Strip-off or Strip-down, It’s All the Same Chapter 7 Strip-off of Junior Liens Disallowed by Supreme Court
Written by Managing Partner Sean Corcoran
Starting in May 2012, bankruptcy courts in the 11th Circuit (Florida, Georgia, Alabama) began allowing debtors to void under-secured junior liens during their Chapter 7 bankruptcy cases. The recent decision by the Supreme Court in Caulkett (Bank of America, N.A. v. David B. Caulkett, 575 US ____ Slip op) has brought the trend to an abrupt halt.
Also known as a “strip-off,” the practice is commonly used in Chapter 13 cases and enables a debtor to void junior liens where there is no excess value in the secured property above the amount secured by a senior lien. In the mortgage context, a common strip-off example is as follows:
- Home Value: $150,000
- 1st Mortgage balance: $160,000
- 2nd Mortgage balance: $35,000
- Net Equity in secured property after deducting 1st: $0
- Value in secured property available for 2nd lien: $0
The resulting negative equity allows the debtor to void or “strip-off” the junior lien leaving the previously secured creditor with an unsecured claim.
The ability of the bankruptcy courts to order strip-offs has remained unchanged since the early 1990s. The Supreme Court’s earlier Dewsnup (Dewsnup v. Timm, 502 US 410) decision defined the limits of a common bankruptcy lien valuing tool known as “strip-down” (reduction of a lien amount to the value of the secured property) to the exclusion of Chapter 7. Since that time, the majority of bankruptcy courts and three circuit courts have read the Dewsnup case broadly as also preventing strip-off in Chapter 7. With the McNeal (In re McNeal, 735 F.3d 1263) decision by the 11th Circuit Court of Appeals, the scope of Dewsnup was limited to Chapter 7 strip-down and therefore did not prevent strip-off. A substantial number of Chapter 7 cases invoking the strip-off remedy followed.
On June 1, 2015, the Supreme Court weighed back in on the issue in the Caulkett case holding that the rule in Dewsnup also applies in Chapter 7 to both strip-down and strip-off. Specifically, in an unanimous decision, the court determined that the same analysis used in the Dewsnup decision applies in the strip-off context: to the extent a secured creditor’s claim is allowed, it cannot be reduced or voided. Therefore, junior liens that find themselves under-secured after deducting the senior mortgage amount are no longer eligible to be voided on the basis of valuation alone.
While this is clearly welcome news for creditors holding secured junior liens, don’t expect the issue to be permanently resolved. The Caulkett opinion repeatedly notes that the Court was stuck with the existing, “unfortunate” case law from Dewsnup seemingly because the Court was not asked to overrule the earlier decision. Presumably, this is the roadmap for any future challenges to the Dewsnup and Caulkett prohibition of Chapter 7 strip-offs (and strip-downs). Stay tuned.
