Indiana Law Review


Indiana Law Review
Volume 15 1982 Number 2

Secured Creditors Under the Bankruptcy Reform Act

Frank R. Kennedy*

I. Introduction

u
[T]he theme of the Bankruptcy Act is equality of distribution." 1

Although Mr. Justice Douglas liked to stress that theme in his opin-
ions for the Supreme Court construing the Bankruptcy Act,2 there
are many dissonances in bankruptcy. The rights of secured creditors
in the estates of their debtors were extensively recognized in the

Bankruptcy Act3 and are still more fully particularized in the
Bankruptcy Reform Act of 1978.4 The reconciliation of the competing
claims of secured and unsecured creditors has been a principal con-

cern of the drafters of the bankruptcy laws and is the focus of the

contributions to this symposium.

Security is a hedge against bankruptcy and other manifestations

of the debtor's insolvency. To the extent a secured creditor obtains
protection against the necessity of sharing in the losses suffered by

other creditors of an insolvent debtor, he frustrates a fundamental

bankruptcy objective. Notwithstanding all the virtues of equality,

however, vindication of this objective of bankruptcy is not the only

relevant consideration in a system of credit and credit administra-
tion. Extension of credit is, at least generally, a voluntary act on the

part of the creditor. Borrowers and purchasers of property and ser-
vices vary in their creditworthiness. The risk of nonpayment by
some debtors is so serious that they are unable to obtain credit
without giving security. Some lenders and vendors are generally un-
willing to extend any credit without taking security. Even when a
prospective debtor is creditworthy and the creditor is able and will-
ing to extend unsecured credit, secured credit may be cheaper or
more easily obtainable.

Thomas M. Cooley Professor of Law, University of Michigan.
'Sampsell v. Imperial Paper & Color Corp., 313 U.S. 215, 219 (1941).
2See also Nathanson v. NLRB, 344 U.S. 25, 29 (1952).
3The Bankruptcy Act is the title given the Bankruptcy Act of 1898, as amended

many times before and after 1950, by Pub. L. No. 879, 64 Stat. 1113 (1950). The
Bankruptcy Act was repealed by Pub. L. No. 95-598, § 401(a), 92 Stat. 2682 (1978).

4Pub. L. No. 95-598, 92 Stat. 2549 (1978).

477



478 INDIANA LAW REVIEW [Vol. 15:477

Accordingly, the bankruptcy laws of the United States (and of

other countries as well)5 recognize the necessary role of secured

credit by permitting the enforcement, subject to limitations, of the

rights of secured creditors. The bankrupcy laws of the United
States have treated as a secured creditor only one who is secured
by a lien against property.6 A creditor who obtains in addition to his
claim against the debtor the personal obligation of another is accord-

ed certain rights appropriate to his position7 but is not a secured

creditor in the context of this discussion. A secured creditor under
the bankruptcy laws holds an interest in or charge against property

of the debtor whose estate is being administered,8 but these laws
have increasingly differentiated in their treatment of various kinds

of secured claims by reference to the nature and origin of the lien of

the creditor.9

II. Nonconsensual Liens

The original lien at common law is one that arises by operation
of law in favor of an artisan or other bailee who renders a kind of
service respecting personal property.10 Not every bailee rendering
service respecting personal property has been protected by a com-

mon-law lien, and a common-law lienor is accorded only the right to

retain the property subject to the lien until the debt incurred for

the service is paid. Common-law liens include those given a carrier,
a warehouseman, a landlord, an innkeeper, and a seller. 11 With a
minor qualification,12 this variety of lien has always been enforceable

under the bankruptcy laws.

Common-law liens have for the most part been superseded in

5European Bankruptcy Laws 58 (the law of Austria), 71 (the law of Belgium),
96-97 (France), 126-27 (Germany), 145 (Sweden) (I. Ross ed. 1974).

"See section 1(28) of the Bankruptcy Act, 11 U.S.C. § 1(28) (1976) (repealed 1978),

and sections 101(28) & 605(a) of Title 11 of the United States Code as enacted in 1978.
It is to be noted that the Bankruptcy Reform Act does not use the term "secured

creditor." See note 66 infra and accompanying text.
7Thus he is protected against competition by the codebtor in the latter's pursuit

of a right of reimbursement, subrogation, or contribution. See 11 U.S.C. § 509(c) (Supp.

IV 1980). This subordination provision in the Bankruptcy Reform Act codifies the prior

case law.
8
11 U.S.C. §§ 101(28), (37) (Supp. IV 1980).

9See notes 61-65 infra.
X0
7 W. HOLDSWORTH, A HISTORY OF ENGLISH LAW 511 (1926),

n
Id. at 511-13; 2 G. Gilmore, Security Interests in Personal Property § 33.2

(1965).

12Common-law liens of distraint for rent were subordinated and restricted by sec-

tion 67c of the Bankruptcy Act. 4 W. Collier, Bankruptcy 1 67.28[1] (14th ed. W.

Moore 1978). They are voidable by the trustee under the Bankruptcy Reform Act. 11

U.S.C. §§ 101 (38), 545(4) (Supp. IV 1980).



1982] SECURED CREDITORS 479

practice by legislation creating statutory liens that accord more ef-
fective and more complete protection to those creditors favored by
the legislature. A statutory lien is typically enforceable by sale upon
compliance with statutory and relevant constitutional procedures.13

A statutory lien may also secure a creditor without reference to any
bailment of goods and may cover real property. Thus statutory liens
include mechanics' liens on real estate and liens for taxes on both

real estate and personal property. While the bankruptcy laws

originally did not differentiate in their treatment of common-law
and statutory liens, the proliferation of statutory liens and a

developing sensitivity to the resulting frustration of the policy of

the bankruptcy laws led to the introduction of restrictions on the en-

forcement of statutory liens by the Chandler Act in 1938.14 These

restrictions have since been extended.15

A variety of lien palpably offensive to the bankruptcy policy of
equal distribution is one obtained by an unsecured creditor through

the prosecution of judicial proceedings against an insolvent debtor.

Thus the bankruptcy laws have treated this kind of lien as a form of
voidable preference if obtained against an insolvent debtor within a

prescribed period before the inception of administration of a

13For example, the statutory requirements for enforcing a warehouseman's lien as

found in U.C.C. § 7-210. Whether acts of enforcement of a statutory lien amount to
state action, subjecting the statute to constitutional scrutiny, depends upon the degree

of involvement of a state functionary or institution. Flagg Bros., Inc. v. Brooks, 436

U.S. 149 (1978) (no state action found where statute merely authorized procedure for

self-help). For a discussion of the constitutional problems engendered by the enforce-

ment of statutory liens, see Note, Creditors' Remedies as State Action, 89 Yale L.J.
538 (1980); Note, 23 Vill. L. Rev. 419 (1978).

"Statutory liens on personalty unaccompanied by possession and liens of distress

for rent were subordinated to the first two classes of unsecured claims entitled to

priority, and liens for wages and rent were restricted. Chandler Act ch. 575, § 67c, 52

Stat. 840, 877 (1938); Kennedy, Statutory Liens in Bankruptcy, 39 Minn. L. Rev. 697,

703-16 (1955).
16
In 1952 most statutory liens on personalty unaccompanied by possession were

invalidated as against the trustee. Kennedy, supra note 14, at 716-22. In 1966,

statutory liens were invalidated as against the trustee if: (1) like a priority, they were

operative only on insolvency or in the event of a general distribution of the debtor's

property; (2) they were not effective against a bona fide purchaser from the debtor; or

(3) they constituted liens of distress for rent. Moreover, tax liens on personalty unac-

companied by possession were postponed to the first two classes of priority claims.

Bankruptcy Act §§ 29(a) and 67c as amended by 80 Stat. 268, 268-69 (1966). The Bankrupt-
cy Reform Act of 1978 allows a pre-petition payment or transfer of his property by the
debtor in discharge of a statutory lien to be attacked as a preference for the first time,

and in liquidation cases a tax lien is subordinated to all the priority claims except

those for taxes. 11 U.S.C. §§ 545, 547, 724(b); Schneyer, Statutory Liens Under the
New Bankruptcy Code—Some Problems Remain, 55 Am. Bankr. L.J. 1 (1981).



480 INDIANA LA WREVIEW [Vol. 15:477

debtor's estate.
16 Although a lien obtained by judicial proceedings is

typically created and regulated by statute, the term "statutory lien"

as used here and in the bankruptcy laws generally does not include

a lien obtainable by an unsecured creditor in pursuing his judicial

remedies for collection. Judicial liens include those obtained incident

to judgment, execution, attachment, garnishment, creditor's bill, and

proceedings supplementary to execution.

