CHAPTER 7, Case No. 809-76399-reg, Adv. Proc. No.809-8493-reg
UNITED STATES BANKRUPTCY COURT FOR THE EASTERN DISTRICT OFNEW YORK
425 B.R. 11; 2010 Bankr. LEXIS 503
February 23, 2010, Decided
COUNSEL: For Thomas Pomilio, Debtor: Richard F Artura, Phillips, Weiner, Artura& Cox, Lindenhurst, NY.
For Stephanie T. Pomilio, Joint Debtor: Richard F Artura, Phillips, Weiner,Artura & Cox, Lindenhurst, NY.
Trustee: Kenneth Kirschenbaum, Kirschenbaum & Kirschenbaum, Garden City, NY.
U.S. Trustee: Diana G. Adams, Office of the United States Trustee, Long IslandFederal Courthouse, Central Islip, NY.
JUDGES: Robert E. Grossman, United States Bankruptcy Judge.
OPINION BY: Robert E. Grossman
In this Chapter 7 case, Thomas and Stephanie T. Pomilio (the "Debtors" or"Plaintiffs") seek judgment by default in their adversary proceeding to "stripoff and avoid the second mortgage lien on their residence (the "Property") under11 U.S.C. Â§Â§ 506(a) and (d) (hereinafter references to title 11 of the UnitedStates Code will be "Bankruptcy Code"). The defendants, MERS as nominee forHomebridge Mortgage Bankers Corp. ("Homebridge") and EMC Mortgage Corp. asservicer for the mortgagee (collectively, the "Defendants") have failed to filean answer or respond to the Debtors' motion for default judgment. The Debtorsargue that they are entitled to judgment by default because they have asserted avalid cause of action in their complaint. According to the Debtors, Â§ 506(d)confers standing upon a Chapter 7 debtor to avoid a validly perfected juniormortgage lien where the lien of the first mortgage exceeds the value of theunderlying collateral. For the reasons set forth below, the Court denies theDebtors' motion and dismisses the complaint.
On August 26, 2009 (the "Petition Date"), the Debtors filed a petition forrelief under Chapter 13 of the Bankruptcy Code. According to an appraisalobtained by the Debtors, the Property had a value of $ 275,000 as of July 11,2009. The Property is encumbered by a first mortgage lien held by America'sServicing Company with a principal balance due in the amount of $ 302,103.00.The Property is also encumbered by a validly perfected second mortgage lien heldby the Defendants securing a note in the original principal amount of $78,000.00 ("Second Mortgage Lien"). On October 14, 2009, the Debtors filed thisadversary proceeding seeking to reclassify any claim filed by the Defendants asunsecured, and seeking to avoid the Second Mortgage Lien pursuant to 11 U.S.C.Â§Â§ 506 (a) and (d).
The complaint was served on the Defendants and the deadline for theDefendants to file an answer or otherwise respond to the complaint was fixed forNovember 16, 2009. An initial pretrial conference for the adversary proceedingwas scheduled for December 2, 2009. Prior to confirmation of the Debtors' plan,on November 30, 2009, the Debtors voluntarily converted their case to a caseunder Chapter 7, and Kenneth Kirschenbaum, Esq. was appointed as the Chapter 7Trustee (the "Trustee"). The pretrial conference in the adversary proceeding wasadjourned to January 11, 2010.
The Defendants failed to timely file an answer and failed to appear at thepretrial conference on January 11, 2010. At the pretrial conference, the Courtnoted the Defendants' default and directed the Debtors to file a motion fordefault judgment against the Defendants. On January 15, 2010, the Trustee fileda report of no assets in the Debtors' case. On January 28, 2010, the Debtorsfiled a motion for default judgment in the adversary proceeding, requesting thatthe Court grant judgment in favor of the Debtors and against the Defendants. Asrequested by the Court, the Debtors filed a memorandum of law in support oftheir motion for default judgment. To date, the Defendants have not filed ananswer to the complaint, nor have they filed a response to the Debtors' motionfor default judgment. Oral argument on the Debtors' motion was held on February22, 2010 and the matter was marked submitted.
