Opinion
Case No. 97-13637-SSM, Adversary Proceeding No. 97-1228
October 6, 1997
Joseph M. Goldberg, Esquire, Washington, D.C., of Counsel for the plaintiff
MEMORANDUM OPINION
A hearing was held in open court on September 30, 1997, on the plaintiff's motion for entry of a default judgment voiding a second-lien deed of trust held by the defendant. The defendant, although given notice of the hearing, did not appear. The court received evidence and then took the motion under advisement to review the applicable law.
Facts
Leroy E. Eastmead ("the debtor") filed a voluntary petition under chapter 13 of the Bankruptcy Code in this court on May 14, 1997. On his schedules, he listed as an asset his residence located at 4 Biscayne Place, Sterling, Virginia. The value of the debtor's interest in the property is shown on the schedules as $117,540. The property is shown as being subject to a first-lien deed of trust in favor of Chase Manhattan Mortgage ("Chase Manhattan") in the amount of $162,000 and to a second lien deed of trust securing a disputed and unliquidated claim of "Commercial Credit" in the amount of $12,000. On May 21, 1997, the debtor filed a plan that expressly treated the Commercial Credit claim as unsecured. Commercial Credit did not object to confirmation, and the plan was confirmed by order of this court on July 29, 1997.
The schedules explain that this value represents $130,000 — presumably the fair market value — "less 10% sales costs."
The proof of claim filed by Chase Manhattan, however, is in the substantially lower amount of $138,507.75 "principal balance" plus an arrearage claim of $10,031.46.
Commercial Credit Corporation has filed a secured claim in the amount of $11,054.64. No evidence is attached to the proof of claim showing that the claimed security interest was perfected by the recording of a deed of trust, but at the hearing the debtor introduced into evidence a copy of the deed of trust from the Loudoun County, Virginia, land records showing that it was recorded on May 26, 1994, in Deed Book 1309, Page 1928.
In the interim, the debtor filed on July 1, 1997, the complaint that is presently before the court. The complaint alleges that the property located at 4 Biscayne Place, described as Lot 912, Section 6, Sugarland Run, Loudoun County, Virginia, is assessed for real estate tax purposes at $130,600 and is worth "bout" the assessed value. The complaint further alleges that the principal balance owed on the Chase Manhattan deed of trust on the filing date of the chapter 13 petition was $138,376.86 and that arrearages were owed in the amount of $11,021.85; that Commercial Credit recorded a deed of trust against the property on or about May 26, 1994, to secure a loan of "about $12,000"; and that the "bulk" of the funds were "for home improvement work" by Nu-Image Construction Inc. which the debtor alleged "was improperly performed." The return of service reflects that the complaint and summons were served on the registered agent of Commercial Credit by first-class mail under F.R.Bankr.P. 7004. Despite such service no answer or other pleading was filed by Commercial Credit.
A response was due by August 4, 1997.
At the hearing on entry of a default judgment, the debtor testified that he bought the property in October 1993 for $144,000, financed by a $142,500 Veterans Administration loan, but that the property needs substantial repairs and is in "a little worse" condition than it was at the time he purchased it. He testified that in his opinion, the value of the property was equal to the tax assessed value of $130,600; that a house similar to his had sold a month ago for $103,000; and that the asking price in his neighborhood for houses similar to his was between $103,000 and $120,000. Based on the evidence presented, the court finds that the fair market value of the debtor's property is $130,600. The debtor also testified that the principal balance on the first deed of trust was $139,776.82 when he filed his chapter 13 petition and that payments were in arrears in the amount of $11,021.85. He further testified that the purpose of the Commercial Credit loan, which was taken out in May, 1994, was to finance home improvements, primarily renovations to the kitchen. While not entirely clear from the debtor's testimony, it appears that the contractor arranged for the financing. The debtor testified that the work was not completed and that the work that was performed was substandard and unacceptable. He further testified that, after he complained, a representative from Commercial Credit came out to the property and inspected the work in late 1994, and that he had received no further communications or demands for payment from Commercial Credit since that time.
The total varies by about $2,000.00 from Chase Manhattan's proof of claim, but the difference is not significant.
Conclusions of Law and Discussion
This court has jurisdiction of this action under 28 U.S.C. § 1334 and 157(a) and the general order of reference entered by the United States District Court for the Eastern District of Virginia on August 15, 1984. Under 28 U.S.C. § 157(b)(2)(K), this is a core proceeding in which final orders and judgments may be entered by a bankruptcy judge, subject to the right of appeal under 28 U.S.C. § 158.
A.
Under chapter 13 of the Bankruptcy Code, an individual may obtain an adjustment of his or her debts through a repayment plan. Section 1322, Bankruptcy Code, sets forth the provisions a confirmable plan may contain. Relevant to the present controversy, a plan may "modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor's principal residence, or of holders of unsecured claims, or leave unaffected the rights of holders of any class of claims." § 1322(b)(2), Bankruptcy Code (emphasis added). The extent to which a claim is secured is determined by reference to § 506(a), Bankruptcy Code, which states in relevant part:
An allowed claim of a creditor secured by a lien on property in which the estate has an interest . . . is a secured claim to the extent of the value of such creditor's interest in the estate's interest in such property, . . . and is an unsecured claim to the extent that the value of such creditor's interest . . . is less than the amount of such allowed claim.