A lien obtained by an agreement between a debtor and his
creditor is no less offensive to the bankruptcy policy of equal treat-

ment of all creditors than is one obtained by the unilateral action of
a creditor through judicial proceedings. Although the bankruptcy

laws have generally been more considerate of the position of a consen-
sual lienor than of a judicial lienor in the avoidance sections,17 the dif-

ferentiation has been diminishing and has nearly disappeared in the

Bankruptcy Reform Act.18 Consensual liens include real estate mort-
gages, security interests in personal property, and miscellaneous

other types of encumbrances arising out of aggreements to give

security.
19

The variety of lien known as an "equitable lien" has been
characterized as neither equitable nor a lien because it confers an in-

equitable advantage over other unsecured creditors but does not

prevail against a bona fide purchaser.20 An equitable lien is a short-
hand term for a species of relief given by a court of equity to a
creditor.

21 Thus equity courts have typically awarded such a lien to a

16This kind of lien was voidable by the trustee without regard to the state of the
creditor's mind under section 67 of the Bankruptcy Act, if obtained during insolvency and

within four months of the filing of a petition by or against the debtor. J. MacLachlan,
Handbook of the Law of Bankruptcy § 202 (1956).

17Thus, until enactment of the reform effected by section 547(b) of the Bankruptcy

Code, reasonable cause to believe that the debtor was insolvent was required to be
shown by the trustee seeking to avoid any consensual lien as a preference under the

Bankruptcy Laws, whereas no such requirement was imposed when the trustee sought
to avoid a judicial lien. See id.

18The differentiation of the treatment of judicial liens and consensual liens as
preferential transfers is largely eliminated by section 547 of the Bankruptcy Code. See 4

Collier on Bankruptcy \ 547.12 (15th ed. L. King 1981) [hereinafter cited as Collier
(15th ed.)].

19A consensual lien is a "security interest" under section 101(37). The term as
used in the Bankruptcy Reform Act has a broader connotation than as used in the

Uniform Commercial Code in that it extends to interests in real property. H.R. Rep.

No. 595, 95th Cong., 1st Sess. 314 (1977), reprinted in [1978] U.S. Code Cong. & Ad.
News 5963, 6271.

20See 1 G. Gilmore, Security Interests in Personal Property 200 (1965) ("Like

the Holy Roman Empire, which was said to be neither holy nor Roman nor an empire,
the equitable lien is neither equitable nor a lien").

21See Britton, Equitable Liens—A Tentative Analysis of the Problem, 8 N.C.L.
Rev. 388 (1930); Glenn, The "Equitable Pledge," Creditors' Rights, and the Chandler

Act, 25 Va. L. Rev. 422 (1939).



1982] SECURED CREDITORS 481

lender of funds for purchasing or improving real property when the
loan is made in reliance on a promise to give security in the
property.22 Equitable liens against personal property have well nigh

disappeared from cases administered under the bankruptcy laws

since the general adoption of the Uniform Commercial Code,23 and

they do not appear frequently in cases involving real property.24 The
bankruptcy laws have been increasingly hostile to such a lien,25 and

the Bankruptcy Reform Act carries the attack further than previous
legislation.

26

A maritime lien, like a common-law or statutory lien, ordinarily
arises by operation of law.27 A maritime lien is nevertheless a
distinctive category subject to different rules respecting its origin,

nature, validity, and priority. The bankruptcy laws have been silent

22See 51 Am. Jur. 2d Liens §§ 33-34 (1970).
23Morris, Bankruptcy Law Reform: Preferences, Secret Liens and Floating Liens,

54 Minn. L. Rev. 737, 753 (1970); but see Warren Tool Co. v. Stephenson, 111 Mich.
App. 274, 161 N.W.2d 133 (1968), criticized in Note, Security Agreements, Equitable
Liens, and the Uniform Commercial Code, 69 Colum. L. Rev. 1280 (1969).

There is no reference to "equitable liens" in the index to J. White & R. Sum-
mers, Uniform Commercial Code (2d ed. 1980); see also 1 G. Gilmore, Security In-
terests in Personal Property 155, 199-200 (1965); 2 id. at 1302.

A notable exception to the demise of equitable liens against personal property is
the equitable right of subrogation accorded a surety on a construction bond against a
fund retained by the obligor of a construction contract. This right, often called an
"equitable lien," has been allowed to prevail as against a trustee in bankruptcy of the

contractor. Pearlman v. Reliance Ins. Co., 371 U.S. 132 (1962); Kennedy, The Inchoate

Lien in Bankruptcy: Some Reflections on Rialto Publishing Co. v. Bass, 17 STAN. L.
Rev. 793, 817-18 (1965).

24The index to the multivolume 15th edition of Collier on Bankruptcy contains no
entry under the heading of "equitable lien" or any similar rubric. Similarly the suc-

cessor to Professor Osborne's Hornbook on Mortgages, G. Osborne, G. Nelson. & D.
Whitman, Real Estate Finance Law (1979), contains no index entries for "equitable
liens" or "equitable mortgages." Compare, e.g., G. Osborne, Handbook on the LaV of
Mortgates ch. 2 (2d ed. 1951), where equitable mortgages are discussed at length.

26See 1 G. Gilmore, Security Interests in Personal Property § 7.2 (1965); 2 id.

§§ 45.3.3, 45.4.
26The trustee will prevail over most equitable liens in personal property as a

hypothetical lien creditor under section 544(a)(3). The Bankruptcy Reform Act includes
no insurance policy against the repetition by an obdurate court of such a decision as

Porter v. Searle, 228 F.2d 748 (10th Cir. 1955) (repossession of stock of merchandise on

the eve of bankruptcy by an equitable lienor sustained against attack by the trustee

under section 60 of the Bankruptcy Act), criticized in 2 G. Gilmore, Security In-

terests in Personal Property § 45.7 (1965) and MacLachlan, The Title and Rights of
the Trustee in Bankruptcy, 14 Rutgers L. Rev. 653, 676 (1960).

"See Landers, The Shipowner Becomes a Bankrupt, 39 U. Chi. L. Rev. 490, 510,
512 (1972). A recent appellate court decision treated a maritime lien in a bankruptcy
case as a statutory lien. In re Mission Marine Assocs., Inc., 633 F.2d 678 (3d Cir. 1980).

See also Landers, supra, at 512-14. Maritime liens nevertheless may sometimes ap-
parently arise by agreement of the parties. Id. at 512.



482 INDIANA LAWREVIEW [Vol. 15:477

in regard to maritime liens, and the case law governing the treat-

ment of such liens in a bankruptcy context is not well developed.
The express grant to bankruptcy courts by the Bankruptcy Reform
Act of the powers of a court of admiralty28 may lead to the formulation
of more distinct rules and a clarification of this area of bankruptcy.

III. Consensual Liens: The Law Prior to 1978

As already intimated, the bankruptcy laws have become increas-
ingly specific in dealing with the rights of secured creditors. The
general tendency of this legislation has been to restrict those rights

in the interest of facilitating attainment of the objectives of the

bankruptcy laws to effect equality of distribution and to afford a

fresh start for the debtor. The first two bankruptcy laws of the
United States made only brief, oblique references to secured
creditors or liens.

29 The Bankruptcy Act of 1867 contained the first
explicit provision protecting valid security interests against the

statutory representative of the unsecured creditors.30

The Bankruptcy Act of 1898 began a deliberate attack on certain
liens by defining the word "transfer" to include a conditional parting
with property as security,31 invalidating preferential and fraudulent

transfers,
32 and by including in a section entitled "Liens" provisions

that enabled the trustee to avoid liens under prescribed conditions.33

The trustee's hand was substantially strengthened in 1910 by the
enactment of the strong-arm clause, which enabled the trustee to

avoid any lien that could have been defeated under nonbankruptcy

law by a judicial lien creditor on the date of the filing of a petition

by or against the bankrupt.34 This provision originally endowed the

28
28 U.S.C. § 1481 (Supp. IV 1980).

28A principal concern of the drafters of the Bankruptcy Acts of 1800 and 1841 was
that the bankrupt estate should be able to obtain the benefit of the debtor's right to

redeem property subject to a secured creditor's lien. See Bankruptcy Act of 1800, ch.

19, § 12, 2 Stat. 19, 24-25 (repealed 1803); Bankruptcy Act of 1841, ch. 9, § 11, 5 Stat.

440, 447 (repealed 1843). The Act of 1800 also contained a provision that a creditor hav-
ing a judicial or statutory security not yet enforced by a pre-petition levy of execution

should not be allowed a preference in distribution over other creditors. Act of 1800, §
31, 2 Stat, at 30.

^Ch. 176, § 14, 14 Stat. 517, 523-24 (repealed 1878). This section also contained

authority for the liquidator of the estate to redeem the bankrupt's property from the

lien of a secured creditor or to sell the property subject to the lien. See also id. § 20,

14 Stat, at 526.
81
Ch. 541, § 1(25), 30 Stat. 544, 545 (repealed 1978).

32Id §§ 60, 67c, 30 Stat, at 562, 564.
83
/d. § 67a (unperfected liens), 67c (liens of judicial proceedings), and 67f (liens of

legal proceedings), 30 Stat, at 564, 565.
MAct of June 25, 1910, ch. 412, § 8, 36 Stat. 838, 840 (repealed 1978) (amending

Bankruptcy Act of 1898, ch. 541, § 47a(2), 30 Stat. 544, 557).



