May 26, 2020

May 26, 2020

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Supreme Court Reaffirms a Chapter 7 Debtor's Inability to Strip a Lien Against Real Property

Reaffirming its 1992 decision in Dewsnup v. Timm, on June 1, 2015, the U.S. Supreme Court in Bank of America v. Caulkett, No. 13-1421, once again ruled that a chapter 7 debtor may not void a junior lien under Bankruptcy Code section 506(d).

In both Dewsnup and Caulkett, the Supreme Court was asked to interpret Bankruptcy Code sections 506(a) and 506(d). Section 506(a) provides that "[a]n allowed claim of a creditor secured by a lien on property . . . is a secured claim to the extent of the value of such creditor'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.) Section 506(d) provides "[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.)

Dewsnup's Prescription Against Lien Stripping Under Section 506(d)

In Dewsnup, the Supreme Court addressed whether a chapter 7 debtor could "strip down" - or reduce - a partially underwater lien to the value of the collateral (i.e., reduce debt of approximately $120,000 to the $39,000 value of the collateral) under section 506(d). In ruling that a chapter 7 debtor could not strip down a partially underwater lien, the Court inDewsnup construed the term "secured claim" in section 506(d) to mean "a claim supported by a security interest in property, regardless of whether the value of that property would be sufficient to cover the claim." Under this construction, section 506(d)'s "function is reduced to voiding a lien whenever a claim secured by the lien itself has not been allowed."

Caulkett's Application to Wholly Underwater Liens

In Caulkett, Bank of America held junior mortgage liens against the houses of two debtors. The amount owed on each debtor's senior mortgage lien was greater than each home's current market value, leaving both of Bank of America's junior mortgage liens whollyunderwater. It was undisputed, however, that Bank of America's loans were valid and Bank of America held allowed claims. The courts below, including the Eleventh Circuit of Appeals, held that section 506(d) allowed the two debtors to void the wholly underwater mortgage liens, and Bank of America appealed.

The Court in Caulkett acknowledged that a straightforward reading of section 506(a) and section 506(d) would allow the debtors to void Bank of America's liens. The Court also repeatedly noted the debtors did not ask to overrule Dewsnup - a decision that six of the justices agreed has been the target of criticism from its inception. Nevertheless, the Court reversed the courts below, holding that Dewsnup's construction of "secured claim" resolved the question in Caulkett. Specifically, because Bank of America held allowed claims which were secured by liens against the debtors' homes, the liens could not be voided under section 506(d) regardless of the value of the underlying collateral. The Court also rejected the debtors' request to "cabin" Dewsnup to partially - as opposed to wholly - underwater liens, finding that using such an approach would be problematic with fluctuating property values and would leave an odd statutory framework where a lien supported by one dollar of collateral value could not be stripped down, but a lien with one dollar less in collateral value could be stripped down.

Implications of Caulkett

Thus, after Caulkett, a chapter 7 debtor may not void a junior lien regardless of whether the lien is partially or wholly underwater. Significantly, however, the decisions in Caulkett andDewsnup do not limit a debtor's ability to strip down - in part or in whole - an underwater lien against property in chapter 11.

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About this Author

Michael S. Greger, creditors rights litigator, Allen Matkins Law Firm

Michael S. Greger is a partner in the firm's Orange County office. His practice concentrates on bankruptcy and creditors' rights law and associated litigation. He has represented secured creditors in virtually all aspects of bankruptcy and state court litigation, including judicial and non-judicial foreclosures, receiverships, in and out-of-court workouts, cramdown and relief from stay litigation, and lender liability trials. In addition, he has represented debtors in possession, trustees, examiners and creditors' committees in a wide variety of bankruptcy matters.

 William W. Huckins, Bankruptcy, Litigation Attorney, Allen Matkins Law Firm

William (Bill) W. Huckins is a bankruptcy and creditor's rights partner in the firm's San Francisco office and largely represents financial institutions, insurance companies and investment funds holding secured claims in bankruptcy court and state court proceedings. Bill also represents property owners, developers and franchisors in a variety of matters. Bill has successfully litigated numerous contested plan proceedings, including cram-down attempts, relief from stay proceedings, avoidance actions, equitable subordination claims, cash collateral proceedings, and lease and license assignments. Bill has also represented several asset purchasers in bankruptcy sale proceedings, including hotly contested asset purchases.