In re Earley

• Decision Date: 05 March 2004
• Docket Number: No. 03 B 38727.,03 B 38727.
• Citation: 305 B.R. 837
• Parties: In re Robert W. EARLEY, Debtors.
• Court: U.S. Bankruptcy Court — Northern District of Illinois

Page 837

305 B.R. 837

In re Robert W. EARLEY, Debtors.

No. 03 B 38727.

United States Bankruptcy Court, N.D. Illinois, Eastern Division.

March 5, 2004.

John J. Ellman, David M. Siegel & Associates, Northbrook, IL, for Debtor.

Kenneth B. Drost, P.C., Barrington, IL, for Triad Financial Corporation.

MEMORANDUM OPINION AND ORDER

A. BENJAMIN GOLDGAR, Bankruptcy Judge.

This matter presents a question that seems to be arising with increasing frequency. Triad Financial Corporation holds a judgment against debtor Robert Earley and has a lien on his wages under the Illinois Wage Deduction Act, 735 ILCS 5/12-801 et seq. (2002) (the "IWDA"). In his chapter 13 plan, however, Earley proposes to treat Triad's claim as unsecured. The question: must a debtor's chapter 13 plan treat as secured the claim of a judgment creditor holding a garnishment lien on the debtor's wages under the IWDA? The answer: no.

1. Jurisdiction

The court has subject matter jurisdiction over this case pursuant to 28 U.S.C. §§ 1334(a) and 157(a), and the district court's Internal Operating Procedure 15(a). This is a core proceeding under 28 U.S.C. § 157(b)(2)(L) (confirmations of plans); see In re Smith, 848 F.2d 813, 816 (7th Cir.1988). The court accordingly may enter a final judgment. Smith, 848 F.2d at 816.

2. Background

The following undisputed facts are drawn from the briefs, the exhibits to the briefs, and the court's own docket.¹

a. The State Court Proceedings

In December 1999, Earley bought a used 1998 Dodge Intrepid from Jack-Son Auto Sales in Waukegan, Illinois. The total sales price was $35,005.40. Following the sale, Jack-Son assigned its contract with Earley to Triad. Earley defaulted on the contract, and Triad brought what it calls "an enforcement action" against Earley in the Circuit Court of Lake County, Illinois. At some point, Triad also repossessed the car. On December 9, 2002, the circuit court entered a judgment in the action in favor of Triad and against Earley for $11,680.10.

A year later, Triad sought to collect its judgment through wage garnishment proceedings under the Illinois Wage Deduction Act, 735 ILCS 5/12-801 et seq. (2002). A summons was issued, and the summons and wage garnishment interrogatories were served on Earley's employer, Lake Forest Hospital. The Hospital answered the interrogatories, indicating that funds were available. Apparently, Earley did not contest the garnishment proceeding (or if he did he was unsuccessful), because on January 27, 2003 the circuit court entered a wage deduction order imposing a lien on Earley's wages in the amount of $11,745.86. The Hospital was ordered to "deduct 15% of the defendant's non-exempt wages ... each pay period" and remit the funds to Triad's lawyer until the judgment (plus interest and costs) was paid in full.

b. The Bankruptcy Proceedings

On September 22, 2003, Earley filed a petition for relief under chapter 13 of the Bankruptcy Code.² Schedule F accompanying the petition listed Triad as an unsecured creditor holding a non-priority claim. With his petition, Earley also filed a proposed chapter 13 plan using the court's Model Plan. Consistent with the petition, the proposed plan did not include Triad in paragraph 5 as a creditor with a secured claim, and so by implication the plan proposed to treat Triad with the class of unsecured creditors to be paid 10% of their claims.

On October 22, 2003, Triad filed a proof of claim for $13,733.24 in Earley's bankruptcy. The form described Triad's claim as "secured" and listed the Dodge Intrepid as collateral although the car had long since been repossessed. Two months later, Triad filed a replacement proof of claim reducing the amount to $11,680.10. This form likewise described Triad's claim as "secured," but it listed as collateral the "wage deduction order."

Now before the court is Triad's objection to the confirmation of the plan and motion to dismiss the case. Citing In re Rasberry, 264 B.R. 495 (Bankr.N.D.Ill.2001), Triad asserts that it has a "perfected security interest" in Earley's wages, including wages earned post-petition. Earley's plan, Triad complains, "does not propose to pay Movant's claim as a secured claim" as section 1325(a)(5)(B)(ii) of the Bankruptcy Code, 11 U.S.C. § 1325(a)(5)(B)(ii), requires. Because Earley is in fact "incapable" of formulating a plan that will pay the value of its secured claim, Triad asks that the case be dismissed.

Earley responds that under Local Loan Co. v. Hunt, 292 U.S. 234, 54 S.Ct. 695, 78 L.Ed. 1230 (1934), pre-petition liens on wages do not survive bankruptcy. According to Earley, not six months ago in In re Pierce, No. 03 B 6812 (Bankr.N.D.Ill.), another judge of this court issued an oral ruling against Triad on this very point, a ruling in which the court cited Hunt. Because Hunt "controls" the outcome, Earley argues, Triad's objection should be overruled and its motion denied.

