On June 1st the Supreme Court expanded its seminal decision in Dewsnup v. Timm, 502 U.S. 410 (1992) to block chapter 7 debtors' attempts to "strip" an out-of-the-money second mortgage lien under Section 506(d) of the Bankruptcy Code, and allow debtors to retain the mortgaged property and any future appreciation in value above the amount of the senior mortgage. Bank of America, N.A. v. Caulkett, No. 13-1421 (U.S. June 1, 2015).

While the implications of this ruling remain to be seen, a contrary ruling would have sent shock waves through the junior mortgage market.

Caulkett filed a Chapter 7 bankruptcy petition and moved to strip an out-of-the-money second mortgage off his home pursuant to Section 506(d) to enable him to keep the home free of the second mortgage.

The U.S. Bankruptcy Court for the Middle District of Florida granted his motion, and the District Court and Eleventh Circuit both affirmed. This created a split with the Fourth, Sixth and Seventh Circuits, which had previously rejected this approach.

Importantly, the debtor expressly declined to ask the Supreme Court to overrule Dewsnup, but rather sought merely to distinguish it because the value of the mortgaged property was insufficient for any value to drop to the second mortgage lien. In Dewsnup, the Supreme Court held that a debtor could not use Section 506(d) to strip down an undersecured lien to the value of the collateral as of the Petition Date, distinguishing between the phrase "allowed secured claim" used in subsection (a) of Section 506 versus the same phrase "allowed secured claim" used in subsection (d). Dewsnup, 502 U.S. at 417.

Six justices joined in Justice Thomas' opinion declining to adopt what it termed the debtor’s “artificial distinction” from Dewsnup, refusing to effectuate an arbitrary difference between a junior lien that had no value versus a junior lien worth $1.

Under Caulkett, a junior mortgagee will hold a secured claim (albeit of no current value) so long as its claim is "allowed" under Section 502 of the Bankruptcy Code and it is secured by an enforceable security interest.

However, the opinion pointedly and repeatedly noted that the debtor did not ask the Court to overrule Dewsnup. It also included a footnote highlighting the scholarly and judicial criticism of Dewsnup (including by Justices Thomas and Scalia, who saw a "methodological confusion [that] enshrouded both the Courts of Appeals and… Bankruptcy Courts"). The only difference in the view of the majority and the three concurring justices, was the refusal of the concurring justices to join in this footnote.

While the long term implications of Caulkett are unclear beyond its immediate context, the Supreme Court protected junior mortgagees from lien stripping by refusing a perfectly reasonable ground to limit Dewsnup to its facts — or as some commentators predicted, even to overrule this precedent.

Going forward, junior lienholders will have some additional leverage over debtors — especially in chapter 7 cases — and need not worry about debtor efforts to get a windfall by voiding "underwater" liens solely due to valuation.

Junior secured creditors will no doubt cite Caulkett as a basis for vindicating their rights in other contexts. The case did not, however involve a chapter 11 debtor, DIP Financing, adequate protection for liens, lien valuation under Section 506(a), a Section 363 sale, or a plan of reorganization, all of which frequently give rise to valuation disputes, and frequently provide different treatment for liens of different priority.

We would expect senior lenders (and debtors) to distinguish Caulkett based on the different statutory language and context of lien stripping under Section 506(c), adequate protection under Sections 362 – 364. This puts more focus on the clarity of intercreditor and lien subordination terms for junior lenders and senior lenders expressing how their respective liens will be treated — rather than leave these issues up to the courts.

Caulkett may neither be a permanent nor broad protection for junior lienholders with valueless liens. Dewsnup remains for the time being a foundation of modern bankruptcy jurisprudence. Its holding — that a debtor cannot strip down liens to the value of the underlying collateral — tipped the balance of power in a bankruptcy proceeding away from debtors and decidedly towards secured creditors.

In the post-Dewsnup world, secured creditors often control a debtor's fate in his bankruptcy case. Debtors effectively cannot take certain significant actions without secured creditor consent. Nevertheless, the six justices joining in the majority opinion practically invited litigants to ask the Court to overturn Dewsnup. Why a majority of the Court did not,sua sponte, decide to overrule Dewsnup shows that this highly criticized precedent has vitality — at least for now.