1982] SECURED CREDITORS 483

trustee with the lien of a judicial proceeding only in respect to prop-

erty in the custody of the bankruptcy court,35 but in 1952 the
hypothetical lien was given the trustee without regard to who had
possession.

36 The strong-arm clause has proved to be a valuable
weapon to the trustee defeating unperfected liens, particularly such
liens on personal property.37

The crucible for subjecting security to the severest test is usually
recognized to be the preference provisions of the bankruptcy laws.

The effectiveness of the preference law in enabling the trustee to
overcome a security interest has been significantly strengthened by a

series of statutory changes beginning in 1938. Congress had made
noteworthy efforts earlier to deal with the use of security interests

to frustrate the preference policy of the bankruptcy laws. A series of
amendments enacted prior to 1938 were intended to render
vulnerable to avoidance security interests perfected within the four

months before bankruptcy.38 These efforts developed out of a recogni-

tion that secret liens offend bankruptcy policy. The doctrine of reputed

ownership, which evolved from Twyne's Case,39 rendered secret

security interests void or voidable by unsecured creditors as a form

of fraud. Peter Coogan has observed that the history of secured

credit for the last two hundred years is largely a record of the efforts

of unsecured creditors to force secured creditors to disclose their

security and of the efforts of secured creditors to find ways of cir-
cumventing the legal strictures imposed on them at the instigation of
unsecured creditors.40 The strong-arm clause was enacted to enable
the trustee in bankruptcy to invoke the doctrine of reputed owner-

ship in the various forms in which it had been adopted by the states.41

But the doctrine did not help the creditors or the trustee in most

states if the secured creditor succeeded in taking possession or other-

wise perfecting his interest before levy by any unsecured creditor or

attachment of the trustee's hypothetical lien. To allow a secured
creditor to prevail against the trustee notwithstanding belated

perfection on the eve of bankruptcy ran counter to bankruptcy policy

86With respect to property not in the custody of the court, the trustee was given
the rights, remedies, and powers of a judgment creditor with an execution returned

unsatisfied. As a practical matter, these rights have been of little use to the trustee.
"Act of July 7, 1952, Pub. L. No. 456, § 23(b), 66 Stat. 420, 430 (repealed 1978).
37See 4B Collier on Bankruptcy 1f 70.55-.62A (14th ed. W. Moore 1978).
MAct of Feb. 5, 1903, ch. 487, § 13, 32 Stat. 797, 799-800; Act of June 25, 1910, ch.

412, § 11, 36 Stat. 838, 842; Act of May 27, 1926, ch. 406, 44 Stat. 662, 666.
3976 Eng. Rep. 809 (Star Chamber 1601).
40Coogan, Public Notice Under the Uniform Commercial Code and Other Recent

Chattel Security Laws, Including "Notice Filing," 47 Iowa L. Rev. 289, 289 (1962).
4145 Cong. Rec. 2277 (1910).



484 - INDIANA LAWREVIEW [Vol. 15:477

in two respects: the belatedly perfected security interest was in-
distinguishable in observable effects from a security interest created

on the eve of bankruptcy to secure an antecedent debt; and the

secrecy of the lien pending the perfection was potentially prejudicial
to creditors who extended credit on the assumption that the secret
lienor was not secured. The effort to deal with this problem finally
succeeded in 1938 with the incorporation of a bona fide purchaser test

in the preference section for the purpose of determining the time

when a transfer to a creditor occurs.42 That turned out to be overkill
because security interests in inventory and certain other kinds of

personalty are never perfected against some bona fide purchasers.43

An amendment to the preference section introducing a lien creditor
test with respect to personalty was added in 1950.44

Although a security interest for a contemporaneous consideration,

if promptly perfected, has generally withstood attack by the trustee

in bankruptcy, the Chandler Act attempted codification of the

Supreme Court precedent of Dean v. Davis** which invalidated a
mortgage for a present loan because the purpose of the loan was to
enable the debtor to make a preferential payment to a particularly in-
sistent creditor.

The most dramatic development in the law of security in this
country occurred during the following two decades. All but one
American state adopted Article 9 of the Uniform Commercial Code.46

The Code simplified the law of personal property security and
significantly improved the position of secured creditors in competi-

tion with unsecured creditors. A result was an enormous expansion in
the use of inventory and accounts receivable as collateral by business

borrowers. At the same time the Code facilitated a vast expansion of
consumer credit, both secured and unsecured. A troublesome pro-
blem generated by this development involved the status of a security

interest created in collateral acquired on the eve of bankruptcy to

secure an antecedent debt. The Uniform Commercial Code sanctioned

"Chandler Act, ch. 575, § 60, 52 Stat. 840, 869 (1938) (repealed 1978).
i3See Corn Exchange Nat'l Bank & Trust Co. v. Klauder, 318 U.S. 434 (1943)

(striking down an assignment of accounts receivable). See also 2 G. Gilmore. Securi-
ty Interest in Personal Property 1302 (1965) ("In the entire history of statutory
drafting, the 1938 revision of § 60 is the classical example of overkill").

"Act of March 18, 1950, ch. 70, § 60, 64 Stat. 24, 26 (1950) (repealed 1978).
45242 U.S. 438 (1917). There were two attempts at codification in section 67d(3) of

the Bankruptcy Act. The original version enacted in 1938 was amended in 1952. Act of
July 7, 1952, ch. 579, 66 Stat. 420, 428 (1952) (repealed 1978). The difficulties presented
by this legislation are discussed in 4 Collier on Bankruptcy f 67.38 (14th ed. W.
Moore 1978).

48The lone state is Louisiana. The record of enactment of the Code is set out
tabularly in 1 U.L.A. 1-2 (Supp. 1981).



1982] SECURED CREDITORS 485

such a security arrangement,47 but it appeared to conflict with the

preference policy of the Bankruptcy Act, especially when the col-
lateral acquired on the eve of bankruptcy did not replace other col-

lateral acquired earlier. Judicial resolution of this problem created

the possibility of easy frustration of the preference policy by allowing

any creditor to obtain protection from the trustee's use of the

preference provisions of the Bankruptcy Act by filing a financing

statement when the credit was extended.48

The treatment of valid secured claims was largely left to im-
plication by the Bankruptcy Act. The enforceability of liens to the
exclusion of priority and general unsecured claims was a matter of
inference, and the relative priority of liens was governed by non-
bankruptcy law except in the limited situation where a security in-
terest was junior by nonbankruptcy law to a lien invalidated or
postponed by the Bankruptcy Act.49 Provision was made for deter-
mining the amount of a deficiency owing an undersecured creditor.50

The right of the trustee to sell property of the estate free of liens
was established by case law.51

The foregoing observations have been confined to the effect of
the provisions of the Bankruptcy Act that applied in straight bank-

ruptcy—that is, liquidation — rather than reorganization or rehabili-
tation under a plan. Beginning in 1933 Congress enacted reorgani-

zation legislation for railroads and corporations52 that assured

secured creditors of absolute priority of their interests in an enter-

prise reorganized under the legislation.53 If the secured creditor did

"See U.C.C. §§ 9-108, -204(3) (1962 Official Text). See 2 G. Gilmore, Security In-

terests in Personal Property §§ 45.6-.7 (1965).

"See, e.g., DuBay v. Williams, 417 F.2d 1277 (9th Cir. 1969); Grain Merchants of
Indiana, Inc. v. Union Bank & Sav. Co., 408 F.2d 209 (7th Cir.), cert, denied, 396 U.S.
827 (1969); Rosenberg v. Rudnick, 262 F. Supp. 635 (D. Mass. 1967).

49The Bankruptcy Act generally dealt with such situations, creating a potential

windfall for the junior lienor or generating circuity of priority, by preserving the im-

paired lien for the benefit of the estate. See Kennedy, The Trustee in Bankruptcy as a

Secured Creditor Under the Uniform Commercial Code, 65 Mich. L. Rev. 1419, 1434-39

(1967).

'"Bankruptcy Act of 1898, ch. 541, § 57h, 30 Stat. 544, 560, superseded by Bankr.

R. 306(d).
5The leading case is Van Huffel v. Harkelrode, 284 U.S. 225 (1931).
62The first reorganization statute was section 77, the railroad reorganization law.

Act of March 3, 1933, ch. 204, §§ 77, 47 Stat. 1467, 1474. This statute was followed by
section 77B, the first general corporate reorganization law. Act of June 7, 1934 ch. 424,

§ 77B, 48 Stat. 911, 912. Section 77 was not amended by the Chandler Act, but section
77B was superseded by Chapters X and XI of that Act.

