Stripping of Liens in Bankruptcy

On June 1, 2015, the U.S. Supreme Court in Bank of America v. Caulkett, (US, Case No. 13–1421, 2015) put to rest an ongoing legal debate by reiterating that a chapter 7 bankruptcy may not be used to “Strip off” or “Strip down” a wholly or partially underwater subordinate lien.

Over 20 years ago, the United States Supreme Court, in Dewsnup v. Timm, 502 U.S. 410 (1992) barred Chapter 7 debtors from stripping a creditor's partially-secured claim down to the value of the collateral securing it. That triggered a great deal of scholarly debate and the development of what is sometimes referred to as a “Chapter 20 Bankruptcy.” In a “Chapter 20” a Chapter 13 bankruptcy is filed to strip and restructure liens after completing a Chapter 7 bankruptcy and discharge.

In the intervening years, some courts, including the Eleventh Circuit Court of Appeals had held Dewsnup did not apply when the junior loan was wholly unsecured (i.e. the first mortgage debt exceeded the current value of the property) rather than partially unsecured. In re: McNeal, 735 F.3d 1263 (11th Cir 2012). Since McNeal was an unpublished opinion, it created some uncertainty, especially within the Southeast states that are part of the Eleventh Circuit with unchallenged stripping of liens permitted to proceed.

From an underwriting standpoint, WFG’s position on this case is as follows:

WFG will not rely on a bankruptcy court order “stripping down” or “stripping off” a subordinate lien in a Chapter 7 bankruptcy entered (1) after the ruling in Caulkett (June 1, 2015) or (2) in a bankruptcy where the case was closed less than one year before the current date.

A foreclosure completed after the “stripping” of liens in a chapter 7 bankruptcy may be insured with Underwriting approval, whether the holder of the stripped lien was noticed or not.

WFG will rely on a bankruptcy court order “stripping down” or “stripping off” a lien appropriately entered in a Chapter 11 bankruptcy.

WFG Agents may rely on a bankruptcy court order “stripping down” or “stripping off” a lien entered in a Chapter 13 bankruptcy Only With Underwriter Approval.

WFG will continue to rely on appropriately entered orders authorizing sale of assets “free and clear” of liens under Bankruptcy Code §363(f).

Preliminary Notes for Underwriting: (Not based on full research)

The Caulkett case interprets a provision of general applicability to all types of bankruptcy. In a Chapter 13 context, the U.S. Supreme Court has previously held that a partially unsecured lien against the debtor’s homestead may not be “stripped down” But that ruling was based on a specific provision of chapter 13. Section 1322(b)(2), which the court concluded prohibits a Chapter 13 debtor from relying on §506(a) to reduce an undersecured homestead mortgage to the fair market value of the mortgaged residence. Nobelman v. American Sav. Bank, 508 U.S. 324, 113 S.Ct. 2106, 124 L.Ed.2d 228 (U.S. 1993) In Re: Woolsey, 696 F.3d 1266 (10th Cir. 2012) includes an interesting discussion of whether this logic is correct, but also holds that a homestead lien may not be partially stripped in a Chapter 13.

11 U.S. Code § 1322 - Contents of plan
(b) Subject to subsections (a) and (c) of this section, the plan may—
(1) designate a class or classes of unsecured claims, as provided in section 1122 of this title, but may not discriminate unfairly against any class so designated; however, such plan may treat claims for a consumer debt of the debtor if an individual is liable on such consumer debt with the debtor differently than other unsecured claims;
(2) modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor’s principal residence, or of holders of unsecured claims, or leave unaffected the rights of holders of any class of claims;