Carvalho v. Federal National Mortgage Ass'n

United States Court of Appeals
For the First Circuit

No. 02-2501

IN RE MARIA CELINA CARVALHO AND FRANCISCO ANDRADE,
Debtors.
___________________

MARIA CELINA CARVALHO AND FRANCISCO ANDRADE,
Plaintiffs, Appellees,

v.

FEDERAL NATIONAL MORTGAGE ASSOCIATION,
Defendant, Appellant.

APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF MASSACHUSETTS

[Hon. Robert E. Keeton, U.S. District Judge]

Before

Selya, Circuit Judge,
R. Arnold,* Senior Circuit Judge,
and Lipez, Circuit Judge.

Deirdre J. Keady, with whom Thomas J. Walsh and Harmon Law
Offices, PC were on brief, for appellant.
Jeffrey M. Frankel for appellees.

July 9, 2003

__________
*The Hon. Richard S. Arnold, of the Eighth Circuit, sitting by
designation.
 SELYA, Circuit Judge. In this case of first impression

at the federal appellate level, we must address the effect of post-

confirmation default and consequent relief from the automatic stay

on the bifurcated lien of a secured creditor. The creditor claims

that, in such circumstances, relief from the automatic stay

nullifies the earlier lien-stripping order, mends the bifurcation,

and restores the lien on the collateral to its original shape.

Both the bankruptcy court and the district court rebuffed this

claim. We too reject it: relief from the automatic stay, in and

of itself, works no such alchemy.

I.

Background

The relevant facts are undisputed. In 1991, the debtors,

Maria Celina Carvalho and Francisco Andrade, borrowed $155,000 from

Federal National Mortgage Association (FNMA). They signed a

promissory note in that amount and secured it by granting FNMA a

first mortgage on a multi-family residence in Dorchester,

Massachusetts (the Property).

Approximately five years later, the debtors filed a

voluntary petition under Chapter 13 of the Bankruptcy Code. See 11

U.S.C. §§ 1301-1330 (allowing individual debtors to reorganize

their debts). FNMA filed a proof of claim, presumably including

arrearages, accrued interest, late charges, and the like, in the

amount of $165,166. Several other creditors also filed claims.

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 Alleging that the then-current value of the Property was

less than the amount owed to FNMA, the debtors asked the court to

bifurcate FNMA's claim into secured and unsecured portions. See 11

U.S.C. § 506(a) (stating that the "allowed claim of a creditor

secured by a lien on property . . . , is a secured claim to the

extent of the value of such creditor's interest . . . and is an

unsecured claim to the extent that the value of [such interest] is

less than the amount of such allowed claim"); see also id. § 103(a)

(making general provisions under Chapter 5 of the Bankruptcy Code

applicable to bankruptcy cases under, inter alia, Chapter 13).

After some skirmishing, not relevant here, the parties stipulated

to the applicability of this lien-stripping protocol. They then

agreed to divide the debt into a secured claim of $105,000

(representing the agreed value of the Property) and an unsecured

claim for roughly $60,000 (representing the balance of the

indebtedness owed to FNMA).

In due course, the bankruptcy court confirmed a Chapter

13 plan (the Plan) that embodied the bifurcation. Under the terms

of the Plan, the debtors were to make regular payments to a court-

appointed trustee, who would then disburse funds to the various

creditors (including FNMA) according to a set schedule. Under this

scenario, FNMA was to receive fixed monthly payments on the secured

portion of its bifurcated claim until that item was paid in full

but was to receive only an aggregate 10% dividend on the unsecured

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portion. See id. § 1322(b)(2) (allowing bankruptcy courts to

approve Chapter 13 plans modifying the rights of most secured

creditors); see also Lomas Mtge., Inc. v. Louis, 82 F.3d 1, 7 (1st

Cir. 1996) (interpreting sections 506(a) and 1322(b)(2) of the

Bankruptcy Code to allow bifurcation of a secured creditor's claim

in a Chapter 13 proceeding). The Plan also incorporated an

agreement to the effect that the debtors would continue to pay FNMA

directly to fund an escrow account for taxes and insurance on the

Property.

