Court Opinion

ID: 9521649
Source: CourtListenerOpinion
Date Created: 2023-08-07 02:09:24.397246+00
Date Added: 2024-06-11T12:50:02.942794
License: Public Domain

OPINION
KLEIN, Bankruptcy Judge.
The bankruptcy court avoided two judgment liens under 11 U.S.C. § 522(f) as impairing the debtor’s exemption in co-owned real estate. Appellant wants the court’s order avoiding the senior $275,000 lien to remain intact on a default theory but wants it reversed as to its own junior lien on the theory the court ignored $91,497.50 of nonexempt equity to which judgment liens can remain attached after bankruptcy.
We agree there is nonexempt equity to which judgment liens may remain attached. Construing § 522(f)(2), which has not been amended since 1994,1 to avoid an absurd result in the case of co-owned property, we hold that consensual liens against the entire fee must be netted out before computing the value of a debtor’s fractional interest for purposes of avoiding judgment liens on which the co-owner is not liable.
Appellant’s theory for exploiting default to squeeze out the senior hen offends the rule that multiple liens impairing exemptions be avoided in order of reverse priority and offends the rule that default judgments should not be entered when they are not warranted on the merits.
As the record is confused by procedural issues and lack of findings, we VACATE and REMAND.
FACTS
The chapter 7 debtor claimed a $50,000 homestead exemption in a co-owned residence he valued at $515,000, encumbered by consensual debt of $232,005, in which he scheduled his 50-percent joint tenancy interest as worth $257,500.
*86If the property had been liquidated without transaction costs on the day of bankruptcy, the debtor’s share as co-owner would have been $141,497.50, or $91,497.50 net of his $50,000 homestead exemption.2
The debtor’s interest was subject to two judgment liens (as one of four co-debtors). In first position was $275,000 owed to American Capital Resources, Inc. (“American Capital”) on a $217,972 judgment; next was $900,000 owed to appellant All Points Capital Corporation (“All Points”) on an $805,631 judgment.
The debtor filed one motion to avoid both judicial liens under § 522(f)(1). The parties agree that if one considers only the debtor’s net equity interest ($141,497.50) and deducts his $50,000 exemption, a judicial lien could withstand § 522(f)(1) avoidance to the extent of $91,497.50.
The obstacle to this result is the language of § 522(f)(2), which prescribes a statutory formula for calculating impairment that does not take fractional interests into account. The sum of “the lien” plus “all other liens on the property” plus the “amount of the exemption that the debtor could claim if there were no liens on the property” is compared with the “value that the debtor’s interest in the property would have in the absence of any liens.” 11 U.S.C. § 522(f)(2).
The debtor argued that § 522(f)(2) analysis should be done lien by lien in reverse order, beginning with All Points’ junior lien. Comparing that lien with the sum of senior liens and the exemption, $557,005 (= $232,005 mortgage + $50,000 exemption + $275,000 American Capital judicial lien), the $515,000 value of the property meant that the All Points lien impaired the $50,000 exemption and was avoidable in full.
All Points contended that the senior $275,000 American Capital lien should be first avoided by default and excluded from the analysis. Under its theory, excluding the senior lien and not adjusting equity to reflect the value of the debtor’s one-half interest until after the $232,005 consensual lien is netted out, there would be equity of $282,995 (= $515,000. - 232,005) for all owners, the debtor’s half of which would be $141,497.50. Deducting a $50,000 homestead exemption would yield $91,497.50 that could survive § 522(f)(2) lien avoidance.
The court granted the lien avoidance motion in its entirety, without making findings of fact and conclusions of law articulating its reasoning about the statutory formula.
The court’s conclusion would follow if it read the statute mechanically by focusing on the phrase “value that the debtor’s interest would have in the absence of any liens” in § 522(f)(2) and comparing the sum of the $232,005 consensual lien and the $50,000 exemption with the $257,500 value of the debtor’s one-half interest in the property, instead of the $515,000 full value of the property.
The avoidance of the senior American Capital lien has an added mystery. No default was entered. Nor did the court indicate that it would enter judgment by default. As there were no findings, we presume that the court was concluding that there was no nonexempt equity for any judicial lien.
All Points appealed.
*87JURISDICTION
Federal subject-matter jurisdiction over this core proceeding under 28 U.S.C. § 157(b)(2)(E) was founded upon 28 U.S.C. § 1334. We have jurisdiction under 28 U.S.C. § 158(a)(1).
