bankruptcy filing. Id. § 541(a)(1). Provided the debtor meets all the requirements, the court may then grant the debtor a discharge, which releases a debtor from personal liability on certain debts. Id. § 727. Thus, Chapter 7 offers debtors the chance to “make a ‘fresh start,’” and “a clean break from his financial past, but at a steep price: prompt liquidation of the debtor’s assets.” Harris v. Viegelahn, 135 S. Ct. 1829, 1835 (2015). By contrast, a Chapter 13 proceeding, often called a “reorganization,” is designed to encourage financially overextended debtors to use current and future income to repay creditors in part, or in whole, over the course of a threeto five-year period. See Harris, 135 S. Ct. at 1835. Only debtors with a “regular income,” which is “sufficiently stable and regular” to enable them to make payments under a plan, are eligible for Chapter 13 reorganization. 11 U.S.C. §§ 101(30), 109(e). Unlike Chapter 7 proceedings, where a debtor’s nonexempt assets are sold to pay creditors, Chapter 13 permits debtors to keep assets such as their home and car so long as they make the required payments and otherwise comply with their obligations under their confirmed plan of reorganization. A Chapter 13 debtor formulating a proposed plan of reorganization must include certain mandatory provisions, but IN THE MATTER OF: BLENDHEIM 15 also has at his disposal various discretionary provisions—the “tools” in the reorganization toolbox. See In re Cain, 513 B.R. 316, 322 (B.A.P. 6th Cir. 2014). Mandatory provisions, which all Chapter 13 plans must contain in order to qualify for confirmation, are set forth in §§ 1322(a) and 1325 of the Bankruptcy Code. Among other things, these sections require a plan to be “proposed in good faith,” 11 U.S.C. § 1325(a)(3); satisfy the “best interests of creditors” test, which requires that the value distributed to holders of allowed, unsecured claims be no less than the amount that would have been paid if the estate were liquidated under Chapter 7, id. § 1325(a)(4); and provide for the submission of all or a portion of the debtor’s future earnings “as is necessary for the execution of the plan,” id. § 1322(a)(1). Discretionary provisions that a debtor may incorporate in his plan are set forth in § 1322(b). These tools include the curing or waiving of a default, id. § 1322(b)(3); the “assumption, rejection, or assignment of any executory contract or unexpired lease,” id. § 1322(b)(7); and the “modif[ication of] 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, or of holders of unsecured claims,” id. § 1322(b)(2). The last provision, providing for the modification of creditors’ rights, is one of the most advantageous tools available to Chapter 13 debtors. For example, we have interpreted § 1322(b)(2) to permit debtors to void liens on their homes to the extent that the lien is wholly unsecured by the value of the home. In re Zimmer, 313 F.3d 1220, 1221 (9th Cir. 2002) (evaluating modification of “unsecured claim[s],” as defined under § 506(a)).2 2 We express no view on whether the Supreme Court’s recent decision in Bank of America, N.A. v. Caulkett, 135 S. Ct. 1995 (2015), which interpreted § 506(d) not to permit a Chapter 7 debtor to strip a wholly 16 IN THE MATTER OF: BLENDHEIM Modification is a powerful tool; voidance—or “avoidance”—of a lien permits debtors to nullify a creditor’s in rem rights by effectively removing from a creditor his right to foreclose on a property. Another useful tool in a Chapter 13 reorganization, which is also available in Chapter 7, is the discharge. 11 U.S.C. §§ 727, 1328. A Chapter 13 debtor seeking a discharge typically proposes a plan in which the discharge is granted at the end of the proceeding, after the debtor completes all required payments under the plan. Id. § 1328(a); cf. id. § 1328(b) (permitting the court to grant a discharge to a debtor who has not completed all payments under the plan under certain limited circumstances). A discharge releases debtors from personal liability on claims and enjoins creditors from taking any action against the debtor in the debtor’s personal capacity. Id. § 524(a). The Bankruptcy Code authorizes debtors to receive a discharge of unsecured debt (such as credit card debt) or secured debt (such as a mortgage on a home). Ordinarily, in case of debtor default on a mortgage, a creditor is not limited to a right of foreclosure on the property; a creditor may also sue the debtor personally for any deficiency on the debt that remains after foreclosure. See Johnson v. Home State Bank, 501 U.S. 78, 82 (1991). The discharge eliminates the creditor’s ability to proceed in personam against the debtor whether the debt is secured or unsecured; in the case of a secured debt, the creditor retains the ability to foreclose on the property but can no longer proceed against the debtor personally. Id.; see also 4 Collier on Bankruptcy ¶ 524.02[2][a]. underwater lien, affects our precedent in this area. As we note infra at Part IV.A, Caulkett does not undermine—and, in fact, supports—our conclusion in this case. IN THE MATTER OF: BLENDHEIM 17 If a debtor’s proposed plan conforms with the mandatory requirements described above and all voluntary provisions similarly satisfy the “good faith” and “best interests of creditors” tests, then the bankruptcy court will confirm the Chapter 13 plan. The Bankruptcy Code provides that the “provisions of a confirmed plan bind the debtor and each creditor,” 11 U.S.C. § 1327, such that any issue decided under a plan is entitled to res judicata effect. Bullard v. Blue Hills Bank, 135 S. Ct. 1686, 1692 (2015) (“Confirmation has preclusive effect, foreclosing relitigation of any issue actually litigated by the parties and any issue necessarily determined by the confirmation order.” (internal quotation marks omitted)). If the debtor complies with his obligations under the confirmed plan and makes all the required payments, the court will grant the debtor a discharge—if appropriate—and close the case. 11 U.S.C. § 350(a). Many debtors, however, fail to complete a Chapter 13 plan successfully, often because they cannot make payments on time. Recognizing this, the Bankruptcy Code permits debtors who fail to complete their plans to convert their Chapter 13 case to a case under a different chapter, or dismiss their case entirely. Id. § 1307(a)–(b). But importantly, upon dismissal or conversion of a case, a debtor loses any benefits promised in exchange for the successful completion of the plan—whether in personam, such as discharge, or in rem, such as lien voidance. The Code treats any lien voided under a Chapter 13 plan as reinstated upon dismissal or conversion, restoring to creditors their state law rights of foreclosure on the debtor’s property. See id. §§ 348(f)(1)(C)(i); 349(b)(1)(C). Section 348 of the Bankruptcy Code governs conversion of a Chapter 13 case to a case under a different chapter. It provides that a creditor holding a security interest 18 IN THE MATTER OF: BLENDHEIM “as of the date of the filing of the [Chapter 13] petition”3 shall “continue to be secured,” meaning that a creditor’s lien will be restored to him upon conversion. Id. § 348(f)(1)(C)(i). Dismissal of a Chapter 13 case has a similar effect—§ 349 provides that any lien stripped under § 506(d) will be reinstated upon dismissal of the case, unless a court orders otherwise. Id. § 349(b)(1)(C). In effect, conversion or dismissal returns to the creditor all the property rights he held at the commencement of the Chapter 13 proceeding and renders him free to exercise any nonbankruptcy collection remedies available to him. See 3 Collier on Bankruptcy ¶ 349.01[2].