Supreme Court Hears Oral Argument on “Lien-Stripping” in Chapter 7 Cases

In 1992, the United States Supreme Court came down with a decision in Dewsnup v. Timm that has caused a stir in the Chapter 7 bankruptcy world ever since. The Court held that, under section 506(d) of the Bankruptcy Code, a Chapter 7 debtor could not “strip down” a lien to the current value of the collateral, thereby getting rid of a junior mortgage lien, when the senior debt owed exceeds the value of the collateral. In part, the Supreme Court went against lien-stripping because the Bankruptcy Act (the predecessor to the Code) provided that liens pass through bankruptcy unaffected and the Bankruptcy Code’s ambiguous language was not a clear departure from this principle.

On November 17, 2014, the Supreme Court granted certiorari in the consolidated cases of Bank of America, N.A. v. Caulkett and Bank of America, N.A. v. Toledo-Cardona addressing lien-stripping under section 506(d). The issue, however, slightly differs from Dewsnup – the Supreme Court is deciding whether the Dewsnup holding, in the context of a partially underwater second mortgage, also applies when the second mortgage is completely underwater. On March 24, 2015, the Supreme Court heard oral argument on this very issue. Based on the American Bankruptcy Institute’s account of the recent proceedings, Justice Scalia, among others, was skeptical that Congress only intended Dewsnup to apply to partially underwater mortgages. Whatever decision the Court comes to, however, is sure to impact the practice of both Chapter 7 Trustees and lenders. We will track this as the Supreme Court nears a decision and provide an update with new information.

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