The Debtors seek judgment against the Defendants claiming that they areentitled to the relief requested in their adversary proceeding, despite the factthat their case was converted to Chapter 7 and they are no longer proposing aplan to repay their creditors under Chapter 13. According to the Debtors, theyhave standing as Chapter 7 debtors to maintain this avoidance action because thelanguage in Â§ 506(d) concerning lien avoidance is not limited only to propertywhich constitute property of the estate. Therefore, the Debtors argue that ifthe property in question is abandoned by the Chapter 7 trustee and no longerconstitutes property of the estate, a Chapter 7 debtor may seek avoidance of alien secured by the debtor's real property under this section. The Debtors alsoargue that in the seminal case Dewsnup v. Timm, 502 U.S. 410, 112 S. Ct. 773,116 L. Ed.2d 903 (1992), the Supreme Court did not specifically find that aChapter 7 debtor lacks standing to avoid a mortgage lien, and therefore theDebtors may continue with this adversary proceeding notwithstanding theconversion of their case from Chapter 13 to Chapter 7. In support of theirargument the Debtors rely on Bankruptcy Code Â§ 522(f), which confers standingupon a Chapter 7 debtor to avoid a non-consensual lien that impairs the debtor'shomestead exemption, as evidence that Chapter 7 debtors have standing in generalto affect liens on their real property.
The Debtors assert that they are entitled to the relief requested in theircomplaint as a matter of law. According to the Debtors, the Supreme Court'sdecision in Dewsnup was narrowly written and is not applicable to the issuesraised in this adversary proceeding. The Debtors assert that Dewsnup must beread narrowly to apply only to a debtor who seeks to "strip down" a primarymortgage lien encumbering the debtor's real property and does not bar the reliefsought by the Debtors in this adversary proceeding which is to "strip off" awholly unsecured junior lien. The Debtors rely heavily on a recent decision Inre Lavelle, No. 09-72389-478, 2009 Bankr. LEXIS 3811, 2009 WL 4043089 (Bankr.E.D.N.Y. Nov. 19, 2009), by Judge Dorothy Eisenberg in which she granted asimilar request for relief by Chapter 7 debtors.
Before judgment by default may be granted, the Court must determine whetherthe Debtors' complaint states a proper cause of action. In In re DrexlerAssociates, 57 B.R. 312 (Bankr. S.D.N.Y. 1986), the Bankruptcy Court for theSouthern District of New York enunciated the standard in this Circuit forevaluating an unopposed motion for default judgment: "Upon a default, the courtgenerally must take the well-pleaded allegations of a complaint as true." Id.(citing Fed. R. Civ. P. 55(a) and (b); Fed. R. Bankr. P. 7055 and 9014; TransWorld Airlines, Inc. v. Hughes, 449 F.2d 51, 63-64 (2d Cir. 1971), reversed onother grounds, 409 U.S. 363, 93 S. Ct. 647, 34 L. Ed.2d 577 (1973)). "However,the court is not required to accept the legal conclusions and need not agreethat the alleged facts constitute a valid cause of action." Id. (citing Au BonPain Corp. v. Artect, Inc., 653 F.2d 61, 65 (2d Cir. 1981); 10 Alan Wright, etal., Federal Practice and Procedure Â§ 2688 (2d ed.). "This court is thereforenot be required [sic] to accept what is essentially a legal conclusion [setforth in the complaint]." Id. (citation omitted).
The relief sought by the Debtors in this adversary proceeding is based on thetheory that a Chapter 7 debtor has the standing to avoid a junior mortgagepursuant to Bankruptcy Code Â§Â§ 506(a) and (d), and therefore avoidance of theDefendants' second mortgage is permitted as a matter of law and is warranted inthis case. The Court finds it is appropriate to test whether the Debtors'complaint states a valid cause of action. The Court concludes that it does not.
The Court's analysis begins with Bankruptcy Code Â§Â§ 506(a) and (d), uponwhich sections the Debtors rely and which the Court agrees govern the issuesraised in this adversary proceeding.
