Previously Discharged Personal Liability Does Not Count Toward Debt Limit

The unsecured debt limit circumscribing eligibility for chapter 13 bankruptcy does not include personal liability on wholly unsecured liens where that liability was discharged in a prior chapter 7 case. Free v. Maliaer (In re Free), No. 14-1395 (B.A.P. 9th Cir. Dec. 17, 2015).

Mr. and Mrs. Free obtained a chapter 7 discharge releasing their personal liability on two wholly unsecured junior liens on their real property. Prior to closure of their chapter 7 case, the Frees filed chapter 13 intending to strip-off the junior liens. The trustee moved to dismiss on the basis that their unsecured debts, including the debts underlying the wholly-unsecured liens, exceeded the debt limits for chapter 13 under section 109(e). The bankruptcy court agreed and dismissed.

Section 109(e) provides in part: “Only an individual with regular income that owes, on the date of the filing of the petition, noncontingent, liquidated, unsecured debts of less than $250,000 . . . may be a debtor under chapter 13 of this title.” Discussing the relevant definitions of terms the court stated, “The term ‘debt’ means liability on a claim. § 101(12).  The term ‘claim’ means . . . right to payment . . . . § 101(5)(A). Thus, there is no ‘unsecured debt’ unless the creditor has a ‘right to payment’ on an unsecured basis.”

Because the debtors had their personal liability discharged in chapter 7, the discharge injunction operates to prohibit any act by the creditor to collect that debt. “Thus, applying the statutory definitions to the words of § 109(e), debts that were discharged in chapter 7 are not ‘unsecured debts.’” In so holding, the court agreed with In re Shenas, 2011 WL 3236182 (Bankr. N.D. Cal. July 28, 2011), where the bankruptcy court found that a prior chapter 7 discharge precluded the creditor from filing an allowable claim for an unsecured debt in the subsequent chapter 13 case.

The BAP walked through the cases relied on by the bankruptcy court in finding that the debtors were ineligible for chapter 13, beginning with Johnson v. Home State Bank, 501 U.S. 78 (1991). The Johnson Court made clear that chapter 7 discharge applies only to in personam liability and does not affect in rem liability on a secured debt. Therefore, a creditor may still file an allowable claim for a secured debt in a subsequent chapter 13, but may not file a claim against the debtor personally. Contrary to the bankruptcy court’s conclusion, Johnson, therefore, supports the finding that the creditors had no unsecured claim against the Frees that would increase their unsecured debt for eligibility purposes.

Similarly, the court rejected the bankruptcy court’s interpretation of Quintana v. Commissioner (In re Quintana) (Quintana II), 915 F.2d 513 (9th Cir. 1990), aff’g (Quintana I), 107 B.R. 234 (B.A.P. 9th Cir. 1989), and Davis v. Bank of America (In re Davis) (Davis I), 2012 WL 3205431 (B.A.P. 9th Cir. Aug. 3, 2012). Those cases dealt with “aggregate debts” in the context of chapter 12 rather than “reviving discharged in personam liability,” and therefore were not controlling.

The court also distinguished Scovis v. Henrichsen (In re Scovis), 249 F.3d 975 (9th Cir. 2001), and Smith v. Rojas (In re Smith), 435 B.R. 637 (9th Cir. BAP 2010), which stand for the proposition that “when determining a debtor’s chapter 13 eligibility, the undersecured portion of a secured creditor’s claim should be counted as unsecured debt.” Neither of the cases involved previous chapter 7 bankruptcies where the debtor’s in personam liability had been discharged. Rather, in both cases the debtor’s obligation to pay the unsecured portion through the plan remained intact.

Finally, the court discussed In re Rosa, 521 B.R. 337 (Bankr. N.D. Cal. 2014). There, the chapter 20 debtor obtained valuation on a lien under section 506(a) in which it was found that the lien was not supported by any equity. The debtor objected to the claim as unsecured and sought to have it declared discharged as a result of her prior chapter 7 bankruptcy. The bankruptcy court agreed, concluding that the fact that the creditor had an allowed secured claim did not mean that upon valuation of the lien as wholly unsecured, the creditor had an allowed unsecured claim.

Discussing the impact of Dewsnup v. Timm, 502 U.S. 410 (1992), and Bank of America v. Caulkett, 135 S. Ct. 1995, 1999 (2015), the court said that any bad faith based on a chapter 20 debtor’s two-step discharge of personal liability in chapter 7 followed by strip-off of the lien in chapter 13 should be addressed in an objection to confirmation rather than in the context of eligibility. The court recognized, however, that such serial filings are not per se bad faith. (citing HSBC Bank USA v. Blendheim (In re Blendheim), 803F.3d 477 (9th Cir. 2015)).

Free BAP 9th opinion Dec 2015