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Burkhart v. Community Bank of Tri-county

United States District Court, D. Maryland

July 27, 2016

EDWIN MICHAEL BURKHART, et al., Debtor-Appellants
v.
COMMUNITY BANK OF TRI-COUNTY, Appellee, and NANCY SPENCER GRIGSBY, Trustee, Necessary Party.

          MEMORANDUM OPINION

          PETER J. MESSITTE UNITED STATES DISTRICT JUDGE

         This Chapter 13 bankruptcy case is on appeal from an Order of the United States Bankruptcy Court for this District. See Burkhart, et al. v. Community Bank of Tri County, et al. (In re Burkhart, et al.), Ch. 13 Case No. 12-26888, Adv. No. 13-00291 (Bankr. D. Md.). After obtaining a lift-stay order from the Court, Debtor-Appellants Edwin Michael Burkhart and Teresa Stein Burkhart (the “Burkharts”) brought an adversary proceeding seeking to avoid wholly unsecured liens attached to their residential real property. Appellee Community Bank of Tri-County (“Tri-County”), which held two of these liens, failed to file timely proofs of claim. When Tri-County did not respond to the Burkharts’ adversary Complaint, the Burkharts moved for default judgment. The Bankruptcy Court, however, denied the Burkharts’ motion, ruling that Tri-County’s liens could not be avoided in the absence of theirs being an “allowed claim”-that is, a claim for which a proof of claim had been filed. The Burkharts have appealed the Bankruptcy Court’s order. For the reasons that follow, the decision of the Bankruptcy Court is AFFIRMED.

         I.

         The Burkharts, who perform government contract work, have accrued substantial obligations in the form of mortgages and liens against their homestead as well as other unsecured debts. Am. Appellant’s Br. 6, ECF No. 8.

         On September 14, 2012, they filed a Voluntary Petition for Bankruptcy under Chapter 13 of the Bankruptcy Code. Voluntary Petition, ECF No. 1-1. That same day, the Bankruptcy Court entered a Notice of Commencement of Chapter 13 Bankruptcy Case, Meeting of Creditors, & Deadlines, which informed the Burkharts’ creditors that the bar date for claims (the “Bar Date”) for non-governmental units was January 23, 2013. Notice of Commencement, ECF No. 1-7.

         On May 16, 2013, nearly four months after the Bar Date, the Burkharts, following a lift-stay, filed a Complaint (in this Court) to Declare Validity, Scope and Extent of Liens of Community Bank of Tri-County and PNC Bank (the “Complaint”). Compl., ECF No. 1-64. The Complaint sought to remove wholly unsecured liens attached to the Burkharts’ real property located at 2060 Barakat Court, Huntingtown, Maryland 20639 (the “Property”).[1] See generally Id. The Property was valued at $435, 000.00.[2] Compl., Ex. 1, ECF No. 1-65. The Burkharts alleged that the following claims were secured by the Property: (1) a first priority lien in favor of Chase Bank in the amount of approximately $609, 500.00[3]; (2) a junior lien in favor of PNC Mortgage (“PNC”) in the amount of $105, 995.75; (3) a junior lien in favor of Tri-County in the amount of $78, 289.71; and (4) a junior lien in favor of Tri-County in the amount of $49, 411.80. Compl. ¶¶ 7-8. The Burkharts alleged that while PNC had filed a timely proof of claim, Tri-County had not, and thus “forfeit[ed] any distributions under a plan in this case.” Id. ¶ 8.

         The Complaint was properly served on PNC and Tri-County. Certificate of Service, ECF No. 1-86. On September 23, 2013, after neither creditor responded, the Burkharts moved for a clerk’s entry of default and default judgment. Mot. Entry Clerk’s Default and Default J., ECF No. 1-89. On the same day, the Clerk entered a default against both PNC and Tri-County. Entry of Default, ECF Nos. 1-91, 1-92.

         On September 29, 2013, the Bankruptcy Court entered a default judgment against PNC, which had the effect of the Burkharts avoiding the lien held by PNC. Order Granting Mot. Default as to PNC, ECF No. 1-95. With respect to Tri-County, however, the Bankruptcy Court denied the motion for default judgment without prejudice. Order Denying Mot. Default as to Tri-County, ECF No. 1-96.

         In response to the Bankruptcy Court’s denial, the Burkharts filed an Amended Motion for Default Judgment against Tri-County. Am. Mot. Default J. as to Tri-County, ECF No. 1-99. They again sought a declaratory ruling to avoid Tri-County’s liens as in rem claims because they were purportedly valueless, and thus wholly unsecured.[4] Id. This time, the Burkharts also pointed to Federal Rule of Bankruptcy Procedure 3002(c)(3), which allows an entity to file a proof of claim “30 days after the judgment becomes final if judgment . . . avoids the entity’s interest in property.” Id. ¶ 5. (quoting Fed.R.Bankr.P. 3002(c)(3)). The Burkharts suggested that, if the Bankruptcy Court were to grant the Burkharts’ Amended Motion for Default Judgment, Tri-County would still be able to file its lien as an unsecured claim and thus participate in the bankruptcy process. See id.