Bankruptcy Code Â§ 506(a)(1) provides in pertinent part:
An allowed claim of a creditor secured by a lien on property inwhich the estate has an interest, or that is subject to setoff undersection 553 of this title, is a secured claim to the extent of thevalue of such creditor's interest in the estate's interest in suchproperty, or to the extent of the amount subject to setoff, as thecase may be, and is an unsecured claim to the extent that the value ofsuch creditor's interest or the amount so subject to setoff is lessthan the amount of such allowed claim. Such value shall be determinedin light of the purpose of the valuation and of the proposeddisposition or use of such property, and in conjunction with anyhearing on such disposition or use or on a plan affecting suchcreditor's interest.
11 U.S.C. Â§ 506(a)(1).
Bankruptcy Code Â§ 506(d) provides
To the extent that a lien secures a claim against the debtor thatis not an allowed secured claim, such lien is void, unless--(I) suchclaim was disallowed only under section 502(b)(5) or 502(e) of thistitle; or (2) such claim is not an allowed secured claim due only tothe failure of any entity to file a proof of such claim under section501 of this title.
11 U.S.C. Â§ 506(d).
The Supreme Court analyzed these two provisions in depth in Dewsnup. TheSupreme Court was called on to resolve a conflict between the Circuit Courtsover whether a Chapter 7 debtor could, based on the fair market value of realproperty, "strip down" the secured creditor's partially secured lien by reducingthe amount of the debt to the "secured" portion of the lien and voiding the liento the extent the lien exceeded the value of the property.
The Supreme Court's ruling turned on the meaning of the words "allowedsecured claim" contained in Bankruptcy Code Â§ 506(d). Did it mean, as urged bythe debtors, that if a claim secured by a lien on property exceeded the value ofthe property, the unsecured portion of the claim was not an "allowed securedclaim" and therefore the corresponding lien could be avoided; or did it meanthat so long as a claim secured by a lien on property was not disallowed as theresult of a claims objection procedure, the corresponding lien could not beavoided?
The Supreme Court considered several arguments raised by both sides ininterpreting these sections, including the debtor's argument that BankruptcyCode "Â§ 506(a) bifurcates classes of claims allowed under Â§ 502 into securedclaims and unsecured claims; any portion of an allowed claim deemed to beunsecured under Â§ 506(a) is not an 'allowed secured claim' within thelien-voiding scope of Â§ 506(d)." Dewsnup, 502 U.S. at 414-15. Under this theory.Bankruptcy Code Â§ 506(a) acts as the mechanism by which a claim secured by alien could be bifurcated into a secured and unsecured claim. The debtors alsoargued in Dewsnup that the result was not affected by whether the property hadbeen abandoned by the Chapter 7 trustee and therefore was no longer property ofthe debtor's estate. The creditor argued that "Â§ 506(a) performs the function ofclassifying claims by true secured status at the time of distribution of theestate to ensure fairness to unsecured claimants. In contrast, the lien-voidingÂ§ 506(d) is directed to the time at which foreclosure is to take place, and,where the trustee has abandoned the property, no bankruptcy distributionalpurpose is served by voiding the lien." Id. at 415. The creditor advancedanother argument, supported by the United States as amicus curiae, that so longas the claim had been allowed pursuant to Â§ 502 and was secured by a lien withrecourse to the underlying collateral, it could not come within the scope of Â§506(d). Id. According to the creditor and the United States, this interpretationof Â§ 506(d) which requires a determination as to whether the claim is otherwisean allowable claim "ensures that the Code's determination not to allow theunderlying claim against the debtor personally is given full effect bypreventing its assertion against the debtor's property." Id. at 416. They arguedthat Â§ 506(d) cannot be used on a stand alone basis to confer standing to avoida lien that secures a valid claim. See id. at 415-17.
The Supreme Court agreed with the secured creditor and the United States, andheld that "Â§ 506(d) does not allow the [debtor] to 'strip down' [the creditor's]lien, because [the creditor's] claim is secured by a lien and has been fullyallowed pursuant to Â§ 502." Dewsnup, 502 U.S. at 417. 1 Under thisinterpretation, the words "allowed secured claim" in Â§ 506(d) are readterm-by-term to refer to a claim that is first allowed under Â§ 502, and securedin the sense that the claim is backed up by a lien on the collateral, regardlessof the value of the collateral. Id. at 416. The Supreme Court found support forthis interpretation in the results of its ruling, which would provide that anyincrease in the value of the property would inure to the benefit of the securedcreditor. This was what the parties had bargained for at the outset. Id. at 417.The Supreme Court also noted that this interpretation comported with applicablelaw prior to passage of the 1978 Bankruptcy Act whereby liens passed throughbankruptcy unaffected. Id. at 417-18. The Supreme Court found no evidence thatCongress, in passing the 1978 Bankruptcy Act, intended to grant to a debtor sucha broad remedy against allowed claims such as to as to render them "unsecured"without explicitly so providing in the Bankruptcy Code. Id. at 420.
