On March 24th, the Supreme Court heard oral argument on the consolidated appeals of two decisions from the Eleventh Circuit Court of Appeals, Bank of America v. Caulkett and Bank of America v. Toledo-Cardona. The appeals address an issue left unresolved by the Supreme Court’s decision in Dewsnup v. Timm: that is, does section 506 of the Bankruptcy Code void, i.e., “strip off” a valid junior mortgage lien in a chapter 7 case if the mortgage loan is completely underwater. These cases involve the treatment in chapter 7 bankruptcy cases of “undersecured” or “underwater” second-lien home mortgages. Debtors who have granted such mortgages have no equity in their houses because the houses are worth less than the amount outstanding on the mortgage loans. Generally, there are two types of junior mortgage liens: closed-end lump-sum mortgage loans, and openend home equity lines of credit (“HELOCs”). Both of these cases involve closed-end, lump-sum mortgage loans, but the result would be the same for HELOCs.

In a chapter 7 case, an individual debtor is able to obtain a discharge of his or her debts following the liquidation of the debtor’s non-exempt assets by a bankruptcy trustee, who then distributes the proceeds to creditors. In Dewsnup, the Supreme Court held that section 506 does not permit an individual chapter 7 debtor to reduce (or “strip down”) a first-lien mortgage loan to the value of the real property where the amount owed is greater than the property value. Relying on Dewsnup, every circuit court to consider the issue except the Eleventh Circuit has determined that section 506 also does not permit individual debtors to void a completely underwater junior secured creditor’s right to foreclose on the property securing the creditor’s claim.