When a creditor, secured by a lien against the debtor's principal residence, is undersecured, a certain tension exists between the two statutes: while § 1322(b)(2) prohibits the rights of such creditors from being modified in a chapter 13 plan, § 506(a) establishes that such claim is secured only to the extent of the value of the collateral. The interplay of the two statutes was addressed by the Supreme Court in Nobleman v. American Sav. Bank, 508 U.S. 324, 113 S.Ct. 2106, 124 L.Ed.2d 228 (1993).
In Nobleman, the debtor sought to bifurcate the claim of an undersecured creditor, which was secured in the debtor's principal residence, into secured and unsecured claims. The Supreme Court held that to permit bifurcation of an undersecured creditor's claim under § 506(a) in a chapter 13 plan would modify the creditor's rights by changing the contractual rights contained within the underlying note. Id. at 331; 113 S.Ct. at 2111. The Court held that such modification is prohibited under § 1322(b)(2) when the creditor was secured solely in the debtor's principal residence. Id.; 113 S.Ct. at 2111. What was not addressed by the Supreme Court, and the question that is before the court presently, is whether a debtor may modify the rights of a wholly unsecured creditor holding a lien against the debtor's principal residence.
As to this issue, courts are divided. The majority position taken by courts post-Nobleman is that a debtor is empowered to modify the rights of such wholly unsecured creditors. See, e.g., Wright v. Commercial Credit Corp. (In re Wright), 178 B.R. 703 (E.D. Va. 1995) (Doumar, J.), appeal dismissed, 77 F.3d 472 (4th Cir. 1996); Lam v. Investors Thrift (In re Lam), 211 B.R. 36, 40-41 (Bankr. 9th Cir. 1997); In re Geyer, 203 B.R. 726, 729 (Bankr. S.D. Cal. 1996); In re Lee, 111 B.R. 715, 716 (Bankr. N.D. Ala. 1995); In re Kidd, 161 B.R. 769, 770-71 (Bankr. E.D.N.C. 1993); see also 8 Collier on Bankruptcy ¶ 1322.06[1][a][i], at 1322-21 (Lawrence P. King ed., 15th ed. rev. 1997) ("The Nobleman opinion strongly suggests, however, that if a lien is completely undersecured, there would be a different result. . . . If the creditor has held a lien on property that had no value (perhaps because the property was fully encumbered by prior liens), then under [the Nobleman] analysis, the creditor would not have been a holder of a secured claim' entitled to protection by section 1322(b)(2). Other courts, however, conclude that § 1322(b)(2) "trumps" § 506(a) and under Nobleman, a debtor is prohibited from stripping the lien of a wholly unsecured creditor which possesses a lien against the debtor's principal residence. See, e.g., Fraize v. Beneficial Mortgage Corp. of N.H. (In re Fraize), 208 B.R. 311, 313 (Bankr. D. N.H. 1997); Barnes v. American General Finance, (In re Barnes), 207 B.R. 588, 593 (Bankr. N.D. Ill. 1997); In re Jones, 201 B.R. 371 (Bankr. D. N.J. 1996); In re Barnes, 199 B.R. 256 (Bankr. W.D.N.Y. 1996); In re Neverla, 194 B.R. 547 (Bankr. W.D.N.Y. 1996).
In this District, the only reported decision is Wright v. Commercial Credit Corp. (In re Wright), 178 B.R. 703 (E.D. Va. 1995), appeal dism. 77 F.3d 472 (4th Cir. 1996). In Wright, Judge Doumar held that Nobleman does not apply when the creditor's claim is completely unsecured and that a debtor was permitted under § 1322(b)(2) to modify the rights of such a creditor, notwithstanding that the creditor's lien was against the debtor's principal residence. Id. at 707. In response to the creditor's argument that the term "secured claim" should be defined as a claim for which a lien exists to secure such claim, the court reasoned as follows:
If that definition were used, any claim for which a lien exists, regardless of the value (or lack thereof) underlying that lien, would be considered secured. However, § 506(a) does not define the term "secured claim" in that manner. Instead, pursuant to § 506(a), a secured claim is secured only to the extent of the value of the creditor's interest in the estate's interest in such property. Where there is no value underlying the claim, there is not a secured claim, despite the existence of a document to the contrary.