53This guaranty was embodied in the "fair and equitable" standard imposed as a
requirement for confirmation of a reorganization plan. Act of March 3, 1933, ch. 204, §
77(e)(1), 47 Stat. 1467, 1478; Chandler Act, ch. 575, § 221(2), 52 Stat. 840, 897 (1938);



486 INDIANA LAWREVIEW [Vol. 15:477

not consent to the provision made for it in the plan, it was protected
by a statutory guaranty of receipt of the full value of its claim

against the debtor's property.
54 Relief afforded political subdivisions

by legislation enacted in the mid-1930's also protected the absolute

priority of secured creditors.55

Rehabilitation legislation enacted by the Chandler Act of 1938

also dealt with security interests in realty owned by a debtor other
than a corporation56 and with security interests in personalty owned
by a wage earner.57 The secured creditor of a wage earner was pro-
tected against any modification of his lien against personalty

without his consent in a Chapter XIII case,
58 but the creditor of a

noncorporate debtor secured by realty might be subjected to cram-

down by the court's confirmation of a plan under Chapter XII that
provided the creditor with the appraised value of his interest in the

realty.
59 The bankruptcy court was empowered in any rehabilitation

case to enjoin enforcement of a lien during the pendency of the

case.
60

IV. Consensual Liens Under the Bankruptcy Reform Act

The Bankruptcy Reform Act is more explicit in regard to the

Consolidated Rock Prods. Co. v. Du Bois, 312 U.S. 510 (1941) (construing the "fair and
equitable" requirement of § 231(1)); Case v. Los Angeles Lumber Prods. Co., 308 U.S.
106 (1939) (similarly construing the same requirement of § 77B(f)(D).

"When a secured creditor or class of secured creditors did not accept the provi-
sions of a plan in a Chapter X case affecting its rights, adequate protection of the
value of their claims was required to be provided by § 216(7) governing "cramdown."

See, e.g., Wachovia Bank & Trust Co. v. Harris, 455 F.2d 841 (4th Cir. 1972). A com-
parable provision enabled the court to confirm a plan under section 77 cashing out

secured creditors without their acceptance if the payment covered the value of their

interests. Act of March 3, 1933, ch. 204, § 77(e), 47 Stat. 1467, 1478.
The "fair and equitable" requirement and the cramdown provision did not apply

in Chapter XI cases, but secured creditors' rights could not be affected by a Chapter

XI plan. But see R.I.D.C. Indus. Dev. Fund v. Snyder, 539 F.2d 487 (5th Cir. 1976),
cert, denied, 429 U.S. 1095 (1977) (sustaining provisions of a confirmed Chapter XI plan

altering a secured creditor's rights with its consent).

"Act of August 16, 1937, ch. 657, § 83(e), 50 Stat. 653, 658.

"Chandler Act, ch. 575, §§ 606(1), 646(2), 52 Stat. 840, 930, 934.
57d § 652(1), 52 Stat, at 934.
M/d § 461(11), 52 Stat, at 922.
"Id. § 468(1), 52 Stat, at 923.

"11 U.S.C. §§ 205(j), 402(c), 516(4), 714, 814, 1014 (1976) (repealed 1978) (Bankrupt-

cy Act §§ 77(j), 83(c), 116(4), 314, 414, 614); see also id. § ll(a)(15) (Bankruptcy Act §
2a(15)). Automatic stays were provided by id. § 548 (Bankruptcy Act § 148) in a

Chapter X case and id. § 828 (Bankruptcy Act § 428) and possibly id. § 907 (Bankruptcy
Act § 507) in a Chapter XII case. These statutory provisions were supplemented by

automatic stays provided by Bankruptcy Rules 8-501, 9-4, 10-601, 11-44, 12-43, and

13-401. See Kennedy, The Automatic Stay in Bankruptcy, 11 U. Mich. J.L. Ref. 177,

177 n.l (1978).



1982] SECURED CREDITORS 487

rights of secured creditors than any previous bankruptcy legislation.

Numerous rights of secured creditors and limitations on those rights
declared in the new law were in doubt under prior law. A number of
limitations are new, and in a few respects secured creditors are

given rights never before recognized in bankruptcy legislation.

A. Valid Liens

The Bankruptcy Reform Act not only defines "statutory lien"61 as
did the Bankruptcy Act62 but also defines "lien,"63 "judicial lien,"64

and "security interest."65 Although setoff is not made a lien by
definition, the new law treats it as one.66 A section entitled "Deter-
mination of secured status" is crucial to the secured creditor's

rights: it spells out the fact that an undersecured creditor has two
claims — a secured claim limited by the value of the interest con-
stituting the security and an unsecured claim in the amount of the
deficiency;

67
it negates an argument that a valuation of the security

for one purpose is thereafter conclusive for other purposes;68 it

specifies the right of a creditor to post-petition interest when his
claim is covered by sufficient collateral, and to attorneys' fees, even

though the latter may not be collectible under nonbankruptcy law;69

and it subjects the security interest to the expenses of preservation

and enforcement.70 An innovative proposal that a secured claim must
be proved in order to be allowed did not survive,71 but it is provided

81
11 U.S.C. § 101(38) (Supp. IV 1980) provides:

"statutory lien" means lien arising solely by force of a statute on specified

circumstances or conditions, or lien of distress for rent, whether or not

statutory, but does not include security interest or judicial lien, whether or

not such interest or lien is provided by or is dependent on a statute and

whether or not such interest or lien is made fully effective by statute ....
62
11 U.S.C. § l(29a) (1976) (repealed 1978). The two definitions are practically iden-

tical except for the inclusion in the 1978 act of a "lien of distress for rent, whether or

not statutory" and the clarifying exclusion of a "security interest or judicial lien."
83
/d. § 101(28) provides: " 'lien' means charge against or interest in property to

secure payment of a debt or performance of an obligation."
M
Id. § 101(27) provides: " 'judicial lien' means lien obtained by judgment, levy, se-

questration, or other legal or equitable process or proceeding."
m
I<L § 101(37) provides: " 'security interest' means lien created by an agreement."
M
See, e.g., id. §506(a) which provides: "An allowed claim of a creditor . . . that is

subject to setoff under section 553 of this title is a secured claim ... to the extent of

the amount subject to setoff . . . ." See also 124 Cong. Rec. 32,398 (1978) (Congressman

Edwards' statement); id. at 33,997 (1978) (Senator DeConcini's statement).
67
11 U.S.C. § 506(a) (Supp. IV 1980).

"Id.

"Id § 506(b); 124 Cong. Rec 32,398 (1978) (Congressman Edwards' statement); id.
at 33,997 (1978) (Senator DeConcini's statement).

70
11 U.S.C. § 506(c).

nH.R. 6, 95th Cong., 1st Sess. § 506(d) (1977).



488 INDIANA LAWREVIEW [Vol. 15:477

that if a challenge or a request directed at a security interest is

filed, proof is required to save it from invalidity.
72

The Bankruptcy Reform Act imposes an automatic stay of most
litigation, proceedings, and acts against the debtor and his property

from the moment a petition is filed by or against the debtor.73 The
impact of this stay falls most heavily on secured creditors, who are
thereby prevented from enforcing their rights in their security un-

less and until they obtain relief. The statutory provisions for the

stay are, however, largely a continuation of prior law. Although

limited automatic stays were provided for in only two of the re-

habilitation chapters enacted in 1938,74 Rules of Bankruptcy Pro-

cedure promulgated in 1973-1976 covered much of the same ground
as the statutory stay.

75 A significant difference in the statutory stay
is the explicit requirement for relief from the stay on request if the

complainant is not provided adequate protection of his interest or

the debtor lacks equity in property not necessary for reorganization.
76

A significant new section explicitly authorizes and regulates the
use of collateral by a debtor during the pendency of a case.77 The
legislation codifies and extends the fragmentary case law respecting

such use that developed under the Bankruptcy Act.78 The same sec-
tion spells out the bankruptcy court's authority to sell property free

of a lien.
79

The Bankruptcy Reform Act recognizes more fully than did the
Bankruptcy Act the power of the bankruptcy court to subordinate

72
11 U.S.C. § 506(d)(1).

lz
Id. § 362. See Kennedy, Automatic Stays Under the New Bankruptcy Law, 12

U. Mich. J.L. Ref. 1 (1978).

"Chandler Act, ch. 575, §§ 148, 428, 52 Stat. 840, 888, 918 (1930); see also id. §
507, 52 Stat. 927.

15See note 60 supra.
76
11 U.S.C. § 362(d)-(f).

7
7d. § 363(a)-(c).

78See Webster, Collateral Control Decisions in Chapter Cases— Clear Rules v.
Judicial Discretion, 51 Am. Bankr. L.J. 197 (1977); Murphy, Use of Collateral in
Business Rehabilitations: A Suggested Redrafting of Section 7-203 of the Bankruptcy
Reform Act, 63 Calif. L. Rev. 1483 (1975).

