Today, the Supreme Court issued a decision in Bank of America, N.A. v. Caulkett reversing the Eleventh Circuit’s decision that allowed individual chapter 7 debtors to “strip” junior liens on their homes when the first priority liens were underwater.  Relying on Dewsnup v. Timm, the Supreme Court unanimously held that section 506(d) of the Bankruptcy Code does not allow the debtor to “strip” a junior creditor’s lien, where the junior creditor’s claim is an allowed secured claim.  

A more complete analysis will follow, but we wanted to bring you this latest Supreme Court decision to your attention right away.

Key Takeaways:

  • The Supreme Court relied on Dewsnup in constructing the meaning of “secured claim” in the context of section 506(d), in which the Court defined the term “secured claim” to mean a claim that was “supported by a security interest in property, regardless of whether the value of that property would be sufficient to cover the claim.” Accordingly, the Supreme Court held that because the claims in question were secured by liens and allowed under section 502, they could not be voided.
  • It should be noted, that the debtors did not ask the Supreme Court to overruleDewsnup, but rather, requested that the Supreme Court limit its decision in Dewsnup to liens that were only partially underwater. In fact, the Court repeatedly noted that the debtors had not requested the Court to overrule Dewsnup, leaving readers to wonder if the result would have been different if the debtors had chosen to make such a request.
  • The Court declined to adopt the debtors’ proposed distinction between wholly and partially underwater liens on the grounds that using the debtor’s approach would leave an “odd statutory framework” in place, under which if a court valued the collateral at a dollar more than the amount of senior mortgage, the debtor could not strip down the lien, whereas if the court valued the collateral at one dollar less than the amount of the senior mortgage, the debtor could strip off the entire junior lien. The Supreme Court expressed concern that, given the frequently changing value of real property, adopting the debtors’ distinction could lead to arbitrary results.
  • The Supreme Court did not address lien-stripping in the chapter 11 context. Given that courts have used Dewsnup to disallow lien-stripping in chapter 11 cases, it remains to be seen the consequences of the Supreme Court’s decision not to overrule Dewsnup, whether or not the Supreme Court was asked to do so.