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Shelton v. Citimortgage, Inc (In re Shelton)

Shelton v. Citimortgage, Inc., Case No. 12-3555 (8th Cir., November 4, 2013)
A secured creditor's lien is not void solely due to the fact that the secured creditor filed an untimely claim.
Procedural context:
The debtor appealed the BAP's ruling which had affirmed the the bankruptcy court's dismissal of the debtor's adversary proceeding seeking to void the secured creditor's lien.
Prior to this chapter 13 debtors' bankruptcy filing, Citimortgage held a lien on the debtors' primary residence for $210,596.66. Citimortgage did not file a proof of claim until after the claims bar date had passed. The debtors objected to the claim urging that it should be disallowed as untimely. The debtors did not contest the substantive validity of the claim or otherwise challenge the validity of the underlying debt or lien. Prior to a scheduled hearing on the timeliness objection, the parties agreed to an order disallowing the claim. The order did not specify the basis for disallowing the claim. The debtors, however, had raised no challenges other than the timeliness argument. The debtors subsequently initiated an adversary proceeding seeking the avoidance of Citimortgage's lien. Again, the debtors did not challenge the substantive validity of the lien or debt. They relied upon Section 506(d) of the Bankruptcy Code which provides that to the extent a lien secures a claim against the debtor which is not an allowed secured claim, such lien is void unless such claim (1) was disallowed only under Sections 502(b)(5) or 502(e); or (2) is not an allowed claim due only to the failure of an entity to file a proof of claim. The debtors argued that neither exception applied because Sections 502(b)(5) and 502(e) do not involve the disallowance of a claim as untimely and because Citimortgage had filed a proof of claim. Citimortgage argued that because a secured lender's lien generally survives bankruptcy even if the secured creditor elects not to file a claim, lien avoidance (rather than mere claim disallowance) would be an unjustified and overly punitive result where the sole basis of claim disallowance was the untimeliness of the claim. The Eighth Circuit agreed with the prior decisions on this issue by the Fourth and Seventh Circuits, which were the only ones that had addressed the issue and which the bankruptcy court had relied on. Both the Fourth and Seventh Circuits concluded that the plain language of Section 506(d) did not void liens where an associated claim was rejected solely due to its untimeliness. The Eighth Circuit also pointed to the bankruptcy court's reliance upon an Eighth Circuit decision, in a different context, that a lien survived bankruptcy notwithstanding Section 506(d) where the bankruptcy court had rejected a claim as untimely but where there had been no finding of invalidity regarding the underlying debt or claim. Referring to the Seventh Circuit's decision in In re Tarnow, 749 F.2d 464 (7th Cir. 1984), the Eighth Circuit cited to that court's observation that destruction of a lien is a disproportionately severe sanction for a default that can only hurt the defaulter, and that while no one wants bankruptcy proceedings to be cluttered up by tardy claims, the simple and effective method of discouraging them is to dismiss the claim against the bankruptcy estate, as distinct from the claim against the collateral itself, because it is untimely. The Eighth Circuit further noted that the Supreme Court in Dewsnup v. Timm, 502 U.S. 410 (1992) had reaffirmed the general principle that valid liens pass through bankruptcy unaffected. Although Dewsnup did not involve the question presented to the Eighth Circuit, the court found it material to the analysis because it finds ambiguity in Section 506 and because it rests upon two important legislative considerations: (1) Bankruptcy Code provisions should not be read in isolation from one another; and (2) they should not be read in isolation from pre-Code practices. The Fourth Circuit recognized these principles from Dewsnup when it joined the Seventh Circuit and held that liens for disallowed claims survive bankruptcy if the sole basis for disallowance is untimeliness. That view, according to the Fourth Circuit, comports with Section 506(d)(2), which clarifies that Congress did not intend for a perfectly valid lien to be extinguished any time a creditor's claim on the bankrupt estate is disallowed. While that provision does not expressly refer to claims that are disallowed solely because they were filed after the bar date, as the Seventh Circuit reasoned, the failure to file a timely claim, like the failure to file a claim at all, does not constitute sufficient grounds for extinguishing a perfectly valid lien. The Eighth Circuit, therefore, aligned itself with the Fourth and Seventh Circuits and rejected the debtor's appealing, but ultimately inequitable and isolated, reading of Section 506(d).
Murphy, Melloy, and Shepherd

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