Mortgage

Supreme Court rejects 2nd lien stripping in Chapter 7 bankruptcies

Bankruptcies may not void a junior mortgage lien on underwater property

The Supreme Court of the United States held in a unanimous decision announced today that a debtor in a Chapter 7 bankruptcy proceeding may not void a junior mortgage lien when the debt owed on a senior mortgage lien exceeds the current value of the collateral if the creditor’s claim is both secured by a lien and allowed under the bankruptcy code.

The ruling, which will benefit commercial lenders, says that bankruptcy courts may not “strip off” junior liens on property if the value of the property used as collateral is less than the amount the debtor owes to the senior lienholder — in other words, the junior mortgage lien is “completely underwater.”

In the case of Bank of America v. Caulkett, Bank of America asserted that junior liens should not be treated as unsecured loans, because the bankruptcy code only “strips off” claims from property that are disallowed and because the Supreme Court’s ruling in Dewsnup v. Timm, disallowing “stripping down” of primary liens to the value of the underlying property, should extend to this case. The defendants argued that second liens should be treated as unsecured, and hence disallowed.

The Court’s unanimous ruling impacts the right of junior lienholders to collect on loans in the event of a debtor’s declaration of bankruptcy and the treatment of previously secured, but subordinate, debt in bankruptcy proceedings. 

From the ruling:

Held: A debtor in a Chapter 7 bankruptcy proceeding may not void a junior mortgage lien under §506(d) when the debt owed on a senior mortgage lien exceeds the current value of the collateral if the creditor’s claim is both secured by a lien and allowed under §502 of the Bankruptcy Code. Pp. 2–7.

The debtors here prevail only if the bank’s claims are “not . . . allowed secured claim[s].” The parties do not dispute that the bank’s claims are “allowed” under the Code. Instead, the debtors argue that the bank’s claims are not “secured” because §506(a)(1) provides that “[a]n allowed claim . . . is a secured claim to the extent of the value of such creditor’s interest in . . . such property” and “an unsecured claim to the extent that the value of such creditor’s interest . . . is less than the amount of such allowed claim.” Because the value of the bank’s interest here is zero, a straightforward reading of the statute would seem to favor the debtors.

This Court’s construction of §506(d)’s term “secured claim” in Dewsnup v. Timm, 502 U. S. 410, however, forecloses that reading and resolves the question presented here. In declining to permit a Chapter 7 debtor to “strip down” a partially underwater lien under §506(d) to the value of the collateral, the Court in Dewsnup concluded that an allowed claim “secured by a lien with recourse to the underlying collateral . . . does not come within the scope of §506(d).” Id., at 415. Thus, under Dewsnup, a “secured claim” is a claim supported by a security interest in property, regardless of whether the value of that property would be sufficient to cover the claim. Pp. 2–4.

(b) This Court declines to limit Dewsnup to partially underwater liens. Dewsnup’s definition did not depend on such a distinction. Nor is this distinction supported by Nobelman v. American Savings Bank, 508 U. S. 324, which addressed the interaction between the meaning of the term “secured claim” in §506(a)—a definition that Dewsnup declined to use for purposes of §506(d)—and an entirely separate provision, §1322(b)(2). See 508 U. S., at 327–332. Finally, the debtors’ suggestion that the historical and policy concerns that motivated the Court in Dewsnup do not apply in the context of wholly underwater liens is an insufficient justification for giving the term “secured claim” a different definition depending on the value of the collateral.

Ultimately, the debtors’ proposed distinction would do nothing to vindicate §506(d)’s original meaning and would leave an odd statutory framework in its place.

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