Underwater Creditors Get SCOTUS Lifeline

On Monday, a unanimous Supreme Court ruled in Bank of America v. Caulkett that debtors could not avoid those second mortgages in Chapter 7 liquidations.

BOA held a second mortgage on the Caulkett home but the first mortgage gobbled it up and BOA was left holding the bag. (Caulkett owed just over $230K on a house worth $98K.) Caulkett sought to void BOA’s mortgage under sec. 506(d) of the Bankruptcy Code. The bankruptcy judge granted the motion and the court of appeals affirmed. The question presented was whether a lien against collateral that had no residual value for the holder was in law what it could not be in fact: a “secured claim.”

The argument advanced by the debtor was based on the plain meaning of the text. That is, “[s]ection 506(a)(1) provides that ‘[a]n allowed claim of a creditor secured by a lien on property . . . is a secured claim to the extent of the value of such creditor’s interest in . . . such property,’ and ‘an unsecured claim to the extent that the value of such creditor’s interest . . . is less than the amount of such allowed claim.'”

The court acknowledged that this was the “straightforward” reading of the statute but rejected it nevertheless based on the 1992 case, Dewsnup v. Timm, 502 U. S. 410. The court there refused to read the statute in a way that would allow the bankruptcy court to “strip down” a junior lien to its true value after subtracting the amount absorbed by a senior lien.  It “defined the term ‘secured claim’ in sec. 506(d) to mean a claim supported by a security interest in property, regardless of whether the value of that property would be sufficient to cover the claim.” Caulkett refused to tamper with that gloss: 

Ultimately, embracing the debtors’ distinction would not vindicate §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. To be sure, the Code engages in line-drawing elsewhere, and sometimes a dollar’s difference will have a significant impact on bankruptcy proceedings. See, e.g., §707(b)(2)(A)(i) (presumption of abuse of provisions of Chapter 7 triggered if debtor’s projected disposable income over the next five years is $12,475). But these lines were set by Congress, not this Court.

The court made clear that Dewsnup was a policy-driven decision and stressed (more than once) that the debtors had not asked that it be overruled. That case of course, removed a risk for second mortgage lenders by giving them a say in liquidation loan modifications or short sales.

Six justices let it be known that Dewsnup “has been a target of criticism.”  (Justice Thomas, who wrote Caulkett, has been one such critic according to New Republic.) Easy money. Did congress originally intend for second mortgage lenders to pass this risk to consumers in the first place? Are the Supremes telegraphing an interest in getting out of the game? Is this a SCOTUS triple dog dare?

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