Amicus Curiae Brief — Dewsnup v. Timm

No. 90-741

Iu the Supreme Court of the United

OCTOBER TERM, 1990

ALETHA DEWSNUP, PETITIONER

Vv.

Louis L. TIMM, ET AL.

ON WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE TENTH CIRCUIT

BRIEF FOR THE UNITED STATES

AS AMICUS CURIAE SUPPORTING RESPONDENTS

KENNETH W. STARR

Solicitor General

STUART M. GERSON

Assistant Attorney General

JOHN G. ROBERTS, JR.

Deputy Solicitor General

RONALD J. MANN

Assistant to the Solicitor General

Department of Justice

Washington, D.C. 20530

ALAN CHARLES RAUL (202) 514-2217

General Counsel

Department of Agriculture

Washington, D.C. 20250-1400

Eric S. BENDERSON

Associate General Counsel for Litigation

Small Business Administration

409 Third Street SW

Washington, D.C. 20416

SSS nneeeeeene ee

——_z{_{_{_—_—_——_——— SE

QUESTION PRESENTED

Section 506(d) of the Bankruptcy Code, 11 U.S.C.

006(d), provides in pertinent part: “To the extent that a

lien secures a claim against the debtor that is not an

allowed secured claim, such lien is void.” The question

presented is whether this provision permits a debtor to

“strip down” a lien to the value of the collateral, when

that value is less than the claim secured by the lien, or

instead whether the provision voids a lien securing a claim

when the claim is not allowed.

TABLE OF CONTENTS

Introduction and summary of argument _............

Argument:

I.

II.

III.

IV.

Close reading of the text of Section 506(d)

shows that its effect is limited to disallowed

SE

The structure of the Code shows that Section

506(d) can apply only to disallowed claims........

A. Section 506 plays an integral role in the

Code’s treatment of disallowed claims...........

B. Application of Section 506(d) to unsecured

claims leads to incongruous results incon-

sistent with other provisions of the Code....

The legisiative history of the Code demonstrates

that Section 506(d) was aimed only at dis-

allowed claims, and that Congress did not con-

template application of the provision to unse-

EE

Petitioner’s reading construes Section 506(d)

to work a dramatic and unexplained change in

pre-Code bankruptcy law .......0...........20..ccccceeeeeeeeeeee

EE SS

Cases:

City of Dallas v. Ryan (In re Brannon), 62 F.2d

TABLE OF AUTHORITIES

959 (5th Cir.), cert. denied, 289 U.S. 742

EELS SES EE

City of Richmond v. Bird, 249 U.S. 174 (1919)....

Emil v. Hanley, 318 U.S. 515 (1943) —.0000000.

Farrey Vv. Sanderfoot, No. 90-350 (May 23, 1991).. 23, 28

(111)

2%

IV

Cases—Continued : Page

Grogan V. Garner, 111 8. Ct. 654 (1991)... ll

Johnson V. Home State Bank, No. 90-693 (June

Ties: SEED scipsiicnaiietadininemainiainsdahiehinaiadtieithiatiaieaeataitiiainaial 6, 24, 25, 29

Kelly v. Robinson, 479 U.S. 36 (1986) —.......--...... 23

Long V. Bullard, 117 U.S. 617 (1886) —.................. 27

Louisville Joint Stock Land Bank v. Radford, 295

RS Ene 26, 27

Midlantic Nat'l Bank v. New Jersey Dep’t of

Envtl. Protection, 474 U.S. 494 (1986) —.......... 23

Oppenheimer v. Oldham, 178 F.2d 386 (5th Cir.

ta ERR ce ESE: pee eA ee eee 24-25

Pennsylvania Dep’t of Public Welfare v. Daven-

*. | So & 8 § eS 9, 23

Swarts v. Hammer, 194 U.S. 441 (1904) 2.0.0... 23

United Savings Ass'n Vv. Timbers of Inwood For-

est Associates, 484 U.S. 365 (1988) —..........-...... 23

United States v. Ron Pair Enterprises, 489 US.

EE ee a 23

Constitution and statutes:

U.S. Const. Amend. V (Takings Clause) ............. 26

Bankruptcy Act of 1898, ch. 541, 30 Stat. 544 23

LETC ASE AUD LTR 23-24

Bankruptcy Act of 1898, ch. 541, 30 Stat. 544 (as

amended by the Chandler Act of 1938, ch. 575,

§ 1, 52 Stat. 895-897) :

§ 216(1), 52 Stat. 895-896 (11 U.S.C. 616(1)

(1976)) ...... tie SA 25

§ 216(7), 52 Stat. 896 mt U.S.C. 616(7)

SUITED chk ocnstbhinduianieeniandeniabeiinniaianaimsaaniiaal 25

§ 216(10), 52 Stat. RIMS OT “dL U. sc. 616

i eee 25

Bankruptcy Aesentmede ond Federal Sudaubie

Act of 1984, Pub. L. No. 98-353, § 448(b), 98

a 22

Bankruptcy Code, 11 U.S.C. 101 et seq.:

Ch. 5, 11 U.S.C. 501 et seq. er a ee 4

I 10

| 4, 6, 11, 12,19

—

Statutes—Continued :

v

Page

ene 10

See 4,5

SE EE ec eee 1l

| ET aa a 11

OS 10, 12

11 U.S.C. 502(b) (6) ......................... nel PETE 1l

ETE TAT IE 11

EE ERS | | ea eeneeene 4

| 10, 20, 21

6 (hE 2, 5, 7, 15, 19, 20, la

11 U.S.C. 506(a)_.... 3, 4, 5, 6, 9, 10, 12, 17, 21, 22

RT EE AR ea 5

a esiasunanaaes 5

I el passim

4), ERE Nn 10, 12

IEE RE 10, 25

ESET Ae ec 12

0 14

RE 13

ih i ef A cliaadaieisial 13

0 28, 29

11 U.S.C. 522 (c) (2) (A) (ii) -..................... 28

I cialis ildnienainsindinintiaiesbibibihat 14, 28

id rtenpepntisemmmnianentiis 16

KR) eee 12

Iii cesntriincaeeniathieaeeearnneineniaiabbte 24

en 24

TIT oi ins niinsiininiettiesinnitenaniatineniielislasdaes 19

| ESERIES HCE 2 4

Ch. 7, 11 U.S.C. 701 et seq. _.............. 2, 3, 15, 16, 18, 19

ie ccisecncsihecsaliiil 4, 7, 13, 14, 21, 27

I i ina ccaahacieciiaaaesibladaaal 18

III issn ncepraniieinabemmnimente 12

EEE EERE 12

I I cicsicicsecsinhenbnciguntddneesdeminadebiatens 11

Ne 6, 11

ts , | 3. En eEreRnreT 21

» BS BR 8. OF Fd a passim

| TER Ree wee nae 18

t 80lUldl”Dl—~— 17

VI VII

Statutes—Continued : Page Miscellaneous—Continued : Page

ET CR 16 ENS cas se es ae 17

hE ll p. 34,914 ........ POUR boa ne oe A RR 22

11 U.S.C. 1129(a) (7) (A) -....-.-.----------------- 16 H.R. 8200, 95th Cong., Ist Sess. (1977) ..........-.-..-. 20

11 U.S.C. 1129(b) (2) (A) -.....---------------e-- 16 H.R. Rep. No. 595, 95th Cong., 1st Sess. (1977) .... 13, 20,

11 U.S.C. 1129(b) (2) (A) (i) (1) ~......... 17 21, 22, 27, 28

11 U.S.C. 1129(b) (2) (A) (i) (IT) 18 . Herbert & Pacitti, Down and Out in Richmond,

11 U.S.C. 1129(b) (2) (A) (iii) —.......... 16 Virginia: The Distribution of Assets in Chap-

ea 17 ter 7 Bankruptcy Proceedings Closed During

11 U.S.C. 1141 (d) (1) (A) (ii) —-............. 12 1984-1987, 22 Rich. L. Rev. 303 (1988) 15

Ch. 13, 11 U.S.C. 1301 et seq. ............... 7, 12, 13, 15, 16, L. LoPucki, Strategies for Creditors in Bank-

