Supreme Court Ends Chapter 7 Lien Stripping

From time to time the CAR lawyers receive questions about the possibility of voiding or "stripping" a lien in a bankruptcy proceeding when the value of the property has fallen below the amount of the lien. Usually this would only apply to a second lien when the value of the property has fallen below the value of the first mortgage; the second lien is now "unsecured" and can be stripped or voided. This process is allowed in a Chapter 13 reorganization but the lien is stripped only if the debtor completes the bankruptcy plan.  

However, in most of the country, a debtor could not use the lien stripping process in a Chapter 7 liquidation.  Only the 11th Circuit (Alabama, Florida, Georgia) allowed this if the lien was totally unsecured, holding they were bound by 11th Circuit precedent. The 11th Circuit had found a distinction in a 1992 Supreme Court case, Dewsnup v. Timm, 502 U.S. 410 (1992), where the Supreme Court held that a Chapter 7 lien that was only partially underwater could not be "stripped" or voided.  Following an unpublished opinion in its own Circuit, some courts in the 11th Circuit had found that a wholly underwater lien could be stripped in Chapter 7.

  

The Supreme Court, in Bank of America, N.A. v. Caulkett, No. 13-1421, was asked to resolve the issue.The Supreme Court held that Dewsnup applied to both partially underwater and fully underwater liens and both were "allowed secured claims" under §§ 502 and 506 of the Bankruptcy Code and could not be voided or stripped in Chapter 7.  Even though the Court recognizes that Dewsnup has been criticized since its inception, it points out the debtors were not asking that it be overruled, only that it be limited to a partially underwater lien.

 

While this case may not have a great impact in California, it does make it clear that a debtor who wants to strip underwater liens cannot use Chapter 7.