Gaglia v. First Federal Sav. & Loan Ass'n

• Decision Date: 30 January 1990
• Docket Number: No. 89-3215,89-3215
• Citation: 889 F.2d 1304
• Parties: , 22 Collier Bankr.Cas.2d 91, 19 Bankr.Ct.Dec. 1697, Bankr. L. Rep. P 73,099 Roland & Lynn GAGLIA, Jr., Appellants, v. FIRST FEDERAL SAVINGS & LOAN ASSOCIATION; Equibank; James R. & Norma J. Stampfel d/b/a Stampfel's Nursery; and The United States of America, Small Business Administration, Appellees.
• Court: U.S. Court of Appeals — Third Circuit

Page 1304

889 F.2d 1304

58 USLW 2330, 22 Collier Bankr.Cas.2d 91,

19 Bankr.Ct.Dec. 1697,

Bankr. L. Rep. P 73,099

Roland & Lynn GAGLIA, Jr., Appellants, v. FIRST FEDERAL SAVINGS & LOAN ASSOCIATION; Equibank; James R. & Norma J. Stampfel d/b/a Stampfel's Nursery and The United States of America, Small Business Administration, Appellees.

No. 89-3215.

United States Court of Appeals Third Circuit.

Argued July 27, 1989.

Decided Nov. 29, 1989.

As Amended Jan. 30, 1990.

Kenneth M. Steinberg (argued), Steidl and Steinberg, Pittsburgh, Pa., for appellants.

Richard S. Ehmann, Hollinshead, Mendelson & Nixon, P.C., Pittsburgh, Pa., for appellee First Federal Sav. & Loan Ass'n of Pittsburgh.

Reed J. Davis (argued), Davis Reilly, P.C., Pittsburgh, Pa., for appellee Equibank.

Charles D. Sheehy, Acting U.S. Atty., Constance M. Bowden, Asst. U.S. Atty. (argued), U.S. Attys. Office, Pittsburgh, Pa., for appellee The U.S. of America, Small Business Admn.

Michal Fox, Community Legal Services, Inc., Philadelphia, Pa., for amicus curiae Consumer Educ. and Protective Ass'n, Inc.

Gary J. Gaertner, Office of Chapter 13 Trustee, Pittsburgh, Pa., for amicus curiae Chapter 13 Standing Trustee.

Before GIBBONS, Chief Judge, HUTCHINSON, Circuit Judge, and REED, District Judge. ^*

OPINION OF THE COURT

HUTCHINSON, Circuit Judge.

Roland and Lynn Gaglia (the Gaglias) filed a voluntary petition under Chapter 7 of the Bankruptcy Code. The United States District Court for the Western District of Pennsylvania, affirming an order of the bankruptcy court, held that the Gaglias could not avoid the portion of secured liens that exceeded the value of the underlying property, since the property was not administered in the bankruptcy proceeding. We will reverse.

I.

The Gaglias purchased a home in 1980. It was financed in large part by a mortgage from Fort Pitt Federal, now First Federal Savings and Loan (First Federal). In 1983, they mortgaged the residence to secure a loan from Equibank. The Equibank loan, guaranteed by the Small Business Administration of the United States (SBA), partially financed a landscaping business, thereby encumbering the property with mortgages exceeding $280,000. When the business failed and sought protection under Chapter 11 of the Bankruptcy Code, Equibank assigned its interest to the SBA.

Later, in 1985, the Gaglias filed their own Chapter 7 petition, listing their residence as their sole asset of any value. After they received their discharge, they started an adversary proceeding in the bankruptcy court to avoid liens. The Gaglias alleged that the property had a value of $34,000 and was subject to a first mortgage, with a balance of $28,873.50, and a second mortgage, with an outstanding balance of more than $200,000, that Equibank had assigned to the SBA. Relying on 11 U.S.C.A. Sec. 506(d) (West Supp.1989), the Gaglias sought an order voiding the SBA's security interest in excess of $5,126.50, the property's claimed value less the balance of the first mortgage. ¹

The bankruptcy court denied relief. Adopting the reasoning of In re Maitland, 61 B.R. 130 (Bankr.E.D.Va.1986), it concluded that Sec. 506 was intended to apply only to property administered under the Code, not to property abandoned or released from the estate. In re Gaglia, 76 B.R. 82, 84 (Bankr.W.D.Pa.1987). The court reasoned that permitting the Gaglias to avoid the liens would be at odds with 11 U.S.C.A. Sec. 722 (West 1979), which provides for the redemption of certain personal property but does not mention real property. Id. Moreover, the court continued, because Sec. 506(d) makes no distinction between real and personal property and offers debtors a better remedy than Sec. 722, allowing debtors to utilize Sec. 506 would render Sec. 722 superfluous. Id.