At some point — the exact date is of no moment — the

debtors began struggling to meet their obligations under the Plan.

When they failed to make the obligatory escrow payments, FNMA

sought relief from the automatic stay in order to exercise its

state-law right of foreclosure against the Property. See 11 U.S.C.

§ 362(a) & (d)(1) (staying proceedings against a debtor or her

estate but allowing a court to lift or modify the stay "for

cause"). FNMA's motion acknowledged the bifurcation of its claim

and prayed generally for relief from the stay. It did not,

however, specify the amount of the debt that it envisioned as

secured.

The debtors were not represented by counsel at this point

in time and interposed no objection. Accordingly, the bankruptcy

court granted FNMA's motion. The court's order did not specify the

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amount of the secured claim, nor did it mention (let alone revoke)

the earlier bifurcation.

Notwithstanding the lifting of the automatic stay, the

debtors continued, albeit with an occasional misstep, to make

payments to the trustee as called for by the Plan.1 When the

debtors finally obtained counsel, they moved to vacate the order

granting relief from the automatic stay. The bankruptcy court

denied this motion on November 13, 2000. For reasons that are not

readily apparent from the record, FNMA nonetheless refrained from

moving forward with a foreclosure proceeding.

Near the end of the following year, the debtors moved to

discharge FNMA's mortgage. By then, they had completed payment of

FNMA's secured and unsecured claims as called for by the Plan and

had offered to pay the arrearages incurred with respect to the

escrow account. Although FNMA had not yet foreclosed on the

Property, it steadfastly refused to accept payments from either the

trustee or the debtors after the date of default.

Consistent with this position, FNMA objected to the

proposed discharge. The main thrust of its objection was that the

debtors had not in fact fully paid (or offered to pay) their debt

because their payments had tracked the Plan instead of the terms of

the seminal promissory note. In FNMA's view, the latter, rather

1
The trustee twice moved to dismiss the case for the debtors'
failure to remain current. Both times, however, the debtors
managed to bring their payments up to date.

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than the former, limned the extent of the debtors' actual

obligation because the bankruptcy court's order lifting the

automatic stay had, in effect, nullified the earlier bifurcation

and reinstated the debt to its original shape. On this basis, FNMA

asserted that the debtors could obtain a discharge of the mortgage

only by paying the full contractual amount owed on the original

indebtedness, dollar for dollar.

The debtors vehemently disagreed with this logic, and the

bankruptcy court rejected it. The court concluded that lifting the

automatic stay lacked the talismanic significance envisioned by

FNMA. It held, moreover, that the confirmation of the Plan had a

res judicata effect, thus limiting FNMA's entitlement to the

amounts provided for in the Plan. Accordingly, the court enjoined

any foreclosure pending an assessment of the debtors' ability to

cure the earlier default.

On FNMA's first-tier appeal, the district court affirmed

the injunction (albeit on a somewhat different rationale). This

second-tier appeal followed. See 28 U.S.C. § 158(a) & (d).

II.

Analysis

As the parties have framed the case, the central issue is

not whether the debtors have a right to attempt to cure their

default, but, rather, how much they must pay in order to do so. In

making this determination, the court of appeals normally looks to

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the bankruptcy court's decision, scrutinizes that court's findings

of fact for clear error, and affords de novo review to its

conclusions of law. See Jamo v. Katahdin Fed. Credit Union (In re

Jamo), 283 F.3d 392, 401 (1st Cir. 2002). Under this paradigm, we

owe no particular deference to the conclusions of the intermediate

appellate tribunal (be it a district court or a bankruptcy

appellate panel). Brandt v. Repco Printers & Lithographics, Inc.

(In re Healthco Int'l, Inc.), 132 F.3d 104, 107 (1st Cir. 1997).

Where, as here, the core dispute is over a question of law,

engendering de novo review, Jamo, 283 F.3d at 401, we are not

wedded to the bankruptcy court's rationale, but, rather, may affirm

its decision on any independently sufficient ground made manifest

by the record. T I Fed. Credit Union v. DelBonis, 72 F.3d 921, 929

(1st Cir. 1995); Resolution Trust Corp. v. Best Prods. Co. (In re

Best Prods. Co.), 68 F.3d 26, 30 (2d Cir. 1995).

