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Ch. 7 Bankruptcy : Debtors Can’t Avoid Out-Of-Equity Mortgages

6/1/2015 | Commercial Litigation Blog

The US Supreme Court released a decision today in the case of Bank of America v. Caulkett, No. 13-1421, regarding out-of-equity mortgages in Chapter 7

The decision probably gladdened the hearts of bankers everywhere, but for Chapter 7 debtors, probably not so much….

Chapter 7 bankruptcy debtors cannot “strip off” the liens of wholly-unsecured second mortgages in bankruptcy, the US Supreme Court ruled today.  “Stripping off” a lien means that the debt that was secured by the lien becomes unsecured.  Unsecured debts are generally wiped out in Chapter 7 bankruptcy.

With this decision, an underwater (out-of-equity) second mortgage will remain valid following Chapter 7 discharge, and could prevent the sale or refinancing of the property years later.

 The Court based its decision on an earlier case, Dewsnup v. Timm, which held that a Chapter 7 debtor could not “strip down” a partially-secured mortgage to the actual value of the property.   (A “strip off” is, effectively, a “strip down” of the entire amount of the mortgage lien.)

This ruling benefits the holders of out-of-the-money mortgages, at the expense of homeowners who are underwater.

The two cases are consistent, but I have to wonder whether Dewsnup waswrongly decided.

Note that Chapter 13 will still permit strip-down and strip-off, though the power to do so as to a Debtor’s principal residence is somewhat limited by other provisions of the Bankruptcy Code.

If you are affected by this decision, particularly as the holder of a mortgage, please call me.

William J. Levant, Esquire