Pub. 6 2015 Issue 4

www.wvbankers.org 10 West Virginia Banker I n an essentially unanimous decision, the Supreme Court of the United States recently held that debtors cannot “strip off ” junior mortgage liens in chapter 7 bankruptcy proceedings when the amount owed to the senior lienholder exceeds the cur- rent value of the collateral. In Bank of America v. Caulkett, ___ U.S. ___, 135 S. Ct. 1995 (June 1, 2015), the borrowers filed petitions for chapter 7 bankruptcy in the United States Bankruptcy Court for the Middle District of Florida. At the time of filing, both borrowers’ homes had a second mortgage that was completely “underwater,” meaning the current value of their homes was less than the amount still owed on the first mortgage. A second mortgage is a “junior lien” because, in the event of a foreclosure, the debt owed on a second mortgage can be collected only after the debt owed on a first mortgage has been satisfied. Bank of America held both junior liens in this case. The Bankruptcy Code voids liens that are not “allowed secured claims.” The bankruptcy court granted the borrowers’ requests to strip off, or void, the junior liens on their homes, and Bank of America appealed to the United States District Court for the Middle District of Florida, which affirmed the bankruptcy court’s decision. The United States Court of Appeals for the Eleventh Circuit also affirmed the lower courts’ decisions. The Supreme Court granted Bank of America’s petition and heard the case. The Supreme Court reversed. In a previous case, Dewsnup v. Timm, the Supreme Court held that chapter 7 debtors cannot “strip down” a partially underwater lien to the current value of the collateral because a partially underwater lien is a “secured claim.” The borrowers in this case argued that the Court’s ruling in Dewsnup does not apply to completely underwater liens be- cause, in the event of a foreclosure, the junior lienholder would not recover anything. Thus, the borrowers asserted that a com- pletely underwater lien is “unsecured.” In this case, the Supreme Court declined to limit Dewsnup to partially underwater liens. It held that a secured claim is a claim supported by a security interest in property, irrespective of the value of the collateral. Under the lien stripping provision of the Bankruptcy Code, the Court held, the term “secured claim” refers to “a claim supported by a security interest in property, regard- less of whether the value of that property would be sufficient to cover the claim.” Therefore, the Court held that an allowed claim secured by a lien on property cannot be stripped down or stripped off in chapter 7 bankruptcy proceedings because it is partially or even completely underwater. This case is a win for lenders who find themselves creditors in chapter 7 cases, as they can now rest easy knowing that their ju- nior liens will survive a debtor’s chapter 7 bankruptcy even if they are entirely underwater. Only time will tell whether the Court’s holding in Caulkett will be extended to chapter 13 cases; at least two bankruptcy courts already have held that it does not apply in chapter 13 cases. n The author presents thesematerials with the understanding that the information provided is not legal advice. Due to the rapidly changing nature of the law, information contained in this publication may become outdated. Anyone using these materials should always research original sources of authority and update this information to ensure accuracy when dealingwith a specificmatter. No person should act or rely upon the information contained in this publication without seeking the advice of an attorney. Julia A. Chincheck and Daniel J. Cohn are lawyers in the Charleston office of Bowles Rice LLP. Ms. Chincheck is a partner of the firm and concentrates her practice in the areas of banking and creditors’ rights and bankruptcy, with emphasis on complex commercial transactions and commercial litigation. Daniel Cohn focuses his practice in commercial and financial service, including mergers and acquisitions, secured lending, bankruptcy, and regulatory matters. For more information, please contact Ms. Chincheck or Mr. Cohn at (304) 347-1100. Chapter 7 Debtors Cannot Strip Junior Liens By Julia A. Chincheck and Daniel J. Cohn, Bowles Rice LLP