17, 18, 19, 25 ruptcy Proceedings (1985) ...0.0.......0.0.000ccc 18

thE ES eae 16, 17, 19 LoPucki & Whitford, Bargaining over Yquity’s

TAT 17 Share in the Bankruptcy Reorganization of

11 U.S.C. 1825 (a) (4) ...---eeeececeececeececeeeeeee 11, 16 Large, Publicly Held Companies, 139 U. Pa. L.

11 U.S.C. 1825 (a) (5) 2.2... .--eceeccececeeeeeeeeeeee 11, 16 TU TE COD accrceccscsecescseeesesennscncescnsusscenccssonnnces 15

lit hl SA RSD 12 S. 2266, 95th Cong., 2d Sess. (1978) 00.0000 21

i ATER 16, 17 S. Rep. No. 989, 95th Cong., 2d Sess. (1978) ...21, 22, 28

a8 Be, See ee) Ls 17 S. Rep. No. 65, 98th Cong., Ist Sess. (1983) .......... 22

TTT 17 T. Sullivan, E. Warren & J. Westbrook, As We

11 U.S.C. 1328 (c) (1) ..--eeceeceeeeceeceoeeceeeeeeeee 17 Forgive Our Debtors (1989) _........--..-.e een 15

Bankruptcy Reform Act of 1978, Pub. L. No. 95- 9 Thompson on Real Property (J. Grimes ed.

I 29 SU UN IIE cilia iestacntnsdaheineindionaeensibions 14

Chandler Act of 1938, ch. 575, 52 Stat. 840 24 E. Warren & J. Westbrook, The Law of Debtors

Frazier-Lemke Act of 1934, ch. 869, 48 Stat. SE SD QED crvccctscnsesiccersvnieninnentinannnisnness 15, 16

ARRAN are ee a ee ee 26, 27

Utah Code Ann. §§ 57-1-20 to 57-1-37 (1990 &

i ediiteianinteninbaiamiaes 2

U.C.C. (1978):

EELS eS ae ae ree 14

Ee a 14

Miscellaneous:

Collier on Bankruptcy :

Vol. 3 (J. Moore 14th ed. 1976) 0.0... 25, 26

Vol. 3 (L. King 15th ed. 1991) 0000. rea 20, 22

Vol. 4B (J. Moore 14th ed. 1979) 0. 24

124 Cong. Rec. (1978) :

SRE eee eee Oe Se eae 17

iat 22

Iu the Supreme Court of the United States

OCTOBER TERM, 1990

No. 90-741

ALETHA DEWSNUP, PETITIONER

Vv.

Louis L. TIMM, ET AL.

ON WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE TENTH CIRCUIT

BRIEF FOR THE UNITED STATES

AS AMICUS CURIAE SUPPORTING RESPONDENTS

INTEREST OF THE UNITED STATES

This case presents the question whether Section 506(d)

of the Bankruptcy Code, 11 U.S.C. 506(d), enables a

debtor to “strip down” a creditor’s lien to the value of the

collateral, when that value is less than the claim secured

by the lien. This question is of great interest to the

United States because its resolution will affect the level

of security of any creditor holding an undersecured claim

against a debtor that goes through bankruptcy, and be-

cause the federal government—whether through the Small

Business Administration, the Farmers Home Adminis-

tration, the Internal Revenue Service, or the Federal De-

posit Insurance Corporation (as administrator of the

properties of a number of failed depository institutions)

—frequently holds such claims.

(1)

2

Because of the United States’ broad perspective on this

question, and because the United States takes a different

view of the statute than either of the parties to the case,

the United States is filing this brief to ensure that the

broadest possible range of views informs this Court’s

evaluation of the question.

STATUTORY PROVISION INVOLVED

The text of 11 U.S.C. 506 is set out in the Appendix to

this brief.

STATEMENT

1. On June 1, 1978, respondents loaned $119,000 to

petitioner and her now-deceased husband. To secure their

obligation to repay the loan, petitioner and her husband

executed a deed of trust, granting a lien on two parcels

of land they owned in Utah, as well as a collateral assign-

ment of a contract to purchase some additional land. In

1979, petitioner defaulted under the terms of the deed of

trust. Pursuant to the deed of trust and Utah law, re-

spondents would have been entitled to accelerate the date

of maturity of the loans (so that the entire amount im-

mediately was due), to issue a notice of default, and

eventually to sell the parcels at a public foreclosure sale

to satisfy the debt and the expenses incurred in attempt-

ing to collect the debt. See J.A. 14, 37-39; Amended Trust

Deed with Assignment of Rents, at 1 & {] 14-15; Utah

Code Ann. §§ 57-1-20 to 57-1-37 (1990 & Supp. 1990).

2. In April 1981, after respondents had issued a notice

of default but before the foreclosure sale occurred, peti-

tioner filed a petition seeking reorganization under Chap-

ter 11 of the Bankruptcy Code. That bankruptcy peti-

tion was dismissed in 1982, as was a second Chapter 11

petition that petitioner filed. Finally, in June 1984, peti-

tioner filed a petition seeking liquidation under Chapter

7 of the Bankruptcy Code, out of which this case arises.

Because of the pendency of these bankruptcy cases, re-

spondents have not been able to conduct their foreclosure

sale. J.A. 15-16.

3

3. In 1987, petitioner commenced this adversary pro-

ceeding, contending that because the debt then held by re-

spondents of approximately $120,000 exceeded the fair

market value of the collateral, the bankruptcy court

should reduce or “strip down” the amount of the lien to

the fair market value of the collateral. In particular,

petitioner argued that, pursuant to Section 506(a), re-

spondents would have an allowed secured claim only to

the extent of the value of their collateral. Petitioner

then argued that Section 506(d)? required the court to

void the lien on the remaining portion of respondents’

claim, which Section 506(a) would treat as an allowed

unsecured claim.

The bankruptcy court refused to grant relief. First, it

valued the collateral at $39,000. The court assumed that

the property had been abandoned, reasoning that peti-

tioner, as the debtor, would not have standing to void

the lien if the bankruptcy trustee still controlled the

property.® Pet. App. 16a-17a. The bankruptcy court then

rejected petitioner’s request, concluding that once prop-

erty is abandoned it no longer falls within the scope of

Section 506(a), which applies only to “property in which

the estate has an interest,” and that it was “inconceiv-

able * * * that Congress could have intended to create an

avoiding power in a Chapter 7 debtor, respecting prop-

erty which is not to be administered through the bank-

1Section 506(a) provides, in pertinent part, that “[a]n 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.”

The entire text of Section 506(a) is set out in the Appendix, infra.

2In pertinent part, Section 506(d) provides: “To the extent that

a lien secures a claim against the debtor that is not an allowed

secured claim, such lien is void.” The entire text of Section 506(d)

is set out in the Appendix, infra.

8In fact, the property had not then been abandoned, but subse-

quently was abandoned on July 11, 1988. See J.A. 24.

4

ruptcy process.” Pet. App. 29a. The district court sum-

marily affirmed. /d. at 12a-13a.

4. The court of appeals also affirmed. The court re-

lied on the effect of the abandonment, which required a

determination by the trustee that the property “is bur-

densome to the estate or * * * of inconsequential value

and benefit to the estate.” Section 554(a); see Pet. App.

5a-6a. The court then determined that the “fundamental

premise” of Section 506(a) was that it applies only when

the estate has an interest in the property. Because “[t]he

estate has no interest in, and does not administer, aban-

doned property,” Section 506(a) should not apply. Id.

at 6a. Finally, the court noted that a contrary result

would be inconsistent with Section 722. In that sec-

tion, Congress specifically granted debtors a limited right

to redeem certain personal property. To hold that Section

506(d) granted a broader right to redeem real prop-

erty, the court reasoned, would be inconsistent with the

narrow language of Section 722. Pet. App. 9a-10a.