ISSUES
1. Whether a partially-avoidable senior judicial lien may be avoided when the lien-holder does not appear in contest of a lien avoidance motion under § 522(f)(1).'
2. Whether § 522(f)(2) requires that liens against the entire fee be subtracted before computing the value of the debtor’s interest in co-owned property.
STANDARD OF REVIEW
Application of basic rules of procedure and construction of the Bankruptcy Code present questions of law that we review de novo. Ruvacalba v. Munoz (In re Munoz), 287 B.R. 546, 550 (9th Cir. BAP 2002).
DISCUSSION
Before explaining why the debtor has nonexempt equity in his co-owned residence, we focus on why the senior judicial lien could not be avoided in full on a theory of default.
I
Two procedural flaws infect appellant’s theory that the senior judicial lien should remain avoided under the 1994 amendments to § 522(f). Lien avoidance is done on a reverse priority basis as a contested matter in which the default requirements of Federal Rule of Civil Procedure 55 apply. Fed.R.Civ.P. 55, incorporated by Fed. R. Bankr.P. 7055 & 9014. Those default rules do not permit entry of judgments that are not warranted on the merits.
A
Otherwise valid judicial hens that are being avoided under § 522(f) as impairing exemptions are deducted in reverse order of priority. This is law of the circuit. Hanger v. Bank of Am. Nat’l Trust & Sav. Ass’n (In re Hanger), 196 F.3d 1292 (9th Cir.1999), aff'g & adopting, 217 B.R. 592, 595 (9th Cir. BAP 1997).
This reverse priority rule is a corollary to the requirement in the § 522(f)(2)(A) statutory formula that liens be assessed for avoidance on a lien-by-lien basis and has the consequence of giving effect to the priority rules of applicable nonbankruptcy law. 11 U.S.C. § 522(f)(2)(A).3
This reverse priority approach is important because it introduces an element of order to the provision of § 522(f)(2)(B) that liens already avoided are excluded from the exemption-impairment calculation with respect to other liens. 11 U.S.C. § 522(f)(2)(B).4
*88Without an ordering rule that specifies the order in which judicial liens are to be removed under § 522(f), dysfunction could reign. Junior lienors could plot, perhaps in collusion with debtors who may have an incentive to preserve a junior judicial lien in favor of a friend or relation, to leapfrog or squeeze out senior lienors, applicable nonbankruptcy law notwithstanding. By requiring-liens to be attacked in reverse order of priority, the priority rules of applicable nonbankruptcy law are honored and opportunities for gamesmanship are reduced.
It is literally impossible for both elements of the operating rule for implementing the § 522(f)(2) equation — reverse priority and ignoring liens previously avoided — to apply if one begins with a lien that is supported by some amount of nonexempt equity. Instead, one must approach lien avoidance from the back of the line, or at least some point far enough back in line that there is no nonexempt equity in sight. As an economist would say, judicial liens are avoided in reverse order until the marginal lien, i.e. the junior lien supported in part by equity, is reached.
By avoiding both liens, the bankruptcy court implicitly concluded that there was no equity to support any judicial lien. For the reasons we shall explain later, that was error.
B
All Points’ contention that American Capital must be eliminated on a default theory is flawed.
The record does not reflect that default was entered against American Capital, notwithstanding that it did not respond to the motion. Without an entry of default, it is not permissible to proceed to the second step and enter default judgment.
All Points nevertheless would have us assume that a default that does not appear in the record was entered and then equate the phantom default with a default judgment in order to squeeze out American Capital. Although the absence of an entered default ought to end the analysis, we will also (in light of our decision to vacate and remand) explain why the rest of All Points’ theory runs afoul of bedrock propositions of default judgment law.
First, it is black-letter law that entry of default does not entitle a plaintiff to judgment as a matter of right or as a matter of law. Fed.R.Civ.P. 55(b)(2), incorporated by Fed. R. Bankr.P. 7055 & 9014; 10 James Wm. Moore et al„ Moore’s Federal Practice § 55.20[2][b] (3d ed.2006) (“not entitled to default judgment as a matter of right”); 10A Charles Alan Wright, Arthur R. Miller & Mary Kay Kane, Wright, Federal Practice and Procedure § 2685 (3d ed.1998) (“not entitled to a default judgment as of right”).
