Court Opinion

ID: 2709564
Source: CourtListenerOpinion
Date Created: 2014-08-05 15:17:22.774902+00
Date Added: 2024-06-11T10:01:27.532300
License: Public Domain

In the

United States Court of Appeals
               For the Seventh Circuit

No. 12-3492

A LEJANDRO P ALOMAR, S R., and R AFAELA P ALOMAR,

                                                Plaintiffs-Appellants,
                                  v.

F IRST A MERICAN B ANK,
                                                 Defendant-Appellee.

             Appeal from the United States District Court
        for the Northern District of Illinois, Eastern Division.
              No. 12 C 2418—Gary S. Feinerman, Judge.

       A RGUED M AY 21, 2013—D ECIDED JULY 11, 2013

 Before P OSNER, M ANION, and R OVNER, Circuit Judges.
  P OSNER, Circuit Judge. Mr. and Mrs. Palomar filed for
bankruptcy under Chapter 7 of the Bankruptcy Code
in July 2011, and a trustee was appointed. A month
after the filing the trustee reported that the estate in
bankruptcy contained nothing that could be sold and
yield money for the Palomars’ unsecured creditors. So
a discharge of their dischargeable debts was entered and
in December the bankruptcy case was closed.
2                                              No. 12-3492

   The day before the trustee issued his no-asset report
the Palomars had filed in the bankruptcy court an adver-
sary action against First American Bank, which held (and
holds) a second mortgage on their home. The original
amount of the loan secured by the mortgage was
$50,000, but the current balance is unknown and the
bank has not bothered to file an appearance in the ad-
versary action. Another lender, LBPS (IBM Lender
Business Process Services, Inc., recently renamed
Seterus), had and has a first mortgage on the Palomars’
home on which the unpaid balance when the Palomars
filed for bankruptcy was $243,000—yet the home was
valued then, according to an appraisal attached to the
debtors’ complaint, at only $165,000. The Palomars
argue that the second mortgage was worthless and
should therefore be “stripped off”—that is, dissolved by
order of the bankruptcy court. As authority they cite
11 U.S.C. § 506(a). The accuracy of the appraisal has not
been questioned, though the Palomars had an incentive
to obtain a low appraisal in order to bolster their argu-
ment for the stripping off of the second mortgage.
  By the time the adversary action was ready to be
decided by the bankruptcy judge, the bankruptcy had
been closed. The judge could have reopened it “to accord
relief to the debtor,” 11 U.S.C. § 350(b), as by stripping
off a lien (if that would be proper relief), provided that
the Palomars had not been responsible for a delay in
pressing their suit that would have harmed the creditors
(that is, provided that the Palomars had not been guilty
of laches). In re Bianucci, 4 F.3d 526, 528 (7th Cir. 1993);
No. 12-3492                                                  3

In re Beaty, 306 F.3d 914, 923 (9th Cir. 2002). But deciding
that the adversary action was meritless, the judge
refused to reopen the bankruptcy proceeding and
instead dismissed the adversary action. The district court
affirmed and the Palomars have appealed to us. First
American Bank has not appeared.
   So far as relates to the appeal, section 506(a) of the
Bankruptcy Code states that “an allowed claim of a
creditor secured by a lien on property . . . is a secured claim
to the extent of the value of such creditor’s interest in
the estate’s interest in such property . . . and is an unse-
cured claim to the extent that the value of such
creditor’s interest . . . is less than the amount of such
allowed claim.” Section 506(d) states that “to the extent
that a lien secures a claim against the debtor that is not
an allowed secured claim, such lien is void.” In re Tarnow,
749 F.2d 464, 465-66 (7th Cir. 1984), explains that
these provisions are best interpreted as confirming the
venerable principle of Long v. Bullard, 117 U.S. 617, 620-21
(1886), that bankruptcy law permits a lien to pass
through bankruptcy unaffected, provided that it’s a
valid lien and secures a valid claim (“an allowed secured
claim”). The holder of such a claim can if he wants
ignore the bankruptcy proceeding and enforce his
claim by foreclosing the lien. But alternatively he can
file the claim in the bankruptcy proceeding, which will
be an unsecured claim to the extent that it exceeds the
value of the collateral. The upside of this way of pro-
ceeding is that if the claim exceeds that value, yet the
debtor has assets sufficient to enable the excess at least or
a portion of it to be paid in satisfaction of an unsecured
4                                                No. 12-3492

