February 5, 2015
by Michael G. Clifford
Wilson & Associates, PLLC
USFN Member (Arkansas, Tennessee)
This article appeared in the USFN e-Update (Jan. 2015 ed.) and is reprinted here for those readers who missed it.
It appears that the U.S. Supreme Court will finally determine whether the Bankruptcy Code permits Chapter 7 debtors to “strip-off” wholly under-secured junior mortgage liens. Certiorari was granted on November 17, 2014 in two consolidated cases out of Florida. See Bank of America, N.A. v. Caulkett (Dkt. 13-1421) and Bank of America, N.A. v. Toledo (Dkt. 14-163). This appeal is set to resolve a 3-1 circuit split, in which only the Eleventh Circuit has held that strip-offs are permissible. (The Eleventh Circuit is comprised of Alabama, Florida, and Georgia.)
In 1992, the U.S. Supreme Court held that a Chapter 7 debtor was not permitted to “strip down” a creditor’s allowed secured claim, where the debtor was attempting to void the portion of a first mortgagee’s lien to the extent that the debt exceeded the underlying collateral’s value. Dewsnup v. Timm, 502 U.S. 410, 112 S. Ct. 773 (1992). The debtor’s argument in Dewsnup hinged upon two subsections of 11 U.S.C § 506.
Section 506(a) states that “an 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 the estate’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.” Section 506(d) then states that “[t]o the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void.”
The debtor argued that Section 506(a) defines what constitutes an allowed secured claim, and that Section 506(d) permits the debtor to void any lien (or portion of it) that does not satisfy the definition. The Supreme Court disagreed with that interpretation, and ultimately held that it was “not convinced that Congress intended to depart from the pre-Code rule that liens pass through bankruptcy unaffected.”
In the consolidated case, the Supreme Court will likely determine the related issue of whether Section 506(d) permits a Chapter 7 debtor to strip-off a junior mortgage lien in its entirety, where the outstanding senior lien exceeds the current value of the collateral. When this issue came before the Fourth, Sixth, and Seventh circuits, they all relied upon Dewsnup, concluding that its holding was equally relevant in circumstances in which a debtor attempts to strip-off (rather than strip-down) an allowed, but underwater, lien. See Ryan v. Homecomings Financial Network, 253 F.3d 778 (4th Cir. 2001); Talbert v. City Mortg. Serv., 34 F.3d 555 (6th Cir. 2003); Palomar v. First American Bank, 722 F.3d 992 (7th Cir. 2013).
In 2012, the Eleventh Circuit departed from the majority in McNeal v. GMAC Mortgage, LLC, 735 F.3d 1263 (11th Cir. 2012). The McNeal court concluded that Dewsnup was not clearly on point because it only disallowed the strip-down of a partially secured mortgage lien, and did not address the strip-off of a wholly unsecured junior lien. Determining that the Dewsnup opinion was not analogous, the Eleventh Circuit held that its pre-Dewsnup precedent (permitting the stripping of a wholly unsecured lien) was still binding. See Folendore v. Small Business Administration, 862 F.2d 1537 (11th Cir. 1989).
Currently, the Eleventh Circuit’s interpretation of Section 506 allows Chapter 7 debtors in Alabama, Florida, and Georgia to strip the liens of wholly under-secured junior mortgages. Consequently, the debtor (or perhaps other unsecured creditors) receive the benefit of any appreciation in the property, not the former lienholder. In all other states, the debtor’s discharge simply absolves the debtor of personal liability on the loan, but does not void the lienholder’s right to foreclose. The Supreme Court’s grant of certiorari should resolve the circuit split, with a decision expected in the latter half of 2015.
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