Cite as: Keith M. Lundin, Lundin On Chapter 13, § 74.10, at ¶ ____, LundinOnChapter13.com (last visited __________).
When the value of property securing a claim is less than the amount of the claim, the claim is an allowed secured claim to the extent of the value and is an unsecured claim for the balance.1 In a Chapter 13 plan, a claim partially secured by personal property is treated as two claims. The debtor can separately classify the secured portion of a partially secured claim. The balance of the debt is treated as an unsecured claim. As a general rule, the unfair discrimination standard in 11 U.S.C. § 1322(b)(1) prohibits treatment of the unsecured portion of a partially secured claim more favorably than other unsecured claims.2
The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA)3 fundamentally disrupted the general rules for the treatment of partially secured claims. Detailed elsewhere,4 BAPCPA enacted an enigmatic hanging sentence at the end of § 1325(a) that precludes application of § 506(a) to debts secured by a purchase money security interest in a motor vehicle acquired for personal use within 910 days of the petition and to debts secured by any other thing of value incurred within one year of the petition. With respect to hanging-sentence debts, courts have concluded that bifurcation is unavailable and even a partially secured hanging-sentence debt must be treated as “fully secured” at confirmation.5 In other words, a debt partially secured by a purchase money security interest in a car acquired by the debtor for personal use within 910 days of the petition cannot be bifurcated into its secured and unsecured claims, and to accomplish confirmation, the plan must propose to pay the debt in full, typically with present value interest.6
BAPCPA also changed the rules with respect to the lien retention rights of partially secured creditors at confirmation. Although not without some controversy, the general rule before BAPCPA was that a partially secured creditor was entitled to retain its lien only until payment of the present value of the allowed amount of the secured portion of its debt through the plan.7 After BAPCPA amendments to § 1325(a)(5)(B)(i), plans must provide that an allowed, partially secured claim holder retains its lien until the earlier of payment of the “underlying debt determined under nonbankruptcy law” or “discharge under section 1328.”8 The practice in many jurisdictions before BAPCPA that Chapter 13 plans could provide for lien release with respect to partially secured debt at the completion of payment of the allowed secured portion of the debt was eliminated by BAPCPA.
BAPCPA also changed the treatment of partially secured claims at conversion or dismissal before completion of payments under the plan.9 At dismissal before completion of payments, the lien of a partially secured creditor must be retained “to the extent recognized by applicable nonbankruptcy law.”10 When a Chapter 13 case is converted to Chapter 7 before completion of payments, a partially secured creditor continues to be secured by its collateral “unless the full amount of such claim determined under applicable nonbankruptcy law has been paid in full as of the date of conversion.”11 The impact of these changes by BAPCPA is that partially secured claim holders retain their lien rights to the full extent of their debt—without regard to the allowance of secured claims during the Chapter 13 case—until the debtor completes payments and receives a discharge. After BAPCPA, full payment of the allowed secured portion of a partially secured claim does not free the debtor’s property of the lien that would extend to the “unsecured” portion of the debt under nonbankruptcy law in the event of conversion or dismissal before discharge.
Finally, partially secured claim holders also received the benefit of enhanced valuation standards after BAPCPA. Detailed elsewhere,12 BAPCPA amended § 506(a)(2) to require “replacement value” for personal property in Chapter 13 cases and, with respect to property acquired for personal, family or household purposes, BAPCPA defined replacement value as “the price a retail merchant would charge for property of that kind considering the age and condition of the property at the time value is determined.”13 For most personal property secured lenders, BAPCPA has inflated the value of their collateral and reduced the extent of the unsecured claim that can be separately managed through the plan.
On unusual facts, a few courts have allowed separate classification of undersecured claims notwithstanding that the result was to treat the unsecured portion of the partially secured claim more favorably than other unsecured claims. In In re Delauder,14 the plan proposed direct payment of an undersecured car lender consistent with the contract terms. The court found that the car lender would receive a greater percentage of the unsecured portion of its claim than would general unsecured creditors. Also, other creditors would have to wait longer than the car lender for payments on their unsecured claims through the Chapter 13 trustee.