claim, the creditor will be better off than by foreclosing his
lien. The downside is that the claim may be disallowed,
in which event the lien will be avoided; for all a lien is
is security, so if there is nothing to secure, the lien is
down the drain. The bankruptcy court’s invalidation of
a lien, if not reversed, will operate as collateral estoppel
should the creditor later try to foreclose, that is, try
to enforce the lien.
  Note however that partial disallowance of a lien credi-
tor’s secured claim doesn’t invalidate the lien, but
merely shrinks it. “If a party in interest requests the
[bankruptcy] court to determine and allow or disallow
the claim secured by the lien under section 502 and the
claim is not allowed, then the lien is void”—but only “to
the extent that the claim is not allowed.” H.R. Rep. No. 95-
595, 95th Cong., 1st Sess. 357 (1977), reprinted in 1978
U.S.C.C.A.N. 5963, 6313.
  If, however, as Tarnow teaches when read alongside
such later decisions as In re Talbert, 344 F.3d 555, 560-61
(6th Cir. 2003), and Ryan v. Homecomings Financial Network,
253 F.3d 778, 781-82 (4th Cir. 2001), the only lien voided
by section 506(d) in whole or part is one securing a claim
rejected in whole or part by the bankruptcy court, the
statute has no application to this case. First American’s
claim was not rejected by the bankruptcy court—it filed
no claim. No one did; this was a no-asset bankruptcy.
And so the bank was free to foreclose its lien outside
of bankruptcy. Nor is there any suggestion that had the
bank filed a claim it would have been rejected. It hasn’t
foreclosed, yet only (we suppose) because at present the
No. 12-3492                                                5

Palomars’ home is worth less (unless the appraisal is
grossly inaccurate) than the sum of the first and second
liens on it, the bank’s lien being the second. In fact it’s
worth less than the first lien, that of LBPS alone. But
someday the house may be “above water,” at which
point First American may decide to foreclose.
  The holdings in Tarnow, Talbert, and Ryan are sup-
ported (as noted in Talbert, 344 F.3d at 560, and Ryan,
253 F.3d at 781-82) by the Supreme Court’s post-Tarnow
decision in Dewsnup v. Timm, 502 U.S. 410 (1992), which
holds that section 506(d) does not allow the bankruptcy
court to squeeze down a fully valid lien to the current
value of the property to which it’s attached. See id. at 417-
18. That’s the relief the debtor in this case is seeking.
The only difference between this case and Dewsnup is
that our debtors want to reduce the value of the lien to
zero. They point to section 506(a), which makes a “claim
of a creditor secured by a lien on property” a “secured
claim” only “to the extent of the value of such creditor’s
interest in [the] property.” That value, the Palomars note,
currently is zero. But Dewsnup treated the undersecured
loan in that case as a “secured claim” within the
meaning of section 506(d), and in so doing denied that
“the words ‘allowed secured claim’ must take the same
meaning in § 506(d) as in § 506(a).” Id. at 417. The point
of section 506(a) is not to wipe out liens but to recognize
that if a creditor is owed more than the current value of
his lien, he can by filing a claim in bankruptcy (rather
than bypassing bankruptcy and foreclosing his lien)
obtain, if he’s lucky, some of the debt owed him that he
could not obtain by foreclosure because his lien is worth
less than the debt.
6                                                 No. 12-3492

