Right Or Wrong, Dewsnup Is Law

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This article was published in Law360 on January 24, 2014. © Copyright 2014, Portfolio Media, Inc., publisher of Law360.

A Chapter 13 debtor sought to void a federal tax lien under Section 506(d) of the Bankruptcy Code to the extent that it exceeded the value of his assets. The Seventh Circuit joined the Tenth Circuit in holding that the U.S. Supreme Court’s interpretation in Dewsnup applies in Chapter 13 cases to preclude lien stripping under 506(d).

In this case the debtor owed federal income taxes for several years, and the Internal Revenue Service recorded a notice of federal tax lien prior to bankruptcy. The tax liability was about $137,000, while the total value of the debtor’s possessions was $1,625. The debtor argued that the tax lien in excess of $1,625 was void.

The question turned on the interaction (or not) of Sections 506(a) and 506(d):

  • Section 506(a) provides that an allowed claim of a creditor secured by a lien on property is “a secured claim to the extent of the value of such creditor’s interest in the estate’s interest in such property” and an unsecured claim to the extent of the deficiency. So, in the context of subsection (a), the term “allowed claim” refers to the entire claim, and “secured claim” refers to a claim equal to the value of the collateral.
  • Section 506(d) provides that “[t]o the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void” (subject to certain special exceptions). So, the issue is whether an “allowed secured claim” under subsection (d) corresponds to the portion of an allowed claim that is a secured claim under subsection (a).

The bankruptcy court found in favor of the IRS, and the debtor appealed. The linchpin of the opinion on appeal was the Supreme Court decision in Dewsnup v. Timm, 503 U.S. 410, 112 Sup. Ct. 773, 116 L. Ed. 2d 903 (1992) in which it held that the term “allowed secured claim” in Section 506(d) was not determined by the treatment in Section 506(a):

Instead, the court determined that, consistent with pre-code rules that liens pass through bankruptcy unaffected, the term “allowed secured claim” in §506(d) means a claim that is, first, allowed under §502 and second, secured by a lien enforceable under state law, without regard to whether that claim would have been deemed secured or unsecured under §506(a).

However, Dewsnup was decided in the context of a Chapter 7 liquidation. Some have argued that it should be limited to Chapter 7 and should not be applied in other types of proceedings.

In advancing this argument, the debtor suggested that Dewsnup was driven by concerns underlying a Chapter 7 bankruptcy, and a Chapter 13 case has a different set of concerns given that it is a reorganization and repayment without liquidation. In response, the Seventh Circuit pointed out that Section 103(a) of the Bankruptcy Code states that “Chapters 1, 3 and 5 of this title apply in a case under Chapter 7, 11, 12 or 13 of this title.” Thus, Section 506 (which is in Chapter 5) applies equally to a Chapter 7 and a Chapter 13 bankruptcy.

In further response to the argument that Section 506(d) should be treated differently in a Chapter 13 in order to fill the purposes, the court commented that there are alternate provisions that would permit voiding liens in a Chapter 13. So it was not necessary to rely on Section 506(d).

The court noted that the alternate lien stripping sections applicable to Chapters 11, 12 and 13 include certain safeguards to protect secured creditors, and allowing lien stripping under Section 506(d) would circumvent those safeguards.

The debtor raised the concern that the alternate provisions would not be available since the IRS had not waived its sovereign immunity. However, the Seventh Circuit was not persuaded that this should make a difference.

The bottom line is that (1) the Supreme Court has spoken in the context of a Chapter 7 proceeding, and (2) there is no basis for interpreting the same sentence differently depending upon the type of proceeding. The Seventh Circuit concluded by noting that the Tenth Circuit addressed the exact same issue and reached the same decision. (See Mortgage Liens: Can Liens Be Stripped Off in a Chapter 13?) The Tenth Circuit seemed to have more reservations about the result than articulated by the Seventh Circuit. However, as summarized in the Tenth Circuit Woolsey opinioin:

Right or wrong, the Dewsnuppian departure from the statute’s plain language is the law. It may have warped the Bankruptcy Code’s seemingly straight path into a crooked one. It may not be infallible. But until and unless the court chooses to revisit it, it is final.

It is not entirely clear what effect Section 506(d) has under Dewsnup, except perhaps to confirm that a lien goes away when the claim it secures goes away. Regardless, it is apparent that Dewsnup is still good law, and trying to limit it to a Chapter 7 liquidation is at best an uphill battle, and more likely a futile one.