Opinion analysis: Bad news for “underwater” homeowners
on Jun 1, 2015 at 5:34 pm
A little over two months ago, the Justices heard oral argument in Bank of America v. Caulkett. The issue is whether in a bankruptcy liquidation (a so-called Chapter 7), the debtor can void a second mortgage when the property (typically, the home) is worth less than the first mortgage. By the end of the arguments, the Justices appeared to have two choices, both of which they regarded as fairly unpalatable. On the one hand, as the bank urged, they could rely on a 1992 decision (Dewsnup v. Timm) that seems to go a long way towards dictating a ruling in the bank’s favor that the second mortgage stays, even if many of them don’t believe that the old decision is very persuasive. On the other hand, they could instead rule in favor of the homeowners that the second mortgage is voidable, even if they don’t think that the distinction that the homeowners are asking them to draw between their situations and the one at issue in the 1992 decision is very persuasive either.
Even if it was hardly a ringing endorsement, a near-unanimous Court (more on that later) followed Dewsnup, in which the Court had ruled that, when a mortgage lien is worth more than the market value of the property at issue, the Bankruptcy Code does not allow courts to reduce the lien’s value to the property’s market value.
Justice Thomas’s opinion for the Court is straightforward: barely seven pages, with none of the anxiety displayed at the oral argument. Section 506(d) of the Bankruptcy Code, the Court explains, allows a debtor to void a lien on his property when it “secures a claim against the debtor that is not an allowed secured claim.” Everyone in the case agreed that Bank of America’s claims are allowed. The real question at issue in the case is whether the claims are secured. And although the text of the Bankruptcy Code seems to suggest that they are not – because the value of the bank’s interest in the property is zero – Dewsnup says otherwise.
In Dewsnup, the Court was dealing with what’s known as a “partially underwater” mortgage: the debtor owed $120,000, but wanted to reduce that debt to $39,000, which was the current value of the collateral securing the debt. But the Court ruled that she could not do so because the creditors’ claim was secured by a lien and was therefore is “secured” for purposes of Section 506(d).
In this case, the homeowners were not partially, but instead completely, underwater: David Caulkett’s house was worth $98,000 when he filed for Chapter 7 bankruptcy, but he owes $183,000 on his first mortgage and $47,000 on his second; Edelmiro Toledo-Cardona’s house was worth just under $78,000 when he filed for bankruptcy, owing $135,000 on his first mortgage and $32,000 on his second. Dewsnup’s reasoning, the Court ruled today, fully applies to mortgages that are completely underwater. Distinguishing between mortgages that are partially and fully underwater, as the homeowners in this case argued that they should, would create an “odd statutory framework”: if a court determined that the value of the property was one dollar more than the amount of the first mortgage, then the second mortgage could not be voided, but the second mortgage could be voided if the property were valued at a dollar less than the first mortgage. “Given the constantly shifting value of real property,” the Court concluded, “this reading could lead to arbitrary results.”
In a footnote in the middle of the opinion, the Court acknowledged that, “[f]rom its inception,” the twenty-three-year-old decision in Dewsnup “has been the target of criticism.” But it emphasized that, “[d]espite this criticism,” the homeowners in this case “have repeatedly insisted that they are not asking us to overrule Dewsnup.” Three Justices – Anthony Kennedy, Stephen Breyer, and Sonia Sotomayor – declined to join the footnote. What will this mean if, in a future case, some other debtor expressly asks the Justices to overrule Dewsnup? Stay tuned . . . .