   The Palomars point out that liens on residential
property can be stripped off in bankruptcies under
Chapter 13 of the Bankruptcy Code, the counterpart
for individual debtors of Chapter 11, which governs
corporate reorganizations. A Chapter 13 plan can “modify
the rights of holders of secured claims, other than a
claim secured only by security interest in real property
that is the debtor’s principal residence, or of holders of
unsecured claims.” 11 U.S.C. § 1322(b)(2). And despite
the exception, courts allow a Chapter 13 plan to
eliminate a secured junior claim (such as a claim secured
by a second mortgage) against residential property if
the security interest no longer has value because what
the debtors owe holders of liens senior to this creditor’s
lien (the holder of a first mortgage for example) exceeds
the value of the property. See In re Bartee, 212 F.3d 277, 292-
95 (5th Cir. 2000); In re McDonald, 205 F.3d 606, 615 (3d
Cir. 2000). That is what the Palomars want now, but to get
it they would have had to file for bankruptcy under
Chapter 13 rather than Chapter 7. The strip-off right
in Chapter 13 is a partial offset to the advantages that
Chapter 13, relative to Chapter 7, grants creditors, such
as access to a larger pool of assets because the debtor
must commit all disposable income for three to five years
to repaying his unsecured debts. 11 U.S.C. § 1325(b)(1)(B).
  The difference between Chapter 13 (also Chapter 11) and
Chapter 7 is the difference between reorganization
and liquidation. In the latter type of bankruptcy the
debtor surrenders his assets (subject to certain exemp-
tions) and in exchange is relieved of his debts (with
certain exceptions), thus giving him a “fresh start.” But in
No. 12-3492                                                  7

a reorganization the assets are not sold—the enterprise
continues—though ownership is transferred from the
debtor to his creditors. Chapter 13 is only analogous to
a reorganization; the debtor does not become a slave.
But unlike what happens in a Chapter 7 bankruptcy, his
assets are not sold; instead he pays his creditors, over a
three- or five-year period, as much as he can afford. 11
U.S.C. § 1325(b). Often this makes the creditors better off
than they would be in a liquidation, for the assets, though
important to the debtor, may have little market value.
   The Palomars point out that liens can sometimes be
stripped off even in Chapter 7 bankruptcies. See 11 U.S.C.
§§ 522(f), 722. The cited provisions relate, however, to
liens on property that is exempt from creditors’ claims.
Section 522(f) allows the debtor to reduce a lien on
exempt property so far as is necessary to preserve the
exemption, while section 722 allows a debtor to redeem
“tangible personal property intended primarily for per-
sonal, family, or household use, from a lien securing a
dischargeable consumer debt” by paying the current
value of the lien. Both provisions support the “fresh
start” policy of Chapter 7, consistent with the aim of
bankruptcy law of balancing the bankrupt’s interests
against his creditors’ interests. In any event, sections 522(f)
and 722 are not available to the Palomars—and “fresh
start” is not an ambulatory policy invokable whenever
a debtor makes an appeal to judicial sympathy.
  And if there were such a principle it wouldn’t be ap-
plicable to this case. Given the gross disparity between
the current market value of the Palomars’ home and the
8                                            No. 12-3492

claims secured by it, First American Bank is unlikely,
to say the least, to foreclose in the immediate or near
future. For that would entail the bank’s incurring
legal expenses to obtain the ownership of property worth
less than the first mortgage on the property; the bank
would be compounding its loss. So all that failing to
extinguish First American’s lien does from a practical
standpoint is deprive the debtors of the chance to make
some money should the value of their home ever exceed
the balance on LBPS’s first mortgage. It is hard to see
how the deprivation of so speculative a future oppor-
tunity could be thought to impair the debtors’ ability to
make a fresh start. The extinction of the lien would
not enable them to obtain a new second mortgage
(unless from a predatory lender) or otherwise improve
their financial situation.
                                              A FFIRMED.

                         7-11-13