Supreme Court to Hear Chapter 7 Lien Stripping Case

On November 17, 2014, the U.S. Supreme Court recently agreed to hear two cases that could have a major impact on debtors across the country. The cases are Bank of America v. David B. Caulkett and Bank of America v. Edelmiro Toledo-Cardona, two Chapter 7 cases on appeal from the Eleventh Circuit Court of Appeals (Alabama, Georgia, and Florida). In each case, the appellate court allowed the bankruptcy debtor to strip off an entirely unsecured junior mortgage held by Bank of America. While lien stripping second and third unsecured mortgages is common across the country in Chapter 13 cases, only the Eleventh Circuit has allowed Chapter 7 debtors to rid themselves of junior liens on their underwater homes.

Bank of America argues that the Eleventh Circuit holding is contrary to the Supreme Court case of Dewsnup v. Timm, which found that “liens pass through bankruptcy unaffected.” However, most courts limit the holding of Dewsnup in Chapter 13 cases to liens secured by equity. The question boils down to whether the Bankruptcy Code prevents a Chapter 7 debtor from stripping off a secured lien that is not secured by any equity in the property. Once the mortgage lien is extinguished and the debt is discharged, the lender has no recourse against the debtor or the property.

If the high court agrees with the Eleventh Circuit, that ruling may pave the way for debtors across the country to extinguish junior mortgages in Chapter 7 without payment. Supreme Court decisions are binding on all federal courts.