INTRODUCTION AND SUMMARY OF ARGUMENT

Chapter 5 of the Bankruptcy Code evaluates and sets

priorities among the claims that creditors hold against

bankrupt debtors. As a general matter, it analyzes

claims pursuant to two criteria: whether they are allow-

able and whether they are secured. Because these cri-

teria are not exclusive, they establish four types of

claims: allowed secured claims, allowed unsecured claims,

disallowed secured claims, and disallowed unsecured

claims. The classification proceeds in two steps. First,

Section 502 determines whether a claim is allowed or dis-

allowed, generally by providing that the claim is al-

lowed unless it falls within one of the exceptions set

forth in the eight subparagraphs of Section 502(b), as

modified by a number of miscellaneous rules set forth

in Sections 502(c) through 502(j). If a claim is not al-

lowed, the creditor will receive no distribution from the

bankrupt’s estate on that claim.

5

Second, Section 506 resolves a number of problems re-

lated to liens and allowed claims. Section 506(a) deals

with allowed claims that exceed the value of the collateral

given to secure repayment; it bifurcates those claims into

an allowed secured claim, in the amount of the value of

the collateral, and an allowed unsecured claim for the

excess, so that the secured creditor can participate in any

distributions to unsecured creditors to the extent of its

unsecured claim. Sections 506(b) and 506(c) then deal

with other situations not at issue here: allowed claims

for less than the value of the collateral given to secure

repayment, and treatment of administrative expenses

related to the collateral.

This case concerns the effect of Section 506(d), which

provides, with certain exceptions: “To the extent that a

lien secures a claim against the debtor that is not an

allowed secured claim, such lien is void.” We think the

meaning of this provision is clear from the statutory text

and structure, the legislative history, and pre-Code prac-

tice. If a creditor has a claim against the debtor secured

by a lien, but that secured claim is not an allowed se-

cured claim, then the creditor’s lien is void. In other

words, if a creditor has a claim secured by a lien and

if the claim is not allowed—typically because it falls

within one of the categories of disallowed claims in Sec-

tion 502(b)—then the lien is also void. This makes

sense, because it would be curious to have a claim dis-

allowed but leave the lien securing that claim unaffected.

Petitioner reads the provision differently, contending

that the key word is not “allowed,” but “secured”—.e.,

the lien is void to the extent that it secures a claim that

is not an allowed secured claim under Section 506(a).

Under this reading, Section 506(d) would operate to re-

duce the creditor’s lien to the value of the allowed se-

cured claim described in Section 506(a). In our view,

this reading makes no sense. It strains the statutory

language, flies in the face of the statute’s structure, and

is flatly inconsistent with the legislative history and pre-

Code practice.

6

The “lien-stripping” allowed under petitioner’s read-

ing would have a dramatic impact on the effect of a sub-

sequent disposition of the property at a price greater

than the bankruptcy court’s valuation. If petitioner is

correct, and the property is foreclosed upon after the

bankruptcy and sells for an amount greater than the

value attributed to the collateral by the bankruptcy court,

the excess will go not to the unpaid creditor who bar-

gained for a lien on the collateral, and not to other cred-

itors who did not receive full payments of their debts

in the bankruptcy, but to the debtor. By contrast, under

our view, the debtor can retain the collateral only by

repaying the entire debt or otherwise settling with the

creditor who bargained for a lien on the collateral. The

bankruptcy, of course, discharged the debtor from in per-

sonam liability, but it should have no effect on the in rem

obligation represented by the lien. See Johnson v. Home

State Bank, No. 90-693 (June 10, 1991), slip op. 3-4.

The text of the main portion of Section 506(d) distin-

guishes between secured claims that are allowed and those

that are not allowed, not, as petitioner would have it,

between allowed claims that are secured and those that

are not secured. Similarly, the two exceptions to the

general rule set forth in the main portion of Section

506(d) are both examples of disallowed claims, not un-

secured claims. Petitioner’s reading transforms the pro-

vision—which makes no specific reference to unsecured

claims at all—into a major vehicle for invalidating liens

based upon the secured or unsecured nature of the related

claim under Section 506(a).

Petitioner’s reading also divorces Section 506(d) from

its integral role in the Code’s treatment of disallowed

claims. To effectuate the disallowance set forth in Sec-

tion 502, the Code discharges the debtor from in per-

sonam liability in Section 727(b). The natural role of

Section 506(d) is to complete this process by preventing

the creditor from gaining any recovery in rem for disal-

lowed claims.

7

The heavy weight that petitioner’s reading places on

Section 506(d) detracts from its focus on allowability

and leads in several ways to anomalous results inconsis-

tent with the structure of incentives throughout the rest

of the Code. First, petitioner’s reading of Section 506

as granting a broad and unlimited right to redeem any

property sets at nought the specific right of redemption

offered by Section 722. That section reflects Congress’s

considered and detailed policy judgment as to the cir-

cumstances under which debtors should be permitted to

retain collateral without paying their debts. By allowing

debtors a broader and less exacting right to redeem prop-

erty under Section 506(d), petitioner would obviate the

need for the right granted in Section 722.

Second, petitioner’s interpretation of Section 506(d)

gives debtors the right to put creditors in a worse situa-

tion than the specifically articulated provisions in Chap-

ters 11 and 13. In those Chapters—where debtors are

agreeing to use their future income to repay their cred-

itors—Congress did specifically determine that it was

appropriate to alter the rights of creditors in their col-

lateral, and included provisions in the Code that make

this unmistakably clear, while protecting the creditor

against adverse treatment that does not further the

policies of the Code. Petitioner’s reading of Section

506(d) grants debtors the same benefits, but gives cred-

itors none of the protections imposed by Chapters 11 and

13. Considering the evident congressional purpose to en-

courage debtors to reorganize and attempt to use their

future income to pay their creditors—rather than liqui-

date and walk away from their debts—it is incongruous

to suppose that the spare language of Section 506 offers

debtors in liquidation proceedings a better deal than the

highly reticulated provisions of Chapters 11 and 13.

The House and Senate Reports accompanying the bills

that became the Code unambiguously reflect the focus

on allowability set forth in the text of Section 506(d)

itself, by describing the operation of the provision as

8

invalidating liens that secure claims disallowed in a bank-

ruptey proceeding. Indeed, the House Report seems to

propose the exact opposite of petitioner’s analysis, by

describing the provision as one that allows “liens to pass

through the bankruptcy case unaffected.” Thus, nothing

in the legislative history suggests the broad role peti-

tioner envisions for Section 506(d); instead, at every

step Congress explained the provision in a manner con-

sistent with the reading we urge.

Finally, as this Court’s cases repeatedly have recog-

nized, Congress in enacting the Baukruptcy Code is un-

likely to have rejected firmly established rules of pre-

Code law without some clear indication of its intent.

Pre-Code law recognized a general rule that liens passed

through bankruptcy unaffected. Bankruptcy law con-

tained no procedure that would allow a debtor in a liqui-

dation proceeding to force a creditor to give up collateral

on which it had received a lien, without paying the full

amount of the debt. Moreover, as this Court has recog-

nized, the legislative history of the Code demonstrates

that Congress was well aware of this prior history and,

indeed, believed that Section 506(d) carried these rules

forward into the Code. This is not the sort of record that

can support the assumption that Congress deprived credi-

tors of rights so well-established.

In sum, petitioner’s reading of Section 506(d) as a

general authorization by Congress to strip down the liens

of secured creditors with allowed claims cannot be

squared with the text, structure, or policies of the Code,

or with the history that led to its enactment. This Court

should reject that reading and affirm the judgment of

the Tenth Circuit.

9

ARGUMENT

I. CLOSE READING OF THE TEXT OF SECTION

506(d) SHOWS THAT ITS EFFECT IS LIMITED

TO DISALLOWED SECURED CLAIMS

The precise language of Section 506(d) is the best

guide to the meaning of the provision. See, e.g., Penn-

sylvania Dep’t of Public Welfare v. Davenport, 110 S. Ct.

2126, 2130 (1990) (applying to the Bankruptcy Code

“the fundamental canon that statutory interpretation be-

gins with the language of the statute itself’). The main

body of the provision states simply: “To the extent that

a lien secures a claim against the debtor that is not an

allowed secured claim, such lien is void.” On its face,

this appears to take one set of circumstances—where “a

lien secures a claim”—and carve out of it a lesser and

included set of cireumstances—where that secured claim

“is not an allowed secured claim.” Liens in the carved-

out set are void. Because both sets of circumstances are

defined by reference to a “claim” that is “secured,” and

because the qualifying additional fact associated with

the carved-out set of circumstances is that the secured

claim is “not * * * allowed,” the most natural under-

standing of the provision is that it operates to void liens

on claims that are secured, but not allowed.