Settled precedent establishes that default judgment is a matter of discretion in which the court is entitled to consider, among other things, the merits of the substantive claim, the sufficiency of the complaint, the possibility of a dispute regarding material facts, whether the default was due to excusable neglect, and the “strong policy” favoring decisions on the merits. E.g., Eitel v. McCool, 782 F.2d 1470, 1471-72 (9th Cir.1986) (citing Moore’s Federal Practice).
Default judgments are disfavored because cases should be decided on their merits whenever reasonably possible. Id.; Pena v. Seguros La Comercial, S.A., 770 F.2d 811, 814 (9th Cir.1985).
Our own precedents recognize that default judgments are the result of a two-step process — entry of default and then judgment by default — designed to assure *89that the plaintiff is entitled to the relief requested. If the plaintiff is not entitled to the relief requested, the court should not enter default judgment and may even enter judgment in favor of the defaulted defendant. Cashco Fin. Servs., Inc. v. McGee (In re McGee), 359 B.R. 764, 771-72 (9th Cir. BAP 2006); Wells Fargo Bank v. Beltran (In re Beltran), 182 B.R. 820, 823-24 (9th Cir. BAP 1995). That situation exists here: the debtor is not entitled to a default judgment on the merits.
II
Addressing the problem of how to calculate § 522(f) impairment when property is co-owned begins with the language of the statute.
Section 522(f)(1)(A) provides in relevant part: “the debtor may avoid the fixing of a lien on an interest of the debtor in property to the extent that such lien impairs an exemption to which the debtor would have been entitled ... if such lien is (A) a judicial lien.” 11 U.S.C. § 522(f)(1)(A) (emphasis supplied).
Section 522(f)(2) prescribes a formula for calculating whether an exemption is impaired:
(2)(A) For the purposes of this subsection, a lien shall be considered to impair an exemption to the extent that the sum of—
(i) the lien;
(11) all other liens on the property; and
(in) the amount of the exemption that the debtor could claim if there were no liens on the property; exceeds the value that the debtor’s interest in the property would have in the absence of any liens.
(B) In the case of a property subject to more than 1 hen, a hen that has been avoided shall not be considered in making the calculation under subparagraph (A) with respect to other hens.
(C) This paragraph shall not apply with respect to a judgment arising out of a mortgage foreclosure.
11 U.S.C. § 522(f)(2) (emphasis supplied). That is, an exemption is impaired if subtracting all of the unavoidable hens and the exemption (totaling $282,005) from the value of the debtor’s half interest ($257,-500) yields zero or less.
The difficulty centers around the operation of the phrase “value that the debtor’s interest in the property would have in the absence of any hens” in § 522(f)(2)(A)(iii) when the debtor has only a fractional interest in property. In the instance of single-owner property, there is no problem because the phrase refers to the maximum exemption that is available to the debtor and nothing in excess of that amount.
But in the case of fractionally-owned property, the outcome depends upon whether one subtracts all hens against the entire fee before addressing the value in the absence of any hens. If all consensual hens against the entire fee are netted out first, then the answer is the same as in the single-owner case. If, however, one does not first net out the consensual hens against the entire fee and applies the literal terms of the statutory formula, then the result could be that judicial hens are avoided that do not impair an exemption.
Under facts of this appeal, it is the difference between avoiding judicial hens only to the extent that they leave the $50,000 exemption to the debtor and avoiding an extra $91,497.50 worth of judicial hens.
Thus, the strict or mechanical approach to applying the statutory formula, which has the advantage of conforming to the letter of § 522(f)(2)(A)(hi), would result in avoiding more judicial hens than the minimum necessary to assure the debtor the *90maximum available homestead when the debtor owns only half the property.
Such a result appears to be at odds with what Congress intended, which was to overrule judicial decisions that all had the consequence of frustrating a debtor’s ability to receive the full exemption authorized by law. H.R.Rep. No. 103-835, 52-54, reprinted in 1994 U.S.C.C.A.N. 3340, 3361-63. In the context of co-owned property, which is not discussed in the House Report, Congress overshot its mark.
The alternative common-sense application realigns the application of the statutory formula to conform with unambiguous Congressional intent. Under this approach, one nets out consensual liens against the entire fee in co-owned property before determining the value of a debtor’s fractional interest and excludes those liens from the calculation of “all other liens on the property” under § 522(f)(2)(A)(ii). As applied in this instance, it would lead to a conclusion that there is $91,497.50 in nonexempt equity to which judgment liens could remain attached after assuring the debtor of his $50,000 exemption.
