Supreme Court Ruling Resuscitates Underwater Second Mortgage Holder Protection
Article by Tom King
On June 1, 2015, the U.S. Supreme Court ruled unanimously in the case of Bank of America, N.A. v Caulkett, that junior mortgages (commonly referred to as second mortgages or home equity loans) may remain as secured claims and not be “stripped off” or “voided” under §506(d) of the Bankruptcy Code. The ruling specifically refers to mortgages on a debtor’s residence for which the amount owed under a senior mortgage is greater than the value of the property in Chapter 7 bankruptcy cases.
The ruling is good news for lenders in cases where there has been a reduction in the value of the debtor’s residence leaving the junior mortgage or home equity loan fully unsecured. Prior to this ruling, the prevailing law in the Circuit Courts of Appeals was that, in order to maintain its secured claim, the junior mortgage holder must have at least one dollar in equity. Otherwise, the claim of the mortgage holder on a debtor’s residence was not considered a “secured claim” and could be “stripped off” or “voided” by the debtor in the Chapter 7 bankruptcy case.
The Supreme Court held that the definition of the term “secured claim” was governed by its prior ruling in Dewsnup v Timm, 502 US 410 (1992). That ruling found that a “secured claim” under §506(d) of the Bankruptcy Code meant a claim supported by a security interest in property regardless of whether the value of that property would be sufficient to cover the claim. This ruling marks a significant clarification of the law with regard to junior mortgage claims on residences owned by Chapter 7 debtors.
This case, at least in the short term, protects junior mortgages - even those that are completely underwater - from being “stripped off” or “voided.” However, it may not be the final word on this issue. The Supreme Court went out of its way to indicate that the parties had not requested that it overrule Dewsnup. Rather, they requested that the Supreme Court limit Dewsnup only to partially underwater mortgage liens as opposed to wholly underwater liens. The Supreme Court indicated:
“The Debtors here have not asked us to overrule Dewsnup, and we decline to adopt the artificial distinction they propose instead."
This and other language in the Supreme Court’s opinion is likely to invite another challenge to the limitation on the debtor’s ability to “strip off” or “void” mortgages that are either wholly or partially underwater, arguing that Dewsnup should be overruled. It is likely to take some time for such a challenge to reach the Supreme Court. Stay tuned.