Before plunging into our analysis, we deem it important

to note what FNMA does not contest. In mounting this appeal, it

challenges neither the validity of the Plan nor the bifurcation of

its claim within the Plan as originally formulated. This bears out

our intuition that both the Plan and the bifurcation were properly

drafted and implemented under existing law. See, e.g., Lomas

Mtge., 82 F.3d at 7; Sapos v. Provident Inst. of Sav., 967 F.2d

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918, 925-26 (3d Cir. 1992).2 Turning to the contentions that FNMA

does advance, its principal thesis is that relief from the

automatic stay, in and of itself, unlocked the shackles of the

Plan; once the bankruptcy court lifted the stay, this thesis runs,

the Plan no longer bound it in any way (and, therefore, the

concessions embodied in the Plan went up in smoke).

The debtors' initial response is that the fact of

confirmation has a res judicata effect sufficient to trump FNMA's

thesis. This counterattack has a certain superficial appeal.

Broadly stated, the doctrine of res judicata operates to bar the

relitigation of issues that were or could have been raised in an

earlier action between the same parties prescinding from the same

set of operative facts. See Allen v. McCurry, 449 U.S. 90, 94

(1980); Kale v. Combined Ins. Co., 924 F.2d 1161, 1165-66 (1st Cir.

1991). The doctrine is not foreign to bankruptcy practice in

general or to Chapter 13 proceedings in particular. Thus,

confirmation of a Chapter 13 plan customarily is res judicata as to

all issues that were or could have been decided during the

2
Typically, bifurcation does not apply to a debtor's principal
residence. See 11 U.S.C. § 1322(b)(2). Here, a part of the
Property served as the debtors' principal residence, but FNMA's
loan was nonetheless subject to bifurcation because the loan was
simultaneously secured by other collateral (i.e., the remaining
units in the multi-family tenement). See Lomas Mtge., 82 F.3d at
7 (holding that the Bankruptcy Code does not prohibit lien-
stripping with regard to multi-unit dwellings); Hammond v.
Commonwealth Mtge. Corp. (In re Hammond), 27 F.3d 52, 56-57 (3d
Cir. 1994) (allowing bifurcation of lien secured by both a
principal residence and personal property).

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confirmation process. See Universal Am. Mtge. Co. v. Bateman (In

re Bateman), 331 F.3d 821, ___ (11th Cir. 2003) [No. 02-11221, slip

op. at 7]; 5 Lawrence P. King et al., Collier on Bankruptcy ¶

1327.01, at 1327-2 (15th ed. 2002).

Although we accept this general rule, it does not pertain

here. A debtor's post-confirmation default, like many other post-

confirmation events, does not come within the preclusive reach of

a confirmed plan. See Barbosa v. Soloman, 235 F.3d 31, 39 n.11

(1st Cir. 2000); Ellis v. Parr (In re Ellis), 60 B.R. 432, 434

(B.A.P. 9th Cir. 1985). This is because the factual circumstances

surrounding post-confirmation events could not have been considered

and resolved by a bankruptcy court at the time of confirmation.

See Harmon v. United States ex rel. Farmers Home Admin., 101 F.3d

574, 582 n.5 (8th Cir. 1996); In re Shaffer, 48 B.R. 952, 957-58

(Bankr. N.D. Ohio 1985). It follows that res judicata does not

supply a serviceable shield in this case. Consequently, we hold

that confirmation of the Plan, without more, did not bar FNMA from

litigating the validity or value of its claim in light of

subsequent (post-confirmation) developments.

Still and all, rejecting a res judicata argument is a far

cry from saying that FNMA's full contractual lien has been

resurrected. FNMA labors to persuade us that the debtors' post-

confirmation default, coupled with FNMA's securing of relief from

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the automatic stay, produced just such a Lazarus-like effect. We

are not convinced.

