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In Re Steck

298 B.R. 244 (D. N.J. 2003)

BANKRUPTCY; LIENS—A debtor may use the lien avoidance powers of a bankruptcy trustee in a Chapter 11 case, but not in a Chapter 13 case, and to avoid a transfer of exempt property a debtor must act within the statutory two year time limit.

A married couple executed a note secured by a mortgage on commercial property. After default, the lender sued and obtained a default judgment. The judgment was docketed and became a lien on all of the borrower’s real property. About a year later, the wife filed for bankruptcy under Chapter 13. Among the assets listed was the commercial property and a personal residence. The borrower claimed full homestead exemption for the residence. The petition listed the lender as a secured creditor with a mortgage on the commercial property, but omitted the fact the lender was also a judgment creditor. An amended petition corrected that information, but did not change the amount of the homestead exemption.

About a year before the amendment was filed, the lender moved for relief from the automatic stay, “principally to pursue its remedies” with respect to the commercial property. Negotiations ensued and the lender, by consent order, was permitted to enforce those rights. Shortly after his wife’s Chapter 13 case was commenced, the husband filed a Chapter 7 case. As part of the administration of that case, the trustee sold the commercial property. The lender received the proceeds and the rents that had been collected by the trustee. As a result, the lender eventually amended its secured proof of claim. There were only two other secured claims filed against the residence, a first mortgage and a federal tax claim.

In this case, the wife sought to reduce or modify the lender’s secured claim and to modify the consent order to reflect that the planned payments did not constitute adequate protection for the lender. She argued that the lender never levied on the house and that she never gave the lender a mortgage on the house. The lender replied that its pre-petition judgment lien gave it the status of a secured creditor with respect to the house and that, as a secured creditor, it was entitled to adequate protection. At the hearing on the matter, the wife claimed that she could avoid the lender’s claim by utilizing section 544 or section 522(f) of the Bankruptcy Code. Section 544 “contains the so-called ‘strong arm’ powers of the trustee. Pursuant to §544(a)(2) the trustee has the status of the creditor possessing an unsatisfied execution, and thereby occupies the priority position of the ideal lien creditor.” The scope of that power is defined by state law. “Under New Jersey law, ‘[i]rrespective of when a judgment creditor obtains or dockets a judgment, the creditor who levies first has priority over all nonlevying judgment creditors.’” On that basis, the wife argued that because there was no levy on her house, she could employ the “strong arm” powers to avoid the lien.

There are two lines of cases concerning the standing of a Chapter 13 debtor to exercise the trustee’s avoidance powers. Here, the Court found that the cases saying that the debtor may not use such power were persuasive. In the Court’s view, that line of cases “appl[ies] a straightforward analysis of the language and structure of the Bankruptcy Code, which [is] in keeping with the directive that where ‘the statute’s language is plain, the sole function of the court is to enforce it according to its terms.’” Although a trustee has the avoidance powers, the Bankruptcy Code only “conferred the avoidance powers upon debtors in possession in Chapter 11 and Chapter 12 cases.” By contrast, the section of the Bankruptcy Code that grants a Chapter 13 debtor certain rights and powers of the trustee does not list section 544 powers. The Court recognized strongly policy arguments to confer the avoidance powers on Chapter 13 debtors, especially because trustees rarely exercise those powers themselves. Otherwise, it found the Bankruptcy Code structure to be unambiguous.

The Court then analyzed whether the debtor could avoid a transfer of the residence as exempt property under section 522(h). In doing so, it applied a five-part test to the facts and held: “(i) the transfer was not a voluntary transfer of property by the debtor; (ii) the debtor did not conceal the property; (iii) the trustee did not attempt to avoid the transfer; (iv) the transferred property is of the kind the debtor would have been able to exempt from the estate if the trustee had avoided the transfer under §522(g); and (v) the debtor seeks to exercise one of the trustee’s avoidance powers enumerated in §522(h).” A debtor must satisfy all five prongs of the test.

Even though all five prongs were met in this case, the debtor’s effort failed because it was untimely. Under the Bankruptcy Code, if a Chapter 13 trustee or a Chapter 13 debtor seeks “to exercise the avoidance powers [he or she] must commence such an action or proceeding not later than 2 years after the entry of the order of relief, which corresponds to the date of filing of the debtor’s petition.” There is no language in the relevant sections of the bankruptcy code relieving the debtor from that time requirement.

The wife was ultimately successful, but only partially so. “[I]t is settled law that a Chapter 13 debtor can utilize §522(f) to avoid a judicial lien that impairs an exception, or a non-possessory, non-purchase money security interest in household goods that would be exempt property under applicable law.” This lien avoidance power allows the debtor “to extinguish or partially avoid the judicial lien of a creditor in property that would otherwise be exempt but for the creditor’s lien.” A lien impairs an exemption when the sum of all liens on a property, plus the amount of the exemption that could be claimed if there were no liens on the property, exceeds “the value that the debtor’s interest in the property would have in the absence of any liens.” Under that formulation, “a debtor is permitted to avoid only that portion of the lien that impairs exemption.” Using the figures in this particular case, the amount of the lien exceeded the impairment by only a small amount. That small amount could not be avoided “and [needed to be] appropriately addressed within the debtor’s Chapter 13 Plan.”

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