BOA v. Caulkett Limits Relief for Homeowners in Chapter 7

Underwater-House-1A Debtor filing a Chapter 7 bankruptcy is afforded protection from losing his or her home when that debtor a) indicates they want to keep their home and keep making payments on the mortgage and b) the amount owed on the home is worth more than the value of the real estate (or is within approximately 10%).

In Bank of America v. Caulkett (2015), the Supreme Court considered the question of whether a debtor can void a second mortgage when the home is worth less than the first mortgage. This would allow a homeowner with two mortgages in a Chapter 7 the potential opportunity to keep their home and eliminate an entire second mortgage.

In a 9-0 decision, the Court said that was going too far.

Section 506(d) of the Bankruptcy Code, Justice Thomas for the Court explained, allows a debtor to void a lien on his property when it “secures a claim against the debtor that is not an allowed secured claim.” Everyone in the case agreed that Bank of America’s claims are allowed. The real question at issue in the case is whether the claims are secured. And although the text of the Bankruptcy Code seems to suggest that they are not – because the value of the bank’s interest in the property is zero – the holding in a case called Dewsnup v. Timm says otherwise.

In Dewsnup, the Court was dealing with what is known as a “partially underwater” mortgage: the debtor owed $120,000, but wanted to reduce that debt to $39,000, which was the current value of the collateral securing the debt. But the Court ruled that she could not do so because the creditors’ claim was secured by a lien and was therefore is “secured” for purposes of Section 506(d).

In this case, the homeowners were completely, underwater: David Caulkett’s house was worth $98,000 when he filed for Chapter 7 bankruptcy, but he owes $183,000 on his first mortgage and $47,000 on his second; Edelmiro Toledo-Cardona’s house was worth just under $78,000 when he filed for bankruptcy, owing $135,000 on his first mortgage and $32,000 on his second. Dewsnup’s reasoning, the Court ruled , fully applies to mortgages that are completely underwater.

Distinguishing between mortgages that are partially and fully underwater, as the homeowners in this case argued that they should, would create an “odd statutory framework”: if a court determined that the value of the property was one dollar more than the amount of the first mortgage, then the second mortgage could not be voided, but the second mortgage could be voided if the property were valued at a dollar less than the first mortgage. “Given the constantly shifting value of real property,” the Court concluded, “this reading could lead to arbitrary results.”

The practical impact of the decision is a cautionary one for Chapter 7 homeowners: if you are underwater to a perceived point of no return on your real property, maybe it’s time to reject the mortgage in the case instead of treading water or worse in the months and years following the mortgage.

If you have a question on a Chapter 7 bankruptcy, please contact the lawyers at Winslow & McCurry, PLLC at (804) 423-1382.