December 01, 2014

SCOTUS to Settle Chapter 7 Lien-Stripping Circuit Split

by Guest Blogger

On November 17, the Supreme Court granted certiorari in the consolidated cases of Bank of America v. Caulkett (Dkt. 13-1421) and Bank of America v. Toledo-Cardona (Dkt. 14-163). At issue in these appeals is whether the Bankruptcy Code permits Chapter 7 debtors to "strip-off" wholly out-of-the-money junior mortgages using Section 506(d). This appeal sets out to resolve a 3:1 circuit split caused by the recent McNeal v. GAMC Mortgage, LLC, 735 F.3d 1263 (11th Cir. 2012), which held that Chapter 7 strip-offs are permissible. Three other circuits (the Fourth, Sixth and Seventh) have held that such strip-offs are impermissible under the Supreme Court's holding in Dewsnup v. Timm, 502 U.S. 410 (1992).

Dewsnup dealt with what bankruptcy lawyers call a "strip down." That is, the debtor in that case attempted void the portion of a first mortgagee's lien to the extent that the debt exceeded the underlying collateral's value. The argument hinged on a construction of two subsections of Section 506 of the Code:

(a)(1) An allowed claim of a creditor secured by a lien on property in which the estate has an interest ... 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.


(d) To the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void....

The Debtor in Dewsnup argued that Section 506(a) defines what constitutes an "allowed secured claim" (i.e., the portion of the debt secured by the value of the collateral) and that Section 506(d) permits a debtor to void any lien (or portion of it) that does not satisfy that definition. The Court disagreed, reasoning that the term "allowed secured claim" is not an actual definition created by Section 506(a), and that the term "allowed secured claim" in Section 506(d) must be read "term by term" to determine whether the lien is voidable. In other words, an allowed undersecured claim may be bifurcated and classified by Section 506(a) into a secured portion and an unsecured portion, but the claim itself is still a variety of an "allowed secured claim." This approach, held SCOTUS, is consistent with the policy objectives of the Code as well as pre-Code practices.

But what happens if the lien is entirely out of the money, and can't reasonably be called any kind of "secured claim"? Subsequent to Dewsnup, debtors attempted to confine its rationale to "strip-downs," and to distinguish them from "strip-offs." Unlike a "strip-down," a "strip-off" is an effort to void a junior lien that is entirely unsecured. Three Courts of Appeal to address the matter held that Dewsnup's rationale applied with equal force to "strip-offs." See Ryan v. Homecoming Fin. Network, 253 F.3d 778 (4th Cir. 2001); In re Talbert, 344 F.3d 555 (6th Cir. 2003); Palomar v. First Am. Bank, 722 F.3d 992 (7th Cir. 2013). In McNeal, however, the Eleventh Circuit permitted the "strip-off" effort, and distinuished Dewsnup on the grounds that a wholly-unsecured mortgage is not any kind of a secured claim, but is instead a wholly-unsecured claim.

The Supreme Court's grant of certiorari in these appeals should resolve the split, one way or another. Here is a link to SCOTUSblog's coverage. I'm not so sure it's easy to predict how the cookie will crumble on this. Professor Lawless, for instance, seems resigned to the fact that SCOTUS will simply expand Dewsnup to proscribe Chapter 7 strip-offs entirely. But ideology and statutory construction may combine to create strange bedfellows and unexpected results here. Justice Scalia's dissent in Dewsnup (a 6-2 decision) was blisteringly-critical of the majority's statutory construction (the "allowed secured claim" in Section 506(d) "can only be referring to that allowed 'secured claim' so carefully described two brief subsections earlier").