In re Worrell, Bankruptcy No. 85-1358.

• Decision Date: 07 July 1986
• Docket Number: Bankruptcy No. 85-1358.
• Citation: 67 BR 16
• Parties: In re Robert B. WORRELL and Joanne M. Worrell, Debtors. Robert B. WORRELL and Joanne M. Worrell, Plaintiffs-Appellants, v. The FEDERAL LAND BANK OF ST. LOUIS, and United States of America, acting through Farmers Home Administration, a Division of the United States Department of Agriculture, Defendants-Appellees.
• Court: U.S. District Court — Central District of Illinois

67 B.R. 16 (1986)

In re Robert B. WORRELL and Joanne M. Worrell, Debtors Robert B. WORRELL and Joanne M. Worrell, Plaintiffs-Appellants, v. The FEDERAL LAND BANK OF ST. LOUIS, and United States of America, acting through Farmers Home Administration, a Division of the United States Department of Agriculture, Defendants-Appellees.

Bankruptcy No. 85-1358.

United States District Court, C.D. Illinois.

July 7, 1986.

Carl F. Reardon, East Peoria, Ill., for Robert and Joanne Worrell.

Douglas R. Lindstrom, Galesburg, Ill., for Federal Land Bank.

L. Lee Smith, Asst. U.S. Atty., Peoria, Ill., for USA-FmHA.

ORDER

MIHM, District Judge.

The Appellants/Debtors, Robert B. Worrell and Joanne M. Worrell, filed this appeal as of right pursuant to Bankruptcy Rule 8001 from an order of the United States Bankruptcy Court of the Central District of Illinois. The bankruptcy court entered an order on July 19, 1985, dismissing the Plaintiffs/Appellants' Complaint to Determine Secured Status of the Federal Land Bank of St. Louis and United States of America, acting through Farmers Home Administration.

The Plaintiffs filed a voluntary petition in bankruptcy under Chapter 7 of the Bankruptcy Code and on March 12, 1985, they filed the adversary proceeding which is the subject of this appeal. At the time that they filed for bankruptcy, the Plaintiffs were the owners of two parcels of real estate which they alleged are worth $293,000 together.

The Defendant, Federal Land Bank of St. Louis, holds a first mortgage on the two parcels of real estate in the amount of $400,528.77. The United States of America, acting through Farmers Home Administration, a division of the United States Department of Agriculture, holds a second mortgage on the Plaintiffs' real estate in the amount of $120,691.53. The total of the first and second mortgages, $521,220.30, exceeds the listed value of the real estate as claimed by the Debtors on their bankruptcy schedule by $228,220.30.

The Plaintiffs, pursuant to 11 U.S.C. § 506(d), petitioned the bankruptcy court to determine the amount of the Defendants' allowed secured claims against the real estate described above, and to the extent that such claims were not secured by the real estate, to declare the Defendants' liens void. As part of their petition, the Plaintiffs also requested that the bankruptcy court determine the maturity and amount of the payment on the secured portion of the Defendants' claim after the court had voided the unsecured portion. The United States of America filed an answer to the complaint of the Debtors, and the Federal Land Bank of St. Louis responded by filing an answer and a first affirmative defense under Rule 12(b) of the Federal Rules of Civil Procedure that the complaint should be dismissed for failing to state a claim.

The bankruptcy court held a hearing on the motion on July 15, 1985, at which time the court heard argument from attorneys for the Debtors and the Defendants. On July 19, 1985, the bankruptcy court entered an order granting the motion to dismiss, and the Debtors filed this appeal on July 29, 1985.

Jurisdiction over this bankruptcy appeal is conferred by 28 U.S.C. § 158(a), which grants the district court jurisdiction to hear appeals from final judgments, orders, and decrees entered in cases and proceedings referred to bankruptcy judges. Bankruptcy Rule 8013 sets forth the applicable standard of review for the district court to use in reviewing the decisions of bankruptcy judges. Rule 8013 states:

"On appeal the district court or bankruptcy appellate panel may affirm, modify, or reverse a bankruptcy court\'s judgment, order, or decree or remand with instructions for further proceedings. Findings of fact shall not be set aside unless clearly erroneous, and due regard shall be given to the opportunity of the bankruptcy court to judge the credibility of the witnesses."

