In Bank of America, N.A. v. Caulkett,[1] the U.S. Supreme Court held that a chapter 7 debtor may not void, or “strip,” a junior mortgage that is completely underwater. To fully appreciate the Supreme Court’s decision, one must understand the interplay between § 506(a) and (d) of the Bankruptcy Code and the Supreme Court’s widely criticized decision in Dewsnup v. Timm.[2]
Section 506(a) provides that “[a]n allowed claim of a creditor secured by a lien on property in which the estate has an interest ... is a secured claim to the extent of the value of such creditor’s interest in ... such property ... and is an unsecured claim to the extent that the value of such creditor’s interest ... is less than the amount of such allowed claim.”[4]
In Dewsnup, a chapter 7 debtor attempted to reduce, or strip down, a partially underwater lien to the value of the underlying collateral under § 506(a) and (d). The amount of the creditor’s claim was not in dispute and was deemed allowed under § 502 of the Bankruptcy Code. However, the debtor argued that under § 506(a), the creditor’s secured claim was limited to the value of the collateral. Hence, the lien on the debtor’s property should likewise be reduced to the value of the collateral under § 506(d) — i.e., the amount of the claim/lien deemed unsecured under § 506(a) should be stripped from the collateral because that portion was not an “allowed secured claim.”
The U.S. Supreme Court rejected the debtor’s argument, concluding that because of an ambiguity resulting solely from the parties’ disagreement over the meaning of “allowed secured claim” in § 506(d), the term could have a different meaning in § 506(a) and (d). Reading § 506(d) completely independently from § 506(a), the Supreme Court held that the debtor could not strip down the lien because the term “allowed secured claim” in § 506(d) merely required that the claim be (1) secured by a lien and (2) allowed under § 502.[6]
Fast-forward to 2015, when the Supreme Court in Caulkett agreed to consider whether a chapter 7 debtor could strip a junior lien that was wholly underwater. Notwithstanding Dewsnup, all of the lower courts, including the U.S. Court of Appeals for the Eleventh Circuit, answered in the affirmative. However, the Supreme Court disagreed and reversed and remanded. The Court succinctly summarized how § 506(a) and (d) suggest that the junior lien should be stripped down because “... if the value of a creditor’s interest in the property is zero — as is the case here — his claim cannot be a ‘secured claim’ within the meaning of § 506(a). And given that these identical words are later used in the same section of the same Act — § 506(d) — one would think this ‘presents a classic case for application of the normal rule of statutory construction that identical words used in different parts of the same act are intended to have the same meaning.’”Under this approach, the Supreme Court acknowledged that the debtor would be permitted to void the junior lien.[8] Nevertheless, the Supreme Court held that the interpretation of § 506(a) and (d) had already been decided by Dewsnup, noting that “there is scant support for the view that § 506(d) applies differently depending on whether a lien was partially or wholly underwater.”[9]
The Supreme Court emphasized that the debtor did not ask the Court to overturn Dewsnup, but rather merely attempted to distinguish its case, and further recognized in a footnote that Dewsnup has been widely criticized. One could infer that the Supreme Court may have been willing to overturn Dewsnup had it been asked to do so. However, it is far more likely that there were insufficient votes to overturn Dewsnup. Indeed, had the Supreme Court wanted to overturn one of its prior decisions, it could have done so even in the absence of an express request.
Conclusion
Whether Dewsnup ever faces a direct challenge in the Supreme Court remains to be seen. Meanwhile, it is firmly established that a chapter 7 debtor may not rely upon § 506(a) and (d) to strip down a junior lien that is either partially or wholly underwater.
[1] ----- U.S. -----, 135 S. Ct. 1995, 192 L.Ed.2d 52 (2015).
[2] 502 U.S. 410, 112 S. Ct. 773, 116 L.Ed.2d 903 (1992).
[3] 11 U.S.C. § 506(a)(1).
[4] 11 U.S.C. § 506(d).
[5] See Dewsnup, 502 U.S. at 417, 112 S. Ct. at 778.
[6] See id. at 418-19, 112 S. Ct. at 778-79.
[7] Caulkett, 135 S. Ct. at 1999 (internal citation omitted.
[8] See id.
[9] Id. 135 S. Ct. at 2001.