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U.S. Supreme Court Rules Junior Liens Cannot be Stripped in Chapter 7 Bankruptcy – Glass & Goldberg | Financing, Property & Bankruptcy Law
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U.S. Supreme Court Rules Junior Liens Cannot be Stripped in Chapter 7 Bankruptcy

U.S. Supreme Court Rules Junior Liens Cannot be Stripped in Chapter 7 BankruptcyThe U.S. Supreme Court has ruled that Chapter 7 debtors cannot discharge junior liens on underwater mortgages, reversing a November 2014 Eleventh Circuit ruling that allowed junior liens to be discharged in bankruptcy when a first mortgage is undersecured.

In Bank of America v. Caulkett, No. 13-1421, merged before the high court with Bank of America v. Toledo-Cardona, No. 14-163, two Florida debtors had second mortgages on their homes and Bank of America held the junior lien in both cases. In addition, both of the debtors’ senior liens were underwater, so the bank would have received nothing if the properties were sold.

Both debtors filed Chapter 7 bankruptcy and sought to have the bank’s junior liens stripped off under 11 U.S.C. § 506(d), which provides that:

“To the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void….” The debtors asserted that the bank’s liens were not secured because under 11 U.S.C. § 506(a)(1), an allowed claim secured by a property lien is only secured “to the extent of the value of [the] creditor’s interest in” the property and is unsecured “to the extent that the value of such creditor’s interest…is less than the amount of such allowed claim.”

In its June 1, 2015, unanimous decision, the Court relied on its prior ruling in Dewsnup v. Timm, 502 U.S. 410 (1992), where it found as long as a claim was supported by a security interest in the property, it was a secured claim, regardless of whether the property value was sufficient to cover the claim.   Therefore, a lien can only be voided under § 506(d) when the claim supporting the lien was not allowed under § 502.

Writing for the Court, Justice Clarence Thomas noted,

Dewsnup’s construction of ‘secured claim’ resolves the question presented here. Dewsnup construed the term ‘secured claim’ in §506(d) to include any claim “secured by a lien and . . . fully allowed pursuant to §502… Because the Bank’s claims here are both secured by liens and allowed under §502, they cannot be voided under the definition given to the term ‘allowed secured claim’ by Dewsnup.”

In addition, the Court declined to distinguish between liens that were wholly underwater, as in the cases here, and those that were partially underwater, as was the case in Dewsnup. “Given the constantly shifting value of real property, this reading could lead to arbitrary results,” Justice Thomas wrote.

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