Supreme Court limits lien stripping in Chapter 7 bankruptcies

A recent Supreme Court ruling restricts the practice of lien stripping in Chapter 7 bankruptcy cases.

The United States Supreme Court recently released a landmark ruling that limits debt relief for secondary mortgages in Chapter 7 bankruptcy filings. The case, Bank of America v. Caulkett, involved debtors whose homes were "underwater" (i.e. they owed more on the mortgage than the homes were currently worth) and who had attempted to strip away junior mortgage liens as part of a Chapter 7 bankruptcy proceeding. This was done by taking advantage of Section 506 of the U.S. Bankruptcy Code; that provision of the Code states that if a lien isn't an "allowed, secured claim," then it is void for purposes of a bankruptcy proceeding.

The mortgagor argued - and the Court eventually agreed - that stripping away the secondary/junior liens of every underwater home in Chapter 7 cases would be patently unfair to lenders because it would essentially transform an otherwise valid, secured financial interest into an unenforceable claim. The Court further explained that, in a Chapter 7 proceeding, nothing in Section 506 would void a junior mortgage lien that is otherwise enforceable and secured by collateral (the home itself) and allowable under Section 502 of the Bankruptcy Code simply because the value of the home is currently less than the value of the primary/senior mortgage.

The Court's rationale

The rationale given by the Court depends not necessarily on strict interpretation of Sections 502 and 506 of the Bankruptcy Code, but instead upon past decisions about the topic of "lien stripping." One case in particular, Dewsnup v. Timm (502 US 410), deals with some of the same issues seen in the Caulkett case. In Dewsnup, the Court found that a "secured claim" for purposes of Section 506 is simply one that is secured by an interest in the property/collateral, and the fact that the property's value is currently less than the full value of the security interest doesn't void the claim.

An important distinction

It is vitally important for both creditors and debtors alike to remember that nothing the Court says in the Caulkett decision - or the Dewsnup one, for that matter - limits the lien stripping power of the Bankruptcy Court in a proceeding initiated under a different chapter of the bankruptcy code. For example, wholly underwater secondary/junior liens can still be treated as unsecured claims and provided for as such in Chapter 13 bankruptcy proceedings.

There are, of course, many differences between Chapter 7 and Chapter 13 bankruptcies, including the qualification criteria, the length of time to achieve a debt discharge, the types of debts that can be discharged, any debt repayment required, and more, so it is key that you select the type of bankruptcy protection that is best for your unique financial situation. An experienced bankruptcy attorney like those at the Nashville law office of Rothschild and Ausbrooks, PLLC, can help you evaluate your debt relief options and find the best way for you to proceed towards a fresh financial start. Call the firm today at 866-656-8909.

Keywords: bankruptcy, Chapter 7, Chapter 13, lien stripping