The United States Supreme Court recently denied certiorari to an Eleventh Circuit appeal which would have addressed the issue of whether section 506(d) of the Bankruptcy Code permits a chapter 7 debt to “strip off”1 a wholly unsecured junior lien in Bank of America, N.A. v. Sinkfield.2 As a result, wholly unsecured junior creditors will continue to suffer the harsh consequence of having its junior lien completely “stripped off” in Eleventh Circuit bankruptcy cases, despite other Circuits around the country holding to the contrary.
The facts of Sinkfield are similar to other lien “strip off” cases that have been flooding Bankruptcy Courts in the Eleventh Circuit for the last few years.3 In this case, the debtor owned real property that was subject to two mortgage liens.4 At the time of the debtor’s voluntary chapter 7 bankruptcy petition, the amount outstanding on the debtor’s first-priority mortgage exceeded the fair market of the real property.5 Relying on In re McNeal,6 the debtor sought a court ruling holding that the mortgage lien asserted by Bank of America, who held the second-priority mortgage on the debtor’s real property, could be avoided because the value of the real property did not extend to Bank of America’s wholly unsecured junior lien.7
To put the Eleventh Circuit’s reasoning in McNeal in perspective, we must first examine the Supreme Court’s holding in Dewsnup v. Timm.8 In Dewsnup, the Supreme Court concluded that a chapter 7 debtor could not “strip down” a partially secured lien under section 506(d) to the current value of the collateral.9 The Dewsnup Court sought out to determine the meaning of the words “allowed secured claim” under section 506(d) of the Bankruptcy Code, and the Supreme Court came up with a two-step test to determine whether a creditor has an “allowed secured claim” that is not subject to avoidance.10 First, the Supreme Court examined whether the creditor’s claim was “allowed” pursuant to section 502 of the Bankruptcy Code.11 Second, the Supreme Court determined whether the creditor’s claim was “secured by a lien with recourse to the underlying collateral.”12 Therefore, the Dewsnup Court was not concerned with whether the junior creditor’s lien was wholly unsecured, but rather with the issue of whether the junior creditor’s lien was based upon a properly-perfected security instrument. Because the junior creditor’s claim in Dewsnup was secured by a lien and was fully allowed pursuant to section 502 of the Bankruptcy Code, the Supreme Court held that section 506(d) did not allow the debtor to “strip down” the junior creditor’s lien.13
Notwithstanding the Supreme Court’s prior holding in Dewsnup, the Eleventh Circuit in McNeal held that a chapter 7 debtor may avoid, or “strip off,” a wholly unsecured mortgage lien on real property.14 The Eleventh Circuit reasoned that the Supreme Court’s holding in Dewsnup was not binding authority on the issue before the court because the debtor in McNeal sought a complete “strip off” of the lien, not just a partial “strip down.”15 After making its distinction between a “strip off” and a “strip down” of a lien, the McNeal court turned to the Eleventh Circuit’s decision in Folendore v. U.S. Small Business Administration,16 which was a bankruptcy case also involving wholly unsecured junior liens.17 In Folendore, the Eleventh Circuit held that a debtor was allowed to avoid a “wholly unsecured” junior lien when a senior lien on the same property exceeded the value of the collateral.18 Thus, the McNeal court concluded that because Dewsnup’s facts were limited to a partially unsecured claim, Dewsnup did not abrogate Folendore, and consequently Folendore remained the controlling precedent within the Eleventh Circuit for wholly unsecured junior liens.19
Seeing it as pointless to try to overcome the Bankruptcy and District Courts in the Eleventh Circuit’s strict adherence to the holdings in McNeal and Folendore, Bank of America entered into stipulated orders with the debtor stripping them of their lien at all three court levels so that it could appeal the issue to the United States Supreme Court or, in the alternative, have the Eleventh Circuit reconsider the issue en banc.20
In Bank of America’s Petition for a Writ of Certiorari, the bank presented three reasons for why the Supreme Court should hear the issue.21 First, Bank of America asserted that the Eleventh Circuit’s reasoning in McNeal and Folendore cannot be reconciled with the Supreme Court’s holding in Dewsnup.22 Second, Bank of America pointed out that all other courts of appeals to consider this issue, namely the Fourth, Sixth, and Seventh Circuits, have concluded that the Supreme Court’s interpretation of section 506(d) in Dewsnup prevents a chapter 7 debtor from “stripping off” a wholly unsecured junior lien securing a valid mortgage loan.23 Finally, Bank of America argued that this case presented an issue “of central importance to the administration of chapter 7 cases and to the treatment of home mortgages in particular,” which the bank contended was an especially important issue following the crash of the housing market. 24 These arguments were insufficient to persuade the United States Supreme Court and Eleventh Circuit, however, as the United States Supreme Court denied certiorari and the Eleventh Circuit denied en banc consideration.25
Consequently, the Eleventh Circuit’s reasoning in McNeal will continue as precedent in bankruptcy cases involving wholly unsecured junior creditors’ liens, while other Circuits around the United States continue following the Supreme Court’s holding in Dewsnup and not allow for wholly unsecured junior liens to be “stripped off.” Until the United States Supreme Court addresses this circuit split, or the Eleventh Circuit reconsiders its holding in McNeal, creditors in the Eleventh Circuit should be prepared to have their wholly unsecured junior liens “stripped off” in chapter 7 bankruptcies.