What goes in the 109(e) bucket? Santos v. Dockery goes to the 9th Circuit Court of Appeals

When I explain Chapter 13 to clients, I usually describe the amount of general unsecured claims as being the size of the clients' “bucket” and I explain that their plan payments might fill 0% to 100% of the “bucket” during the plan, before the “b

ucket” is tossed out (discharged), with certain exceptions such as student loans, for example.

Section 109(e) provides a limit on the maximum size of the “bucket” for individuals and spouses. To be eligible for Chapter 13, debtor(s) must owe “on the date of the filing of the petition, noncontingent, liquidated, unsecured debts of less than $360,475…” This amount was set as of April 1, 2010 and is adjusted every three years. It applies uniformly accross the country, despite the significant variations in real estate values and amounts of home loans.

In depressed (or recessed) real estate markets, like now, it is common for debtors to use Chapter 13 to avoid junior undersecured home loans pursuant to 11 U.S.C. Sections 506(a) and (d). In states with relatively high real estate values, like California, junior home loans can be hundreds of thousands of dollars. If the avoided junior home loan increases the debtors' “bucket” size, then they often become ineligible for Chapter 13. As a practical matter, middle class consumer debtors are excluded from the more complicated and expensive Chapter 11 and must therefore surrender their homes.

Persuasive statutory and public policy arguments favor not counting undersecured junior home loans subject to 11 U.S.C. Section 506, in the 109(e) unsecured debt limit. Santos v. Dockery (In re Santos), Case Number 12-55145, is now pending before the 9th Circuit Court of Appeals seeking a ruling on this important consumer debtor issue.

On January 20, 2012 Santos appealed a District Court order affirming the Bankruptcy Court's order dismissing their case upon a finding that they were inelgible to be Chapter 13 debtors due to their unsecured debts being above the 109(e) unsecured debt limit. The Debtors had secured claims against their primary residence that were subject to 522(f) and 506 which were determined to put them over the limit. The Bankruptcy Court followed Smith v. Rojas, 435 B.R. 637, 649-650 (9th Cir. BAP 2010). The District Court read 109(e) as “noncontingent, liquidated and unsecured debts” rather than “noncontingent, liquidated, unsecured debts”, a subtle and significant difference from the plain language.

Debtors and Appeallants argue that creditors with holding claims secured by consensual liens (trust deeds) determined to be unsecured for plan purposes pursuant to the collateral valuation provision 506(a), hold liens avoided pursuant to 506(d) only after debtors successful complete all plan payments, and therefore hold “contingent” rather than “noncontingent” unsecured claims. Since 109(e) only counts “noncontingent” unsecured claims, liens subject to 506(a) and (d) should not be counted in 109(e)'s petition date noncontingent unsecred debt limit.

Debtors' arguent that claims secured by liens subject to 506 are “contingent” unsecured claims on the petition date is further supported by related Bankruptcy Code proivisions providing that consensual lien holders subject to 506, unlike judgment lien holders subject to 522(f), retain their lien rights to credit bid upon a sale of the collateral during the plan, pursuant to 363(k), and retain their liens, pursuant to 348(f)(1)(B), if the case is converted to Chapter 7 at any time during the plan.

Furthermore, since practical circumstances exist whereby some debtors will elect to continue paying their entirely undersecured junior home loans (contractually), rather than moving the court pursuant to 506(a) for valuation of the primary residence and 506(d) lien avoidance at the conclusion of the plan, it is not appropraite to presume applicaiton of 506 to all undersecured claims. The uncertainty existing in whether or not debtors will elect to move for 506 valuation and lien avoidance is sharply contrasted with the practical certainty that all debtors will use 522(f) to avoid judgment liens whenever possible, thereby distinguishing the 9th Ciruit Court of Appeals decision of Scovis v. Henrichsen (In re Scovis), 249 F.3d 975 (9th Cir. 2001) (holding judgment liens subject to 522(f) are to be counted under 109(e)).

Debtors also raise a 14th Amendment Equal Protection argument that different debtors similarly situated are afforded disparate access to Bankrutpcy Protection under Chapter 13. They argue that there is no rational basis for excluding middle-class consumer debtors from Chapter 13 (who are economically excluded from reorganizing under Chapter 11), based upon fixed debt limits that prejudice certain debtors in certain geographic areas with inflated housing markets such as California relative to other geographic areas where housig values are significantly lower.

Debtors are hopeful that the 9th Circuit Court of Appeals will distinguish Scovis and overrule Smith v. Rojas, thereby allowing them to stay in Chapter 13 and keep their home. They also hope their successful efforts in this appeal will pave the way for other middle class homeowners in California, and other states with relatively high real estate vales and undersecured home loan, to be able to affordably reorganize under Chapter 13 and saved their homes too.

The alternative of throwing the home out with the “bucket” doesn't benefit anyone.


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