Petitioner reads this provision as turning not on

whether the secured claim is allowed or not alowed, but

on whether an allowed claim is secured or unsecured.

According to petitioner, what the provision means is that

a lien securing an unsecured claim is void. But the pro-

vision is triggered only “[t]o the extent that a lien se-

cures a claim,” and if a lien secures a claim the claim is

not, at least in common parlance, unsecured. It is true

that under certain circumstances Section 506(a) divides

allowed claims secured by liens into secured claims and

unsecured claims for purposes of distributions in the

bankruptcy proceeding. But if, as petitioner supposes,

the purpose of Section 506(d) was to deal with liens se-

10

curing these unsecured claims, it is implausible that Con-

gress would have signalled such an intent with a general

reference to circumstances in which “a lien secures a

claim,” rather than by a specific reference to Section

50¢(a) or to unsecured claims. Moreover, it is incon-

sistent to say—as petitioner urges—that the prime situa-

tion at which the provision is directed is one where, be-

cause the collateral is worth less than the amount of the

claim, the lien in fact fails to secure the claim. Under

petitioner’s reading, a provision that applies ‘“‘[t)o the

extent that a lien secures a claim” actually applies only

to the extent that the lien does not secure the claim.

This reading is unnatural at best.*

That Section 506(d) turns on allowability is confirmed

by the nature of the two exceptions to the body of Sec-

tion 506(d). If Section 506(d) was concerned with the

treatment of liens on unsecured claims, the exceptions

presumably would address situations in which the unse-

cured status of a claim nevertheless did not trigger the

general rule. By their terms, however, both of the excep-

tions are for disallowed claims. The first exception, Sec-

tion 506(d)(1), protects liens that secure claims dis-

allowed under Sections 502(b) (5) and 502(e). The sec-

ond exception, Section 506(d)(2), protects the liens of

secured creditors who fail to obtain allowed secured claim

status solely because they fail to file a proof of claim

under Section 501. Pursuant to Section 502(a), a claim

is not allowed unless a proof of claim is filed; thus, absent

Section 506(d)(2), liens securing payment of these

claims would be voided by the main body of Section 506.

4 The text argues that the reference in Section 506(d) to claims

that are not allowed secured claims was aimed at disallowed secured

claims rather than at claims that become allowed unsecured claims

by operation of Section 506(a). We note that, under any reading

of the statute, we need not address the fourth type of claim, a

disallowed unsecured claim, because it is not possible for Section

506(a) to produce a disallowed unsecured claim; Section 506(a), by

its terms, applies only to “[a]n allowed claim.”

11

In our view, it is more than a coincidence that there are

no references to allowed unsecured claims in the excep-

tions to Section 506(d); the most likely explanation is

that allowed unsecured claims do not fall within the body

of Section 506(d) in the first place.

Il. THE STRUCTURE OF THE CODE SHOWS THAT

SECTION 506(d) CAN APPLY ONLY TO DISAL-

LOWED CLAIMS

A. Section 506 Plays an Integral Role in the Code’s

Treatment of Disallowed Claims

A broader look at the structure of the Code confirms

the integral role of Section 506(d) in the disposition of

disallowed claims, a role that is completely unrelated to

the status of the claims as secured or unsecured. See,

e.g., Grogan V. Garner, 111 S. Ct. 654, 659 n.13 (1991)

(applying to Bankruptcy Code the teaching that “ijn

determining the meaning of the statute, we look not only

to the particular statutory language but to the design of

the statute as a whole and to its object and policy”)

(quotation omitted). As we mentioned above, Section 502

of the Code sets forth several categories of claims and

subjects them to adverse treatment by excluding them

from the group of claims that are allowed. For example,

Section 502(b)(1) disallows claims that are unenforce-

able under state law, Section 502(b) (4) disallows claims

for fees payable to attorneys or other insiders that exceed

the reasonable value of the services, and Sections

502(b) (6) and 502(b)(7) disallow excessive claims for

compensation for termination of a lease or employment

contract.

In the bankruptcy proceeding itself, the holder of a

disallowed claim receives no distribution for that claim.®

Two provisions address the post-bankruptcy consequences

of disallowed status. First, Section 727(b) grants elig-

ible debtors a discharge “from all debts” that arose be-

5 See Sections 726(a); 1124(3)(A), 1325(a) (4) and (5).

12

fore the bankruptcy, “whether or not a claim based on

any such debt * * * is allowed under section 502”; this

protects the debtor from any subsequent in personam

liability on disallowed claims.* Second, Section 506(d)

deals with in rem liability, voiding liens that secure pay-

ment of the disallowed claims, ensuring that the dis-

favored creditor does not retain any avenue from which

it might seek payment. In the absence of Section 506(d),

a creditor holding a pre-bankruptcy judgment lien se-

curing a disallowed claim could proceed after the bank-

ruptcy to satisfy its claim out of any remaining property

of the debtor, even if the property has been protected

from creditors under the Code.”

In sum, the structure of the Code demonstrates a clear

need and coherent purpose for Section 506(d), which—

contrary to petitioner’s submission—has nothing to do

with allowed unsecured claims. Every definitive use of

the provision points, like its language, to a focus on dis-

allowed status rather than on unsecured status.

B. Application of Section 506(d) to Unsecured Claims

Leads to Incongruous Results Inconsistent with

Other Provisions of the Code

The best confirmation of the accuracy of the natural

reading of the text described above comes from considera-

* Compare Section 1141(d)(1)(A) (ii) (similar treatment in Chap-

ter 11 discharge) ; Section 1328 (similar treatment in Chapter 13

discharge).

7 The coherence of this structure of provisions to effectuate the

purposes of Section 502 is illuminated by the analogous provisions

the drafters used to grant special treatment to unmatured alimony

and child-support obligations. Section 502(b)(5) disallows these

claims to the extent that they are unmatured; accordingly, pursuant

to Sections 507 and 726, these obligations are not liquidated and

prepaid in the bankruptcy. On the other hand, Section 523(a)(5)

protects them from the normal discharge rules of Section 724(b),

and Section 506(d)(1) protects liens that secure these claims from

invalidation under Section 506(d), regardless of the value of the

collateral or the amount of the allowed secured claim, as determined

under Section 506(a).

—_

13

tion of the bizarre results of petitioner’s reading, which

cannot be squared with the specific rights granted debtors

in Section 722 or the detailed creditor-protective provi-

sions set forth in Chapters 11 and 13.

1. Congress recognized the harsh straits debtors would

face under a firm rule that did not allow debtors to alter

any of the rights of secured creditors. Accordingly, in

Section 722 it granted debtors a right in certain limited

circumstances to redeem personal property by paying the

creditor the value of the collateral, even if the value paid

is less than the debt.* The rights granted to the debtor

are limited carefully; they apply only to “tangible per-

sonal property intended primarily for personal, family,

or household use.”* Also, the debtor cannot leave its

creditor in suspense during a long bankruptcy proceed-

ing, because Section 521(2)(A) requires the debtor to

notify the court within 30 days of the filing if it intends

to redeem the collateral, and Section 521(2)(B) requires

the debtor to complete the redemption within 45 days

thereafter.

Under petitioner’s reading Section 722, with its specific

and limiting restrictions, is wholly superfluous, because a

debtor, at any time or from time to time, and without

regard to the nature of the collateral, could come to the

* The history of this provision is particularly damaging to peti-

tioner’s reading, because it demonstrates that Congress well under-

stood that, in the absence of Section 722, the normal provisions of

bankruptcy law would require the debtor to pay the entire amount

of the debt if he wished to retain the collateral, even if the debt

exceeded the value of the collateral. See H.R. Rep. No. 595, 95th

Cong., Ist Sess. 128 (1977) (“fI]t does little good to allow the

debtor an exemption of wearing apparel, household goods, or health

aids subject to an indefeasible security interest * * * if the debtor

must pay more than the property is worth for the privilege of con-

tinuing to use the property.”).

