Holding: A debtor in a chapter 7 bankruptcy proceeding may not avoid a junior mortgage lien under Section 506(d), even if the amount of debt owed on a senior mortgage lien exceeds the current value of the collateral.
In a recent U.S. Supreme Court decision (Bank of America v. Caulkett), the Court reversed the Eleventh Circuit’s decision that allowed individual chapter 7 debtors to “strip,” or avoid entirely, junior liens on their homes when those homes were “underwater,” which occurs when the debtors owe more on a first mortgage than their houses are worth, leaving the second mortgage completely unsecured.
Bank of America urged the Court to rely on the 1992 decision of Dewsnup v. Timm, 502 U.S. 410, in which the Court held that a chapter 7 debtor cannot reduce a “partially” secured second mortgage (“strip down”) to the current value of the property. The Court in Caulkett extended its Dewsnup decision to hold that a chapter 7 debtor may not completely avoid (“strip off”) a junior mortgage lien when the outstanding debt owed to a senior lienholder exceeds the current value of the collateral. Now, a junior mortgage lien survives the bankruptcy and the lender can foreclose on it to collect on the loan either when the value of the collateral appreciates or when the first mortgage is paid off.
This holding is important for the rights of lenders who offer second mortgage financing to their customers. If the Court had ruled against BOA, the ability of borrowers to obtain second mortgages would likely have either disappeared or become subject to much higher interest rates as a result of the impairment of the ability to keep the collateral.