The court also relied on a perceived conflict with 11 U.S.C.A. Sec. 362(d)(2) (West Supp.1989). That section states that a court shall, after notice and hearing, grant a party in interest relief from the automatic stay if the debtor has no equity in the property and the property "is not necessary to an effective reorganization." 11 U.S.C.A. Sec. 362(d)(2). According to the bankruptcy court, this section requires the stay to be lifted at a secured creditor's request so that he "may pursue his remedy against the liened property for whatever benefit he may perceive," a purpose that would be frustrated if a debtor could use Sec. 506 to avoid the undersecured portion of a lien and "redeem" the property at market value. Gaglia, 76 B.R. at 84. The court reasoned that the Gaglia's interpretation of Sec. 506(d) was too drastic a change from practice under the Bankruptcy Act to stand in the face of the inclusion of Sec. 362(d)(2), which indicated to the court that Congress wanted to balance debtors' rights in over-encumbered assets against the interest of the lenders. ²

The district court affirmed. It too concluded that Sec. 506(d) applied only to property sold by the estate and that permitting a debtor to utilize it would render Sec. 722's limitation to personal property meaningless. In re Gaglia, 97 B.R. 250, 251 (W.D.Pa.1989). Furthermore, the district court stated that allowing Chapter 7 debtors to avoid liens would discourage the use of Chapters 11 and 13, and would be inequitable. Id. at 251-52.

The Gaglias appeal. We have jurisdiction pursuant to 28 U.S.C.A. Sec. 158(d) (West Supp.1989). Since the interpretation of Sec. 506(d) presents a question of law, our review is plenary. See Walters v. United States Nat'l Bank, 879 F.2d 95, 96 (3d Cir.1989); In re Roach, 824 F.2d 1370, 1371-72 (3d Cir.1987).

II.

Section 506 of the Bankruptcy Code provides, in relevant part:

(a) An allowed claim of a creditor secured by a lien on property in which the estate has an interest, or that is subject to setoff under section 533 of this title, is a secured claim to the extent of the value of such creditor's interest in the estate's interest in such property, or to the extent of the amount subject to setoff, as the case may be, and is an unsecured claim to the extent that the value of such creditor's interest or the amount so subject to setoff is less than the amount of such allowed claim. Such value shall be determined in light of the purpose of the valuation and of the proposed disposition or use of such property, and in conjunction with any hearing on such disposition or use or on a plan affecting such creditor's interest.

....

(d) To the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void, unless--

(1) such claim was disallowed only under section 502(b)(5) or 502(e) of this title; or

(2) such claim is not an allowed secured claim due only to the failure of any entity to file a proof of such claim under section 501 of this title.

11 U.S.C.A. Sec. 506(a), (d) (West 1979 & Supp.1989). ³

The Gaglias rely on what they contend is the plain meaning of Secs. 506(a) and 506(d). They assert that Sec. 506(a) bifurcates a secured creditor's claim into a secured and an unsecured component, with the claim secured to the extent that the creditor may look to the underlying collateral. See United States v. Ron Pair Enter., --- U.S. ----, 109 S.Ct. 1026, 1029, 103 L.Ed.2d 290 (1989) ("Subsection (a) of Sec. 506 provides that a claim is secured only to the extent of the value of the property on which the lien is fixed; the remainder of that claim is considered unsecured.") (footnote omitted); In re Lewis, 875 F.2d 53, 56 (3d Cir.1989) (similar analysis of Sec. 506). The SBA would therefore have a secured claim for the difference between the market value of the property and the remaining amount of the first mortgage, with the rest of its claim unsecured. The unsecured portion, the Gaglias argue, is then void under Sec. 506(d). The Gaglias contend that the SBA would receive the same amount if the property were liquidated and that lien avoidance simply duplicates the results of a forced sale.

The majority of the bankruptcy and district courts that have considered this issue agree that the language of Sec. 506 allows a Chapter 7 debtor to void liens secured by property that is not administered. See, e.g., In re Garnett, 88 B.R. 123, 124 (Bankr.W.D.Ky.1988) (majority view allows Chapter 7 debtor to void unsecured portion of mortgage), aff'd, United States ex rel. Farmers Home Admin. v. Garnett, 99 B.R. 757 (W.D.Ky.1989). Although no court of appeals has directly ruled on the question, the two cases that have discussed the application of Sec. 506 in this context indicate that a debtor may use Sec. 506(d) to avoid liens. In In re Folendore, 862 F.2d 1537 (11th Cir.1989), the debtors sought to avoid a lien held by the SBA that was junior to two mortgages that secured debts exceeding the property's value. In holding that the SBA's lien could be avoided, the court did not expressly consider whether the property was to be liquidated. It noted, however, that while the debtors had been discharged their case had not been closed, and the senior mortgagees could foreclose on the property at any point. Id. at 1538 n. 2, 1540. This suggested that the property was not subject to liquidation. Recognizing that the SBA's mortgage would be eliminated by such a foreclosure, the court refused to allow the SBA to retain its secured interest in the hope of attaching any equity the debtor could generate. The court reasoned that if the SBA's lien were preserved, the debtor would have no incentive to remain on the property and could abandon it, "leav[ing] a creditor like the SBA with nothing, which is exactly what section 506(d) on its face says it has." Id. at 1540.

In In re Lindsey, 823 F.2d 189 (7th Cir.1987), the trustee abandoned the estate, which contained no assets of benefit to the unsecured creditors. The bankruptcy court allowed the debtors to avoid liens under Sec. 506 and gave them thirty days to redeem the property by paying the lenders its current market value. Instead,...