FNMA's asseveration relies heavily upon In re Miano, 261

B.R. 391 (Bankr. D.N.J. 2001). At first blush, Miano bears a

family resemblance to the case at hand. There, as here, an

undersecured creditor acquiesced in bifurcation of its claim

against the debtors. Id. at 392. There, as here, the creditor

obtained relief from the automatic stay after the debtors failed to

comply with the confirmed plan. Id. There, as here, the creditor

demanded full payment of the original indebtedness. In a brief

opinion, the bankruptcy court found for the creditor, reasoning

that once the debtors defaulted and the court lifted the stay, the

confirmed plan no longer bound the creditor. Id. at 392-93.

Upon careful perscrutation, we find that the resemblance

between the two cases is more apparent than real. There are a

number of salient distinctions. For one thing, the Miano debtors

sold the encumbered property at a price much higher than the value

originally ascribed to it by the bankruptcy court. In

contradistinction, the instant debtors have not sold the Property

at all (indeed, they have made plain their desire to retain

possession of it). For another thing, Miano involved a short-term

situation in which the debtors made absolutely no payments under

the confirmed plan. This stands in stark contrast to the situation

before us, where the Plan has run its course and the debtors have

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made virtually all the payments called for under it (they have even

offered to make the side payments due to FNMA, albeit with some

hiccoughs along the way). While principles of equity may suggest

that Chapter 13 debtors who turn their backs on a confirmed plan

from the get-go cannot expect to reap its benefits, cf. In re

Pearson, 214 B.R. 156, 164 (Bankr. N.D. Ohio 1997) (referring to

effect of conversion from Chapter 13 to Chapter 7), the debtors in

this case did not forsake the Plan. To the contrary, they

struggled mightily to comply with its provisions.

Even leaving these distinctions to one side, we find the

Miano decision singularly unpersuasive. The court's legal analysis

strikes us as seriously flawed. Moreover, the decision rests on a

porous legal foundation; none of the cases cited by the court

stands for the proposition that relief from the automatic stay

necessarily includes relief from the confirmed plan as a whole.

Even when read for all they are worth, these cases at most

reiterate the venerable saw that a debtor's post-confirmation

default can provide good cause for relief from the automatic stay.

See, e.g., W. Equities Inc. v. Harlan (In re Harlan), 783 F.2d 839,

841 (9th Cir. 1986) (per curiam); Ellis, 60 B.R. at 434; In re

Binder, 224 B.R. 483, 490 (Bankr. D. Colo. 1998); In re Smith, 104

B.R. 695, 700 (Bankr. E.D. Pa. 1989); In re Wright, 54 B.R. 553,

555 (Bankr. E.D. Pa. 1985); Anaheim Sav. & Loan Ass'n v. Evans (In

re Evans), 22 B.R. 980, 983 (Bankr. S.D. Cal. 1982). Indeed, many

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of the cases indicate that, in spite of relief from the automatic

stay, the confirmed plan continues to bind both debtors and

creditors in other respects. See, e.g., Ellis, 60 B.R. at 436

(allowing debtor to cure a default by resuming payments under the

confirmed plan notwithstanding the granting of relief from the

automatic stay); Binder, 224 B.R. at 490 ("Granting relief from

stay for Debtor's default in performance of post-confirmation

obligations to [Creditor] does not upset the plan; it implements

it."). We therefore refuse FNMA's invitation to accord Miano

precedential force.

FNMA mounts one last argument in support of reversing the

lien-stripping order and reinstating the full amount of the

original debt. It asserts that a Chapter 13 plan is akin to a

contract and that, given their default, the debtors cannot now

expect FNMA to perform its side of the bargain. This argument is

unavailing.