* The legislative history shows that the limitation to certain goods

was intentional, so that the right would apply only to property neces-

sary for the debtor to make a fresh start. See H.R. Rep. No. 595,

95th Cong., Ist Sess. 127-128 (1977).

14

court under Section 506(d) and have the court strip

down a lien to the value of the collateral. Moreover, al-

though Section 722 alters the creditor’s rights only if the

debtor tenders full payment within 45 days, petitioner’s

reading of Section 506(d) would reduce the value of the

lien immediately, and leave the debtor an option—to be

exercised at any time before foreclosure—to tender to

the creditor the amount of the lien and thus retain the

collateral free and clear. This effectively grants the

debtor an opportunity to speculate as to market changes

in the value of the collateral that is utterly inconsistent

with the rigorous deadlines set forth in Section 521.

Moreover, if petitioner is correct, there are no circum-

stances under which Section 722 would grant debtors

more favorable treatment than Section 506(d). It is

highly unlikely that Congress would have limited Section

722 so precisely if it was completely superfluous in light

of Section 506(d).”

1 Basic property principles provide that if a debtor pays a credi-

tor the entire sum secured by the collateral (that is, under petition-

er’s reading, the value of the collateral as determined by the bank-

ruptey court), there would be no remaining debt for the creditor's

lien to secure, and thus the creditor no longer would be able to con-

duct a foreclosure sale. See 9 Thompson on Real Property § 4808

(J. Grimes ed. 1958 & Supp. 1981) (real property); U.C.C. § 9-506

(1978) (personal property). Of course, after a foreclosure is con-

ducted, the entity that purchased at that sale would own the col-

lateral and, absent some state-law right of redemption that con-

tinues after foreclosure, the debtor would be able to regain the

collateral only by purchasing it from the subsequent owner. See

Thompson on Real Property, supra, § 4822 (real property); U.C.C.

§ 9-504(4) (1978) (personal property).

11 The consistently guarded approach that Congress took in decid-

ing to alter the rights of lienholders is also apparent from Section

522(f), which grants the debtor a limited and carefully delineated

right to avoid liens on exempt property. The power applies only to

two particularly disfavored types of liens: (1) judicial liens and

(2) nonpossessory, nonpurchase-money security interests in house-

hold goods, tools of the trade, or health aids. Thus, it never could

apply to purchase-money security interests, any lien in real estate,

15

2. Petitioner’s reading of Section 506(d) also under-

mines the incentives established by the finely reticulated

provisions of Chapters 11 and 13. The distinction be-

tween a Chapter 7 bankruptcy, on the one hand, and a

Chapter 11 or Chapter 13 bankruptcy, on the other hand,

is fundamental. In a liquidation proceeding under Chap-

ter 7, “the debtor gives up all non-exempt assets, the

Trustee in Bankruptcy sells these assets, and the pro-

ceeds are distributed pro rata to creditors.” E. Warren

& J. Westbrook, The Law of Debtors and Creditors 179

(1986). By contrast, in a payout proceeding under

Chapter 11 or 13, “a debtor can propose to keep all assets

in exchange for promising to pay off debts over a period

of time out of future income.” /bid."

To encourage debtors to agree to use their future in-

come to repay their debts in Chapter 11 and 13 proceed-

ings, which theoretically benefit society because a debtor

or, indeed, any bargained-for lien in personal property other than

the especially favored types of property mentioned above. This

provision’s careful delineation of particular types of collateral and

particular types of loans bespeaks an entirely more attentive and

compromising attitude than petitioner’s reading of Section 506,

which suggests a Congress ready to alter creditors’ rights wholesale,

without any concern for the nature of the particular transaction

being affected.

12 It is important to recognize that a debtor’s agreement-to use its

future income to pay its creditors has a dramatic effect on the

amounts received by creditors. In Chapter 7 proceedings, the dis-

proportionate majority of the cases produce nothing for general

unsecured creditors. See, e.g., Herbert & Pacitti, Down and Out in

Richmond, Virginia: The Distribution of Assets in Chapter 7 Bank-

ruptey Proceedings Closed During 1984-1987, 22 U. Rich. L. Rev.

303, 310-211 (1988) (no assets for general unsecured creditors in

97% of Chapter 7 cases). Payout plans typically promise much more

for creditors, see, ¢.g., T. Sullivan, E. Warren & J. Westbrook, As

We Forgive Our Debtors 45 n.27 (1989) (median repayment of

45% promised in confirmed Chapter 13 plans) ; LoPucki & Whitford,

Bargaining over Equity’s Share in the Bankruptcy Reorganization

of Large, Pubiliely Held Companies, 139 U. Pa. L. Rev. 125, 142

(1990) (median repayment of 27% in large Chapter 11 cases),

although it is not clear exactly how much actually is repaid.

16

“can keep assets instead of liquidating them, often at sac-

rifice prices,” E. Warren & J. Westbrook, supra, at 179,

the Code not only allows debtors to keep their assets, it

also provides a number of other benefits not available to

debtors in Chapter 7 bankruptcies. Most important of

these for this case are the specific provisions that au-

thorize Chapter 11 plans that “impair * * * any class of

claims, secured or unsecured,” Section 1123/b)(1), and

Chapter 13 plans that “modify the rights of holders of

secured claims,” Section 1322 (b) (2)."

Not surprisingly, the Code does not trust blindly in the

good will of debtors to ensure that they do not abuse the

power to alter the rights of secured creditors. Thus, this

power is strictly defined, in an attempt to see that it is

exercised only to further legitimate bankruptcy purposes

without unnecessarily harming the secured creditor. Most

importantly, the plan must pay all nonconsenting creditors

at least as much as they would receive in a Chapter 7

liquidation. Sections 1129(a) (7) (A), 1825(a) (4). More-

over, both Chapters prohibit confirmation of any plan in

which the debtor retains collateral over the objection of

a secured creditor unless the creditor retains a lien equal

to the amount of its allowed secured claim, and is sched-

uled to receive under the plan property or payments with

a present value equal to the amount of its allowed secured

claim. See Sections 1129(b)(2)(A), 13825(a)(5)." Be-

13 Perhaps the most notable of the other benefits is the ability of a

consumer debtor to receive a broader discharge in a Chapter 13

bankruptcy than he could in a Chapter 7 bankruptcy. Compare Sec-

tion 1328(a) (exceptions from discharge after successful completion

of a Chapter 13 plan) with Section 523(a) (exceptions from dis-

charge under Chapters 7 and 11, or under Chapter 13, if debtor fails

to complete payments under plan).

1 Technically, it would be possible for a court to confirm a Chap-

ter 11 plan over a creditor’s objections without retaining these pro-

tections for the creditor by determining that the pian granted the

creditor the “indubitable equivalent” of its claims, Section 1129

(b) (2)(A) (iii), but it is unlikely that anything determined to be

the indubitable equivalent would protect the creditor less than the

17

cause obligations under the plan are obligations of the

debtor that continue after bankruptcy," the creditor thus

receives, in return for any reduction of its lien, a per-

sonal and continuing obligation of the debtor to repay the

debt up to the value of the collateral as determined by the

bankruptcy court.

Moreover, both Chapters limit the circumstances under

which debtors can reduce liens. First, a plan under

Chapter 13 cannot alter the rights of a secured creditor

~ holding a mortgage on the debtor’s principal residence.

Section 1322(b)(2). Second, in reorganizations under

Chapter 11, where the greatest amount of money is likely

to be at stake, a secured creditor has the right, by waiv-

ing any unsecured claim against the debtor, to prevent

reduction of the amount of its lien by electing treatment

under Section 1111(b) (2).

protections outlined in the text, as the contemporaneous legislative

explanations of the provision make clear. See 124 Cong. Rec. 32,407,

34,007 (1978).

