Upon learning that its borrower has filed a case under chapter 11 of the Bankruptcy Code,  a secured lender may decide not to participate in that case. The lender may want to ignore the bankruptcy case in order to avoid the expense of retaining bankruptcy counsel, or, relying on the general rule that liens pass through bankruptcy unaffected,  may simply prefer to wait until the chapter 11 case ends and then enforce its lien. In a recent Fifth Circuit Court of Appeals decision, Acceptance Loan Company, Incorporated v. S White Transportation, Incorporated (In the Matter of S. White Transportation, Incorporated), 725 F.3d 494 (5th Cir. 2013), the Court held that the lien of  a secured lender who ignored its borrower’s chapter 11 case was not extinguished by confirmation of the borrower’s chapter 11 reorganization plan, despite the secured lender’s receipt of notices regarding the borrower’s chapter 11 case. Nevertheless, the Acceptance decision highlights the risk that a court outside the Fifth Circuit might reach a different result. The take away from the Fifth Circuit’s decision is that it is better for a secured lender to suffer the “slings and arrows” of active participation in a chapter 11 case than to ignore the case and risk losing its lien.

The facts of the S. White Transportation case are straightforward. Acceptance Loan Company, Incorporated (Acceptance) made a loan to S. White Transportation, Incorporated (SWT). The loan was secured by a mortgage on SWT’s office building. Acceptance and SWT spent years litigating the validity of Acceptance’s lien in state court. SWT then filed a chapter  11 petition. SWT’s bankruptcy schedules listed Acceptance’s secured claim as “disputed,” thereby requiring Acceptance to file a proof of claim in order to receive a distribution in the case. Acceptance received several notices regarding SWT’s chapter case, but did not file a proof of claim. The bankruptcy court confirmed a plan of reorganization (the “Plan”) for SWT that provided no recovery for Acceptance.

Shortly after confirmation of SWT’s Plan, Acceptance sought an order from the bankruptcy court (1) declaring that Acceptance’s lien had survived confirmation of the Plan, or (2), in the alternative, amending the confirmation order to provide for Acceptance’s lien. The bankruptcy court denied Acceptance’s motion based, in part, on the language in section 1141(c) of the Bankruptcy Code. That language states, in pertinent part, that “property dealt with by the plan is free and clear of all claims and interests [i.e., liens] of creditors . . ” The bankruptcy court found that Acceptance had participated in SWT’s chapter 11 case by reason of Acceptance’s receipt of notices regarding that case. As a result, the bankruptcy court denied Acceptance’s motion, and held that SWT’s confirmed plan extinguished Acceptance’s lien. Acceptance appealed to the district court, which reversed the bankruptcy court’s ruling, thereby reinstating Acceptance’s lien. SWT then appealed to the Fifth Circuit Court of Appeals.

The Fifth Circuit affirmed the district court’s decision. In doing so, the court looked to an earlier Fifth Circuit case that prescribed the conditions under which Bankruptcy Code section 1141(c) would operate to extinguish a secured lender’s lien. That earlier case held that Bankruptcy Code section 1141(c) will extinguish a secured lender’s  lien only when the following four conditions have been satisfied: (1) the plan must be confirmed, (2) the property that is subject to the lien must be dealt with by the plan, (3) the lienholder must participate in the case, and (4) the plan must not preserve the lien. The only condition in dispute in the case before it was whether SWT had participated in Acceptance’s chapter 11 case by reason of SWT’s receipt of notices issued in the chapter 11 case. The Fifth Circuit held that Acceptance’s mere passive receipt of notices regarding SWT’s chapter 11 case did constitute a legal dictionary’s definition of “participation,” namely, “the act of taking part in something, such as a partnership, a crime or a trial.”

The Fifth Circuit found support for  its ruling in the Seventh Circuit Court of Appeals’ decision in In re Penrod, 50 F.3d 459 (7th Cir. 1995). In that case, the debtor’s plan provided for payments to the secured lender, but failed to specifically preserve the secured lender’s lien. The Seventh Circuit held that secured creditor had participated in a case by filing a proof of claim. Consequently, confirmation of the debtor’s reorganization plan extinguished the secured creditor’s lien.. The Fifth Circuit distinguished a contrary decision by a Maryland bankruptcy court in In re Reg’l Bldg.Sys., 251 (B.R. 274, 287 (D. Md. 2000), which held that notice alone satisfies the participation requirement for extinguishment of liens under Bankruptcy Code section 1141(c).. While the bankruptcy court in the Maryland case held that mere receipt of notice of the bankruptcy by a secured lender constituted a sufficient level of  “participation” to extinguish the secured lender’s lien, the Fourth Circuit Court  of Appeals’ decision affirming the bankruptcy court’s order identified facts reflecting a more extensive degree of participation in the debtor’s case by the secured lender than mere receipt of notices.

 The S. White Transportation, Incorporated decision preserved the lien of a secured lender who received notice of a borrower’s chapter 11 case, but took no action whatsoever in that case. However, it remains to be seen whether courts outside the Fifth Circuit will follow that decision. The Fifth Circuit’s opinion acknowledged that Bankruptcy Code section 1141(c) contains no language stating that participation by a secured lender in a chapter 11 case is a condition for extinction of a secured lender’s lien. Notably, numerous United States Supreme Court decisions interpreting the Bankruptcy Code have held that, when a statute’s language is plain, a court’s sole function is to enforce the statute according to its terms. See, e.g.Hartford Underwriters Insurance Company v. Union Planters Bank, N.A., 530 U.S. 1 (2000). The Supreme Court has also held that a court may not read into the Bankruptcy Code language that does not appear in the text of the statute. See, Travelers Casualty & Surety Co. of America v. Pacific Gas & Electric Co., 549 U.S. 443 (2007). The language of Bankruptcy Code section 1141(c) providing that, after plan confirmation, property dealt with by the plan is “free and clear of all claims and interests of creditors . . .” is clear and unambiguous. Notably, that section contains no language making a secured lender’s participation in a chapter 11 case a condition for extinguishment of the secured lender’s lien. Furthermore, it can be argued that the language of Bankruptcy Code section 1141(c) is sufficiently broad to override the uncodified rule that liens pass through bankruptcy unaffected. Therefore, outside of the Fifth Circuit, a bankruptcy court or Circuit Court of Appeals construing Bankruptcy Code section 1141(c) based on the rules of statutory construction prescribed by the United States Supreme Court might well hold that, unless a reorganization plan or confirmation order expressly preserves a secured creditor’s lien, a confirmed chapter 11 reorganization plan will extinguish a secured lender’s lien,whether or not that secured lender participated in its borrower’s chapter 11 case. In such a case, a secured lender could preserve its lien only by proving that it did not receive actual or constructive notice of the debtor’s bankruptcy case, in which event extinguishment of the secured lender’s lien would deprive the secured lender of its property (i.e., its lien) without due process of law in violation of the Fifth Amendment to the United States Constitution.

The lesson to be drawn from the S. White Transportation, Incorporated decision is that, even if  a secured lender decides not to file a proof of claim in a borrower’s chapter 11 case, the lender s must still participate in that chapter 11 case by taking affirmative take steps to  protect its lien. The secured lender’s failure to do so could very well result in Bankruptcy Code section 1141(c) extinguishing the secured lender’s lien.