Creditors Holding Underwater Secured Claims in Bankruptcy Thrown Lifeline by SCOTUS

On June 1, 2015, the Supreme Court of the United States (“SCOTUS”) issued its opinion for a pair of cases, which yielded a favorable holding for secured creditors in bankruptcy.  The cases of Bank of America, N.A. v. Caulkett and Bank of America, N.A. v. Toledo-Cardona involved debtors who were in Chapter 7 bankruptcy and who each owned a home encumbered with a senior mortgage lien and a junior mortgage lien.  In both cases, the values of both houses were less than the senior mortgage lien, which left the junior mortgage liens wholly underwater.  Both debtors sought to void the junior mortgage liens under Section 506(d) of the Bankruptcy Code, which 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 each case, the Bankruptcy Court granted the debtor’s motion, which was subsequently affirmed by both the district and the federal appellate courts.  To arrive at its decision in the Caulkett and Toledo-Cardona cases, SCOTUS revisited its holding in the case of Dewsnup v. Timm.  502 U.S. 410.  In Dewsnup, the junior mortgage lien was only partially underwater.  SCOTUS concluded, however, in Caulkett that whether the junior mortgage lien was either partially or wholly underwater, it was a distinction without a difference.  SCOTUS determined that an allowed claim secured by a lien with recourse to the underlying collateral did not come within the scope of Section 506(d).  This meant that a “secured claim” included a claim secured by a lien on a residence, regardless of whether the value of the home would be sufficient to repay either part or all of the claim.  In its 9-0 decision in Caulkett, SCOTUS upheld the result in Dewsnup by reaffirming that a debtor cannot strip a junior mortgage from his or her residence under Section 506 of the Bankruptcy Code if the creditor’s claim is both secured by a lien on the residence and allowed as a secured claim under Section 502 of the Bankruptcy Code.  SCOTUS’ opinions in the foregoing pair of cases likely come as welcome news to secured creditors who are already in the unenviable position of holding either partially or wholly underwater junior mortgage liens.  While these decisions neither improve a home’s value nor upgrade the priority of the secured creditor’s lien, they do not add insult to injury by allowing the debtor to either partially or completely strip the secured creditor’s already devalued lien.