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Impact of Supreme Court’s Caulkett Decision on Junior Lienholders’ Market

For banks and lenders engaged in the junior lienholder market, taking a secondary position to the primary secured lender is risky enough without the added frustration of lenient bankruptcy laws allowing discharge of “worthless debts.” Fortunately, the U.S. Supreme Court expanded the notion – first set in 1992 in Dewsnup v. Timm – that “upside down” mortgages are not necessarily dischargeable under Section 506(d) of the Bankruptcy Code and debtors cannot petition to “strip” junior liens on a property even if the lien is essentially worthless.

In Bank of America v. Caulkett, the Supreme Court examined a case involving an underwater homeowner and a lienholder eager to keep its junior lien intact and decided 9-0 that the bank is within its rights to retain the security interest (essentially) regardless of the overall value of the property.

Details of Bank of America v. Caulkett

Under 11 U. S. C. §506(d) – which is a component of the Bankruptcy Code – “the extent that a lien secures a claim against the debtor that is not an allowed secured claim [that claim is considered] void.” An “allowed secured claim” is one that is supported by property value “to the extent of the value of such creditor’s interest,” and is not defined to include valueless property.

Relying on this deduction, two debtors sought relief from a junior lienholder on two separate residential properties. In essence, the bankruptcy petitioners argued that since each property was worth less than the outstanding balance on the primary security, there would be no way the junior lienholders could receive payment even if the properties were sold.

Therefore, according to the petitioners, the lien should be considered “not an allowed secured claim,” and therefore void (i.e., dismissed). For both properties, the Bankruptcy Court, U.S. District Court, and Eleventh Circuit concurred, dismissing the junior liens to the detriment of the bank.

The Court’s Analysis in Favor of Junior Lienholders

In a rare unanimous verdict, the Court held that the debtors could not successfully discharge a junior lien as long as the lien is properly secured (i.e., perfected) and otherwise meets the definition of an “allowed secured claim” mentioned above. In its analysis, the Court took exception to the borrowers’ assertions that the junior liens did not meet the definition of “properly secured,” since there was technically no underlying collateral.

By contrast, the Court held that the fair market value of a security interest is essentially irrelevant to the analysis, and if a claim is secured with the proper documentation and protocol, the discharge rules do not apply. More specifically, the Court held that “a ‘secured claim’ is a claim supported by a security interest in property, regardless of whether the value of that property would be sufficient to cover the claim.”

Contact a Ft. Lauderdale Creditors’ Rights Law Firm For Assistance

If you are in the junior lienholders’ market, or otherwise need sound legal advice about creditors’ rights under federal or Florida laws, please do not hesitate to contact the Law Office of Michael L. Feinstein today: (954) 767-9662.