Chapter 7 Debtors May Not Void a Junior Mortgage

The United States Supreme Court, in Bank of America v. Caulkett, recently held that a debtor in a Chapter 7 bankruptcy proceeding may not void a junior mortgage where the debt owed on a senior mortgage exceeds the present value of the property. The Caulkett decision overruled the Eleventh Circuit case of McNeal v. GMAC Mortgage, LLC, 735 F.3d 1263 (11th Cir. 2012), which held a Chapter 7 debtor could “strip off” a wholly unsecured lien.

In Caulkett, Mr. Caulkett (the “Debtor”) had two mortgage liens on his house – one senior and one junior. Bank of America (the “Bank”) held the junior mortgage lien. The amount owed on the Debtor’s senior mortgage lien was greater than the house’s current market value. Thus, the Bank’s junior mortgage lien was wholly underwater – if the house was sold today, then the Bank would receive nothing from the sale because the house is worth less than the amount of the senior mortgage lien. The Debtor filed for Chapter 7 bankruptcy and moved to “strip off” the junior mortgage lien held by the Bank. The bankruptcy court granted the motion and both the District Court and the Court of Appeals for the Eleventh Circuit affirmed. The Supreme Court reversed.

In reaching its decision, the Supreme Court was called upon to decide whether the Bank’s junior mortgage lien was an “allowed secured claim” as defined in Section 506(d) of the Bankruptcy Code. Although the Court noted that the Debtor would be able to void the Bank’s claim under a straight forward reading of Section 506, the Court found that the phrase “secured claim” had previously been construed by the Court in Dewsnup v. Timm, 502 U.S. 410 (1992), where a debtor attempted to “strip down” a partially underwater lien. In Dewsnup, the term “secured claim” was construed to include any claim secured by a lien and fully allowed pursuant to Section 502 of the Bankruptcy Code, regardless of whether the value of the property would be sufficient to cover the claim. The Court was not willing to limit its holding in Dewsnup to partially underwater liens.

The Court found that because the Bank’s claim was secured by a lien and allowed under Section 502, it could not be voided under the definition given to the term “allowed secured claim” by Dewsnup. As such, the Bank’s junior mortgage lien could not be “stripped off” and survived the Debtor’s Chapter 7 bankruptcy proceedings.