LIEN CAPPING IN CHAPTER 13

(COMMISSION TRACK NUMBER 333)

Present Law

Chapter 7 provides an in personam discharge. Thus, the discharge in Chapter 7 has no effect on secured claims. As a result, postpetition appreciation (or depreciation) accrues to the benefit of the creditor. In contrast, Chapter 13 contains a "lien capping" provision. A debtor can value the property securing the lien, pay off the value of the secured claim under the Chapter 13 plan, and retain the property free and clear of the lien. Nobelman v. Am. Sav. Bank, 508 U.S. 324 (1993). Postpetition appreciation (or depreciation) accrues to the benefit of the debtor. Lien capping is not allowed if the lien is solely secured by the debtor's personal residence, Bankruptcy Code Section 1322(b)(2), which is never the case with nonconsensual tax liens.

In Chapter 13, what happens if (a) the secured tax claim is paid off, (b) the debtor retains the asset, (c) the plan is not completed and the case dismissed, and (d) unsecured tax debt remains unpaid? Does the tax lien remain attached to the asset? Case law splits. Cf. In re Campbell, 160 B.R. 198 (Bankr. M.D. Fla. 1993) (debtors entitled to have statutory tax lien released after I.R.S.'s allowed secured claim is paid in full even though unsecured tax debt remained undischarged and unpaid), aff'd, In re Campbell, 180 B.R. 686 (M.D. Fla. 1995); with Gibbons v. Opechee Distributors, Inc. (In re Gibbons), 164 B.R. 207 (Bankr. D.N.H. 1993) (voiding of lien under Chapter 13 plan not allowed until debtors complete plan).

While retaining the same split in result, some cases focus on sections 349(b)(1)(C) and 506(d). Under section 506(d), to the extent a lien is not secured by property, it is void. Under section 349(b)(1)(C), any lien voided under section 506(d) is reinstated if a case is dismissed. When the secured portion of a bifurcated lien is paid in full in Chapter 13, has the secured creditor's lien been satisfied or avoided? If satisfied, then the government's lien is not reinstated. In re Cooke, 169 B.R. 662 (Bankr. W.D. Mo. 1994). If avoided, then the government's lien is reinstated. In re Scheierl, 176 B.R. 498 (Bankr. D. Minn. 1995).

The same issue arises if a case is converted to Chapter 7 instead of dismissed. Again, case law splits. Compare, In re Stoddard, 167 B.R. 98 (Bankr. S.D. Ohio 1994) (if allowed secured claim paid in full in Chapter 13 before conversion, no additional payment required to redeem vehicle from creditor after conversion) with In re Jordan, 164 B.R. 89 (Bankr. E.D. Mo. 1994) (debtors not entitled to release of lien even though secured portion of claim paid in full in Chapter 13).

Proposals Before the Commission

Commission Track Number 333. The Justice Department proposes that the government's tax lien should not be released unless and until a Chapter 13 plan is completed. See Justice Proposal, p. 96-7.

The Internal Revenue Service proposes that the government's tax lien should not be released unless and until a Chapter 13 plan is completed. IRS Proposal, p. 53. See also Unnumbered Government Working Group Proposal.

Task Force Position

The Task Force proposes that if a Chapter 13 case is dismissed after full payment of the government's secured claim, the government retains its right to attach its tax lien to any property acquired postpetition or any property owned prepetition that was not included in valuing the government's secured claim.

Reasons for Position

The government should not receive a windfall. The government's lien should not reattach to property against which the debtor has previously paid off a tax lien. Thus, postpetition appreciation (or depreciation) would accrue to the debtor.

The government's windfall is particularly troubling in cases involving "small" debtors. Under current case law, a debtor cannot avoid the federal government's lien in household goods. See, Commission Track Number 334. Under the government's proposals, a debtor might be required to buy off a lien in household goods and clothing once in a bankruptcy and a second time in an offer in compromise (at least to the extent those goods exceed $2,500 in value).

Questions, comments or suggestions? kbercik@taxcounsellor.com

Last updated June 1, 1997