The Supreme Court recently held that a debtor in a Chapter 7 bankruptcy proceeding may not void a junior mortgage lien under §506(d) when the debt owed on a senior mortgage lien exceeds the current value of the collateral if the creditor’s claim is both secured by a lien and allowed under §502 of the Bankruptcy Code.
In Bank of America, N.A. v. Caulkett, 135 S.Ct. 1995 (2015), the debtors each owned homes that were encumbered with both senior and junior mortgage liens. The values of the home were below the amount owed on the senior liens, leaving the junior mortgage liens entirely underwater. When the debtors filed their Chapter 7 bankruptcies, they moved to “strip off”, or void, the junior mortgage liens under §506 of the Bankruptcy Code.
Section 506(d) provides, “To the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void.” The dispute between the debtors and the lender rested on their interpretations of whether the junior mortgages were “secured” within the meaning of §506(d).
Despite the debtors’ urging, the Court refused to distinguish its holding Dewsnup v. Timm (502 U.S. 410, 112 S.Ct. 773, 116 L.Ed.2d 903 (1992)), and relies on Dewsnup to construe the meaning “secured” within the context of §506(d). In Dewsnup, the Court held that if a claim “has been ‘allowed’ pursuant to §502 of the Code and is secured by a lien with recourse to the underlying collateral, it does not come within the scope of §506(d).” Since the debtors did not dispute that the claims were allowed under §502, the Court held that the junior mortgages could not be stripped.
Debtors who want to strip their second (or any other junior) mortgages will have to file a Chapter 13 bankruptcy.
Stripping a junior mortgage becomes less viable as property values increase. If you are interested in stripping a junior mortgage, you should obtain the most thorough valuation possible, at least a comparative market analysis, if not a complete appraisal.
Finally, debtors can still strip judgment liens in a Chapter 7 bankruptcy.