- - - - - - - - - - - - - - Footnotes - - - - - - - - - - - - - - -1 Pursuantto Bankruptcy Code Â§ 502, a timely filed claim is "allowed" if no party ininterest objects, or the bankruptcy court makes a determination that the claimis valid, thereby overruling any objection made by a party in interest. 11U.S.C. Â§ 502.- - - - - - - - - - - - End Footnotes- - - - - - - - - - - - - -
The Dewsnup Court recognized that in a Chapter 7 case, '"a bankruptcydischarge extinguishes only one mode of enforcing a claim - namely, an actionagainst the debtor in personam - while leaving intact another - namely, anaction against the debtor in rem.'" Dewsnup, 502 U.S. at 418 (quoting Johnson v.Homestate Bank, 501 U.S. 78, 84, 111 S. Ct. 2150, 2154, 115 L. Ed.2d 66 (1991)).If the debtor in Dewsnup was permitted to avoid the lien, the debtor would beextinguishing the creditor's in rem rights against the property itself. Such aresult would have been contrary to the purpose of Chapter 7, which is to givethe debtor a fresh start, not an undue advantage. The Supreme Court's ruling isconsistent with the policy that any increase in the value of the propertypost-petition should be preserved for the benefit of the creditor, whichbargained for the mortgage. See id. at 417-18.
The Debtors argue that standing is a "non-issue" because (i) the SupremeCourt in Dewsnup did not find that the debtor lacked standing to avoid the lien,(ii) Chapter 7 debtors have standing to affect non-consensual liens againsttheir property under Â§ 522(f), and therefore debtors must have standing ingeneral to affect liens against their property, and (iii) there is norequirement in the text of Â§ 506(d) that the property sought to be affected mustbe "property in which the estate has an interest." Presumably, the thirdargument is based on the fact that this section speaks in terms of avoidingliens which secure claims against the debtor, and not liens against property ofthe debtor's estate. However, the Debtors miss the point. The question is notwhether the Debtors have standing to avoid the Defendant's lien under Â§ 506(d),but whether Â§ 506(d) confers standing upon the Debtors, or any party, to avoidsuch a lien. 2
- - - - - - - - - - - - - - Footnotes - - - - - - - - - - - - - - -2 ThisCourt makes no determination regarding the rights a Chapter 7 trustee may haveunder the Bankruptcy Code, which issue is not before this Court.- - - - - - - - - - - - End Footnotes- - - - - - - - - - - - - -
In Dewsnup, the Supreme Court specifically recognized that Â§ 506(d) servesthe "function of voiding a lien whenever a claim secured by the lien itself hasnot been allowed." Dewsnup, 502 U.S. at 415-16. This function cannot occurunless and until a secured claim is disallowed. The Supreme Court pointed to Â§502 as the operative section under which a court determines whether a claim isdisallowed. Dewsnup, 502 U.S. at 417 ("[W]e hold that Â§ 506(d) does not allowpetitioner to "strip down" respondent's lien, because respondents' claim issecured by a lien and has been fully allowed pursuant to Â§ 502.") (emphasisadded). The Debtors claim that Â§ 506(d) acts as a source of power for thedisallowance of the claim, but this argument was impliedly rejected by theSupreme Court in Dewsnup. See id. at 415-17; Laskin v. First Nat 7 Bank ofKeystone (In re Laskin), 222 B.R.872, 875-76 (B.A.P. 9th Cir. 1998). Courts haveconcluded that based on the Supreme Court's analysis in Dewsnup, Â§ 506(d) doesnot provide a mechanism to "disallow" a claim. Rather, this section acts topermit the avoidance of liens based on the disallowance of claims secured bysuch liens during the bankruptcy process. Laskin, 222 B.R. at 875-76; Ryan v.Homecomings Fin. Network, 253 F.3d 778, 783 (4th Cir. 2001); Talbert v. CityMortgage Servs. (In re Talbert), 344 F.3d 555, 561 (6th Cir. 2003). The SupremeCourt "implicitly adopted" the analysis that "Â§ 506(d) confers no standing onanyone" to avoid a lien; it merely "'provides the avoidance consequences ofimplementing a host of discrete powers conferred in other parts of the Coderather than