U.S. Supreme Court Holds Chapter 7 Debtor Cannot ‘Strip Off’ Wholly Unsecured Junior Mortgage

The U.S. Supreme Court recently held that a debtor in a Chapter 7 case cannot “strip-off” or void a wholly unsecured junior mortgage under section 506(d) of the Bankruptcy Code. A copy of the opinion is available at: Link to Opinion.

The debtors in the consolidated cases both had two mortgages on their homes. The petitioner held a second-position mortgage on each of the homes. The senior mortgage on each home exceeded its fair market value, meaning that the junior mortgages were entirely unsecured and “underwater.”

Each debtor moved to “strip-off” or void the junior mortgage liens pursuant to section 506(d) of the Bankruptcy Code, 11 U.S.C. 506(d). The Bankruptcy Court granted the motion in each case, and both the District Court and U.S. Court Appeals for the Eleventh Circuit affirmed.

The second lien mortgagee petitioned the Supreme Court for writs of certiorari, which were granted.

The Court began with a textual analysis of subsection 506(d), which provides that “[t]o the extent that a lien secures a claim against the debtor that is not an allowed secured clam, such lien is void.”

The Court explained that a creditor’s claim is deemed “allowed” under section 502 of the Bankruptcy Code if no interested party objects or the Bankruptcy Court decides a claim should be allowed if an objection is filed.

The parties agreed that the bank’s claims were “allowed,” but disagreed on whether they were “secured” under subsection 506(d).

The Supreme Court held that its prior decision in Dewsnup v. Timm, 502 U.S. 410 (1992) controlled.

Dewsnup involved a Chapter 7 bankruptcy debtor that sought to “strip down” or reduce a $120,000 lien to the value of the collateral, which was $39,000. The Court refused to permit this, reasoning that the term “secured” in section 506(d) was ambiguous, and holding that section 506(d) does not apply to an allowed secured claim, and that a debtor could not strip down the lien to the value of the property serving as collateral.

The Court rejected the debtors’ argument that Dewsnup should be limited to the partially unsecured liens involved in that case, reasoning that the definition of “secured claim” arrived at in Dewsnup — that a claim is “secured” if it is “secured by a lien” and “has been fully allowed pursuant to § 502” — does not depend on whether a lien is partly or entirely unsecured.

The Supreme Court also rejected the debtors’ argument that section 506(a) should be construed as applying to a secured claim supported by collateral with some value, reasoning that adopting such an artificial reading would mean that the same words — “allowed secured claim” — meant different things in subsections 506(a) and 506(d).

The Court likewise disagreed with the debtors that its decision in Nobelman v. American Savings Bank, 508 U.S. 324 (1993) controlled, finding that case inapposite because it involved the interaction between section 506(a) and section 1322(b)(2), but not 506(d), and because the Court in Dewsnup had already refused to define the term “secured claim” in subsection 506(d) differently than in subsection 506(a), depending on the value of the collateral.

The Supreme Court concluded by reasoning that treating a secured claim differently based on the value of the collateral would not shed light on subsection 506(d)’s meaning and would be “odd” because if, as the debtors urged, “a court valued the collateral at one dollar more than the amount of a senior lien, the debtor could not strip down a junior lien under Dewsnup, but if it valued the property at one dollar less, the debtor could strip off the entire junior lien.”

The Court held this would lead to “arbitrary results,” as the value of real property fluctuates constantly.

Accordingly, the judgments of the Eleventh Circuit Court of Appeals were reversed, and the cases remanded for further proceedings.

Patrick Kane is an Associate at the law firm Maurice Wutscher LLP, practicing commercial litigation, consumer litigation, insurance recovery, and equine law.