On June 1, 2015, the Supreme Court of the United States decided Bank of America, N.A. v. Caulkett, 135 S. Ct. 1995 (2015) in a unanimous opinion—except for a footnote—authored by Justice Thomas, and determined that a chapter 7 debtor may not void a junior lien under § 506(d) of the Bankruptcy Code even when the debt owed on the senior lien exceeds the present value of the property.
The facts of the two cases, consolidated on appeal, were straightforward. The debtors in each case had two secured liens on their respective houses. Bank of America held the second priority, or junior lien, on each home. The value of each home was less than the first priority lien and thus Bank of America’s lien in second position was “wholly underwater”. The debtors each filed a chapter 7 bankruptcy case and subsequently moved to “strip off”, or invalidate, the junior liens held by Bank of America. The bankruptcy court in each case granted the motion, the district court affirmed, and the Eleventh Circuit Court of Appeals similarly affirmed citing prior Eleventh Circuit precedent.
The Supreme Court reversed the Eleventh Circuit based on its own precedent in Dewsnup v. Timm, 502 U.S. 410 (1992), but the Court began its analysis by stating that the plain language of § 506 suggests the debtors are entitled to the relief granted to them by the Eleventh Circuit. The Court noted that § 506(a)(1) 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 “an unsecured claim to the extent that the value of such creditor’s interest . . . is less than the amount of such allowed claim.” Because “secured claim” is so described in § 506(a)(1), the Court reasoned that when the exact same phrase is used in § 506(d) it should have the same meaning. However, the Court found that “secured claim” in § 506(d) means something other than what it means in § 506(a)(1), based upon Dewsnup.
While Caulkett involved an attempt by a chapter 7 debtor to “strip off” a junior lien, Dewsnup involved an attempt by a chapter 7 debtor to “strip down” a first priority lien to the value of the collateral at the time of the motion, based upon § 506. The Court held in Dewsnup that if a claim is “allowed” under § 502 (provision in the Bankruptcy Code dealing with allowance of claims) and “is secured by a lien with recourse to the underlying collateral, it does not come within the scope of § 506(d).” 502 U.S. at 415. As explained in Caulkett, Dewsnup defined “secured claim” in § 506(d) to mean “any claim ‘secured by a lien and . . . fully allowed pursuant to § 502’” notwithstanding the description of “secured claim” in § 506(a)(1). Caulkett, 135 S. Ct. at 1999. Based upon Dewsnup, the Court concluded in Caulkett that the debtors were unable to strip off the junior liens because the liens were both secured by the property and allowed under § 502.
Even though Dewsnup provided the answer to the issue presented in Caulkett, Justice Thomas, writing for the Court, seemed open to the idea that Dewsnup was wrongly decided and could be overruled. However, the Court noted that the parties did not ask the Court to overrule Dewsnup. Instead, the debtors asked the Court to distinguish Dewsnup to the facts of that case. The Court concluded that the cases were not distinguishable for any legal significant reason and refused, however.
But, as mentioned above, the disputed footnote caused some to question what was really going on in the decision. Three Justices: Kennedy, Breyer, and Sotomayor each declined to join the rest of the Court in a footnote in the middle of the opinion. The disputed footnote stated “[f]rom its inception Dewsnup . . . has been the target of criticism [citations omitted]. Despite this criticism, the debtors have repeatedly insisted that they are not asking us to overrule Dewsnup.” Caulkett, 135 S. Ct. 2000 n.†. Since six other Justices joined the disputed footnote that is critical of Dewsnup, it has caused speculation that the debtors in the case made a strategic error in not asking for Dewsnup to be overruled, and it has created questions about the validity of that case going forward if there is another challenge.
While underwater lienholders may have other reasons to worry, the risk of their liens being invalidated by debtors in chapter 7, at least for now, should not be one of those concerns.