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Underwater Mortgages Cannot Be Stripped Down in Chapter 7 - For Now at Least: Caulkett

The United States Supreme Court has unanimously ruled that a junior mortgage that is 'under water' - that is, the value of the house is less than the senior mortgage - cannot be stripped down or removed as an unsecured claim in a chapter 7 bankruptcy. And yet, the opinion seems to invite a challenge to the very case the court is relying upon for its conclusion.

Caulkett v. Bank of America, the Supreme Court case decided June 1, 2015, holds that the court's 1992 ruling in Dewsnup v. Timm, 502 US 410, had already decided the issue in question. In Dewsnup, the court was asked to find a partially underwater mortgage unsecured to the extent that there is no equity to support it. For example, if a house was worth $100,000, and had a first mortgage of $80,000 and a second mortgage of $50,000, the debtors in Dewsnup believed the junior mortgage should be reduced to $20,000 as a secured claim and the remaining $30,000 would be treated as an unsecured claim in chapter 7, discharged in bankruptcy.

The Dewsnup court ruled against the debtors, 6 to 2. The recent case, Caulkett, had similar facts, except that the junior mortgage was entirely underwater (say, using the example above, the senior mortgage was $110,000, leaving no equity for the second mortgage).

The Caulkett court followed the same statutory analysis as Dewsnup. However, the Caulkett analysis begins with a compelling grgument that the debtor's interpretation is correct: "Section 506(d) [of the bankruptcy code] provides, 'To the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void.' ... In other words, if the value of a creditor's interest in the property is zero - as is the case here - his claim cannot be a 'secured claim' within the meaning of Section 506(a). And given that these identical words are later used in the same section of the same Act - Section 506(d)-one would think this 'presents a classic case for application of the normal rule of statutory construction that identical words used in different parts of the same act are intended to have the same meaning.' [citration omitted]"

But the court went on with bad news for the debtors: "Unfortunately for the debtors, this Court has already adopted a construction of the term 'secured claim' in Section 506(d) that forecloses this textual analysis ... Rather than apply the statutory definition of 'secured claim' in Section 506(a), the [Dewsnup] Court reasoned that the term 'secured' in Section 506(d) contained an ambiguity because the self-interested parties before it disagreed over the term's meaning. ... In other words, Dewsnup defined the term 'secured claim' in ยง506(d) to mean a claim supported by a security interest in property, regardless of whether the value of that property would be sufficient to cover the claim."

Based on the Dewsnup statutory analysis, the Caulkett court ruled that the same analysis applies to wholly unsecured mortgages. The relatively short opinion - seven pages - was written by Justice Thomas, and the decision was unanimous.

And yet - three of the court members dissented form one part of the decision, a footnote no less. There is only one footnote to the opinion: a footnote that starts "From its inception, Dewsnup v. Timm, 502 U. S. 410 (1992), has been the target of criticism." The footnote goes on to cite the dissent to Dewsnup by Justice Scalia. The footnote concludes, "Despite this criticism, the debtors have repeatedly insisted that they are not asking us to overrule Dewsnup." The main text of the opinion also stated, twice, that the debtors had not requested the Court to overrule Dewsnup.

Justices Kennedy, Sotomayor and Breyer dissented from the footnote criticizing Dewsnup. Which means, of course, that Justice Thomas, Scalia, Alito, Ginsburg, Kagen and Chief Justice Roberts did NOT object to this Dewsnup criticism.

What is going on here? The original Dewsnup opinion was written by Justice Blackmun, and supported by five other justices, of which Justice Kennedy is the only member of the Dewsnup majority still on the court. The dissent in the case was written by Justice Scalia, joined by his ideological opposite, Justice Souter. Oral arguments had taken place a few days before Justice Thomas joined the court, so he took no part in the Dewsnup decision.

It would be a fair analysis that, of the current court members and Justice Scalia and Thomas, at least, would be sympathetic to be a challenge to Dewsnup. It would be a further fair reading that only Justice Kennedy and the other two footnote-objectors would uphold Dewsnup and the other justices might well be sympathetic to a challenge to it.

The Caulkett footnote, criticizing Dewsnup is certainly not needed for the case. Rather than providing supplementary information concerning the case, as footnotes usually do, it provides instead a criticism of the precedent case upon which the case was based. Could there be a clearer signal inviting a challenge?

The Bankruptcy Code is a federal law, interpreted by countless court decisions, including on occasion decisions by the United States Supreme Court. My practice concentrates on bankruptcy. If you live in the Greater Rochester NY area and would like an analysis of your situation to determine if a bankruptcy is appropriate for you, please contact attorney Peter Scribner.

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