The objection and motion are fully briefed and ready for decision.

3. Discussion

Earley's plan properly treats Triad's claim as unsecured, but not because Hunt controls the issue. It does not. Triad's claim is unsecured because of the nature of Triad's lien and the interplay between the IWDA and the automatic stay under the Bankruptcy Code, 11 U.S.C. § 362(a). Triad's objection will therefore be overruled and its motion to dismiss denied.

a. The Proof of Claim Question

Before reaching the matter of the garnishment lien, a preliminary question must be addressed. Earley asserts that Triad's proof of claim lists a debt secured only by the car. Because the car was repossessed, he says, Triad's claim is unsecured. Triad answers that a replacement proof of claim was later filed based on the judgment. Triad adds that because the later proof of claim calls itself "secured," and because Earley did not object to the proof of claim, Triad's claim is secured. Both parties, in other words, deem the proofs of claim conclusive on the question of whether Triad has a secured claim.

Both parties are mistaken. Not only are proofs of claim not conclusive on the question of secured status, they are irrelevant to it. In making these arguments, Earley and Triad confuse the claims allowance process under sections 501 and 502 with the process for determining secured status and valuing collateral under section 506. See In re Taylor, 289 B.R. 379, 386 (Bankr.N.D.Ind.2003); Hildebrand v. Hays Imports, Inc. (In re Johnson), 279 B.R. 218, 223 (Bankr.M.D.Tenn.2002); In re Fareed, 262 B.R. 761, 765 (Bankr.N.D.Ill.2001).

The Code provides a process for creditors to make claims for payment out of the assets of the bankruptcy estate. Section 501 permits a creditor to file a "proof of claim," 11 U.S.C. § 501(a), which under section 502(a) will be deemed "allowed" unless there is an objection. 11 U.S.C. § 502(a). If there is, section 502(b) requires the court (after notice and a hearing) to "determine the amount of such claim" and to allow the claim unless it falls into one of nine categories. 11 U.S.C. § 502(b). Specific procedural rules apply to proofs of claim and claims objections. See Fed. R. Bankr.P. 3001-3008.

The Code provides a separate process for determining whether a creditor's claim is secured and valuing the creditor's collateral. Taylor, 289 B.R. at 386. Section 506 governs those processes — processes that take place only if there is first an "allowed claim" under section 502(a), 11 U.S.C. § 506(a) — and a separate procedural rule applies to them. See Fed. R. Bankr.P. 3012. Unlike the allowance of claims, which will occur on its own through sheer inertia, the valuation of collateral and the determination of secured status require judicial action, usually (though not always) prompted by motion. Id; see Taylor, 289 B.R. at 386.

Because the processes under sections 502 and 506 are separate, the operation of one has no effect on the operation of the other. Hence, the allowance of a claim means simply that the claim is valid and has been allowed as to "amount." 11 U.S.C. § 502(b); Fed. R. Bankr.P. 3001(f); Taylor, 289 B.R. at 386; In re Adams, 270 B.R. 263, 269 (Bankr.N.D.Ill.2001); Fareed, 262 B.R. at 765. That a claim is "allowed" says nothing at all about whether the claim is secured or unsecured, or what value the collateral securing the claim might have. Fareed, 262 B.R. at 765 (noting that "nothing in § 502 distinguishes between secured and unsecured claims"); Taylor, 289 B.R. at 386 n. 4.

By filing its proof of claim, then, Triad established that it had a valid claim for $11,680.10. But the proof of claim did not establish that the claim was secured. Despite the claim's allowance, Earley remained entitled to contest Triad's secured status. And he has contested it, proposing a plan that treats Triad's claim as unsecured. See Taylor, 289 B.R. at 386 n. 4; Hildebrand, 279 B.R. at 224.

b. The Wage Deduction Question

So to the main question: is Earley entitled in his plan to treat Triad's claim as unsecured? He is, and the reasons why are fairly straightforward. Under Illinois law, the lien that the IWDA confers attaches only when wages are earned. The automatic stay, however, prevents the lien from attaching to wages earned post-petition. With no collateral securing the lien, the creditor's claim must be deemed unsecured. To the extent Rasberry holds otherwise, the court respectfully declines to follow it.

Because the "`basic federal rule' is that state law governs the substance of claims," Raleigh v. Illinois Dep't of Revenue, 530 U.S. 15, 20, 120 S.Ct. 1951, 147 L.Ed.2d 13 (2000) (quoting Butner v. United States, 440 U.S. 48, 57, 99 S.Ct. 914, 59 L.Ed.2d 136 (1979)), the IWDA is the proper starting point for considering the nature of Triad's claim. The IWDA provides a simple and convenient method for a judgment creditor to collect his judgment by latching on to the judgment debtor's wages and having the wages paid directly to the creditor. See generally 735 ILCS 5/12-801 et seq. (2002).

The...