Monday, June 29, 2015

The Supreme Court Takes a Firm Stand Against Lien Stripping in Chapter 7 Bankruptcies

A recent hot topic in bankruptcy law has been whether a debtor in Chapter 7 can strip off or down a lien that is wholly unsecured. On June 1, 2015, the Supreme Court put the topic to rest by ultimately deciding that debtors in a Chapter 7 cannot strip off or down a lien that is wholly or partially unsecured if it was originally both secured and allowed under §506(d) of the Bankruptcy Code.  
The concept is that debtors who have multiple allowed secured liens on property would be able to reduce the amount of the lien down to the fair market value of the property. If the value of the property was more than the senior mortgage, then the junior mortgages would be reduced to the remaining fair market value of the property. If the fair market value of the property was less than the senior mortgage, the junior mortgages could be avoided and reclassified as unsecured debt.
What is an allowed secured claim? 11 U.S.C. § 502 provides that an allowed claim is one in which there is no objection by a party in interest. Even if there is an objection, the Court has the power to determine if the claim should be allowed or not. According to section 506 of the bankruptcy code, an allowed secured claim exists where a creditor has secured a lien on the property in which the estate has an interest or that is subject to setoff, and is secured to the extent of the value of the creditor's interest in the estate's interest in such property. This means that an allowed secured claim exists where a creditor has a claim over a piece of property of the debtor, and either there is no objection to the claim coming in, or the Court has determined the claim should be allowed. The most common secure claims are mortgages, tax liens, or car loans. 
There are two cases of note that have come before the Supreme Court in the last 25 years that change this for chapter 7 debtors. The first was decided in 1992, when the Court refused to allow the Debtor to "strip down" or reduce the amount owed on the second mortgage to the remaining fair market value. Dewsnup v. Timm,  502 U.S. 410 (1992). In that case, the Debtor contended that she owed more than the fair market value of her home, and petitioned the Court to allow her to reduce the amount owed to match the fair market value. The Court reasoned that this could not be done because the claim in question had already been allowed and was secured by a lien, therefore, could not be reclassified as "not allowed" for purposes of avoiding them or reducing them. Id. The Court in this case agreed that the definition of a "secured" claim rested not on if it was fully secured, meaning equaled the value of the property, but rather, was secured by a lien at all, and whether the claim  had been "fully allowed" in the bankruptcy proceeding. Id. In other words, if the claim was secured by a lien, but the entire amount of the claim had been allowed initially, the amount of the claim could not be reduced.
The second case was decided on June 1, 2015 and took the Dewsnup decision one step further. The Court decided in Bank of America v. Caulkett that debtors in a chapter 7 could not avoid a claim that is entirely underwater if it was originally allowed and secured. 135 S. Ct. 1995 (2015). In this case, the second mortgage of the debtors was completely underwater, meaning the fair market value of the property owned was less than the first mortgage owed, leaving nothing for the second mortgage to attach to. The Court applied the same reasoning it used in Dewsnup years before, saying there was no distinction between partially secured and totally unsecured multiple liens. Id. The Court continued with the line of reasoning that if the claim was originally fully allowed and secured, it should remain so throughout the case.
These two decisions take away the ability of chapter 7 debtors to avoid fully or partially underwater liens during their bankruptcy if they are fully allowed and secured at the beginning of the case. After these cases, the best way to avoid the debt in chapter 7 cases would be to object to the claim as it came in, and leave it to the court to decide whether it should be allowed or not. 

By:  Samantha Marriott, Attorney at The Law Offices of Jason A. Burgess, LLC

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