79
11 U.S.C. § 363(f). As pointed out at note 51, supra, the court's authority had

been established by judge-made law, and section 363(f) may be viewed as a codification
and clarification of the law applicable to such sales. Compare section 5-203(b) of the
Bankruptcy Act of 1973 and the accompanying Note 2, H.R. Doc. No. 137, Part II, 93d

Cong., 1st Sess. 191-92 (1973) (trustee may sell property free of liens without a hearing
unless a dispute arises). Bankruptcy Rule 606(b)(3), not being inconsistent with the

statutory provision, may appropriately govern the procedure in such a sale. See Ken-
nedy, An Adversary Proceeding Under the New Bankruptcy Rules, with Special
Reference to a Sale Free of Liens, 79 Com. L.J. 425 (1974). But compare proposed

Bankruptcy Rule 6004(d), which was circulated to the bench and bar on March 1, 1982
for comment and which would eliminate any requirement for an adversary proceeding
to obtain authority to sell property free of liens.



1982] SECURED CREDITORS 489

valid liens. Section 364, which authorizes the trustee or debtor in

possession to obtain post-petition credit, explicitly accords to the

court the power to grant a security interest to the post-petition
creditor that is senior or equal to pre-petition liens. This power is
subject to a showing at a hearing on notice that the credit is not

otherwise obtainable and that the holder of any existing lien that is

subordinated to or required to share equal priority with the newly

granted security interest is afforded adequate protection.80

Section 510, which authorizes the court to subordinate one claim

to another claim,81 contemplates the possibility of subordination of a

secured claim as well as an unsecured claim. The legislative intent
in this respect is evident from the provision in subsection (c) of that

section for the transfer of any subordinated lien to the estate.

B. Avoidance of Liens

The new bankruptcy law enlarges the trustee's powers of avoidance
at the expense of secured creditors. Thus the trustee's strong arm
as a hypothetical lien creditor has been extended by endowing him

with the status of a hypothetical bona fide purchaser of realty as

against any creditor who failed to take available steps to perfect his
lien against such a purchaser.82 The same section negates the
mischievous doctrine of some Bankruptcy Act cases that purported

MSuch authority was explicitly granted only in cases under sections 77 and 77B
and Chapter X under prior law. 11 U.S.C. §§ 205(c)(3), 516(2) (1976) (repealed 1978). Sec-
tion 344 authorized the issuance by a debtor in possession or receiver of certificates of
indebtedness in a Chapter XI case, but no reference was made to the relative priority
of such certificates. Id. § 744. See generally Banker, Certificates of Indebtedness in

Reorganization Proceedings: Analysis and Legislative Proposals, 50 Am. Bankr. L.J. 1
(1976).

81
11 U.S.C. §§ 510(a)-(c) (Supp. IV 1980). The subordination may simply enforce an

agreement executed prior to the filing of the petition (§ 510(a)) or apply equitable prin-

ciples recognized under prior law (§ 510(c)).
82
Ia\ § 544(a)(3). Of course, the trustee may also prevail under this paragraph

against an absolute transferee of the debtor's realty who had failed to perfect his in-
terest by recordation or the taking of possession, but the most likely victim of the new
weapon of the trustee is a mortgagee.

A new section declares a pre-petition security agreement purporting to cover
property acquired by a debtor after the filing of the petition to be ineffective except as

to proceeds, products, offspring, rents, or profits of property subject to a valid pre-

petition security interest. 11 U.S.C. § 552. The invalidation of the after-acquired prop-

erty clause follows what scant case authority there was under the Bankruptcy Act.

See In re Sequential Information Systems, [1969-1973 Transfer Binder] Secured Tran-

sactions Guide (CCH) 1 51,749 (Bankr. S.D.N.Y. Dec. 15, 1970). An unsettling excep-
tion for the creditor having such a security interest allows the bankruptcy court, after

notice and a hearing, to modify the creditor's lien in proceeds, products, offspring,

rents, or profits "based on the equities of the case." 11 U.S.C. § 552(b).



490 INDIANA LAWREVIEW [Vol. 15:477

to authorize a trustee to be subrogated to the position of any lienor,

irrespective of the validity of his lien or of the amount of his lien, to
defeat any junior lien.83

The most significant changes in the avoidance sections, so far as
a secured creditor is concerned, are found in section 547, the new
preference section. The period of vulnerability of a preferential
transfer is reduced to ninety days unless the preferred creditor is

an insider;84 a preference to an insider remains voidable for a year.

The cutback on the reach of the trustee's avoiding power when no
insider is involved is countered by an elimination of the requirement

that the creditor have had reasonable cause to believe that the debtor

was insolvent at the time of the transfer and by the creation of a
presumption that the debtor was then insolvent.85 These aids are
available, however, only when the trustee is attacking a preferential
transfer made within the ninety-day period preceding bankruptcy.
A transfer cannot occur for the purposes of the preference section
before the debtor had an interest in the collateral;86 therefore, the

potential for a creditor to insulate his after-acquired collateral from

attack by filing a financing statement before its acquisition is

significantly diminished.87 On the other hand, the floating lien of a
lender secured by inventory or accounts receivable is afforded pro-

tection when the lienor is fully secured at the beginning of the
period of vulnerability of a preference or when the lienor did not im-
prove his position during the period.88

The section dealing with setoff likewise contains a new provision
enabling the trustee to avoid a pre-petition setoff to the extent the

83
11 U.S.C. § 544(b). The doctrine nullified by the revised subsection was criti-

cized by Kennedy, The Trustee in Bankruptcy as a Secured Creditor Under the

Uniform Commercial Code, 65 Mich. L. Rev. 1419 (1967), and supported by Coun-

tryman, The Use of State Law in Bankruptcy Cases (Part II), 47 N.Y.U. L. Rev. 631,
657-61 (1972).

84
11 U.S.C. § 547(b)(4). An "insider" is defined in § 101(25) to include 18 categories

of persons.
85See id. § 547(f). The presumption of insolvency is intended to be rebuttable. H.R

Rep. No. 595, supra note 19, at 375, [1978] U.S. Code Cong. & Ad. News at 6331; S.
Rep. No. 989, 95th Cong., 2d Sess. 89 (1978), reprinted in [1978] U.S. Code Cong. & Ad.
News 5787, 5875.

86
11 U.S.C. § 547(e)(3).

87The Code, therefore, overrules the cases cited supra note 48.
88
11 U.S.C. § 547(c)(5). This paragraph, embodying a recommendation of a commit-

tee of the National Bankruptcy Conference, was a reconciliation of the view favoring

full recognition in bankruptcy of a floating lien on after-acquired collateral and the

position that all security interests arising in collateral proceedings acquired by a debt-

or during the four-month period preceding bankruptcy should be avoided as preferen-

tial. See H.R. Rep. No. 595, supra note 19, at 179, 204-19, [1978] U.S. Code Cong. & Ad.
News at 6164-79. For a captious view of section 547(c)(5), see Eisenberg, Bankruptcy
Law in Perspective, 28 U.C.L.A. L. Rev. 953, 959-71 (1981).



1982] SECURED CREDITORS 491

creditor was able thereby to improve the position he held vis-a-vis

the debtor ninety days before the filing of the petition.89 The same
section retains the features of the law of setoff under the Bankrupt-

cy Act, including the disallowance of setoff of a claim acquired dur-

ing the debtor's insolvency on the eve of or after the filing of the

petition.
90 Similar treatment is provided for a debt incurred by a

creditor during the debtor's insolvency and the ninety-day period

before the filing of the petition for the purpose of effecting a setoff.91

The effort to codify the doctrine of Dean v. Davis,92 which in-
validated a security interest given for the purpose of enabling the

debtor to prefer other creditors, was terminated by omission of any
provision in the new law purporting to deal with this situation. The
attempted solution in the Bankruptcy Act had caused too many
problems for debtors and potential lenders and purchasers dealing

with debtors in good faith to warrant its retention.93

The Bankruptcy Reform Act extends the right of a debtor to
avoid liens against exempt property far beyond anything found in
prior bankruptcy law. The Chandler Act had codified a Supreme
Court ruling that allowed a debtor to avoid a judicial lien obtained

against exempt property during the debtor's insolvency and within
four months of his bankruptcy.94 The new law enables the debtor to
avoid any judicial lien that impairs his exemption, without regard to

when it was obtained or the solvency of the debtor at the time of its
attachment.95 Moreover, the debtor is authorized to avoid any non-

possessory non-purchase-money security interest impairing his ex-

emption in tangible personal property of practically any kind except

an automobile.96 The premise of this provision is that because of the

89
11 U.S.C. § 553(b). The application of this test only to pre-petition setoffs is in-

tended to deter them in the interest of enhancing the chances that debtors in distress

may survive financial crises as a result of the exercise of restraint by their bank
creditors.

W
I<L § 553(a)(2). This provision is derived from section 68b(2) of the Bankruptcy

Act. See Bankruptcy Act of 1898, ch. 541, § 68b(2), 30 Stat. 544, 565.
91
11 U.S.C. § 553(a)(3). This provision codifies a limitation on setoff recognized by

prior case law. See, e.g., Cusick v. Second Nat. Bank, 115 F.2d 150 (D.C. Cir. 1940); cf.
Katz v. First Nat'l Bank, 568 F.2d 964 (2d Cir. 1977).

