U.S. Supreme Court Rules Debtors Cannot Void Or Strip Off Totally Unsecured Junior Mortgage In Chapter 7 Bankruptcy
On June 1, 2015, the U.S. Supreme Court, applying its rationale and holding in the 1992 Dewsnup decision, held that a Debtor in a Chapter 7 bankruptcy may not void or strip off a totally unsecured junior mortgage under Section 506(d) of the Bankruptcy Code. Bank of America v. Caulkett, 575 U.S. ___, No. 13-1421, and Bank of America v. Toledo-Cardona, No. 14-163 (U.S. June 1, 2015). Justice Thomas (who did not take part in the Dewsnup decision) delivered the opinion of the Court in which all Justices joined except with respect to the footnote in which Justice Kennedy, Justice Breyer and Justice Sotomayor did not join.
The case should have no effect upon lien-stripping in the reorganization chapters of the Code. For example, the decision appears to preserve the application of 506(a) and use of 1322(b)(2) to strip liens in Chapter 13 matters.
Section 506(d) provides, “To the extent that a lien secures a claim against the Debtor that is not an allowed secured claim, such lien is void.” Accordingly, Section 506(d) permits the debtors to strip off a banks junior mortgage only if the bank’s claim is “not an allowed secured claim.” Generally, a claim filed by a creditor is deemed “allowed” under Section 502 if no interested party objects or if, in the case of an objection, the Bankruptcy Court determines that the claim should be allowed under the Code.
In Caulkett, Debtors’ relied upon Section 506(a)(1) to void or strip off junior lien mortgages that are totally unsecured. Section 506(a)(1) provides that “An 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 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”. Debtors have consistently argued that where the creditor’s senior lien mortgage on the property is secured by nothing, his claim cannot be a secured claim within the meaning of Section 506(a) and given that these identical words are used later in the same section of the Act – 506(d) one would think this presents a classic case for application of the normal rule of statutory construction.
Nevertheless, the Court observed that in Dewsnup v. Timm, 502 U.S. 410 (1992) Court had already adopted a construction of the term “secured claim” in Section 506(d). In Dewsnup, the Court confronted a situation in which a Chapter 7 Debtor wanted to “strip down” or reduce a partially underwater lien under Section 506(d) to the value of the collateral. Specifically, the Debtor sought to reduce debt of approximately $120,000 to the value of the collateral securing her debt at that time ($39,000). In short, Dewsnup defined the term “secured claim” in 506(d) to mean a claim supported by a security interest in property, regardless of whether the value of that property would be sufficient to cover the claim.
Accordingly, the Court held that the reasoning of Dewsnup dictates that a Debtor in a Chapter 7 bankruptcy proceeding may not void a junior mortgage lien under Section 506(d) where the debt owed on the senior mortgage lien exceeds the current value of the collateral.