acting as an avoiding power per se.'" Laskin, 222 B.R. at 875 (quoting Oregon v. Lange, 120 B.R. 132, 135 (B.A.P. 9th Cir. 1990)). Other courtsinterpreting Dewsnup in this context have reached the same result. See Ryan, 253F.3d at 783 ("Section 506 was intended to facilitate valuation and dispositionof property in the reorganization chapters of the Code, not to confer avoidingpower on a Chapter 7 debtor.") (quoting Laskin, 222 B.R. at 876; Talbert, 344F.3d at 561-62 (quoting Laskin, 222 B.R. at 876; and Ryan, 253 F.3d at 783; forthe same proposition); In re Cunningham, 246 B.R. 241, 247 (Bankr. D. Md. 2000)(quoting Laskin for the same proposition); and In re Virello, 236 B.R. 199(Bankr. D.S.C. 1999) (Dewsnup stands for the proposition that Â§ 506(d) does notconfer upon a Chapter 7 debtor the power to strip down liens.).
The Debtors' second argument, which relies on the avoidance powers containedin Â§ 522(f) as evidence that Chapter 7 debtors have standing in general to avoidliens, also fails to provide a basis for standing in this case. Section 522(f)specifically confers upon Chapter 7 debtors the authority to avoid certain liensas follows: "[T]he debtor may avoid the fixing of a lien on an interest of thedebtor in property to the extent that such lien impairs an exemption to whichthe debtor would have been entitled under subsection (b) of this section ...."11 U.S.C. Â§ 522(f) (emphasis added). The standing conferred upon Chapter 7debtors is limited to avoidance of non-consensual liens which impair thedebtor's applicable exemption, and does not apply to mortgage liens. The Debtorsfail to explain how this statute compels a finding that Chapter 7 debtors havestanding in general to avoid a lien for any other purpose, In fact, theBankruptcy Code grants to Chapter 7 debtors certain specific powers, such as thepower to avoid certain liens under Â§ 522(f) and the power to redeem personalproperty under Â§ 722. However, the Court cannot extrapolate from these statutesa general right by a Chapter 7 debtor to avoid liens.
The Debtors' third argument appears to be based on the premise that whetheror not the property which is subject to the lien has been abandoned by theTrustee, the Debtors have standing to bring this action. The Debtors draw thisconclusion because there is no requirement in the text of Â§ 506(d) that theproperty be "property of the estate." This argument does not provide a basis forconcluding that the Debtors have standing to bring this action because Â§ 506(d)does not even address the type of property at issue. Rather, this section turnson whether claims against the debtor have been allowed or disallowed. Withoutthe occurrence of a prior allowance process, a lien cannot be avoided under thissection. 3
- - - - - - - - - - - - - - Footnotes - - - - - - - - - - - - - - -3 TheDebtors are correct that the Dewsnup Court did not rule on whether abandonmentof the property by the Chapter 7 trustee affected the debtor's right or standingto avoid a lien on such property. The issue regarding standing does not turn onwhether the property is "'property of the estate" or whether it has beenabandoned, but turns on whether Â§ 506(d) gives a Chapter 7 debtor the right orstanding to avoid a lien on the debtor's property.- - - - - - - - - - - - End Footnotes- - - - - - - - - - - - - -
The Court is aware that in the Lavelle decision, Judge Eisenberg recentlyconcluded that based on a plain reading of Â§ 506, the rationale of Dewsnupshould not be extended to bar a Chapter 7 debtor from seeking to avoid a juniormortgage lien where the value of a first priority lien exceeded the value of thereal property. Lavelle distinguishes Dewsnup by concluding that there is nospecific language in the decision which prevents the Court from finding that ina case under Chapter 7 a wholly unsecured junior lien can be "stripped off."While this is a well reasoned argument which finds support in a number ofscholarly articles discussing Dewsnup, this Court is nevertheless persuaded thatit is constrained to apply Dewsnup to the facts of the case before this