This below article was published October 31, 2021 on the NACTT Academy website (www.considerchapter13.org)

Jane Debtor has a home with a mortgage. An unsecured creditor obtains a judgment against Jane for a credit card debt. The creditor’s attorney records a certified copy of the judgement order with the county register of deeds, thereby converting the unsecured claim against Jane in personam, to a secured claim against her personally and her real property in rem.

Debtor files a Chapter 13 plan which provides for all her debt, including the secured judgement lien claim. She files a plan which provides that after completion of her plan payments and discharge of her debt, said judgment lien is rendered void and she gets her “fresh start.” If her homestead exemption plus senior liens are robust enough, then the judgment lien can be avoided completely under 11 U.S.C. § 522(f). If not, she can treat the unavoidable remainder as a secured claim under 11 U.S.C. § 506(a).

But what happens to the lien when the secured judgment creditor with secured treatment in the plan files an “unsecured” claim (either inadvertently or intentionally)? The Chapter 13 Trustee is not going to want to sign off on a plan that treats a claim as “secured” when that creditor has filed his claim as “unsecured.” Sometimes this conflict between the secured plan treatment and the unsecured claim is resolved at the request of the Chapter 13 Trustee by striking the secured treatment from the plan. As a result, the language in the plan that dealt with the secured lien is sometimes removed and the “unsecured” claim effectively renders the debtor’s plan provision(s) ineffective became they don’t make it in the confirmation order.

By filing the claim as “unsecured” the creditor makes an end run around plan treatment of the lien under 11 U.S.C. § 522(f) and/or 11 U.S.C. § 506(a). Furthermore, by filing the claim as unsecured, the creditor also denies the debtor the opportunity to file a secured claim on the creditor’s behalf under FRBP 3004 (nor can the debtor’s attorney amend the claim and change it from unsecured to secured, though it would be in the debtor’s best interest in this scenario).

Under U.S. Nat’l Bank in Johnston v. Chase Nat’l Bank of N.Y.C., 331 U.S. 28, 33 (1947) (hereafter “Johnson”), “there are several avenues of action open to a secured creditor of a bankrupt…” and one of those options is that the secured creditor may “surrender or waive his security claim as an unsecured one.” Id. at 35; see also Salyersville National Bank v. Bailey (In re Bailey) 664 F3d 1026, 1029 (6th Cir. 2011) (hereafter “Bailey”) citing Johnston.
The problem for the debtor with a judgment lien is twofold: 1) even if there is an excellent legal rationale that the creditor has waived his lien rights by filing an unsecured claim, an order this argument does not make. In practice, the debtor will need something she can record with the register of deeds office (a certified copy of an order of treatment of the lien) to show that the recorded lien is either satisfied or otherwise rendered void, to transfer clear title; furthermore 2) in certain circumstances courts have been unwilling to say that the filing of an unsecured claim automatically renders a secured creditors’ lien rights null and void per the reasoning of Johnson.

For example, per In re Footes, No. 19-11844-SR (Bankr. E.D. Tenn. Sept. 13, 2019) (hereafter “Footes”), the Chapter 13 Debtor filed a plan in which creditors Ridge Loan Company, World Finance Corporation, and Credit Central, LLC were treated as secured creditors with various non-purchase money security interests in miscellaneous personal property. Said secured interests were treated under the plan per applicable code provisions 11 U.S.C. § 522(f) and/or § 506(a) in Section 3.2 of the plan. Each creditor filed a claim, and with each claim a signed security agreement was attached. However, none of the security agreements specified the collateral, and on each claim form the creditor indicated on Part 9-1 that the claim was “not secured.” The Trustee objected to confirmation of the debtors’ plan for “treating certain unsecured creditors as secured, thereby unfairly discriminating against different claims within the same class.”
In assuming arguendo that the collateral exists and can be identified, and that the security agreements are enforceable, the Footes court followed the reasoning cited supra of Johnson that a party can in some cases waive his right to his security by filing his claim as unsecured. The Court also cited Bailey for the proposition that a creditor cannot later change course and subsequently assert a secured interest, and thus the unsecured claim constitutes a waiver. However, the Footes Court did not find the creditors in that case had totally waived their due process lien treatment rights at that early stage of the case, pre confirmation, and the Court noted that the claims had not been disputed via the debtor’s Schedules nor the objection process. But the Footes Court did uphold the Trustee’s objection and find the proposed plan treatment was unfair discrimination against different claims in the same class.

In reaching its holding, the Footes court applied Section 1322(b)(1) providing that a chapter 13 plan may designate a class or classes of unsecured claims, but not unfairly discriminate against any class so designated. The Court reasoned that the fairness scrutiny of the allowable § 1322(b)(1) disparate treatment lies within the discretion of the Bankruptcy judge on a “case by case basis,” citing In re Williams, 253 BR 220, 224 (Bankr. W.D. Tenn. 2000) (citing In re Groves, 39 F.3d at 214; In re Dodds,140 B.R. 542, 544 (Bankr. D. Mont. 1992); In re Freshley, 69 B.R. 96, 97 (Bankr. N.D. Ga. 1987)).

