U.S. Supreme Court Weighs in on Mortgage "Strip-Offs"

Yesterday the United States Supreme Court ruled that a Chapter 7 debtor may not avoid - aka "strip off" - a second mortgage even though the amount owed on the first mortgage exceeds the value of the home that secures the loans.* This ruling is consistent with the law applied in bankruptcy courts in Virginia for many years. The decision originated from two bankruptcy cases in Florida in which Chapter 7 debtors were allowed to strip off their second mortgages.

The backdrop for yesterday's ruling is the Supreme Court's 1992 decision, Dewsnup v. Timm, that a Chapter 7 debtor cannot "strip down" a mortgage to the value of the real property collateral. The debtors involved in yesterday's ruling had asked the Court to limit the Dewsnup case to a "strip down" scenario and allow a "strip off" if the debtor can show that the second mortgage is wholly underwater. However, the Court found that the debtors had offered no compelling reason to limit Dewsnup: "[E]mbracing the debtors' distinction would not vindicate [Bankruptcy Code] §506(d)'s original meaning, and it would leave an odd statutory framework in its place. Under the debtors' approach, if 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. Given the constantly shifting value of real property, this reading could lead to arbitrary results."

In our view, notwithstanding the Supreme Court's unanimous opinion, yesterday's ruling seems to leave the door open to a future challenge to the Dewsnup case. Two times the Court pointed out that the debtors had not asked that Dewsnup be overruled, and in a footnote the Court pointed out that "[f]rom its inception, Dewsnup ½ has been the target of criticism." Further, near the end of the opinion the Court noted that "[e]ven if Dewsnup were deemed not to reflect the correct meaning of §506(d), the debtors' solution would not either." So while the Supreme Court's new ruling provides some welcomed clarity to the law of lien stripping in Chapter 7, it could be that the final word on the subject remains to be said. *

The case is Bank of America, N.A. v. Caulkett.