Supreme Court Disallows Junior Lien Stripping in Chapter 7 - Some Thoughts for Prospective and Recent Chapter 7 Debtors

The Supreme Court of the United States held in a unanimous decision announced on June 1, 2015, that a debtor in a chapter 7 bankruptcy proceeding may not strip a junior mortgage from his or her property when the amount of the debt owed on a senior mortgage exceeds the current value of the property.  

In the case of Bank of America v. Caulkett, Nos. 13-1421 and 14-163 (June 1, 2015) the debtor asserted that a junior mortgage held by Bank of America was "completely underwater." Therefore, the debtor argued that the junior mortgage should be treated as only an unsecured claim and that the mortgage should be removed from the property permanently.  This was previously allowed in Florida under the Eleventh Circuit precedent In re McNeal v. GMAC Mortg., 735 F.3d 1263 (11th Cir. 2012) and was a powerful tool debtors in bankruptcy could use to get out from overwhelming debts and also keep their principal residence.

With the decision in Caulkett, a debtor who wishes to keep his or her primary residence cannot remove junior underwater mortgages from the property but must either reaffirm the junior mortgage, pay the junior mortgage, or surrender the property, similar to what debtors have done with first mortgages for years.  

While this obviously creates new challenges for prospective debtors planning a potential bankruptcy, it provides even greater challenges for debtors who successfully stripped a junior mortgage in a chapter 7 recently.  For these debtors, it is possible the prior junior mortgage holder could seek to undo the previous order stripping their mortgage and seek to have their mortgage reinstated.  How far back is too far will have to be worked out by the courts.  

The good news for debtors, however, is that many of the junior mortgages which have been stripped encumbered property which is still worth far less than the first mortgage.  A recently stripped second mortgage holder would need to expend attorney's fees in order to have the junior mortgage reinstated, and for the most part, it is difficult to see how the creditor would ever realize immediate cash to offset those expenditures.  

Fortunately for debtors in this position, most banks are unlikely to spend money now for the chance of possibly getting money later, and my prediction is that few creditors will seek this relief.  Only time will tell.  If you have questions about this, contact me at mnardella@nardellalaw.com.