In re Meyer

• Decision Date: 31 July 2007
• Docket Number: BAP No. CC-06-1135-KMoB.,Bankruptcy No. SA 05-16733-JB.
• Citation: 373 B.R. 84
• Parties: In re Stephen Louis MEYER, Debtor. All Points Capital Corp., Appellant, v. Stephen Louis Meyer, Appellee.
• Court: U.S. Bankruptcy Appellate Panel, Ninth Circuit

Page 84

373 B.R. 84

In re Stephen Louis MEYER, Debtor All Points Capital Corp., Appellant, v. Stephen Louis Meyer, Appellee.

BAP No. CC-06-1135-KMoB.

Bankruptcy No. SA 05-16733-JB.

United States Bankruptcy Appellate Panel of the Ninth Circuit.

Argued and Submitted November 15, 2006.

Filed July 31, 2007.

Scott E. Schutzman, Lee W. Chin, Law Offices of Scott E. Schutzman, Santa Ana, CA, for All Point Capital Corp.

R. Gibson Pagter, Pagter and Miller, Santa Ana, CA, for Stephen Louis Meyer.

Before: KLEIN, MONTALI, and BRANDT, Bankruptcy Judges.

OPINION

KLEIN, Bankruptcy Judge.

The bankruptcy court avoided two judgment liens under 11 U.S.C. § 522(f) as impairing the debtor's exemption in co-owned real estate. Appellant wants the court's order avoiding the senior $275,000 lien to remain intact on a default theory but wants it reversed as to its own junior lien on the theory the court ignored $91,497.50 of nonexempt equity to which judgment liens can remain attached after bankruptcy.

We agree there is nonexempt equity to which judgment liens may remain attached. Construing § 522(f)(2), which has not been amended since 1994,¹ to avoid an absurd result in the case of co-owned property, we hold that consensual liens against the entire fee must be netted out before computing the value of a debtor's fractional interest for purposes of avoiding judgment liens on which the co-owner is not liable.

Appellant's theory for exploiting default to squeeze out the senior lien offends the rule that multiple liens impairing exemptions be avoided in order of reverse priority and offends the rule that default judgments should not be entered when they are not warranted on the merits.

As the record is confused by procedural issues and lack of findings, we VACATE and REMAND.

FACTS

The chapter 7 debtor claimed a $50,000 homestead exemption in a co-owned residence he valued at $515,000, encumbered by consensual debt of $232,005, in which he scheduled his 50-percent joint tenancy interest as worth $257,500.

If the property had been liquidated without transaction costs on the day of bankruptcy, the debtor's share as co-owner would have been $141,497.50, or $91,497.50 net of his $50,000 homestead exemption.²

The debtor's interest was subject to two judgment liens (as one of four co-debtors). In first position was $275,000 owed to American Capital Resources, Inc. ("American Capital") on a $217,972 judgment; next was $900,000 owed to appellant All Points Capital Corporation ("All Points") on an $805,631 judgment.

The debtor filed one motion to avoid both judicial liens under § 522(f)(1). The parties agree that if one considers only the debtor's net equity interest ($141,497.50) and deducts his $50,000 exemption, a judicial lien could withstand § 522(f)(1) avoidance to the extent of $91,497.50.

The obstacle to this result is the language of § 522(f)(2), which prescribes a statutory formula for calculating impairment that does not take fractional interests into account. The sum of "the lien" plus "all other liens on the property" plus the "amount of the exemption that the debtor could claim if there were no liens on the property" is compared with the "value that the debtor's interest in the property would have in the absence of any liens." 11 U.S.C. § 522(f)(2).

The debtor argued that § 522(f)(2) analysis should be done lien by lien in reverse order, beginning with All Points' junior lien. Comparing that lien with the sum of senior liens and the exemption, $557,005 (= $232,005 mortgage + $50,000 exemption + $275,000 American Capital judicial lien), the $515,000 value of the property meant that the All Points lien impaired the $50,000 exemption and was avoidable in full.

All Points contended that the senior $275,000 American Capital lien should be first avoided by default and excluded from the analysis. Under its theory, excluding the senior lien and not adjusting equity to reflect the value of the debtor's one-half interest until after the $232,005 consensual lien is netted out, there would be equity of $282,995 (= $515,000 - 232,005) for all owners, the debtor's half of which would be $141,497.50. Deducting a $50,000 homestead exemption would yield $91,497.50 that could survive § 522(f)(2) lien avoidance.

The court granted the lien avoidance motion in its entirety, without making findings of fact and conclusions of law articulating its reasoning about the statutory formula.

The court's conclusion would follow if it read the statute mechanically by focusing on the phrase "value that the debtor's interest would have in the absence of any liens" in § 522(f)(2) and comparing the sum of the $232,005 consensual lien and the $50,000 exemption with the $257,500 value of the debtor's one-half interest in the property, instead of the $515,000 full value of the property.

