SCOTUS Re-affirms Limit on Bankruptcy Relief

According to the New York Times, recently the Supreme Court ruled that homeowners who declare Chapter 7 bankruptcy will be unable to void second, unsecured mortgages on their underwater homes. The ruling clarifies existing limits on how bankruptcy affects certain debts and the ability for debtors to discharge or minimize their debt through the bankruptcy process.

Bankruptcy Limits

Bankruptcy impacts debt in different ways. Generally, debts are divided into two categories: secured and unsecured.

Secured debt is debt that is backed by a lien on specific property, such as a home mortgages or auto loans. If the debtor defaults on the loan, the lender can take the property.

Unsecured debt is debt that is not backed by a lien on specific property. If you default, in order to gain access to your money or property, the lender must go to court and obtain a judgement.

Courts have generally ruled that under Chapter 7 or Chapter 13 bankruptcy, even if the value of the property is lower than that amount of the lien on the property (and thus is “underwater”), the amount of debt on the property cannot be lowered to match the value of the property. That holding is based on a 1992 Supreme Court decision, in Dewsnup v. Timm, in which the court stated that a claim is secured by a security interest in property, even if the property’s value is less than the claim, and that the claim could not be lowered, or “stripped down,” to match value of the property. Thus, if the homeowner owed $100,000 but the home was only valued at $60,000, the homeowner could not lower the debt on the property to $60,000 – he would still owe the entire $100,000.

Recent Supreme Court Ruling

Recently, the Supreme Court decided Bank of America, N.A. v. Caulkett. The case was brought by a homeowner in Florida who purchased a home using two mortgages – one mortgage covered 80% of the price of the home, and a second mortgage covered the rest. When the homeowner filed for bankruptcy, the home’s value had depleted to the point that the second mortgage was entirely underwater. The homeowner argued that the second mortgage was unsecured, because the mortgage was for more than the home’s value, and therefore could be voided by the bankruptcy court. In contrast, the lender argued that a claim is secured regardless of the property’s value.

The arguments centered around the 11th Circuit Court of Appeals’ interpretation of the Dewsnup case. In this case, the 11th Circuit ruled that the Dewsnup decision did not apply to this case because that case had involved a failed attempt to “strip down” the loan – meaning the bank would have received something from the property’s value and then only the remaining unpaid portion of the debt would be cancelled out. The 11th Circuit said that this case was different because it involved an attempt to “strip off” the loan, which means the loan would be voided entirely without the bank/lender receiving anything from the property’s value.

The Supreme Court overturned the 11th Circuit’s decision, and held that Dewsnup applied to loans even if the property secured has no value whatsoever. The homeowner was unable to discharge, void, or lower the mortgages on his home.

The bankruptcy process is complex and it can be difficult to understand how nuances in the law may impact your ability to seek relief. At Carnal & Mansfield, P.A., our Florida attorneys will help you understand your options, guide you through the process and allow you make the best decision for you and for your family.