This standard is the same as that under Rule 52(a) of the Federal Rules of Civil Procedure for an appellate court's review of a district court's findings of fact.

In appealing the decision of the bankruptcy court, the Plaintiffs contend that the bankruptcy court does indeed have jurisdiction under § 506(d) of the Bankruptcy Code, 11 U.S.C. § 506(d), to value the Defendants' security (the two parcels of real estate) and to void the Defendants' mortgages to the extent that they exceed the fair market value of the real estate and its improvements. In other words, the Plaintiffs argue that the Defendants should retain a secured claim with a lien upon the real estate only in the amount of the appraised value of the property, and to the extent that the Defendants' claims exceed the fair market value of the real estate, the court should find that the claim is unsecured and void.

The Defendants take the position that the bankruptcy court acted properly in dismissing the Plaintiffs' Complaint to Determine Secured Status, because a Chapter 7 debtor cannot utilize § 506(d) to avoid any portion of the Defendants' liens upon the Plaintiffs' real estate. The Defendants argue that it is against public policy for a court to use § 506(d) to allow a Chapter 7 debtor to avoid a real estate mortgage lien, because that would enable the debtor to retain more than he could in a Chapter 11 or Chapter 13 bankruptcy. The Defendants try to further bolster their arguments by comparing § 506(d) with § 722 of the Bankruptcy Code and arguing that § 722, by specifically allowing a Chapter 7 debtor to redeem personal property, implicitly excludes such a debtor from redeeming any real property.

This appeal, then, presents the Court with the issue of whether § 506(d) of the Bankruptcy Code allows a debtor to avoid a real property mortgage to the extent that the mortgage exceeds the value of the mortgaged property. Because the bankruptcy court answered this question in the negative and dismissed the Debtors' complaint, the bankruptcy court never determined the fair market value of the Debtors' two parcels of real estate and did not discuss the procedure whereby the Debtors would be able to redeem their property. The issue before this Court is clearly a matter of law for this Court to determine, and a review of the relevant cases shows that courts are divided on this issue.

Section 506 of the Bankruptcy Code provides:

"Section 506. Determination of Secured Status.

(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 set off under section 553 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 set off, 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 set off 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. § 506 (1984) (the exceptions (1) and (2) under § 506(d) are not applicable to this case)."

The Notes of Committee on the Judiciary, Senate Report No. 95-989 explains section 506(a) by saying:

"Subsection (a) of this section separates an undersecured creditor\'s claim into two parts: He has a secured claim to the extent of the value of his collateral; and he has an unsecured claim for the balance of his claim. . . . Throughout the bill, references to secured claims are only to the claim determined to be secured under this subsection, and not to the full amount of the creditor\'s claim.

Subsection (d) provides that to the extent a secured claim is not allowed, its lien is void. . . . "

The Notes of Committee on the Judiciary, House Report No. 95-595 describes the operation of § 506(d):

"Subsection (d) permits liens to pass through the bankruptcy case unaffected. However, if a party in interest requests the court to determine and allow or disallow the claim secured by the lien under section 502 and the claim is not allowed, then the lien is void to the extent that the claim is not allowed."

As noted earlier, the courts which have considered this question are divided over whether Chapter 7 debtors can use § 506 to avoid a lien on real property. The leading case on this issue is In re Tanner, 14 B.R. 933 (Bankr.W.D.Penn.1981), which held that a Chapter 7 debtor can use the provisions of § 506 to avoid a lien on real property to the extent that the amount of the lien exceeds the value of the collateral. The vast majority of the courts which have considered this issue are in accord with Tanner, including three decisions out of the Bankruptcy Courts of the Northern District of Illinois and a decision by U.S. Bankruptcy Judge Larry Lessen in the Central District of Illinois. In re Lindsey, 64 B.R. 19 (1986); In re Lyons, 46 B.R. 604 (Bankr.N.D.Ill.1985); In re Roth, 38 B.R. 531, 540 (Bankr.N.D.Ill.), aff'd, 43 B.R. 484 (N.D.Ill.1984); Walker v. First Federal Savings & Loan, 11 B.R. 43 (Bankr.N.D.Ill. 1981). The Tanner court...