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Argument analysis: Navigating between Scylla and Charybdis on underwater mortgages

After today’s oral argument in Bank of America v. Toledo-Cardona and Bank of America v. Caulkett, it was hard to say how the Court might ultimately rule on the question before it – whether the Bankruptcy Code allows courts to void a second mortgage when even the first mortgage is completely worthless.  What was clear, though, is that the Justices were (all things being relative) having a pretty good time – one lawyer who tracks laughs at the Court compared the scene to the famous comedy improv group Second City.  And why not?  No matter how the case turns out, there was a lot for them to like about it.  Even if the Justices were not always familiar with the intricacies of bankruptcy law and procedure, it nonetheless offered excellent advocates on both sides, weighty policy questions, and intellectually interesting questions about how the Court should deal with precedent that the Justices don’t like, but without the media spotlight and tension that often accompany higher-profile cases.   

Arguing on behalf of Bank of America, which urged the Court to hold that its junior mortgages on Toledo-Cardona’s and Caulkett’s houses could not be voided, Danielle Spinelli emphasized that Toledo-Cardona and Caulkett were asking the Court to allow them to keep their houses and strip off the second mortgages, thereby preventing Bank of America from recovering any of its money even if the value of the houses later rebounded.  But that prompted Justice Ruth Bader Ginsburg to ask the first of many questions about practical and policy concerns:  What, she asked, is the value of a completely underwater second mortgage, and how likely is it that the second mortgage will actually regain any value?  Spinelli assured her that, although the homeowners in this case were “very underwater,” they were “not typical.”  In some cases, she told the Court, the second mortgage would no longer be underwater if the home gained even as little as four or five thousand dollars in value.  With the upswing in the housing market, she explained, houses are “coming out from underwater every day.”

Justice Sonia Sotomayor also expressed some discomfort with the implications of the bank’s proposed rule – specifically, the possibility that it would allow the holders of second mortgages to hold negotiations between the debtor and the first lender “hostage,” preventing them from reaching an amicable solution and avoiding foreclosure.  Spinelli countered that Sotomayor’s concern was “not a bankruptcy problem”; “it’s a housing policy issue,” she said.

Spinelli also fielded questions from all sides at the Court about the Court’s 1992 decision in Dewsnup v. Timm, holding that when a mortgage lien is worth more than the market value of the property, Section 506(d) of the Bankruptcy Code does not allow courts to reduce the value of the lien to that market value.  Justice Antonin Scalia reminded Spinelli that he had “dissented in Dewsnup,” and “continue[s] to believe that dissent was correct.”  Why, he asked Spinelli, shouldn’t the Court “limit Dewsnup to the facts that it involved, which is a partially underwater mortgage?”  That kicked off a broader discussion among the Justices about how they should deal with decisions that they believe to be wrong; that in turn led to a discussion about whether banks had relied on the decision in Dewsnup, such that the Court should not rule in favor of the homeowners here.  Spinelli agreed that the banks had relied on the decision “to make millions of loans,” but she conceded that reliance was not “actually . . . the most compelling argument as to why the Court shouldn’t depart from Dewsnup.”  Spinelli’s concession led to one of several light moments today, when Justice Elena Kagan told her that she had “read the two Dewsnup opinions, and it seems to me that Justice Scalia clearly has the better of the argument” – eliciting a triumphant “yes!” from Scalia. Chief Justice John Roberts appeared more sympathetic to the bank’s argument that it is difficult to distinguish between the partially underwater mortgages at issue in Dewsnup and the completely underwater mortgages here; he drew a laugh (apparently unintentionally) when he observed that the distinction is a “particularly fluid” one in this case, because the mortgages can easily vacillate between being partially and fully underwater as home values rise or fall.

Arguing on behalf of the debtors, Stephanos Bibas also fielded questions about the practical and policy impact of his proposed rule.  Justice Stephen Breyer, for example, emphasized that the Court’s ruling wouldn’t just apply to homeowners; it would also extend to businesses that go bankrupt.  And Justice Anthony Kennedy told Bibas that “it’s hard for me to think that a decision in your favor wouldn’t, in a sense, hurt borrowers because the market for a second [mortgage] is going to dry up or become much more expensive.”  Bibas countered by citing economic experts who have concluded that “resolving subordinate loans was the biggest obstacle to the housing recovery.”  And Justice Scalia – despite his tough questions for Spinelli – pressed Bibas to explain why, under his rule, if a lien is worth one dollar, the lienholder wouldn’t lose it, but the lien would be stripped if it were worth one dollar less – that is, zero.  Do you think, Scalia continued, that this is the line that Congress wanted to draw?  Bibas later attempted to push back against the bank’s contention that the Court should not allow the debtors to strip off second mortgages so that the holders of the mortgages could benefit from subsequent increases in home value.  Future value, he maintained, has no significance in bankruptcy, which focuses only on an item’s current value.

Like Spinelli, Bibas also had to deal with the Court’s decision in Dewsnup.  He declined to argue that it should be overruled, telling the Court that his clients could prevail even if Dewsnup remains good law.  Justice Ginsburg countered that “the law would be much more coherent if either Dewsnup applies to the totally underwater as well as partially underwater, or Dewsnup is overruled.”  Bibas’s response – that his reasoning “is still more faithful to the text than” the bank’s – drew questions from Justice Sotomayor, who complained that such a result would give “exactly the same phrase in the statute two different meanings, depending on whether one’s underwater or not, completely or partially.”

Toward the end of the argument, Justice Kagan summarized (as she seems to do so often) the choice facing the Justices.  On the one hand, she told Bibas that “these distinctions that you are drawing between partially underwater and fully underwater are not terribly persuasive.”  But on the other hand, she continued, “the only thing that may be less persuasive is Dewsnup itself.”  Which of these will be the lesser of two evils for the Court in the end?  We will know by summer.

Recommended Citation: Amy Howe, Argument analysis: Navigating between Scylla and Charybdis on underwater mortgages, SCOTUSblog (Mar. 24, 2015, 6:38 PM),