18 Section 1141(d)(1) accomplishes this for Chapter 11 plans, by

providing for a discharge of pre-petition debts “[e]xcept as other-

wise provided in * * * the plan.” In Chapter 13 plans, this

generally is accomplished by provisions in Sections 1328(a)(1) and

1328(c)(1) that prevent discharge of any debt that does not mature

during the pendency of the plan (which is treated under Section

1322(b)(5)). It is possible, with respect to short-term secured

claims, which do mature during the term of the plan, for a debtor

who fails to complete payments under the plan to secure a discharge

under Section 1328(b) without making all of the payments with

respect to those claims, but the price for that debtor is that it must

forgo the benefits of the broader discharge it would have received

under Section 1328(a), see note 13, supra. Moreover, the creditor

at that point would be entitled to take the collateral in satisfaction

of the unpaid obligation, because, as mentioned in the text, the

Chapter 13 plan must allow the creditor’s lien to continue in effect

securing the obligation of the debtor under the plan.

16 Section 1111(b)(2) itself does not directly affect the amount

of the lien, but simply allows the creditor to avoid the operation of

Section 506(a) and treat its entire allowed claim as secured. But

because Section 1129(b)(2)(A)(i) (I) prevents confirmation over a

creditor’s objection of a Chapter 11 plan that does not grant the

esis 18

Petitioner’s reading of Section 506(d) would allow

debtors to shortcut these complicated creditor-protective

provisions and receive a better deal under Section 506(d)

—availab'e in a Chapter 7 liquidation proceeding—than

Congress offered debtors to encourage them to use their

future income to pay off their debts under Chapters 11

and-13. Mest obviously, petitioner’s reading allows the

lien to be stripped without requiring any personal obliga-

tion on the part of the debtor to repay any amount of

the debt; a discharge under Section 724, unlike the dis-

charges available in Chapters 11 and 13, protects the

debtor from any further personal liability. Also, peti-

tioner’s reading makes lien-stripping available at the op-

tion of the debtor, without regard to the creditor’s wishes,

and thus would allow a Chapter 7 debtor to reap a wind-

fall if a bankruptcy court undervalued property, by pur-

chasing the property at the court’s valuation, and immedi-

ately reselling it at a profit. This is difficult to reconcile

with the Section 1111(b) election discussed above, which

allows a creditor, after it can evaluate the value chosen

by the bankruptcy court and the likelihood of recovery on

its unsecured claim, to waive its unsecured claim and

creditor a lien in the amount of its allowed secured claim, the

inevitable effect of an 1111(b) election is to grant the creditor a

lien for the full amount of its claim.

To be sure, the present value of the amounts required to be paid

the creditor under Section=#129(b)(2)(A)(i)(II) is only the value

of the collateral, rather than the total amount of the lien. Thus, a

debtor faced with a Section 1111(b) election by an undersecured

creditor must make payments to the creditor that total the amount

of the claim, with a present value equal to the value of the collateral.

Although many debtors may be able to satisfy this requirement

without incurring any burden beyond the burden of paying the

present value of the collateral (by extending the period over which

payments are made), in many circumstances a Section 1111(b)

election will make it extremely difficult for a debtor to avoid paying

an undersecured creditor amounts with a present value that exceeds

the value placed on the collateral by the bankruptcy court. See gen-

eral uwcki, Strategies for Creditors in Bankruptcy Proceed-

ing’ § 12.7.5 (1985).

i

19

then retain a lien for the full amount of its debt. Fi-

nally, petitioner’s reading allows consumers in Chapter 7

bankruptcies to avoid the specific restrictions Congress

imposed on consumer payout plans, which prevents modifi-

cation of home mortgages, see Section 1322(b) (2). It is

difficult to believe that Congress wrote the specific provi-

sions in Chapters 11 and 13, granting debtors limited

rights to reduce creditor’s liens, with the understanding

that Section 506(d) granted debtors a broad and un-

limited right to do so unrestrained by any of the con-

straints articulated in Chapters 11 and 13.

Petitioner’s approach takes an innocuous, though im-

portant, provision intended to effectuate the policy deci-

sions reflected in the provisions of Section 502 that dis-

allow disfavored claims, and transforms it into a major

disruption of the finely tuned and harmonious scheme of

debtor and creditor protections realized throughout the

Code."”

17 Section 552 of the Code offers yet another example of the

incongruous effects of petitioner’s reading. Under that Section, a

creditor is entitled to enforce provisions of a security agreement

that grant the creditor a lien on proceeds, rents, and profits arising

out of its collateral. It is hard to reconcile this broad protection

of lien rights with the effect petitioner sees in Section 506, which

deprives a creditor of future appreciation in the value of its col-

lateral by locking in the value of a creditor’s lien to a value of the

collateral determined by the bankruptcy court. If Congress would

let a creditor retain proceeds, rents, and profits—which necessarily

increase the value of the security held by the creditor—it is hard

to see why Congress would deprive the creditor of something much

more fundamental to its bargain: the full value of its collateral as

it may exist from time to time.

20

Ill. THE LEGISLATIVE HISTORY OF THE CODE

DEMONSTRATES THAT SECTION 506(d) WAS

AIMED ONLY AT DISALLOWED CLAIMS, AND

THAT CONGRESS DID NOT CONTEMPLATE AP-

PLICATION OF THE PROVISION TO UNSECURED

CLAIMS

The language of Section 506(d) as enacted in 1978

first appeared in the 95th Congress in H.R. 8200.'* The

entire section-by-section analysis of this provision in the

accompanying House Report explained:

~ 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. The void-

ing provision does not apply to claims disallowed only

under section 502(e), which requires disallowance

of certain claims against the debtor by a codebtor,

surety, or guarantor for contribution or reimburse-

ment.

H.R. Rep. No. 595, 95th Cong., Ist Sess. 357 (1977)

(emphases added). This passage makes two points im-

portant to this case. First. the first sentence indicates

that the provision generally allows liens to pass through

the bankruptcy unaffected, a concept directly opposed to

petitioner’s contention that the purpose of Section 506(d)

is to strip liens to the judicially determined Value of the

collateral. Second, the passage suggests a single excep-

tion, for cases in which the creditor comes into the bank-

ruptcy and the court disallows its claim. Nothing in this

passage suggests the broad intent petitioner ascribes to

this provision, and her reading makes a mockery of the

Committee’s promise that liens will pass through un-

affected.

18 For a general discussion of the legislative history of Section

506, see 3 Collier on Bankruptcy { 506.03 (L. King 15th ed. 1991).

21

The Senate introduced a comparable bill in the same

Congress, S. 2266. This bill contained a similar version

of Section 506(d), which differed only in the language of

the exceptions. The section-by-section analysis of this bill

displays a similar intent: “Subsection (d) provides that

to the extent a secured claim is not allowed, its lien is

void unless the holder had neither actual notice nor

knowledge of the case, the lien was not listed by the

debtor in a chapter 9 or 11 case or such claim was dis-

allowed only under section 502(e).” S. Rep. No. 989,

95th Cong., 2d Sess. 68 (1978) (emphasis added). Like

the explanation in the House Report, the Senate Report

shows that the purpose of Section 506(d) was to invali-

date liens securing disallowed claims.”

“It is frv-cful to compare the legislative explanation of this

provision to the explanation the Senate offered in the same report

for Section 722, which, as discussed above, granted debtors a limited

right of redemption with respect to certain types of personal prop-

erty. The report explained: “This right to redeem is a very sub-

stantial change from current law.” S. Rep. No. 989, supra, at 95.

If petitioner were correct in reading Section 506(d) as an even

broader weapon effectively granting an unconstrained right to

redeem any type of collateral, surely the explanation for Section

506(d) at least would have alluded to this even more substantial

change from prior law.

The introductory portion of the House Report did note that “[o]ne

of the more significant changes from current law in proposed title

11 is the treatment of secured creditors and secured claims.” H.R.

Rep. No. 595, supra, at 180. But it went on to describe the specific

change to which it was referring: the provisions of the bill that

distinguish between secured and unsecured claims, rather than

between secured and unsecured creditors. That relatively procedural

change, of course, is indubitably clear on the face of Section 506(a).

There is not a hint of the revolutionary import petitioner attaches

to Section 506(d).

20 Although there is no committee report explaining why Congress

chose to enact the House version of Section 506(d), Senator

DeConcini and Representative Edwards each introduced into the

Congressional Record for his respective Chamber detailed comments

explaining in substantially identical terms that the additional ex-

ception contained in the Senate bill (which protected tax authorities

22

In surn, Congress’ contemporaneous explanations of the

purpose of Section 506(d) explicitly describe its effect on

a lien as turning on whether the claim is allowed or dis-

allowed, not—as petitioner would have it—on whether the

claim is secured or unsecured under Section 506(a).