Court.The Fourth and Sixth Circuits and the Ninth Circuit Bankruptcy Appellate Panelagree that Dewsnup applies to bar a Chapter 7 debtor from avoiding an allowed,secured mortgage lien against the debtor's property, whether the mortgage lienis partially secured or wholly unsecured. Talbert, 344 F.3d at 555-56; Ryan, 253F.3d at 779; Laskin, 222 B.R. at 875-76. In each of these cases, the issuebefore the court was whether the reasoning of the Supreme Court in Dewsnupextended to bar a Chapter 7 debtor from avoiding a junior lien holder's claimsolely on the basis that it is wholly unsecured. According to the FourthCircuit, "[f]ollowing the Supreme Court's teachings in Dewsnup, as we must, wediscern no principled distinction to be made between the case sub judice andthat decided in Dewsnup. The Court's reasoning in Dewsnup is equally relevantand convincing in a case like ours where a debtor attempts to strip off, ratherthan merely strip down, an approved but unsecured lien." Ryan, 253 F.3d at 782.As recognized by the Ninth Circuit Bankruptcy Appellate Panel in Laskin, thereasons cited by the Supreme Court for its holding in Dewsnup, that liens passthrough bankruptcy unaffected, and that the bargained-for consensual liengranted by the mortgagor to the mortgagee contemplated that the mortgagee's lienstays with the property until its disposition at foreclosure or sale, should notchange based on the value of the collateral in relation to the debt. Laskin, 222B.R. at 876. In Talbert, the Sixth Circuit concluded that under the reasoning ofDewsnup, if a claim is not disallowed under Â§ 502 and is secured by a validjunior lien, then the debtor may not utilize Â§Â§ 506(a) and (d) to avoid thejunior lien, regardless of whether the amount of the senior lien exceeds thevalue of the property. Talbert, 344 F.3d at 561.
These same courts have concluded that Dewsnup does not apply toreorganization chapters which have claims allowance processes, In Chapter 13, adebtor may propose a plan which pursuant to Â§ 1322(b)(2) modifies "the rights ofholders of secured claims, other than a claim secured only by a securityinterest in real property that is the debtor's principal residence ...." 11U.S.C. Â§ 1322(b)(2). "Secured" in Â§ 1322(b)(2) is defined by Â§ 506(a), while"secured" in Â§ 506(d) is not. Laskin, 222 B.R. at 875. Furthermore, Â§1325(a)(5)(B)(ii) requires that claims be determined in the confirmationprocess, which does not exist in a Chapter 7 case. The court in Laskin alsorefused to apply Chapter 13 case law regarding lien "strip-off" to a Chapter 7case because "[t]hose authorities do not support the free-standing lienavoidance sought [by the Chapter 7 debtor]." Laskin, 222 B.R. at 875. In Chapter11 cases, Â§ 1123(b)(5) permits a plan proponent to "modify the rights of holdersof secured claims, other than a claim secured only by a security interest inreal property that is the debtor's principal residence ...." In addition, Â§1129(b) contemplates the modification of lien rights of secured creditors in thecontext of confirmation of a Chapter 11 plan. There is no such similar rightfound in Chapter 7 because Chapter 7 is not a reorganization chapter. As thereis no need to undergo a claims allowance process for the purposes of proposingand confirming a plan which pays creditors, there is no corresponding right fora Chapter 7 debtor to avoid liens. See Talbert, 344 F.3d at 561-62 (The purposeof Â§ 506 is to provide a mechanism for valuation and disposition of property inthe reorganization chapters, not for use by a Chapter 7 debtor). This Courtfinds the reasoning of each of these cases to be persuasive. The holding ofDewsnup applies to the facts of this case and bars the Debtors from obtainingthe relief they seek in this adversary proceeding.
For the reasons set forth above, the Debtors' motion is denied and theadversary proceeding shall be dismissed. An order consistent with thisMemorandum Decision shall be entered forthwith.
Dated: Central Islip, New York
February 23, 2010
By: /s/ Robert E. Grossman
Robert E. Grossman
United States Bankruptcy Judge