92See note 45 supra.
93H.R. Doc. No. 137, Part II, 93d Cong., 1st Sess. 177 (1973).

"Chandler Act ch. 575, § 67a(4), 52 Stat. 840, 876 (1938) (repealed 1978) (codifying

Chicago, Burlington & Quincy Ry. v. Hall, 229 U.S. 511 (1913)). See 4 Collier on
Bankruptcy 1 67.15[2] (14th ed. W. Moore 1978).

95
11 U.S.C. § 522(f)(1).

**Id. § 522(f)(2). The constitutionality of this provision and that cited in the
preceding footnote has been widely attacked with diverse results. The attacks have
been predicated primarily on the fifth amendment and do not raise any serious ques-
tion as to the prospective constitutionality of an application to liens that arose after

the effective date of the Bankruptcy Reform Act. Compare Note, Constitutionality of



492 INDIANA LAWREVIEW [Vol. 15:477

minimal value of the collateral for the purposes of a forced sale,

such a lien does not serve the purpose of enabling the creditor to

realize his claim by foreclosing his security interest. Because of the

debtor's need for the property and its high replacement cost, how-

ever, the creditor's right to seize and sell the property invests him

with coercive debt-collecting power that is incompatible with the
fresh-start policy of the Bankruptcy Act. That, at any rate, is the ra-

tionale for giving the debtor for the first time the right under the

bankruptcy laws to avoid a security interest for his own benefit.
Section 522, the exemption section, also recognizes that the debtor

may avoid any lien against exempt property for his own benefit that
was not created by a voluntary transfer and was not avoided by the
trustee.97 Even if the trustee avoids a lien, the debtor may claim an
exemption in property recovered by the trustee if the property had

not been voluntarily transferred or concealed by the debtor.98

C. Liens in Rehabilitation Cases

The Bankruptcy Reform Act consolidates provisions that deal
with rehabilitation as distinguished from liquidation. Reorganization

of corporations, partnerships, and individually owned enterprises
may be effected under Chapter 11," and secured claims as well as
unsecured claims may be dealt with in a plan proposed and con-
firmed under that chapter. 100 An official creditors' committee ap-
pointed in a Chapter 11 case, like an official creditors' committee

elected under Chapter XI of the Bankruptcy Act,101 can represent
only the unsecured creditors,102 but there is authority for the ap-

pointment of additional committees, including one or more commit-

Retroactive Lien Avoidance Under the Bankruptcy Code Section 522(f), 91 Harv. L.

Rev. 1616 (1981) (arguing against constitutionality) with Note, Lien Avoidance Under

Section 522(f) of the Bankruptcy Code: Is Retrospective Application Constitutional?,

49 Fordham L. Rev. 615 (1981) (upholding constitutionality) and 27 Wayne L. Rev. 1281
(1981) (upholding constitutionality).

97
11 U.S.C. § 522(h).

98/d § 522(g).
"Chapter 11 is a consolidation of Chapters VIII, X, XI, and XII of the Bankruptcy

Act. H.R. Rep. No. 595, supra note 19, at 220-24, 242-54, [1978] U.S. Code Cong. & Ad.
News at 6179-84, 6201-13.

100
11 U.S.C. § 1123(b)(1). A plan may also deal with any class of equity interests.

101
11 U.S.C. § 738 (1976) (Bankruptcy Act § 338) (repealed 1978); Bankr. R. 11-27,

id. app.; While Chapter X of the Bankruptcy Act provided for creditors' committees,
there was no official creditors' committee in a Chapter X case. See id. §§ 609-613
(Bankruptcy Act §§ 209-213); Bankr. R. 10-211, id. app.

102
11 U.S.C. §§ 1102(a)(1), 151102(a) (Supp. IV 1980). A creditors' committee may be

elected in a Chapter 7 case pursuant to section 705(a), and as in a Chapter 11 case the

committee members must be holders of unsecured claims.



1982] SECURED CREDITORS 493

tees for secured creditors.
103 A plan of reorganization under Chapter

11 may modify any secured debt with the consent of the creditor or
of prescribed majorities of secured creditors in the same class.104 If
the plan leaves the secured creditor or a class of secured creditors

unimpaired, acceptance is presumed without the necessity of any
solicitation.

105
If the provisions of a plan affecting a secured debt are

neither accepted nor deemed accepted, the court may nevertheless
confirm a plan if it is found by the court to be "fair and equitable"

and does not "discriminate unfairly." 106 The standard of "fair and
equitable" is satisfied with respect to secured claims if the plan pro-

vides as follows:

(i) (I) that the holders of such claims retain the lien secur-

ing such claims, whether the property subject to such lien is
retained by the debtor or transferred to another entity, to

the extent of the allowed amount of such claims; and
(II) that each holder of a claim of such class receive on

account of such claim deferred cash payments totalling at
least the allowed amount of such claim, of a value, as of the
effective date of the plan, of at least the value of such

holder's interest in the estate's interest in such property;

(ii) for the sale, subject to section 363(k) of this title, of

any property that is subject to the lien securing such claims,

free and clear of such lien, with such lien to attach to the

proceeds of such sale, and the treatment of such lien on pro-

ceeds under clause (i) or (iii) of this subparagraph; or

(iii) for the realization by such holders of the indubitable
equivalent of such claims.107

m
Id. §§ 1102(a)(2), 151102(b).

l0
*Id. §§ 1122, 1126(a)-(c), 1129(a). Because all claims in a particular class must be

substantially similar to each other (§ 1124(a)), each holder of a secured claim is or-

dinarily in a separate class. A single class of multiple holders of secured claims may be
appropriate when they are (1) lienholders secured under a common indenture or mort-
gage, (2) banks participating in large loans secured by common collateral, or (3) holders
of mechanics' liens having equal priority in respect to common property. D. Epstein &
M. Sheinfeld,

#
Business Reorganization Under the Bankruptcy Code: Teaching

Materials 172* (1979).
105
11 U.S.C. § 1126(f). A claim is unimpaired if the plan (1) leaves the creditor's

rights unaltered; (2) cures any pre-petition default that entitled the creditor to ac-

celerate the maturity of the debt and reinstates the original maturity date; or (3) pro-

vides for cash payment of the allowed amount of the claim on the effective date of the
plan. Id. § 1124.

m
Id. § 1129(b).

m
Id. § 1129(b)(2)(A). This provision is derived from the cramdown provisions of

Chapters X and XII of the Bankruptcy Act. See notes 54 & 59 supra. The reference in
subparagraph(AMiii) to the "indubitable equivalent" was derived from In re Murel



494 INDIANA LAWREVIEW [Vol. 15:477

At a late stage in the legislative process Congress was per-
suaded to provide specialized relief for the holders of secured claims

against property without recourse against their debtors for personal

liability beyond that afforded by their collateral. The concern arose
particularly out of the confirmation of plans under Chapter XII of

the Bankruptcy Act which allowed the retention by partnerhip debt-

ors of the property securing nonrecourse indebtedness on payment

to the creditors of the appraised value of the property.108 Relief was
provided in section 1111(b) by giving a nonrecourse creditor in a

Chapter 11 case an allowable claim as if he had recourse, but the

relief was unavailable if the property was disposed of at a sale
where the nonrecourse creditor could bid.109 Both recourse and non-
recourse creditors are given an option under section 1111(b)(2) to

waive their unsecured claims and to become secured creditors in the
full amount of their claims without regard to the value of their col-
lateral.

110 Creditors exercising that option are permitted to retain

their liens until the full amount of their claims has been paid, but
the present value of the payments need not exceed the value of

their collateral.
111 The option is intended to enable secured creditors

to realize the benefit accruing from a post-confirmation appreciation

of value of their collateral.

Holding Corp., 75 F.2d 941 (2d Cir. 1935) (involving cramdown under former section

77B). 124 Cong. Rec. 32,407 (1978) (statement of Congressman Edwards); id. at 34,007

(statement of Senator DeConcini).
108See Collier (15th ed.), supra note 18, 1 1111.02(1].
109
11 U.S.C. § llll(b)(l)(A)(ii). The recourse creditor retains his right of recourse

whether or not the property is sold, provided he does not opt for the section 1111(b)(2)

election discussed in the next sentence in the text.
no

Ia\ § 1111(b)(2). This option is not available, however, if the interest of the

creditor in collateral of the debtor is of inconsequential value. Id. § llll(b)(l)(B)(i).

Moreover, a recourse creditor may not choose the § 1111(b)(2) option if the property is
sold. It is not clear why sale should deprive only the recourse creditor of the option.
Under section llll(b)(l)(A)(ii) the sale, however, had the effect of eliminating the

status of the nonrecourse creditor as a recourse creditor. Arguably, therefore, the

nonrecourse creditor is likewise barred from the section 1111(b)(2) election by the sale.

See Pachulski, The Cram Down and Valuation Under Chapter 11 of the Bankruptcy
Code, 58 N.C.L. Rev. 925, 948 n.100 (1980).

