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Allen Matkins Legal Alert
June 12, 2015              
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Supreme Court Reaffirms the Inability of a Chapter 7 Debtor to Strip a Lien

Reaffirming its 1992 decision in Dewsnup v. Timm, on June 1, 2015, the U.S. Supreme Court in Bank of America v. Caulkett, No. 13-1421, once again ruled that a chapter 7 debtor may not void a junior lien under Bankruptcy Code section 506(d).

In both Dewsnup and Caulkett, the Supreme Court was asked to interpret Bankruptcy Code sections 506(a) and 506(d). Section 506(a) provides that "[a]n 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 "is an unsecured claim to the extent that the value of such creditor's interest . . . is less than the amount of such allowed claim." (Emphasis added.) Section 506(d) provides "[t]o the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void." (Emphasis added.)

Dewsnup's Prescription Against Lien Stripping Under Section 506(d)

In Dewsnup, the Supreme Court addressed whether a chapter 7 debtor could "strip down" - or reduce - a partially underwater lien to the value of the collateral (i.e., reduce debt of approximately $120,000 to the $39,000 value of the collateral) under section 506(d). In ruling that a chapter 7 debtor could not strip down a partially underwater lien, the Court in Dewsnup construed the term "secured claim" in section 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." Under this construction, section 506(d)'s "function is reduced to voiding a lien whenever a claim secured by the lien itself has not been allowed."

Caulkett's Application to Wholly Underwater Liens

In Caulkett, Bank of America held junior mortgage liens against the houses of two debtors. The amount owed on each debtor's senior mortgage lien was greater than each home's current market value, leaving both of Bank of America's junior mortgage liens wholly underwater. It was undisputed, however, that Bank of America's loans were valid and Bank of America held allowed claims. The courts below, including the Eleventh Circuit of Appeals, held that section 506(d) allowed the two debtors to void the wholly underwater mortgage liens, and Bank of America appealed.

The Court in Caulkett acknowledged that a straightforward reading of section 506(a) and section 506(d) would allow the debtors to void Bank of America's liens. The Court also repeatedly noted the debtors did not ask to overrule Dewsnup - a decision that six of the justices agreed has been the target of criticism from its inception. Nevertheless, the Court reversed the courts below, holding that Dewsnup's construction of "secured claim" resolved the question in Caulkett. Specifically, because Bank of America held allowed claims which were secured by liens against the debtors' homes, the liens could not be voided under section 506(d) regardless of the value of the underlying collateral. The Court also rejected the debtors' request to "cabin" Dewsnup to partially - as opposed to wholly - underwater liens, finding that using such an approach would be problematic with fluctuating property values and would leave an odd statutory framework where a lien supported by one dollar of collateral value could not be stripped down, but a lien with one dollar less in collateral value could be stripped down.

Implications of Caulkett

Thus, after Caulkett, a chapter 7 debtor may not void a junior lien regardless of whether the lien is partially or wholly underwater. Significantly, however, the decisions in Caulkett and Dewsnup do not limit a debtor's ability to strip down - in part or in whole - an underwater lien against property in chapter 11.

 

Greger Michael S Michael S. Greger
Partner
Restructuring, Insolvency & Bankruptcy | Financial Services
Orange County
(949) 851-5436
(949) 553-8354 (fax)
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Huckins William William Huckins
Partner
Restructuring, Insolvency & Bankruptcy | Litigation | Financial Services
San Francisco
(415) 273-7426
(415) 837-1516 (fax)
Email William