To the extent that a confirmed plan resembles a contract,

there is no legally sound reason why the remedy for every default

necessarily should be rescission. Generally speaking, the law of

contracts recognizes a wide spectrum of potential anodynes. See

generally 3 E. Allan Farnsworth, Farnsworth on Contracts §§ 12.1 to

12.3 (2d ed. 2003). Here, it seems clear that, under the

bankruptcy court's ukase, FNMA stands to receive a condign remedy

(either specific performance or expectation damages) with respect

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to the debtors' default. The root purpose of a contract remedy is

"to place the plaintiff-promisee in as good a position as [it]

would have occupied had the defendant-promisor not breached the

contract," 24 Richard A. Lord, Williston on Contracts § 64:1, at 7

(4th ed. 2002) (collecting cases), and either of these remedies

would accomplish that goal by making FNMA whole. That is why other

courts have approved the use of such remediation in comparable

circumstances. See, e.g., Ellis, 60 B.R. at 436 (allowing debtor

to avoid foreclosure so long as she cured the default on her

reorganization plan); cf. Green Tree Accept., Inc. v. Hoggle (In re

Hoggle), 12 F.3d 1008, 1010 (11th Cir. 1994) (emphasizing that

permitting debtors to cure post-confirmation defaults is consistent

with Chapter 13's overarching policy).

FNMA resists this straightforward answer, urging us to

subject defaulting debtors to a more draconian penalty in order to

discourage repetitive defaults and a generally nonchalant attitude

anent compliance with reorganization plans. We regard such

punitive measures as unnecessary, unwise, and incompatible with the

goals of the Bankruptcy Code. We explain briefly.

Bankruptcy law endeavors to strike an equitable balance

between the debtors' needs — especially the need for a fresh start

— and the creditors' rights. The bankruptcy court must hold that

delicate balance steady and true. As matters stand, the Code gives

bankruptcy courts more than adequate powers to ensure that debtors

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do not engage in gamesmanship or otherwise flout the provisions of

Chapter 13. See Perry v. Commerce Loan Co., 383 U.S. 392, 404

(1966); Hoggle, 12 F.3d at 1011-12. To accept FNMA's position

would tilt the scales in favor of secured creditors, allowing them

to use the fortuity of even a technical post-confirmation default

to disrupt a confirmed plan. That would confuse the function of an

order lifting the automatic stay with the function of an order

dismissing a Chapter 13 petition.

III.

Conclusion

We need go no further. In this case, we have been asked

to hand a new weapon to a secured creditor at the expense of the

debtors' honest efforts to carry out the provisions of a confirmed

plan of reorganization. Neither the Bankruptcy Code nor the case

law affords any compelling reason why we should do so. We hold,

therefore, that bifurcation of a creditor's claim into secured and

unsecured portions is not annulled by the mere act of granting

relief from the automatic stay.3 Consequently, we affirm

3
We regard it as unlikely that a bankruptcy court has the
authority, in the exercise of its discretion, to rescind a lien-
stripping order merely because it deems the creditor entitled to
relief from the automatic stay. After all, Chapter 13 is designed
to ensure that debtors enjoy a fresh start. See H.R. Rep. No. 95-
595, at 118 (1978), reprinted in 1978 U.S.C.C.A.N. 5787, 5963,
6078-79. Exceptions to this policy should be construed narrowly.
In re Pelkowski, 990 F.2d 737, 744-45 (3d Cir. 1993). Moreover,
allowing the easy resurrection of contractual liens would likely
redound to the detriment of other creditors. See Harmon, 101 F.3d
at 583 (suggesting that a creditor's retention of its full,

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the order staying foreclosure until the debtors' ability to cure

their post-confirmation default can be ascertained. To that end,

we remand this case to the district court with instructions that

it, in turn, remand the matter to the bankruptcy court for further

proceedings aimed at determining the precise amounts owed to FNMA

and what fees and interest, if any, should be assessed in

consequence of the debtors' earlier default.

Affirmed. Costs shall be taxed in favor of the

appellees.

original lien even after lien-stripping "might violate the
prohibition against differential treatment within the class of
unsecured claims"); United Carolina Bank v. Hall, 993 F.2d 1126,
1128-29 (4th Cir. 1993) (explaining that even after a post-
confirmation default and a consequent lifting of the stay, allowing
excess payments would "adversely affect[] other creditors, as the
resources available in a Chapter 13 proceeding are finite"). Here,
however, the bankruptcy court has made plain that it never intended
to restore FNMA's contractual lien against the debtors to its
original contours. Thus, we need not determine the scope of the
bankruptcy court's discretionary authority.

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