Lien Stripping in Chapter 11 Bankruptcy Cases: Lessons for Secured Creditors

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In Chapter 7 liquidations, the Supreme Court holds that a lien passes through the bankruptcy case unaffected, notwithstanding the discharge of the debtor’s other unsecured debt. Thus, a secured creditor could elect to abstain from participating in a bankruptcy case and the lien securing the collateral would remain intact after the bankruptcy case is over.

The Bankruptcy Code preserved this rule in Chapter 11 cases with one statutory exception: Liens are extinguished if the property securing the lien was “dealt with” by a confirmed plan under Chapter 11. Specifically, Section 1141(c) of the Bankruptcy Code provides that “after confirmation of a plan, the property dealt with by the plan is free and clear of all claims and interests of creditors, equity security holders, and of general partners in the debtor,” and makes no distinction between secured and unsecured creditors.

In a recent case of first impression, the Second Circuit considered lien stripping in Chapter 11 cases. The court held that, where a plan “deals” with a secured creditor’s lien and the secured creditor “participates” in the bankruptcy case, confirmation of a plan extinguishing the lien can be valid, notwithstanding the maxim. The court’s decision will now guide how lower courts in the Second Circuit treat lienholders whose lien was contemplated to be extinguished under a plan and failed to actively participate in the bankruptcy case.

Listen as our authoritative panel of bankruptcy practitioners reviews the lienstripping jurisprudence that has developed over the past few decades, with a specific focus on Chapter 11 cases.