Although the latter approach has intuitive appeal because it achieves a result consistent with the notion that the debtor is entitled to no more than the exemption, it must be conceded that it requires a generous interpretation of § 522(f)(2) because the precise language of the statute does not ineluctably yield that conclusion. Nor does this approach answer the question of how to deal with judicial liens against the entire fee.
Courts are divided between the strict and the common-sense approaches to the § 522(f) question after the 1994 Amendments.
Nationally, the majority position, which includes the First, Third, and Eleventh Circuits, rejects mechanical application of the statutory formula in cases where a debtor co-owns property. All three courts of appeal that have addressed the question have concluded that mechanical application of § 522(f)(2)(A) produces a result at odds with the statutory purpose. Nelson v. Scala, 192 F.3d 32, 35 (1st Cir.1999); Miller v. Sul (In re Miller), 299 F.3d 183, 186-87 (3d Cir.2002); Lehman v. Vision-Span, Inc. (In re Lehman), 205 F.3d 1255, 1257 (11th Cir.2000). These courts either net the total outstanding secured debt balance owed by both co-owners against the entire fee before calculating the value of the debtor’s fractional interest in the property or achieve a result that assures that the debtor does not enjoy more than the amount of the available exemption.
Our own precedent under the pre-1994 version of § 522(f) applied the same approach by requiring all encumbrances to be deducted before determining the debt- or’s fractional interest. Wiget v. Nielsen (In re Nielsen), 197 B.R. 665, 670 (9th Cir. BAP 1996), cited with approval, Miller, 299 F.3d at 186.
A minority of courts apply the statutory formula literally and mechanically by allowing a debtor to deduct the full amount of liens from the proportional interest in the value of the property. E.g., Zeigler Eng’g Sales, Inc. v. Cozad (In re Cozad), 208 B.R. 495 (10th Cir. BAP 1997); In re White, 337 B.R. 686 (Bankr.N.D.Cal.2005).
In concrete terms, the choice between the common-sense and the mechanical applications of the statute in situations where property is co-owned is the difference between protecting only the debtor’s $50,000 California exemption from judicial liens or protecting $141,497.50.
We agree with the three courts of appeals to have considered the question that mechanical application of the statutory formula would lead to an absurd result not intended by Congress. Miller, 299 F.3d at *91187 (“absurd”); Lehman, 205 F.3d at 1257 (“absurd”); Nelson, 192 F.3d at 35 (“outcome at odds with the purpose of Congress”). The goal is to achieve a balance between debtor and creditor by assuring that a debtor receives the full exemption permitted by law and that creditors secured by judicial liens do not lose their secured positions in value that is not exempt.
Accordingly, we adhere to our view stated in Nielsen, a case interpreting the pre-1994 version of § 522(f), that “it is common sense in bankruptcy in a lien avoidance context that joint encumbrances be deducted from the joint value of the property.” Nielsen, 197 B.R. at 671. Hence, nonavoidable encumbrances on co-owned property must be deducted from the total value of the property before a debtor’s fractional interest is determined.
CONCLUSION
Since there are no findings of fact and conclusions of law regarding the underlying substantive questions, we VACATE the order avoiding the liens of American Capital and All Points and REMAND for further proceedings consistent with this decision.

. Section 522(f)(2) was not amended by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Pub.L. 109-8, 119 Stat. 23.

. ($515,000 value — $232,005 mortgage) = $282,995 h- 2 = $141,497.50. Deduct $50,000 homestead = $91,497.50.

. The statutory exemption-impairment formula is:
(A) For the purposes of this subsection, a lien shall be considered to impair an exemption to the extent that the sum of—(i) the lien; (ii) all other liens on the property; and (iii) the amount of the exemption that the debtor could claim if there were no liens on the property; exceeds the value that the debtor's interest in the property would have in the absence of any liens.
11 U.S.C. § 522(f)(2)(A) (emphasis supplied).

. The provision is:
(B) In the case of a property subject to more than 1 lien, a lien that has been avoided shall not be considered in making the calculation under subparagraph (A) with respect to other liens.
11 U.S.C. § 522(f)(2)(B).