The Footes Court discussed applying the often employed “Leser test” , but then looked to the Eastern District of Michigan Court for a more “streamlined test” which asks: “(1) Is there a good faith, rational basis for the separate classification; (2) is the separate classification necessary to the debtor’s rehabilitation under the Chapter 13; and (3) Is there a meaningful payment to the discriminated class.” Citing In re Quinn, 586 B.R. 1, 5 (Bankr. E.D. Mich. 2018) (hereafter “Quinn”) (quoting In re Belton, No. 16-03040-JW, 2016 WL 7011570, (Bankr. D.S.C. October 13, 2016) (collectively hereafter “Belton analysis”).
The Footes Court, further citing Quinn reasoned: “In determining which test to apply the court also considered that ‘[t]he various tests seem too inflexible to properly reflect the discretion that this Court has with respect to confirmation of a Chapter 13 plan that contains a separately classified creditor,’ and that ‘the tests can function as a starting point for the court’s analysis, but should not be a barrier to confirmation of a Chapter 13 plan.’” See Id. quoting In re Engen, 561 B.R. 523, 538 (Bankr. D. Kan. 2016)). Finally, the Footes court found that a totality of circumstances inquiry was most appropriate in that case as in the Quinn case, starting with the Belton analysis.

Applying Belton, the Footes court found the debtor had a good faith basis to treat the claims as secured in the proposed plan. However, with the creditors having waived their rights to a “secured status,” the debtor could not meet the second prong of Belton, as the Footes court found that debtor had other options to deal with these claims, including filing Adversary Proceedings under 11 U.S.C. Section 544 to determine the validity of the lien(s); and the court did not rule out other more “creative solutions.” Thus, the Court denied confirmation of the debtor’s plan as proposed.
Then the Court considered whether the Debtor’s attorney and the Trustee could agree to strike the secured treatment of the creditors at issue and just confirm a modified plan treating said creditors as general unsecured claimants. Though the court had previously cited In re Bailey for the proposition that secured creditors could waive their rights, the court found that such an 11th hour change to the plan concerning the creditors at issue, without proper notice to them, would not satisfy due process, their unsecured claims notwithstanding.

The Footes court distinguished In re Taylor, 280 B.R. 711 (Bankr. S.D. Ala. 2001) where the creditor filed an unsecured claim prior to plan confirmation and tried to amend it much later in the process, 3 months before completion of the plan. The Footes Court noted that the creditor in Taylor had notice it was being treated as an unsecured creditor at the outset of the case, and then had waived its rights by filing an unsecured claim intentionally early on, and only much later amended the claim as secured at the end of the case. The Footes Court apparently thought possible inadvertence and timing was a consideration in arriving at total waiver of secured status in Taylor (Taylor also involved a judgement lien). It would seem the Footes court was implying that inadvertence may have been the cause of the unsecured claims filed in the early pre confirmation stage in that case. The Footes court therefore sustained the Trustee’s objection but allowed the debtor 10 days to file an amended plan and give the three creditors adequate notice of any proposed changed treatment to unsecured.

In the many cases that have held that a creditor has totally waived its right to later assert a secured claim after filing an unsecured claim, the secured assertion invariably came much later in the case after confirmation, or even after the case has been completed entirely, and it seems there is a laches feel to those cases. See e.g. Bailey (where a bank entered into an agreed order with the Trustee concerning its secured status, and then filed a “wholly unsecured claim” against the bankruptcy estate, recovering under it, said creditor was later barred from seeking to enforce a deficiency claim against the debtor pursuant to a reaffirmation agreement for the same underlying debt claim, as “[i]t was too late in the day to choose a different tack…”; and In re Barrera, No. 10-26730 (Mid. Dist. FL November 29, 2016) (where a judgment lien creditor with secured liens against both a home and a vehicle was barred post discharge from seeking to enforce a $3,500 secured claim under 11 U.S.C. Section 506 against the vehicle after it had asserted a fully unsecured claim pre confirmation, rather than an appropriate 506 split claim, and collected an unsecured dividend against the whole claim over the course of a 5 year Chapter 13 plan.) In Footes, this was at the beginning of the case, so there was much greater opportunity for the creditors to amend their claims without prejudice prior to confirmation, or in the alternative for the debtor to amend her plan.

In the Footes case, the debtor was also dealing with relatively inconsequential non-purchase money liens regarding personal property, so filing an amended plan, serving it, and getting on with it may not be such a big deal for that debtor there. But when dealing with judgment liens against real property, the consequences are substantial, and if a debtor’s attorney catches it early, or anytime pre plan competition, he should deal with it. The debtor’s attorney should be particularly wary of secured judgement lien creditors filing unsecured claims and consider proactive steps in response. In my experience, this outreach usually solves the problem so that a judgement lien against real estate does not rear its ugly head after discharge and create the potential for post discharge litigation.
For example, the Debtors’ attorney might consider (1) calling and or emailing the creditor or his agent and asking them to correct their claim and filing it in conformity with the plan treatment with supporting documentation, including any applicable security agreement, collateral list, or more importantly, a recorded judgment lien when real estate is involved; (2) offering to provide copies of what the Debtor’s attorney has at his disposal, especially recorded judgment liens; and (3) if the creditor fails or refuses to amend his claim with supporting documentation and appropriate secured designation, send a letter to the secured creditor or his agent documenting all efforts. If the creditor still fails to amend his claim at that point, it should be difficult for him to later argue the unsecured claim was filed due to “inadvertence” if he tries to change course and assert a secured lien. Finally consider (4) if the secured claim involves a judgment lien and it is still not corrected by the time of confirmation, file an Adversary Proceeding soon after confirmation of the case to determine the validity of the lien(s), and if opposed by the creditor after the above resolution efforts, seek attorney fees for any apparent bad faith gamesmanship. Another possible option is to file a motion under Rule 3012 to determine the value of the secured claim.