Last week, the U.S. Supreme Court issued a decision of interest for mortgage lenders. In Bank of America, N.A. v. Caulkett, a unanimous Court held that a Chapter 7 debtor cannot “strip off,” or void, a second lien mortgage, even though it is completely underwater. The decision answers a question specific to debtors in Chapter 7 proceedings. Pursuant to the Court’s 1992 decision in Dewsnup v. Timm, it had been established that a Chapter 7 debtor cannot “cram down” a mortgage lien to the property’s appraised value, it being held that the potential upside due to a future increase was part of the creditor’s lien.
Previously, in Nobelman v. American Savings Bank, the Court held that a Chapter 13 debtor could strip off a wholly unsecured second mortgage, although the Bankruptcy Code prevents Chapter 13 debtors from cramming down a first mortgage secured only by the debtor’s residence. However, Chapter 7 and Chapter 13 offer different options. Thus, the question remained whether the a Chapter 7 debtor could take advantage of the Bankruptcy Code’s cram down provision, which generally permits a debtor to reduce a lien to the value of the collateral on which the lien exists. In Caulkett, the Supreme Court resoundingly answered the question in the negative. In Chapter 7 cases, even an entirely underwater lien cannot be stripped off and the property on which the lien is filed remains liable for the debt.
Although the ruling is clear, practical issues remain to be addressed.
For example, if a residence is entirely underwater due to mortgage liens that exceed its value, will debtors who are no longer personally liable for the debt continue to make payments? Similarly, if there is no value in a property above the first mortgage, will a junior secured lender foreclose?
Curiously, the Caulkett Court also hinted that a majority of the Justices question the reasoning of the Dewsnup decision. Writing for the Court, Justice Thomas included a footnote in which he noted that Dewsnup had been subject to criticism since the decision was first announced, but also noted (three times) that the appellants had not asked the Court to overrule Dewsnup. Three of the nine Justices declined to join in the footnote, although they concurred in the result. The Court’s frank acknowledgement of the existing criticism of its earlier decision, coupled with the express mention of the fact that the appellants did not request that Dewsnup be overruled, may be a signal that, in an appropriate case, at least six of the Justices would accept the invitation to revisit Dewsnup, and possibly overturn it.
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