Under Section 506(d), “the lien is void to the extent that

the claim is not allowed” (H.R. Rep. No. 595, supra, at

357)—not, as under petitioner’s reading, to the extent

that the claim is unsecured. Section 506(d) voids a lien

“to the extent a secured claim is not allowed” (S. Rep.

No. 989, supra, at 68)—not, as under petitioner’s read-

ing, to the extent an allowed claim is unsecured. There

is not so much as a snippet of legislative history to sug-

gest any relation between Section 506(d) and the bifurca-

tion established by Section 506(a) or, indeed, any appli-

cation of Section 506(d) to unsecured claims at all. It is

almost unimaginable to believe that this is the kind of

record one would find if Congress intended the provision

to have the meaning urged by petitioner.’

who had no knowledge of the bankruptcy) was deleted because it

was superfluous in light of the general provision in the House bill

that Section 506(d) would not void liens held by creditors that did

not file in the bankruptcy. 124 Cong. Rec. 32,414-32,415, 34,014

(1978). Again, there is not a hint here that the provision should

have any effect on unsecured claims.

21 Section 506(d) was amended by the Bankruptcy Amendments

and Federal Judgeship Act of 1984, Pub. L. No. 98-353, § 448(b),

98 Stat. 374. The amendments did not affect the main portion of

the provision, but only made technical correcting changes to the

exceptions, and revised the language of the existing exceptions “to

make clear that the failure of the secured creditor to file a proof

of claim is not a basis for avoiding the lien of the secured credi-

tor.” S. Rep. No. 65, 98th Cong., Ist Sess. 79 (1983); see 3 Collier

on Bankrvptey © 506.03, at 506-14 (L. King 15th ed. 1991) (dis-

cussing the history of the amendment); id. © 506.07, at 506-68 to

506-70, 506-72 to 506-73 (discussing problems in interpretation that

led to the amendment).

23

IV. PETITIONER’S READING CONSTRUES SECTION

506(d4) TO WORK A DRAMATIC AND UNEX-

PLAINED CHANGE IN PRE-CODE BANKRUPTCY

LAW

As this Court has recognized for decades, Congress is

“not writing on a clean slate” when it amends the bank-

ruptey laws. Emil v. Hanley, 318 U.S. 515, 521 (1948).

Consequently, this Court has shown a considerable reluct-

ance to accept arguments that would interpret vague or

innocuous provisions of the Code to wreak major changes

in pre-Code practice that are not discussed in the legisla-

tive history. “[A] major change in the existing rules

would not likely have been made without specific provi-

sion in the text of the statute; it is most improbable that

it would have been made without even any mention in

the legislative history.” United Savings Ass’n v. Timbers

of Inwood Forest Associates, 484 U.S. 365, 380 (1988)

(citation omitted). Examination of pre-Code practice

shows that the rule petitioner seeks would conflict with

the meaning of prior law, as interpreted by this Court

and understood by the Congress that drafted the Code.

Although many tiings may have been unclear about

the treatment of secured creditors under the Bankruptcy

Act of 1898, one bedrock principle was beyond dispute:

absent some policy consideration specifically reflected in

the Code, liens passed through bankruptcy unaffected.**

Indeed, Section 67d of the Act made this explicit:

2 See, e.g., Pennsylvania Dep't of Public Welfare v. Davenport,

110 S. Ct. at 2133 (“We will not read the Bankruptcy Code to erode

past bankruptcy practice absent a clear indication that Congress

intended such a departure.”); United States v. Ron Pair Enter-

prises, 489 U.S. 235, 245 (1989); Kelly v. Robinson, 479 U.S. 36,

47 (1986); Midlantie Nat'l Bank v. New Jersey Dep’t of Envtl.

Protection, 474 U.S. 494, 501 (1986). For cases applying this rule

to interpret bankruptcy statutes predating the Code, see Emil v.

Hanley, 318 U.S. at 521; Swarts v. Hammer, 194 U.S. 441, 444

(1904).

“8 This Court recently acknowledged this general pre-Code rule

in Farrey V. Sanderfoot, No. 90-350 (May 23, 1991), slip op. 6

Liens given or accepted in good faith and not in

contemplation of or in fraud upon this Act, and for

a present consideration, which have been recorded ac-

cording to law, if record thereof was necessary in

order to impart notice, shall not be affected by this

Act.

30 Stat. 564.%* Nor can it be said that the strong lan-

guage of the statute was undermined by judicial excep-

tions. As this Court recognized, “Section 67d * * * de-

clares that liens given or accepted in good faith and not

in contemplation of or in fraud upon this act, shall not

be affected by it.” City of Richmond v. Bird, 249 US.

174, 177 (1919).*

(“Ordinarily, liens and other secured interests survive bank-

ruptey.”); see Johnson Vv. Home State Bank, No. 90-693 (June 10,

1991), slip op. 5 (“a bankruptcy discharge extinguishes only one

mode of enforcing a claim—namely, an action against the debtor

in personam—while leaving intact another—-namely, an action

against the debtor in rem”).

24 The animus against liens incurred under questionable circum-

stances continues in the new Code. See Sections 547, 548.

25 See also, e.g., City of Dallas v. Ryan (In re Brannon), 62 F.2d

959, 961 (5th Cir.) (“[T]rue liens, however arising, which are not

expressly invalidated by the Bankruptcy Act, remain good, and

the trustee takes his title * * * subject to them.”), cert. denied,

289 U.S. 742 (1933). See generally 4B Collier on Bankruptcy

" 70.70 (J. Moore 14th ed. 1979).

To be sure, the specific phrase regarding the continuing validity

of liens was removed in a reorganization of this Section in 1938,

but this seems to have been done not to remove the rule of validity,

but instead because “the draftsmen of the 1938 Act desired gen-

erally to specify only what should be invalid.” 4B Collier on Bank-

ruptey © 70.70, at 771 (J. Moore 14th ed. 1979) (emphasis in

original). There is no doubt that the alteration of the language

had no substantive effect. As the Fifth Circuit explained:

It is true that * * * the Chandler Act did not retain the old

language saying expressly that liens valid in bankruptcy shall

‘not be affected by anything herein,’ but that provision was

simply declaratory of the obvious import reflected, and still

06. nner

Examination of the Act’s treatment of undersecured

creditors confirms this understanding in the precise con-

text relevant to the case at hand: outside of reorganiza-

tion proceedings,** no provision of the Act countenanced

involuntary reduction of the amount of a creditor’s lien

for any reason other than payment of the debt; the Act

generally dealt only with in personam liabilities. Cf.

Johnson Vv. Home State Bank, No. 90-693 (June 10, 1991),

slip op. 5-6 (drawing a similar distinction in treatment of

mortgages under the Code). Practice under the Act gave

an undersecured creditor three options: “(1) to prove

his claim as an unsecured claim and surrender his secu-

rity; or (2) to prove his claim as a secured claim and

give the bankrupt credit for the value of the security; or

(3) not to prove at all and rely solely on the security.”

3 Collier on Bankruptcy { 57.07[3], at 169 (J. Moore

14th ed. 1976). The first option is irrelevant to our in-

quiry; if the creditor waives its lien, the effect on its

rights is not involuntary. The third option grants the

creditor rights analogous to the result under Section

506(d)(2): the lien passes through the bankruptcy un-

affected. See 3 Collier on Bankruptcy { 57.20(3] (J.

Moore 14th ed. 1976). The second option most closely

resembles the present facts, where the secured creditor

attempts to receive a share of the bankrupt’s estate to

reflected, frequently in the substantive terms of the law, and

the omission of such redundancy is not significant.

Oppenheimer Vv. Oldham, 178 F.2d 386, 389 (1949).

26 Chapter X of the Act did permit modification of liens in con-

nection with a plan of reorganization. 11 U.S.C. 616(1), 616(10)

(1976). But this provision, like the analogous provisions in the

new Chapters 11 and 13 discussed above, included a variety of

mechanisms to protect the unconsenting creditor. See Section

616(7). The existence of this narrow provision, a precursor of

the provisions of Chapters 11 and 13 discussed above, undermines

petitioner’s reading of Section 506(d) as a wide-ranging lien-

stripping provision, by showing the longstanding tradition of allow-

ing such a remedy only in connection with a reorganization pro-

ceeding that affords substantial protections to affected creditors.