By virtue of their waiver of unsecured deficiency claims, creditors who choose the
section 1111(b)(2) option are not entitled to application of the "best interest of

creditors" test of section 1129(a)(7)(A)(ii). This provision assures to each creditor a distribu-

tion at least equal to what he would receive on liquidation under Chapter 7. His accep-

tance of a position as a secured creditor without regard to the value of the collateral

disentitles him to any expectation of any distribution as an unsecured creditor. 124

Cong. Rec. 32,408 (1978) (Congressman Edwards' statement); id. at 34,007-08 (Senator

DeConcini's statement).
in124 Cong. Rec. 32,407 (1978) (Congressman Edwards' statement); id. at 34,007

(Senator DeConcini's statement).



1982] SECURED CREDITORS 495

Chapter 11 retains special legislation protective of the interests

of financiers of certain transportation equipment.
112 The legislation is

intended to permit the possession of such equipment to be taken by

the holder of a purchase-money security interest in such equipment

within a prescribed period after default, and neither the automatic

stay nor the injunctive power of the bankruptcy court can save the
equipment from the reach of the creditor.113

Chapter 13 of the Bankruptcy Reform Act is the successor to
Chapter XIII of the Bankruptcy Act, but it contains significant re-

forms that affect secured creditors. While Chapter XIII afforded

relief only to wage earners and similarly employed or compensated
debtors,

114 Chapter 13 is available to any individual with regular in-

come, including a self-employed debtor engaged in business. 115 There

are limitations on eligibility with respect to the size of the debtor's

secured and unsecured indebtedness,116 but the effect is to substan-

tially increase the number of persons eligible for relief under this
chapter.

Another significant extension of the scope of the chapter is its
authorization for the adjustment of both secured and unsecured debt

without the consent of the creditors.117 A plan may not reduce or ex-
tend a claim secured only by the debtor's residential real estate,118

112
11 U.S.C. §§ 1110, 1168. Section 1110 relates to "aircraft, aircraft engines, pro-

pellers, appliances, or spare parts" and "vessels of the United States." Section 1168

relates to "rolling stock equipment or accessories used on such equipment, including

superstructures and racks" and applies only in railroad reorganizations under Chapter

11.
118The rationale for these exceptions is set out in H.R. Rep. No. 595, supra note 19,

at 238-41, 405, 423, [1978] U.S. Code Cong. & Ad. News at 6197-201, 6361, 6379; S. Rep.
No. 989, supra note 85, at 117, 136, [1978] U.S. Code Cong. & Ad. News at 5903, 5922;
124 Cong. Rec. 32,396-97 (1978) (statement of Congressman Edwards); id. at 34,005
(statement of Senator DeConcini). As therein explained, the new legislation is intended
to qualify the absolute right of a financier of transportation equipment conferred by

provisions of the Bankruptcy Act to seize such equipment upon default. That the

legislation fails to conform to the legislative design, see Kennedy, Automatic Stays

Under the New Bankruptcy Law, 12 U. Mich. J.L. Ref. 1, 35-37 (1978).
U4
11 U.S.C. § 1006(8) (1976) (repealed 1978) (Bankruptcy Act § 606(8)) ("whose prin-

cipal income is derived from wages, salary or commissions").
115
11 U.S.C. § 101(24) (Supp. IV 1980) ("whose income is sufficiently stable and

regular to enable such individual to make payments under a plan under chapter 13 of
this title, other than a stock broker or a commodity broker"); id. § 109(e).

ut
Ia\ § 109(e). The petitioning debtor must have "noncontingent, liquidated,

unsecured debts of less than $100,000 and noncontingent, liquidated secured debts of

less than $350,000" in order to be eligible. A joint petition may nevertheless be filed
by an individual and his or her spouse, even though only one of them has regular in-
come, but their aggregate indebtedness must meet the limitations mentioned in the
first sentence.

"Yd §§ 1322, 1325.
n
*Id. § 1322(b)(2).



496 INDIANA LAWREVIEW [Vol. 15:477

but if the debtor is in default in respect to such a debt, his plan may
provide for the curing of the default within a reasonable time during

the pendency of the case.119 In the meantime, regular payments must

be made on the secured debt. A plan may not provide for payments
over a period exceeding three years, unless the court approves a

longer period of up to five years.120 The discharge obtainable under a
Chapter 13 plan does not extend to debts on which the last payment

is due after the final payment under the plan.

A Chapter 13 plan may be confirmed by the court without the
consent of any creditor.121 Secured creditors are protected by section

1325(a)(5), which entitles the holder of each secured claim that can be

modified, to one of the following modes of treatment: (1) a provision
that is accepted by the creditor; (2) retention of the creditor's lien

and distribution of property of a present value as of the effective

date of the plan not less than the allowed amount of the creditor's

secured claim; or (3) surrender of the property securing the claim.

The second alternative is the one most frequently chosen, and con-
siderable litigation has been engendered respecting the proper mode
of determining the present value of the claim.122

A Chapter 13 plan must provide each unsecured creditor at least
as much as would have been paid on liquidation under Chapter 7, 123

but because many petitioning debtors have no nonexempt assets of
any significant value, many plans have been proposed for confirma-

n9
Id. § 1322(b)(5). Considerable litigation and diversity of judicial views have

developed in respect to what constitutes a reasonable time under section 1322(b)(5).
Compare Coleman v. Brown (In re Coleman), 5 Bankr. 812 (W.D. Ky. 1980) (3 years not
reasonable) with In re Lynch, 12 Bankr. 533 (W.D. Wis. 1981) (3 years held reasonable).

There has also developed a diversity of opinion as to whether, after acceleration

of the maturity of mortgage indebtedness by a creditor on account of a pre-petition

default, the option to cure the default remains available under section 1322(b)(5). Com-
pare In re Williams, 11 Bankr. 504 (S.D. Tex. 1981) (default held not curable after the

creditor had elected to accelerate maturity because of the default) with Di Pierro v.

Cullen (In re Toddeo), 9 Bankr. 299 (E.D.N.Y. 1981) (default allowed to be cured where

Chapter 13 petition filed before entry of final judgment of foreclosure by state court;

state law respecting effect of creditor's acceleration held not to be binding on the court

in construing section 1322(b)(5)). See generally Beck, The Plight of the Defaulting Mort-
gagor, 15 Ind. L. Rev. 561 (1982).

120
11 U.S.C. § 1322(c) (Supp. IV 1980).

121
Ia\ § 1325(a), requiring the court to confirm a Chapter 13 plan if it meets six re-

quirements specified in the subsection. Unlike sections 651 and 652 of the Bankruptcy

Act, § 1325(a) of Title 11 does not require the consent of either secured or unsecured

creditors.
122See Bowman & Thompson, Secured Claims Under Section 1325(a)(51(B): Col

lateral Valuation, Present Value, and Adequate Protection, 15 Ind. L. Rev. 569 (1982);
Comment, Bankruptcy Reform Act of 1978: Chapter 13 Cramdown of the Secured
Creditor, 1981 Wis. L. Rev. 333.

123
11 U.S.C. § 1325(a)(4).



1982] SECURED CREDITORS 497

tion that provide only for payment of secured debts and no pay-
ment, or only minimal payment, of unsecured claims. At this junc-
ture the numerous opinions of the courts considering such plans are
in disarray as to whether they may be deemed to satisfy the stan-
dards of confirmation.

124

Chapter 9 of the Bankruptcy Code provides for the adjustment
of debts of a municipality,

125 defined to include any "political subdivi-

sion or public agency or instrumentality of a state." 126 The filing of a
petition for relief under Chapter 9 triggers an automatic stay of the

same scope as that provided by section 362 of Title 11, but in addi-
tion the stay operates against the enforcement of a "lien on or aris-

ing out of taxes or assessments owed to the debtor." 127 The provi-
sions of Chapters 3, 5, and 11 that apply to holders of secured claims

generally apply in Chapter 9 cases,128 and their construction in

Chapter 7 and particularly Chapter 11 cases may be assumed to be
persuasive in Chapter 9 cases.

D. Discharge

Traditionally, discharge of a bankrupt has not barred the en-

forcement of a lien securing the debt.129 The discharge has been
viewed as affecting only the claim for a deficiency. Although an un-

fortunate phrase in section 524 has given rise to confusion in a few

quarters,130 the intention of Congress to leave the enforceability of a

valid lien intact after discharge cannot be doubted.131

l2
*See LoPucki, "Encouraging" Repayment Under Chapter 13 of the Bankruptcy

Code, 18 Harv. J. of Legis. 347 (1981); Note, Chapter 13 De Minimis Plans: Toward a
Consensus on "Good Faith" 9 Hofstra L. Rev. 593 (1981); Note, "Good Faith" and
Confirmation of Chapter 13 Composition Plans: Analysis and a Proposal, 65 Minn. L.
Rev. 659 (1981); Note, Abusing Chapter 13 of the Bankruptcy Code: The Problem of
Nonrepayment, 55 N.Y.U.L. Rev. 941 (1981); Comment, Good Faith in Chapter 13: A
New Wild Card for Bankruptcy, 8 Ohio N.U.L. Rev. 102 (1981); Note, Filing For Per-
sonal Bankruptcy: Adoption of a "Bona Fide Effort" Test Under Chapter 13, 14 U.
Mich: J.L. Ref. 321 (1981).

