Published on: January 12, 2016

On June 1, 2015, the United States Supreme Court, in a unanimous decision, issued its decision in Bank of America, N.A. v. Caulkett and held that wholly unsecured junior mortgages constitute “allowed secured claims” and are therefore not subject to being stripped off by Chapter 7 debtors in bankruptcy. The decision comes after months of speculation and fear on the part of junior mortgage holders that their liens may be voided in bankruptcy simply because the debt owed under the senior mortgage eclipsed the value of the home. But there is much more to this decision than meets the eye, and junior mortgagees should not start breaking out the bubbly just yet.

The ultimate holding of the Court finds its roots in the case of Dewsnup v. Timm, a 1992 United States Supreme Court decision. The issue in Dewsnup, as in Caulkett, is how one defines the phrase “allowed secured claim” in 11 U.S.C. § 506(d). Section 506(d) states that “[t]o the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void[.]” (Emphasis added). The voiding of such liens is often called “lien stripping” or the “stripping off” of a lien. 11 U.S.C. § 506(a), which bifurcates claims into secured and unsecured, provides that an “allowed claim of a creditor secured by a lien on property in which the estate has an interest . . . is a secured claim to the extent of the value of such creditor’s interest in the estate’s interest in such property . . . and is an unsecured claim to the extent that the value of such creditor’s interest . . . is less than the amount of such allowed claim.” (Emphasis added). The debtor in Dewsnup was seeking to have the unsecured portion of the senior mortgage stripped off. Based solely on a reading of the above two subsections, it would appear that to the extent an allowed claim exceeds the value of the underlying collateral, it is “unsecured” and therefore “not an allowed secured claim.” This means that the unsecured claim or portion of the claim would be voidable.

Despite the above, in Dewsnup, the Court stated, over the impassioned dissent of Justices Scalia and Souter, that the text was actually ambiguous and, as such, it relied upon the pre-bankruptcy code practice whereby liens on real property passed through bankruptcy unaffected in holding that the portion of the lender’s senior mortgage that was unsecured could not be stripped off. The Court held that a “major change” from pre-bankruptcy code “practice” must be the result of more than an ambiguous provision in the Bankruptcy Code without any related legislative history supporting such a departure. In his dissent, Justice Scalia believed the majority had created an ambiguity in the text and, after an extensive examination of the Bankruptcy Code and the arguments of the parties and amici curiae, stated that Sections 507(a) and 507(d), when read together, require holding that the unsecured portion of a mortgagee’s lien is voided.

Over a decade later, two debtors whose senior mortgages exceeded the values of their respective homes sought to have their wholly unsecured second mortgages voided under Section 506(d). After the Eleventh Circuit Court of Appeals granted the debtors the relief they sought, the Supreme Court, in an effort to resolve a Circuit Court split on the issue, granted certiorari. Confronted with Dewsnup, rather than request it be overruled, the debtors argued instead that the Court should simply reach a different conclusion based solely on the fact that the junior mortgages they sought to have voided were wholly unsecured as opposed to Dewsnup’s partially unsecured senior mortgage. This strategy proved fatal.

At the oral argument stage, several Justices voiced their displeasure with the Dewsnup decision. In fact, the circumstances surrounding the Caulkett decision as a whole suggest that certain Justices, if asked, would have elected to overrule Dewsnup and hold that debtors may strip off both partially unsecured mortgages and wholly unsecured junior mortgages. First, despite Caulkett being a unanimous decision, three Justices refused to join a footnote to the opinion which stated, with citation, that Dewsnup had been the “target of criticism.” Second, the Court, at several points in the opinion, including in the footnote, reiterated that the debtors had not asked the Court to overrule Dewsnup and often seemed begrudgingly resigned to the fact that Dewsnup compelled its ultimate decision. Finally, Justice Scalia stated at oral argument that he still believed his dissent in Dewsnup was “correct,” and Justice Kagan agreed. Despite their express disagreement with Dewsnup, both joined the opinion in Caulkett. It may be that it was the Court’s historical hesitance in overruling prior precedence without an express request from one of the litigants, more than any persuasive legal argument, which ultimately led to the Caulkett decision.

Despite the clear holdings of Dewsnup and Caulkett that a debtor may not strip off a partially or wholly unsecured mortgage under Section 506(d), the circumstances surrounding the underlying opinions suggest that the Court may be open to a future direct challenge to their continued validity. While mortgagees should take a breath and enjoy their recent success, they should also confront and begin planning for the very real possibility that a future debtor will ultimately convince the Court to abbreviate the celebration.

A copy of the Bank of America, N.A. v. Caulkett Decision can be found by [click here].

For questions regarding this article please contact Ed Allcock at eallcock@meeb.com.