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Avoiding Security Interests Without Adversary Proceeding. . . Why do I Need an Attorney?

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In 1995, the Fourth Circuit decided Cen-Pen Corp. v. Hansen, 58 F.3d 89 (4th Cir. 1995), which decided the notice requirements within a Chapter 13 case to alter the security interests of a secured creditor. The facts around how the security interest arose were a little convoluted, but suffice it to say, the pre-bankruptcy security status of the lien was not at issue.

However, the Hanson’s filed a Chapter 13 plan that treated Cen-Pen as an unsecured creditor. The plan further required creditors to submit proofs of claim and objections within a specified time period and provided that the plan would be automatically confirmed if no objections were received. A few years after the Hansen’s received their discharge, Cen-Pen filed a Complaint in bankruptcy court to determine the validity of its liens on the Hanson residence

The Hanson’s argument rested on 11 USC § 1327(c) which reads that, “[e]xcept as otherwise provided in the plan or in the order confirming the plan, the property vesting in the debtor under subsection (b) of this section is clear of any claim or interest of any creditor provided for by the plan.” Id. The Hanson’s argued that because Cen-Pen received a copy of the plan in which they were treated as an unsecured creditor and failed to object prior to confirmation, the confirmation of the plan acted as res judicata due to § 1327 as to Cen-Pen’s current claim of having a valid lien against the Hanson’s property.

The Court began by noting the general rule that liens pass through bankruptcies unaffected, see Dewsnup v. Timm, 502 U.S. 210 (1992), and that “for a debtor to extinguish or modify a lien during the bankruptcy process, some affirmative step must be taken toward that end.” Cen-Pen Corp., 58 F.3d at 92. The court looked to Bankruptcy Rule 7001(2) for that affirmative step. That rule requires the initiation of an adversary proceeding “to determine the validity, priority, or extent of a lien or other interest in property.” Id.

Noting with favor the holding of the Northern District of Indiana, the Court repeated that the “confirmation generally cannot have preclusive effect as to the validity of a lien, which must be resolved in an adversary proceeding.” Cen-Pen Corp, 58 F.3d at 93 (citing In re Beard, 112 B.R. 951 (Bankr.N.D.Ind. 1990)). Continuing, “if an issue must be raised through an adversary proceeding it is not part of the confirmation process and, unless it is actually litigated, confirmation will not have a preclusive effect. . . [and a] secured creditor is not bound by the terms of the confirmed plan with respect to limitations upon the scope or validity of the lien securing its claim.” Id.

The Hanson’s maintained that the plan “provided for” Cen-Pen’s claim sufficiently to satisfy the requirements of § 1327(c). The Fourth Circuit refuted this by citing several district courts that held that a plan “provides for” the lien held by a secured creditor only when it provides for payment to the creditor in an amount equal to its security. Based on this, the court did not believe that treatment in the plan was not enough to alter the security interest, absent payment in full or the initiation of an adversary proceeding.

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