The underwater second deed of trust was listed on Schedule F in the debtor’s prior Chapter 13 case as an unsecured claim.
Functionally, the lien was without value.
But, the debtor, now my client in a subsequent case, took a gentle tongue lashing from a bankruptcy judge about the classification of the claim on the schedules.
The debtor was complaining that the lien hadn’t been stripped in the previous case, as he expected.
The judge saw the scheduling choice as an indication that the debtor wasn’t paying attention in his prior case.
I saw it, more probably, as a case of a confused bankruptcy lawyer. The prior lawyer saw an absolutely underwater mortgage, and gave it the practical, rather than the formal, treatment it should have.
[I also saw the issue as the sort of question that a layman cannot be expected to know.]
So, let’s walk through the differences between liens and allowed, secured claims.
We’re lucky: “lien” is defined in the code.
§101 (37) The term “lien” means charge against or interest in property to secure payment of a debt or performance of an obligation.
So, a lien is the right in property associated with an obligation. The definition says nothing about the value of the lien.
Schedule D asks for a list of secured creditors. The instructions begin
State the name, mailing address … and last four digits of any account number of all entities holding claims secured by property of the debtor as of the date of filing of the petition.
The face amount of the claim secured by the lien is listed with the other info about the lien. Tellingly, the last column of information on the lien is the amount of the claim that is unsecured.
Only at end of the info required about the secured claim are we asked whether there’s any real value to actually secure the claim.
Classification of the claim, then, is dependent on the existence of a legal right against something the debtor owns, even if the lien is so far down the line of claimants to the collateral as to be worthless.
So we know where to list the claim.
Allowed secured claim
The meaningful sorting, the division of apples from oranges, begins when we talk about valuing secured claims.
Section 506 provides us with the definition of an allowed secured claim. Now, we start talking about practicalities.
(a)(1) An allowed claim of a creditor secured by a lien on property in which the estate has an interest… is a secured claim to the extent of the value of such creditor’s interest in the estate’s interest in such property… and is an unsecured claim to the extent that the value of such creditor’s interest …is less than the amount of such allowed claim.
So, the holder of the underwater junior lien on my client’s house had a lien, but not an allowed secured claim. The value of the collateral was less than the senior liens. The junior’s mortgage lien entitled it to nothing on account of the lien.
Image courtesy of Flickr and Dan McKay