Applying the five-factor test in In re Husted,15 the court approved this separate classification because general unsecured claim holders were actually benefited by the proposed discrimination. The car lender’s claim in Delauder was a long-term debt on which the last installment was due under the contract after the last payment under the plan. If paid through the Chapter 13 trustee, the allowed secured claim would have to be paid in full during the life of the plan at a higher monthly rate, reducing the dividend available for unsecured claim holders from 25 percent to approximately 18 percent. The discrimination in favor of the car lender actually advantaged other unsecured claim holders, and the court approved separate classification of the partially secured claim:
[A]lthough this court would not, as a routine matter, permit an undersecured automobile loan to be paid directly by a debtor outside the plan, such treatment is not improper in this case. Here, the last payment on the automobile loan is due after the last payment under the plan, the direct payment does not reduce the dividend to unsecured creditors and does not appear to be motivated primarily by a desire to avoid the trustee’s commission, and the plan otherwise complies with all the requirements for confirmation. For these reasons, the court cannot find that the plan unfairly discriminates against general unsecured creditors.16
Similarly, in In re Smith,17 the debtors were permitted to separately classify a partially secured car loan for payment in full with contract interest notwithstanding that the plan split other undersecured claims and paid less than 100 percent to unsecured claim holders. In Smith, the debtors worked for Chrysler. Five months before bankruptcy, using a “green slip” from Chrysler, the debtors bought a 1997 Dodge Stratus at a special price. The plan proposed to pay the $20,800 owed to Chrysler on the Stratus in full consistent with contract terms notwithstanding that the Stratus was worth only $18,000. Another undersecured car loan was split into secured and unsecured components and received less favorable treatment through the plan. The bankruptcy court permitted the more favorable treatment of Chrysler’s claim based on this reasoning:
[T]hey did not intend to file a bankruptcy petition at the time they purchased the 1997 Dodge Stratus from Chrysler. . . . [T]hey chose to treat Chrysler’s claim as fully secured to illustrate their good faith . . . . Chrysler had good reason to be upset . . . . [T]hey had purchased a new car from Chrysler only five months prior to the petition date and made no payments on the debt prior to filing their Chapter 13 case. . . . [Section] 1322 does not require a debtor to classify and treat two claims secured by similar collateral identically when the circumstances surrounding those obligations are different. . . . [T]he circumstances surrounding the respective loans justifies the difference in treatment . . . . [I]t serves to rectify the unfairness which would result to Chrysler if the debtors chose to pay less than the full amount of its claim. . . . . [D]ebtors likely will be unable to carry out their plan without the proposed disparity in treatment of the claims of Chrysler . . . . [T]he debtors’ good faith in proposing the amended plan would have been suspect if they proposed less than full payment to Chrysler.18
With respect to claims that are partially secured by real property, the rules discussed above for personal property apply except that claim splitting under § 506(a) may be interrupted by § 1322(b)(2) when the collateral is a debtor’s home. Section 1322(b)(2) prohibits a Chapter 13 debtor from modifying the rights of a creditor with a claim that is secured only by a security interest in real property that is the debtor’s principal residence.19 As interpreted by the Supreme Court in Nobelman, § 1322(b)(2) prohibits a Chapter 13 debtor from splitting a partially secured home mortgage into its secured and unsecured claims.20 Although Justice Thomas acknowledges in Nobelman that § 506(a) might be consulted in a Chapter 13 case to determine the allowable amounts of the secured and unsecured portions of a partially secured home mortgage, this use of § 506(a) is of little practical significance if the mortgage cannot be modified through the plan. If protected from modification by § 1322(b)(2), after Nobelman, the partially secured home mortgage must be treated as a unitary, secured claim through the plan. Debts “secured” by a principal residence with respect to which there is no value to support an allowed secured claim generally can be “stripped off” and treated as unsecured claims.21
1 11 U.S.C. § 506(a). See § 105.1 [ Valuation, Claim Splitting and Dewsnup ] § 76.1 Valuation, Claim Splitting and Dewsnup. This statement of the fundamental principle of how secured claims are determined under § 506(a) of the Bankruptcy Code was shaken but not disabled by the Supreme Court’s decision in Dewsnup v. Timm, 502 U.S. 410, 112 S. Ct. 773, 116 L. Ed. 2d 903 (Jan. 15, 1992). In Dewsnup, the Supreme Court held that a Chapter 7 debtor cannot use § 506(d) to void a lien on real property to the extent that the creditor’s claim exceeds the value of its collateral. In reaching this conclusion, the majority opinion in Dewsnup attempts to distinguish the meaning of “allowed secured claim” in § 506(a) from the meaning of those identical words in § 506(d). Dewsnup could be read that the unsecured portion of an undersecured lien holder’s claim remains secured notwithstanding that the claim is appropriately split into its secured and unsecured components by § 506(a). If so interpreted, Dewsnup would change the conventional wisdom that a partially secured claim holder has two claims in a Chapter 13 case that can be separately provided for by the plan.