         On October 25, 2013, the Bankruptcy Court issued a Memorandum Opinion with respect to the Amended Motion for Default Judgment (“Bankruptcy Court Memorandum 1”), adopting the reasoning of White v. FIA Card Services, N.A., 494 B.R. 227, 230 (W.D. Va. 2012), and concluding that 11 U.S.C. § 506(d)(2) only voids a lien that secures a claim against the debtor which is not an allowed secured claim, except when that claim is not treated as an allowed secured claim simply because the creditor has elected not to file a proof of claim. Bankr. Ct. Mem. 1 at 2-3, ECF No. 1-101. Thus, as the Bankruptcy Court reasoned, since Tri-County had not filed a proof of claim, its lien could not be avoided by reason of § 506(d)(2). Id. 3. The Bankruptcy Court gave the Burkharts fourteen days to respond. Id.

         On November 12, 2013, the Burkharts filed a response, arguing that they were not seeking to “void” Tri-County’s lien under 11 U.S.C. § 506(d), but rather to “avoid” the lien under 11 U.S.C. §§ 506(a) and 1322(b). Burkharts’ Resp. to Mem. Op. Am. Mot. Default 6-7, ECF No. 1-103. The Burkharts argued that fifteen years of Fourth Circuit law permitted the lien avoidance they sought under 11 U.S.C. §§ 506(a) and 1322(b). Id. 7-11.

         On January 9, 2014, the Bankruptcy Court issued a second opinion and order dealing with the Amended Motion for Default Judgment (“Bankruptcy Court Memorandum 2”), reaffirming its earlier position that, absent an allowed claim filed by Tri-County, the court could not enter an order that would avoid its lien. Bankr. Ct. Mem. 2 at 3, ECF No. 1-104. As the Bankruptcy Court reasoned, since Tri-County did not file a proof of claim, it did not not have an allowed secured claim. Accordingly, its claim could not be evaluated under 11 U.S.C. § 506(a), and its lien could not be avoided pursuant to 11 U.S.C. § 506(d).[5] Id. In consequence, the Bankruptcy Court issued an order dismissing the Burkharts’ Complaint without prejudice as to Tri-County. Order Dismissing Compl. ECF No. 1-105. This Appeal followed. ECF No 1.

         II.

         On appeal, the Burkharts contend that the Bankruptcy Court erred in dismissing their adversary proceeding against Tri-County. They submit that their Complaint was a “garden variety” lien avoidance action under 11 U.S.C. §§ 506(a) and 1322(b); that lien avoidances in Chapter 13 cases under § 506(a) and § 1322(b) have a long history in the Fourth Circuit; and that language in 11 U.S.C. § 506(d) - which requires the filing of a proof of claim prior to declaring any lien “void” - is immaterial to the relief they seek.[6] Am. Appellants’ Br. 11, 13-17. They also suggest that Federal Rule of Bankruptcy Procedure 3002(c)(3), which governs the process for filing proofs of claim, supports their position because it would allow Tri-County to file a proof of its unsecured claim after default judgment. See Id. 17-19; see also Appellants’ Suppl. Br. 6-11.

         In response, the Trustee argues that the Bankruptcy Court was correct to rely on §§ 506(a) and 506(d) which, together with § 1322(b)(2), form the basis for value-based lien avoidances in Chapter 13 proceedings. Appellee’s Br. 10, ECF No. 12. Although the mechanism for value-based lien avoidances is frequently misunderstood by debtors, the “voiding” component is found in § 506(d). See Id. 11-15, 19-20. As the Trustee explains, § 506(d) does not allow lien avoidance when the underlying claim is not “allowed” because a proof of that claim has not been filed. Id. 20-23. According to the Trustee, the Burkharts are effectively seeking to bypass the proof of claim and claim allowance processes with respect to Tri-County. Such a maneuver, says the Trustee, is not only improper under the plain text of the applicable statutory provisions; it also fails to respect the underlying policies of bankruptcy law. Id. 23-24; see also Appellee’s Suppl. Br. 2, ECF No. 2. The Trustee also argues that Bankruptcy Rule 3002(c)(3) is irrelevant to the analysis, but if anything, undermines the Burkharts’ arguments. Id. 23; see also Appellee’s Suppl. Br. 3-7.

         III.

         The Court has jurisdiction over this Appeal pursuant to 28 U.S.C. § 158(a)(1), which gives “[t]he district courts of the United States . . . jurisdiction to hear appeals (1) from final judgments, orders, and decrees; . . . of bankruptcy judges entered in cases and proceedings referred to the bankruptcy judges under section 157 of this title.” The issue raised in this case - i.e., whether a Chapter 13 debtor can avoid a completely unsecured junior lien when no proof of claim has been filed - is a question of law. Legal questions decided by the bankruptcy court are subject to de novo review in the district court. In re Meredith, 527 F.3d 372, 375 (4th Cir. 2008).

         IV.

         The issue before the Court appears to be one of first impression.

         The Court begins with a brief overview of the relevant statutory provisions and case law.

         A.

         Chapter 13 of the Bankruptcy Code allows individual debtors to “obtain adjustment of their indebtedness through a flexible repayment plan approved by a bankruptcy court.” Nobleman v. American Savings Bank, et al., 508 U.S. 324, 327 (1993). The elements of a confirmable Chapter 13 plan are set forth in 11 U.S.C. § 1322, which provides, in part, that a plan may

modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor’s principal residence, or of holders of unsecured claims, or leave unaffected ...

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