125
11 U.S.C. §§ 109(c), 941, 943.

12t
Id. § 101(29).

™Id. § 922.
126See id. § 901.
l29See Long v. Bullard, 117 U.S. 617 (1886).
180
11 U.S.C. § 524(a): "A discharge ... (2) operates as an injunction against the

commencement ... of an action, the employment of process, or any act, to collect . . .
from property of the debtor." The court in In re Williams, 9 Bankr. 228 (D. Kan. 1981)

held that the quoted language barred enforcement of a secured claim after discharge of

the underlying debt.
mSee H.R. Rep. No. 595, supra note 19, at 361, [1978] U.S. Code Cong. & Ad.

News at 5963; S. Rep. No. 989, supra note 85, at 76, [1978] U.S. Code Cong. & Ad.
News at 5787.



498 INDIANA LAWREVIEW [Vol. 15:477

Only an individual is entitled to a discharge in a case under

Chapter 7,
132 but the discharge obtainable by virtue of the confirma-

tion of a Chapter 11 plan is comprehensive and practically absolute

in the case of a corporate or partnership debtor.
133 An individual re-

mains subject to the exceptions that apply in a Chapter 7 case,134 but

these are unlikely to be important so far as the enforcement of a

secured claim is concerned. Thus a secured creditor is bound by the
terms of a plan confirmed under Chapter 11, notwithstanding subse-

quent default in the performance of the executory features of the

plan.

Confirmation of a Chapter 13 plan does not discharge the debtor.

When the debtor completes all the payments under a confirmed
Chapter 13 plan, however, the court ordinarily is required to dis-

charge the debtor from all debts "provided for by the plan" except

those for alimony, support, and maintenance and those not payable

within the term of the plan.135 Thus, any debt, whether secured or

unsecured, that is not provided for by the plan survives the dis-

charge granted under section 1528. Plans that omit any reference to

a secured debt on the assumption that the debtor will maintain

payments to the creditor subject the debtor to the risk that the
underlying obligation remains unaffected by the discharge insofar as

it becomes unsecured.136 If the debtor does not complete payments
under the plan, the court may nevertheless grant a limited dis-
charge of the same scope as that obtainable in a Chapter 7 case if
the debtor's failure to perform in full was due to circumstances for
which the debtor is not justly accountable.137 The effect of a dis-
charge on a secured claim in a Chapter 13 case is not likely to be

any different, whether it is a complete or limited discharge.

V. Conclusion

What is the net effect of the Bankruptcy Reform Act on the
rights of secured creditors? The new law has been criticized for the
degree to which it authorizes the bankruptcy court to impair those

rights.
138 On the other hand it has been criticized for its failure to

132
11 U.S.C. § 727(a)(1).

m
Id. § 1141(d)(1).
m
Id. § 1141(d)(2).
m

Id. § 1328(a).
138See Countryman, Letter to the Editor, 85 Com. L.J. 28 (1980).
mll U.S.C. § 1328(b), (c).
138See Eisenberg, supra note 88, at 955-71; Reisman, The Challenge of the Propos-

ed Bankruptcy Act to Accounts Receivable and Inventory Financing of Small-to-
Medium-Sized Business, 83 Com. L.J. 169, 174 (1978) ("[t]he proposed Bankruptcy Act
would virtually negate the effectiveness of Article 9 security interests in bankruptcy

proceedings . . . .").



1982] SECURED CREDITORS 499

constrain secured creditors' rights sufficiently to assure a fuller

measure of attainment of the objectives of bankruptcy law. 139 The
survey undertaken in this Article has suggested that the principal

effect of the new law on secured creditors is to particularize and
thus to clarify the ways in which their rights have been affected.140

Undoubtedly the most dramatic effect can be found in Chapter 11,
which authorizes the confirmation of plans of reorganization that

may impair secured creditors' rights. Most business reorganizations
attempted and effected under the Bankruptcy Act did not directly

affect secured creditors' rights at all, because Chapter XI, by far the

most frequently invoked reorganization chapter, could deal only with

unsecured debts. This limitation, however, constituted a serious

drawback in the usefulness of the chapter as a vehicle for enabling
debtors in distress to develop viable reorganization plans.

Although the new act for the first time explicitly authorizes the
use and disposition of property subject to security interests during

the pendency of a case, the relevant statutory provisions codify

prior case law more than they modify it or establish new law. More-
over, the new act recognizes in numerous contexts the secured cred-
itor's right to "adequate protection" when his rights are or may be
affected by exercise of the powers granted the bankruptcy court.

Automatic stays of the exercise of secured creditors' rights are

more fully elaborated in the new act than they were in the prior act,
but much of this elaboration provides new limitations on the scope
and operation of the stays and new safeguards of the secured credi-
tor's rights. Not surprisingly, given the objectives of bankruptcy
legislation, the trustee's rights to avoid liens against the debtor's

mSee Gordanier, The Indubitable Equivalent of Reclamation: Adequate Protec-
tion for Secured Creditors Under the Bankruptcy Code, 54 Am. Bankr. L.J. 299, 299
(1980) ("[i]n facilitating business reorganizations, . . . the Code may prove to be no more
successful than its predecessor, the Bankruptcy Act, and for the same reason: secured
creditors have, practically speaking, a veto over many if not most of the plans pro-
posed under chapter 11"); Note, From Debtor's Shield to Creditor's Sword: Cram
Down Under the Chandler Act and the Bankruptcy Reform Act, 55 Chi.-Kent L. Rev.
713 (1979).

140This theme with variations is elaborated in Coogan, The New Bankruptcy Code:
The Death of Security Interest?, 14 Ga. L. Rev. 153 (1980). See also Committee on
Developments in Business Financing, Structuring and Documenting Business Finan-
cing Transactions Under the Federal Bankruptcy Code of 1978, 35 Bus. Law. 1645

(1980); Del Gaudio, Article 9 of the Uniform Commercial Code and the Bankruptcy

Reform Act of 1978, 12 U. Tol. L. Rev. 305 (1981); Massari, Adequate Protection
Under the Bankruptcy Reform Act in Annual Survey of Bankruptcy Law— 1979 at
171 (W. Norton ed. 1979); Poe, Further Thoughts on Secured Creditors Under the New
Bankruptcy Code, 28 Emory L.J. 649 (1979); Rome, The New Bankruptcy Act and the
Commercial Lender, 96 Banking L.J. 389 (1979); Shanor, A New Deal for Secured
Creditors in Bankruptcy, 28 Emory L.J. 587 (1979).



500 INDIANA LAWREVIEW [Vol. 15:477

property have been extended, but there are also changes cutting in

the other direction.

The wisdom and worth of the new law must be judged in the light of
experience — how well it works in practice. When Congress con-
ferred pervasive jurisdiction on the bankruptcy court over pro-

ceedings arising under Title 11 and proceedings arising in or related

to cases under Title 11 of the United States Code,141 it was sensitive
to the need to remove bankruptcy judges from involvement in mat-
ters of administration.

142 A principal consideration in adopting this
reform was to assure secured creditors that their controversies with
the trustee as the representative of unsecured creditors would be

heard and determined by an impartial tribunal free from the in-

fluence that derives from continual contact with the administration

of a case. The separation of judicial from administrative functions is,
however, more an expression of an aspiration than a reality in non-
pilot districts, where there are no United States trustees to assume
and exercise necessary administrative responsibilities.143 Moreover,

the future of the pilot project is now imperiled because of efforts
under way in Washington to eliminate the United States trustee
program as a budgetary item in the appropriation for the Depart-
ment of Justice. Whether the proper balance is drawn between the
rights of secured creditors and the rights of unsecured creditors and

debtors depends crucially on the judgment and discretion exercised

by the bankruptcy judges. Congress has entrusted them with more
judicial authority and responsibility than was ever granted them
under prior legislation. If the need for separate administrative per-

sonnel can be met, the new dispensation should significantly en-
hance the effectiveness and efficiency of the bankruptcy system in

rehabilitating distressed debtors as economic units and in facil-

itating the faster and fuller payment of their debts, both secured
and unsecured.

141
28 U.S.C. § 1471(b), (c) (Supp. Ill 1979).

li2See 124 Cong. Rec. 32,410 (1978) (statement of Congressman Edwards); id. at
32,391 (statements of Congressman Butler); id. at 34,010, 34,018 (statements of Senator
DeConcini); H.R. Rep. No. 595, supra note 19, at 101, 109-10, [1978] U.S. Code Cong. &
Ad. News at 6062, 6070-71

143United States trustees are authorized to be appointed and to serve only in 18
judicial districts. 11 U.S.C. § 1501 (Supp. IV 1980); 28 U.S.C. § 581 (Supp. Ill 1979).