The wait is over for homeowners hoping to strip their underwater junior liens in chapter 7 New York bankruptcy. The U.S. Supreme Court consolidated a pair of cases, Bank of America, N.A. v. Caulkett and Bank of America, N.A. v. Toledo-Cardona, because their facts were largely the same, and it held that the answer was no. The opinion was nearly unanimous—as in three justices chose not to concur on a footnote.
The debtors in the cases owed more on their senior mortgages than their houses were worth, and they sought to strip the liens on their underwater junior mortgages in chapter 7. Normally, debtors in those circumstances will discharge the mortgages in chapter 7 but then complete a chapter 13 case to strip the liens (called “chapter 20”). The respondents in these two cases argued that the Bankruptcy Code as written allowed them to skip the chapter 13 case entirely, and the Eleventh Circuit Court of Appeals (Al., Fla., and Ga.) agreed with them. If they had won, the benefits to underwater homeowners would have been quite significant.
At issue was the meaning of 11 U.S.C. § 506(d), which states that “To the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void.” The parties agreed that Bank of America’s claims were “allowed” claims, but they disagreed as to whether they were “secured.” The Bankruptcy Code defines a “secured claim” as having any value, so even the Court speculated that the homeowners appeared to have a point based on statutory construction.
However, the Court conceded that a 1992 case, Dewsnup v. Timm, disallowed this straightforward definition. Although that case was brought in chapter 7 by a debtor who merely wanted to cram down her junior mortgage to the extent it was underwater—but not entirely as Caulkett and Toledo-Cardona were attempting to do. In Dewsnup, the Court defined a “secured claim” as a security interest in the property irrespective of its value. Following that case, the Court then rejected the homeowners’ arguments for compartmentalizing Dewsnup‘s definition to situations in which the homeowner was merely trying to cram-down a junior lien, the most persuasive one being that the Court didn’t want to create the possibility of a “statutory framework” in which a debtor with a junior mortgage with one dollar of equity would be treated arbitrarily from another with a junior mortgage worth nothing.
Finally, the contested footnote (it didn’t even get a number; it was the only one) discussed the federal and bankruptcy courts’ dissatisfaction with the Dewsnup ruling. It’s unclear why any of the justices disagreed with these facts.
Perhaps the homeowners would have been more successful had they directly challenged the definition of “secured claim,” but they chose not to, probably because they believed their odds of success were lower. Future underwater homeowners have nothing to lose.
The opinion in Caulkett can be found here (pdf).
On the bright side, at least underwater New York homeowners aren’t worse off by the Caulkett decision. They can still attempt a “chapter 20” bankruptcy, or they can short-sell their homes. On the other hand, homeowners intent on staying put would be well-advised to consult with an experienced New York bankruptcy lawyer before committing to any course of action. “Chapter 20” isn’t right for everyone, and chapter 13 bankruptcy benefits from professional help for success.
For answers to more questions about bankruptcy, the automatic stay, effective strategies for dealing with foreclosure, and protecting your assets in bankruptcy please feel free to contact experienced Chapter 7 Bankruptcy Lawyer Brooklyn NY Bruce Weiner for a free initial consultation.