26

compensate for a shortfall between the value of its col-

lateral and the amount of its claim. In this situation, it

is clear that the creditor was entit’ed to pursue the col-

lateral to the full extent of its debt. even if the “security

proved subsequently to be more valuable than estimated”

in the bankruptey court. Jd. 9 57.20[6.2], at 359.27

The best illustration of the clear understanding of the

inviolability of liens in bankruptey proceedings is this

Court’s response to the Frazier-Lemke Act, a statute that

indisputably did a'ter the richts of lienholders. As this

Court explained. the “avowed object” of that Act—like

petitioner’s reading of Section 506(d)—“is to take from

the mortgagee rights in the specific property held as secu-

rity; and to that end ‘to scale down the indebtedness’ to

the present value of the property.” Lovisville Joint Stock

Land Bank v. Radford. 295 U.S. 555, 594 (1935). Under

the Act, if the holder of a mortgage on a farm owned by

a bankrupt consented, the debtor could buy the farm for

its then appraised value by a series of payments over

six years. If the creditor did not consent, the bankruptcy

court would stay proceedinvs for five years, at which

point the debtor could purchase the property for its ap-

praised value, whether or not the creditor consented. /d.

at 575-576.

In the course of invalidating this statute under the

Takings Clause, this Court undertook a comprehensive

examination of the rights of secured creditors against

bankrupt debtors. It repeatedly rejected any notion that

existing law forced creditors to suffer the intrusions peti-

tioner finds in Section 506(d) of the Code. With respect

*? There was some question as to what would happen if the

creditor received more from the collateral than the amount of its

outstanding debt. Apparently, “in this rare case,” where the credi-

tor had collected more than its full claim, the valuation of the

collateral might be reconsidered, apparently so that the creditor

could be forced to return any distribution it had received from the

estate. See 3 Collier on Bankruptcy © 57.20[6.2), at 358-359 (J.

Moore 14th ed. 1976).

27

to the general law of creditor’s rights, the Court ex-

plained: “No instance has been found, except under the

Frazier-Leinke Act, of either a statute or decision com-

pelling the mortgagee to relinquish the property to the

mortgagor free of the lien unless the debt was paid in

full.” Radford, 295 U.S. at 579. With respect to national

bankruptcy laws, the Court concluded that “none had,

prior to the Frazier-Lemke amendment, sought to compel

the holder of a mortgage to surrender to the bankrupt

either the possession of the mortgaged property or the

title, so long as any part of the debt thereby secured

remained unpaid.” Jd. at 581-582. It noted that the fed-

eral bankruptcy laws had permitted certain property to

be exempted from general creditors, but explained, by

reference to the rule in Long v. Bullard, 117 U.S. 617,

620-621 (1886), that this had only a limited effect, be-

cause “unless the mortgagee released his security, in or-

der to prove in bankruptcy for the full amount of the

debt, a mortgage even of exempt property was not dis-

turbed by bankruptcy proceedings.” Radford, 295 U.S.

at 582-583.

Finally, it is clear that Congress drafted and passed

the Code with full understanding of this practice. As we

mentioned above, the House Report accompanying Section

506(d) explicitly stated its understanding that the gen-

eral import of Section 506(d) was to permit “liens to

pass through the bankruptcy case unaffected.” H.K. Rep.

No. 595, supra, at 357. We submit that it passes belief

that the House would have described a provision working

the dramatic change petitioner sees in Section 506(d) by

reference to the pre-Code maxim that liens pass through

bankruptcy unaffected.

Congress’ understanding of the law on this point ap-

pears even more clearly from the history of related pro-

visions. For example, as mentioned above, when Congress

drafted Section 722—the one provision in the Code that

does allow a debtor in a liquidation case to retain collat-

eral without paying the debts that encumber that col-

28

lateral—it noted that under the existing law, a debtor

faced with an undersecured creditor “must pay more than

the property is worth for the privilege of continuing to

use the property.” H.R. Rep. No. 595, supra, at 128. Con-

gress could not have thought this statement to be correct

if it had thought that the pre-Code law provided for the

lien-stripping petitioner seeks to read into Section 506(d).

Finally, as this Court has recognized, a similar under-

standing is evident from the history of Section 522(c)

(2) (A) (ii), which provides that a bankruptcy does not

affect liens on exempt property unless the liens are voided

under Section 506(d). If petitioner is correct, this pro-

vision would mean that liens on exempt property are un-

affected only in the rare case in which the creditor is

fully secured; under our reading, of course, the liens

would be affected only if the claim was disallowed. The

latter reading is the only one consistent with Congress’

intent. Citing Radford and Long v. Bullard, both the

House and the Senate Reports explained that Section

506(d) (as incorporated by reference into Section 522(c) )

followed the rule that the “bankruptcy discharge does not

prevent enforcement of valid liens,” and that by enact-

ment of Section 522(c) the Code was accepting this rule

“with respect to the enforcement of valid liens on non-

exempt property as well as on exempt property.” H.R.

Rep. No. 595, supra, at 361; S. Rep. No. 989, supra, at

76. This passage demonstrates two things. First, Con-

gress clearly understood that existing law did not pro-

vide for any reduction in liens of undersecured creditors

with allowed claims because of a bankruptcy of their

debtors. Second, it thought that Section 506(d) carried

that rule forward in the Code. See Farrey v. Sander-

foot, No. 90-350 (May 23, 1991), slip op. 6 (citations

omitted) (“[I]t was well settled when § 522(f) was

enacted that valid liens obtained before bankruptcy could

be enforced on exempt property, including otherwise ex-

empt homestead property. Congress generally preserved

this principle when it comprehensively revised bankruptcy

29

law with the Bankruptcy Reform Act of 1978.”).2° Con-

gress could not rationally have explained Section 522(c)

in this manner if petitioner’s reading of Section 506(d)

was correct.

In sum, the text of Section 506(d) strongiy indicates

that the provision affeets only a secured claim that is not

allowed. The structure of the Code shows that this is a

sensible reading, and that petitioner’s reading is incon-

sistent with the painstaking approach Congress took in

the provisions that affected the rights of lienholding cred-

itors. Finally, the legislative history and pre-Code prac-

tice show a consistent history of protection for the rights

of secured creditors that petitioner would have stripped

by Section 506(d), and not a snippet of a suggestion that

Congress intended to intrude on those rights here. At

bettom, it is just not plausible that Congress could have

granted debtors the broad new remedy against allowed

unsecured claims that petitioner sees in Section 506(d)

without specifically mentioning this powerful remedy

someplace in the Code or in its legislative history.

—

** See also Johnson v. Home State Bank, No. 90-693 (June 10,

1991), slip op. 4 (“Codifying the rule of Long v. Bullard, 117 U.S.

617 (1886), the Code provides that a creditor's right to foreclose

on the mortgage survives or passes through the bankruptcy.”).

30

CONCLUSION

The judgment of the court of appeals should be affirmed.

Respectfully submitted.

KENNETH W, STARR

Solicitor General

STUART M. GERSON

Assistant Attorney General

JOHN G. ROBERTS, JR.

Deputy Solicitor General

RONALD J. MANN

Assistant to the Solicitor General

ALAN CHARLES RAUL

General Counsel

Department of Agriculture

ErIc S. BENDERSON

Associate General Counsel for Litigation

Small Business Administration

JUNE 1991

APPENDIX

§ 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 setoff 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 setoff, 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 sub-

ject to setoff 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.

(b) To the extent that an allowed secured claim is se-

cured by property the value of which, after any recovery

under subsection (c) of this section, is greater than the

amount of such claim, there siiall be allowed to the holder

of such claim, interest on such claim, and any reasonable

fees, costs, or charges provided for under the agreement

under which such claim arose.

(c) The trustee may recover from property securing

an allowed secured claim the reasonable, necessary costs

and expenses of preserving, or disposing of, such property

to the extent of any benefit to the holder of such claim.

(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.

(la)