At the hearing, counsel for the debtor also cited to In re Williams, 166 B.R. 615 (Bankr. E.D. Va. 1994) (Adams, J.) as supporting his position. The court, however, finds that Williams is distinguishable from the case at hand. In Williams, the debtor, in the context of confirmation of a chapter 13 plan, sought to avoid a wholly unsecured judgment lien against his principal residence. Id. at 616. Judge Adams found that Nobleman did not apply because the claim sought to be avoided was a nonconsensual judgment lien. Id. at 618. The court first examined the statutory definitions of a "judicial lien" and a "security interest" in § 101, Bankruptcy Code, concluding that the former was the result of involuntary judicial process, while the latter arose from a consensual agreement. Id. The court then looked to the express language of § 1322(b)(2), which prohibited the modification of rights of holders of only a [c]laim secured only by a security interest in real property that is the debtor's principal residence" and held that neither § 1322(b)(2) nor Nobleman prohibited the lien stripping of a wholly unsecured judicial lien. Id.
This court will follow Wright, not only because it arises from this District but because the court finds its reasoning persuasive. As the uncontradicted evidence is that the defendant is a wholly unsecured lien holder, the debtor is permitted to modify the rights of such lien holder under § 1322(b), Bankruptcy Code and such lien is void under § 506(d), Bankruptcy Code. Accordingly, a separate judgment will be entered voiding the deed of trust in favor of the defendant.
Section 506(d), Bankruptcy Code provides:
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.
At the hearing, the court noted a problem that could potentially arise if this case were subsequently converted to one under chapter 7 of the Bankruptcy Code. Under § 1307(a), Bankruptcy Code, a debtor may convert a case to one under chapter 7 "at any time." While the court in this instance is permitting the stripping of a lien that is wholly unsecured, the court notes that such a practice is not permitted in chapter 7. In Dewsnup v. Timm, 502 U.S. 410, 112 S.Ct. 773, 116 L.Ed.2d 903 (1992), the Supreme Court held that § 506(d), Bankruptcy Code, does not allow a chapter 7 debtor to [strip down] a creditor's lien to a judicially determined value of collateral. An interesting issue would arise if the court permitted a lien to be voided, but the debtor subsequently converted his case to one under chapter 7. However, the court is unlikely to be confronted with such a situation in the present case because counsel for the debtor informed the court at the hearing that the debtor had within the past year received a chapter 7 discharge. While this does not prevent the debtor from being a chapter 7 debtor, it certainly discourages it because he would be ineligible under § 727(a)(8), Bankruptcy Code, to receive a discharge if the present case were converted to chapter 7.
B.
It appears to the court from the evidence presented at the hearing, along with the claim being listed on the debtor's schedules as "unliquidated" and "disputed," that the debtor is also seeking to challenge the amount of the claim, raising the defense that the work for which the money was borrowed was defective and never completed. However, the court will not grant a default judgment as to the amount of the claim. The complaint does not allege or fairly put the defendant on notice that the amount of the claim was being challenged in addition to its secured status. The prayer for relief contains no statement seeking to set aside or reduce the amount of such claim, and while the court must accept the well-pleaded allegations in the complaint as true, default judgment cannot be entered for relief not fairly raised in the complaint. See 10 Moore's Federal Practice 3d § 55.12[1], at 55-18 (1997) ("Upon entry of default, the facts alleged by the plaintiff in the complaint are deemed admitted. However, plaintiff's conclusions of law are not deemed established. Thus, the court may grant only the relief for which a sufficient basis is asserted in the complaint.") (Emphasis added). While the defendant, by not pleading, in effect consented to a judgment finding it to be an unsecured creditor, it cannot be inferred that it was consenting to an adjudication of the amount of its claim. Furthermore, while the complaint and motion for default judgment were both served on the registered agent of the defendant, neither was served at the address listed in the proof of claim.
More fundamentally, however, the court has concerns as to whether the debtor has a sufficient defense as to the amount of the claim. Essentially, the debtor seems to assert that since the debt was incurred for home improvements, and since the work was faulty, he is relieved from any underlying liability on the loan obtained to finance such repairs. The court has serious doubts that unsatisfactory work performed by a contractor has any bearing or could possibly relieve the debtor from underlying liability for a note entered into to finance the repairs. Put another way, if a person purchases a used car from a dealer, financed by an unrelated third party, and the car turns out to be a "lemon," the person's liability to the bank remains unaffected. In any event, because the complaint does not fairly put the defendant on notice of such allegations, the court need not reach the issue at this time. To the extent that the debtor seeks to challenge the amount of the creditor's claim, the debtor may file an objection to the claim.
But see Gray v. Atlantic Permanent SL Assn., Inc. (In re Gray), 49 B.R. 540 (Bankr. E.D. Va. 1985) (Bonney, J.) (deed of trust voided where contractor as agent for lender fraudulently induced debtor to sign home improvement loan documents).
Since the note to Commercial Credit Corp. was signed on May 24, 1994, and the records of this court reflect that the debtor subsequently filed a chapter 7 petition on September 11, 1995, and received a discharge on January 16, 1996, it seems likely that any personal liability of the debtor has been discharged. None of this is set forth in the complaint, however, and the issue can be more properly addressed in the context of an objection to claim.