Ninth Circuit Permits Lien-Voidance For Chapter 20 Debtors

Bankruptcy practitioners routinely advise secured creditor clients to file protective proofs of claim in bankruptcy proceedings despite those clients' ability to ignore bankruptcy proceedings and decline filing claims without imperiling their lien due to the protections afforded by state law foreclosure rights.1 But a recent Ninth Circuit decision is causing attorneys and clients to reconsider whether this traditionally conservative approach is simply too risky in Chapter 13 cases. HSBC Bank v. Blendheim (In re Blendheim), No. 13-35412, 2015 WL 5730015 (9th Cir. Oct. 1, 2015).

The Blendheims filed for Chapter 13 relief after receiving a Chapter 7 discharge, making them what is commonly referred to as "Chapter 20" debtors. Holding a first-position lien secured by the Blendheims' West Seattle condominium, HSBC filed a timely proof of claim, to which the Blendheims filed an objection. HSBC did not respond, and hearing no response, the court entered an order disallowing HSBC's claim. HSBC was served with the order, but continued to take no action until several months later when the Blendheims filed an adversary proceeding seeking, among other things, to void HSBC's first-position lien pursuant to Bankruptcy Code §506(d). 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."

Citing HSBC's timely filed proof of claim, receipt of service of the Blendheims' objection, and full and fair opportunity to contest the disallowance of its claim but simply choosing not to, the Ninth Circuit distinguished its decision from Fourth, Seventh, and Eighth Circuit precedent holding that bankruptcy courts may not use § 506(d) to void liens whose claims have been disallowed on the sole basis that their proofs of claim were untimely filed. Rather, the panel concluded that while "[v]oidance of a lien posed a more drastic consequence than simple disallowance of HSBC's claim in the bankruptcy proceeding" because "voiding the lien would eliminate HSBC's state-law right of foreclosure," HSBC's refusal to defend its lien was tantamount to forfeiting its claim.

Finding that the lien was properly voided under § 506(d), the Ninth Circuit next examined whether any provisions of the Bankruptcy Code functioned to reinstate the previously voided lien at the conclusion of the Blendheims' Chapter 13 proceeding. HSBC argued that a discharge was necessary to obtain the benefits of lien...