On June 1st, the Supreme Court of the United States released an opinion which settles a controversy in the lower courts over lien stripping in Chapter 7 bankruptcy cases.  With Bank of America, N.A. v. Caulkett, the Court overturned two cases from the 11th Circuit permitting debtor’s to avoid wholly unsecured junior liens in Chapter 7 bankruptcies.  The Supreme Court declined to find a distinction between partially secured and wholly unsecured liens and held that a debtor in a Chapter 7 may not void a lien under Section 506(d) when the debt owed on a senior mortgage lien exceeds the value of the collateral if the creditors claim is both secured by a lien and allowed under Section 502.  The decision was based, at least in part, on the definition of “secured claim” as it relates to Section 506(d) which the Court defined as a “claim supported by a security interest in property, regardless of whether the value of that property would be sufficient to cover the claim.”  Consequently, debtors seeking to void a lien under 506(d) can only do so “whenever a claim secured by the lien itself has not been allowed.”

The Court agreed to hear these cases due to the Eleventh Circuit’s split from the Supreme Court’s much criticized decision in Dewsnup which dealt with “strip down’s” in Chapter 7 cases.  The Eleventh Circuit had attempted to draw a distinction from the Dewsnup case by limiting its application to partially secure liens rather than wholly unsecured liens thereby permitting debtors in Chapter 7 cases to strip off liens when amount of debt on the senior lien exceeded the value of the collateral.  The Eleventh Circuit’s insistence on following its own precedent often created a struggle with bankruptcy court judges within the Eleventh Circuit who were torn between the clear demand of the Circuit Court and their own interpretation of the Supreme Court’s decision in Dewsnup.

With this decision, the Supreme Court has answered its own critics and declared unambiguously that neither “strip downs” nor “strip offs” are permitted in Chapter 7 cases unless the claim securing the lien has been disallowed.  The Court did not make this decision retroactive which would have created chaos for lenders, mortgage servicers, title insurers and lower courts trying to reconcile reinstated liens on already disposed properties.  However, the Court’s ruling is a victory for lenders and creditors who will now have the right to fully pursue their claims against borrowers rather than have their liens extinguished by a judicially drawn value.