/Debtors Cannot Strip Liens Off Of Underwater Houses in Chapter 7 Bankruptcy
The U.S. Supreme Court reversed a lower-court decision allowing debtors to “strip off” underwater second liens in Chapter 7 bankruptcy, saying precedent required it to keep such mortgage claims intact.
Justice Clarence Thomas, caught between his usual adherence to the strict wording of statutes and the competing doctrine of stare decisis, ruled that a prior decision carved out an exception from bankruptcy law for mortgage liens.
The unanimous decision in Bank of America v. Caulkett is a victory for lenders who said it would be unfair to require them to give up potentially valuable claims simply because a home’s current value is depressed. It’s a defeat for consumer advocates who favor using bankruptcy to reduce the amount borrowers owe against their houses, although borrowers can still strip underwater second liens through the more costly and time-consuming process of Chapter 13 bankruptcy.
While bankruptcy judges generally can order reductions in unsecured debts like credit card balances, loans secured by liens on real estate are protected by the fact the lender can seize the collateral. The question in this case was whether a second lien claim for more than could be recovered by selling the house fit the definition of “secured.”
The Supreme Court already has ruled that in Chapter 13 reorganizations, where debtors with reliable income set up a plan to repay creditors over time, second mortgages with no collateral value to back them up can be stripped. And Section 506(a) of the Bankruptcy Code, which applies to Chapter 7 liquidations, also defines a “secured claim” as being secured by property worth more than the claim and “unsecured claim” as being worth less.
“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,’” Thomas wrote.