The avoidance of the senior American Capital lien has an added mystery. No default was entered. Nor did the court indicate that it would enter judgment by default. As there were no findings, we presume that the court was concluding that there was no nonexempt equity for any judicial lien.

All Points appealed.

JURISDICTION

Federal subject-matter jurisdiction over this core proceeding under 28 U.S.C. § 157(b)(2)(K) was founded upon 28 U.S.C. § 1334. We have jurisdiction under 28 U.S.C. § 158(a)(1).

ISSUES

1. Whether a partially-avoidable senior judicial lien may be avoided when the lienholder does not appear in contest of a lien avoidance motion under § 522(f)(1).

2. Whether § 522(f)(2) requires that liens against the entire fee be subtracted before computing the value of the debtor's interest in co-owned property.

STANDARD OF REVIEW

Application of basic rules of procedure and construction of the Bankruptcy Code present questions of law that we review de novo. Ruvacalba v. Munoz (In re Munoz), 287 B.R. 546, 550 (9th Cir. BAP 2002).

DISCUSSION

Before explaining why the debtor has nonexempt equity in his co-owned residence, we focus on why the senior judicial lien could not be avoided in full on a theory of default.

I

Two procedural flaws infect appellant's theory that the senior judicial lien should remain avoided under the 1994 amendments to § 522(f). Lien avoidance is done on a reverse priority basis as a contested matter in which the default requirements of Federal Rule of Civil Procedure 55 apply. Fed.R.Civ.P. 55, incorporated by Fed. R. Bankr.P. 7055 & 9014. Those default rules do not permit entry of judgments that are not warranted on the merits.

A

Otherwise valid judicial liens that are being avoided under § 522(1) as impairing exemptions are deducted in reverse order of priority. This is law of the circuit. Hanger v. Bank of Am. Nat'l Trust & Sav. Ass'n (In re Hanger), 196 F.3d 1292 (9th Cir.1999), aff'g & adopting, 217 B.R. 592, 595 (9th Cir. BAP 1997).

This reverse priority rule is a corollary to the requirement in the § 522(f)(2)(A) statutory formula that liens be assessed for avoidance on a lien-by-lien basis and has the consequence of giving effect to the priority rules of applicable nonbankruptcy law. 11 U.S.C. § 522(f)(2)(A).³

This reverse priority approach is important because it introduces an element of order to the provision of § 522(f)(2)(B) that liens already avoided are excluded from the exemption-impairment calculation with respect to other liens. 11 U.S.C. § 522(f)(2)(B).⁴

Without an ordering rule that specifies the order in which judicial liens are to be removed under § 522(f), dysfunction could reign. Junior lienors could plot, perhaps in collusion with debtors who may have an incentive to preserve a junior judicial lien in favor of a friend or relation, to leapfrog or squeeze out senior lienors, applicable nonbankruptcy law notwithstanding. By requiring liens to be attacked in reverse order of priority, the priority rules of applicable nonbankruptcy law are honored and opportunities for gamesmanship are reduced.

It is literally impossible for both elements of the operating rule for implementing the § 522(f)(2) equation — reverse priority and ignoring liens previously avoided — to apply if one begins with a lien that is supported by some amount of nonexempt equity. Instead, one must approach lien avoidance from the back of the line, or at least some point far enough back in line that there is no nonexempt equity in sight. As an economist would say, judicial liens are avoided in reverse order until the marginal lien, i.e. the junior lien supported in part by equity, is reached.

By avoiding both liens, the bankruptcy court implicitly concluded that there was no equity to support any judicial lien. For the reasons we shall explain later, that was error.

B

All Points' contention that American Capital must be eliminated on a default theory is flawed.

The record does not reflect that default was entered against American Capital, notwithstanding that it did not respond to the motion. Without an entry of default, it is not permissible to proceed to the second step and enter default judgment.

All Points nevertheless would have us assume that a default that does not appear in the record was entered and then equate the phantom default with a default judgment in order to squeeze out American Capital. Although the absence of an entered default ought to end the analysis, we will also (in light of our decision to vacate and remand) explain why the rest of All Points' theory runs afoul of bedrock propositions of default judgment law.

First, it is black-letter law that entry of default does not entitle a plaintiff to judgment as a matter of right or as a matter of law. Fed.R.Civ.P. 55(b)(2), incorporated by Fed. R. Bankr.P. 7055 & 9014; 10 JAMES WM. MOORE ET AL., MOORE'S FEDERAL PRACTICE § 55.20[2][b] (3d ed.2006) ("not entitled to default judgment as a matter of right"); 10A CHARLES ALAN WRIGHT, ARTHUR R. MILLER & MARY KAY KANE, Wright, Federal Practice and Procedure § 2685 (3d ed.1998) ("not entitled to a default judgment as of right").

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