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Bankruptcy Court Rules that It Cannot Strip Off Junior Lien without Proof of Claim Filed by Either Party

J.M. Gandy (Uploaded by User:Merchbow) [Public domain], via Wikimedia CommonsA bankruptcy court dismissed adversary proceedings brought in a Chapter 13 case, in which the debtors sought to strip off junior liens held by the U.S. government for loans issued through the Small Business Administration (SBA). In re Brisco, 486 B.R. 422 (Bankr. N.D. Ill. 2013). The SBA had junior liens on two properties owned by the debtors:  their residence and a rental property. The SBA did not file proofs of claim for either lien by the deadline established by the Federal Rules of Bankruptcy Procedure (FRBP), and the court held that this prevented it from valuing the SBA’s liens as requested by the debtors. The debtors objected, arguing that the SBA’s failure to file proofs of claim apparently shielded their liens from avoidance, but the court noted that the Bankruptcy Code allows a debtor to file a proof of claim on a creditor’s behalf.

The debtors owned two properties: their residence, which was appraised at $135,000 and had a first-priority lien held by JPMorgan with a secured claim of $161,064.57, and a rental property appraised at $100,000, with a first-priority lien and secured claim by JPMorgan of $213,829. The SBA had junior liens on both properties and secured claims of $25,800 and $25,700, respectively. The court entered a judgment reducing the amount of JPMorgan’s secured claim on the rental property to its value of $100,000, with the remaining $113,829 becoming an unsecured claim under 11 U.S.C. § 506(a).

In two adversary proceedings brought against the United States, the debtors asked the court to rule that the SBA’s liens were wholly unsecured under § 506(a), and to strip the liens off the two properties under 11 U.S.C. §§ 506(d) and 1322(b)(2). The United States moved to dismiss for failing to state claims on which the court could grant relief, in large part because of the absence of proofs of claim. Secured creditors are not required to file a proof of claim, but if they choose to do so, the deadline for a governmental unit is set by FRBP 3002(c)(1). If the creditor does not file a proof of claim, the debtor may do so for them under 11 U.S.C. § 501(c).

The court granted the motions to dismiss, ruling that it was not able to grant the debtors’ request to value the SBA’s secured claims under § 506(a), which is a necessary step in the lien-stripping process, since the SBA’s claims were not “allowed” claims under 11 U.S.C. § 502 without proofs of claim. Brisco, 486 B.R. at 427. Since the court could not value the liens under § 506(a), it also could not grant relief under §§ 506(d) or 1322(b)(2). The court rejected the debtors’ argument that “the SBA’s arguments [would] lead to absurd results,” Brisco at 429, noting that the debtors could have filed proofs of claim themselves.

Devin Sawdayi has represented clients in personal bankruptcy cases in Los Angeles since 1997. We help people create plans that enable them to pay debts on a manageable schedule in Chapter 13 cases, sell assets to pay off debts in Chapter 7 cases, and obtain a final discharge of some remaining debts. Contact us today online or at (310) 475-9399 to schedule a free and confidential consultation to see how we may help you.

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Photo credit: J.M. Gandy (Uploaded by User:Merchbow) [Public domain], via Wikimedia Commons.