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June 25, 2015
Bank of America, N.A. v. Caulkett – Secured Allowed Underwater Junior Mortgage Liens Not Voidable in Chapter 7 Proceedings
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In a unanimous decision, Bank of America, N.A. v. Caulkett [1], the U.S. Supreme Court held that a debtor in Chapter 7 bankruptcy proceedings may not void underwater junior mortgage liens under §506(d) of the Bankruptcy Code if the creditor’s claim is (a) secured by a lien, and (b) allowed under the Code. This decision reversed the Eleventh Circuit Court of Appeals’ ruling and expanded the definition of a “secured claim,” as interpreted in the 1992 Supreme Court decision of Dewsnup v. Timm.[2]

Debtors in Caulkett sought to void junior mortgage liens on homes with senior mortgage liens in an amount that exceeded the homes’ current market values, asserting that §506(d) permitted debtors to strip off junior mortgage liens that were not “an allowed secured claim.” Both parties agreed that the liens at issue were allowed, pursuant to §502 of the Code. However, debtors argued the liens were not secured. A plain language reading of the Bankruptcy Code supports the debtors’ position; “an allowed secured claim of a creditor secured by a lien on property […] is an unsecured claim to the extent that the value of such a creditor’s interest […] is less than the amount of such allowed claim.[3]” On its face, the Code would appear to classify underwater junior mortgage liens as “unsecured claims,” thus making the liens voidable.

However, the Supreme Court adopted an interpretation of the §506(d) term “secured claim” in Dewsnup which supplants this plain language interpretation. In Dewsnup, the Supreme Court reasoned that claim was a “secured claim” if it was supported by a security interest in property, regardless of whether the value of that property would be sufficient to cover the claim. The Dewsnup interpretation of “secured claim” included any claim “secured by a lien and […] fully allowed pursuant to §502.” So, despite the fact that the Caulkett junior mortgage liens were wholly underwater, the Court reasoned they were nonetheless secured and allowed, therefore not voidable under §506(d).

The Court alluded that this decision was the better of two bad options, acknowledging the criticism Dewsnup has received for over two decades, and suggesting multiple times that because the debtors had not asked for Dewsnup to be overruled, the Court’s hands were tied. The Court opted to err on the side of uniformity, opining that adopting the debtor’s definition of “secured claims,” which included partially underwater liens but not wholly underwater liens, would “leave an odd statutory framework.” Whether a future litigant opts to expressly challenge Dewsnup remains to be seen, but for the time being the Caulkett decision should prove beneficial for lenders.

 

[1] 575 U.S. ___ (2015)

[2] 502 U.S. 410 (1992)

[3] 11 U.S.C. §506(a)

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