Supreme Court Ruling Protects Second Mortgage Holders

The Supreme Court today ruled unanimously against borrowers who sought to void second mortgages in Chapter 7 bankruptcy when their houses were worth less than the balance owed on the first mortgages. ABA filed a friend-of-the-court brief in the cases — Bank of America v. Caulkett and Bank of America v. Toledo-Cardona¬ — arguing that the lower court rulings allowing junior liens to be “stripped off” did not align with previous Supreme Court rulings and would cause widespread disruption in housing markets.

In both cases, Bank of America held a second mortgage with junior lien status on underwater homes in Florida. Because the homes were worth less than the outstanding debt to the senior lienholders, the borrowers sought to void the debt on the second mortgage entirely through the bankruptcy process.

The Supreme Court declined to revisit a 1992 ruling in Dewsnup v. Timm that prevents debtors from avoiding claims in bankruptcy by “stripping down” real property to its current market value, noting that the lienholders’ security interest in the property remains, even if the value of the property is nothing.

ABA noted in its brief that the appellate court’s reasoning would be deeply disruptive, “invalidat[ing]petitioner’s liens entirely without any payment at all. The destabilizing effects of an adverse decision in these cases on the $40 billion market for commercial loans secured by inferior liens are apparent.”