2 See § 149.1 [ Power to Classify Unsecured Claims: Tests for Unfair Discrimination ] § 87.1 Power to Classify Unsecured Claims: Tests for Unfair Discrimination. See, e.g., In re Hitch, No. 07-70803, 2009 WL 1542791 (Bankr. C.D. Ill. May 29, 2009) (Gorman) (Deficiency claim must be treated the same as other unsecured claims.); In re Gunn, 37 B.R. 432 (Bankr. D. Or. Feb. 10, 1984) (Hess) (It is unfair discrimination to pay 100% of a partially secured debt and only 3% of other unsecured debts.). Accord In re Gaskin, 79 B.R. 388 (Bankr. C.D. Ill. Nov. 4, 1987) (Altenberger); In re Dant, 9 B.R. 117 (Bankr. E.D. Va. Feb. 10, 1981) (Shelley); In re Cooper, 3 B.R. 246 (Bankr. S.D. Cal. Mar. 18, 1980) (Katz); In re Blevins, 1 B.R. 442 (Bankr. S.D. Ohio Dec. 7, 1979) (Sidman); In re Fizer, 1 B.R. 400 (Bankr. S.D. Ohio Dec. 3, 1979) (Sidman).
3 Pub. L. No. 109-8, 119 Stat. 23 (2005).
4 See discussion beginning at § 75.1 In General: Modification Without § 506.
5 See § 451.1 [ In General: Modification Without § 506 ] § 75.1 In General: Modification Without § 506.
6 See §§ 451.1 [ In General: Modification Without § 506 ] § 75.1 In General: Modification Without § 506 and 451.2 [ Motor Vehicles and Any Other Thing of Value ] § 75.2 Motor Vehicles and Any Other Thing of Value.
7 See § 104.2 [ Lien Retention ] § 74.12 Lien Retention before BAPCPA.
8 11 U.S.C. § 1325(a)(5)(B)(i), as amended by BAPCPA, discussed in § 447.1 [ Lien Retention, Including in No-Discharge Cases ] § 74.13 Lien Retention after BAPCPA, Including in No-Discharge Cases.
9 See §§ 447.1 [ Lien Retention, Including in No-Discharge Cases ] § 74.13 Lien Retention after BAPCPA, Including in No-Discharge Cases, 533.1 [ Lienholders’ Rights at Conversion under § 348(f) ] § 145.3 Lienholders’ Rights at Conversion under § 348(f) after BAPCPA and 541.1 [ Consequences of Dismissal ] § 153.2 Consequences of Dismissal Added or Changed by BAPCPA.
10 11 U.S.C. § 1325(a)(5)(B)(i)(II), discussed in § 541.1 [ Consequences of Dismissal ] § 153.2 Consequences of Dismissal Added or Changed by BAPCPA.
11 11 U.S.C. § 348(f)(1)(C)(i), discussed in § 533.1 [ Lienholders’ Rights at Conversion under § 348(f) ] § 145.3 Lienholders’ Rights at Conversion under § 348(f) after BAPCPA.
12 See § 450.1 [ New Valuation Standards ] § 76.7 Valuation after BAPCPA.
13 11 U.S.C. § 506(a)(2), discussed in § 450.1 [ New Valuation Standards ] § 76.7 Valuation after BAPCPA.
14 189 B.R. 639 (Bankr. E.D. Va. Nov. 28, 1995) (Mitchell).
15 142 B.R. 72 (Bankr. W.D.N.Y. June 5, 1992) (Ninfo).
16 189 B.R. at 645–47.
17 222 B.R. 846 (Bankr. N.D. Ind. May 29, 1998) (Dees).
18 222 B.R. at 855–56. See also In re Ross, 161 B.R. 36 (Bankr. C.D. Ill. Nov. 18, 1993) (Altenberger) (Not unfair discrimination to pay in full long-term lease of real estate and claim for purchase of cabin located on the real estate where purchase price of cabin was $15,000 and current value of the cabin was only $5,200, notwithstanding that other unsecured claim holders would receive only 9% dividend. Undersecured claim was co-signed by or guaranteed by the debtor’s employer, and the debtor contended that he would lose his job if the debt for the cabin was not paid in full.); In re Ragsdale, 15 B.R. 668 (Bankr. N.D. Ga. Oct. 17, 1980) (Drake) (Plan proposing to pay undersecured creditor 100% and other unsecured creditors 0% did not unfairly discriminate where note was secured by an automobile used in debtor’s business and obligation would have been reaffirmed in a Chapter 7 case and paid out of future earnings.).
19 See § 118.1 [ Most Home Mortgages Cannot Be Modified: § 1322(b)(2) and Nobelman ] § 79.1 Most Home Mortgages Cannot Be Modified: § 1322(b)(2) and Nobelman.
20 See § 118.1 [ Most Home Mortgages Cannot Be Modified: § 1322(b)(2) and Nobelman ] § 79.1 Most Home Mortgages Cannot Be Modified: § 1322(b)(2) and Nobelman for further discussion of Nobelman v. American Savings Bank, 508 U.S. 324, 113 S. Ct. 2106, 124 L. Ed. 2d 228 (June 1, 1993), and the “splitting” of claims that are protected from modification by § 1322(b)(2).
21 See § 128.1 [ Modification of Unsecured Home Mortgage: Before and After BAPCPA ] § 80.13 Modification of Unsecured Home Mortgage: Before and After BAPCPA.