Bank of America, NA v. Caulkett; Bank of America, NA v. Toledo-Cardona

In this case, the Supreme Court is confronted with two provisions in § 506 of the Bankruptcy Code. Section 506(a) states that “[a]n allowed claim of a creditor secured by a lien on property in which the estate has an interest . . . is a secured claim to the extent of the value of such creditor’s interest in the estate’s interest in such property.” Section 506(d) states that “[t]o the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void.” The parties in this case disagree over whether the language “allowed secure claim” in 506(d) refers to the language “allowed . . . secured claim” in 506(a) and thus, whether a chapter 7 debtor can strip off—or, in other words, remove—a junior mortgage lien from the property when the loan is completely underwater.

Bank of America contends that § 506(a) is not applicable in this case because as held in Dewsnup v. Timm, § 506(d) only eliminates liens from the property of invalid claims, and Bank of America's underwater junior mortgage loans are valid claims and are secured by liens supported by collateral. On the other hand, Caulkett and Toledo-Cardona (“the borrowers”) argue that § 506(d) does apply in this scenario and Bank of America's junior mortgage loans are not valid claims as § 506(d) voids completely underwater liens (such as the one in this case). Additionally, the borrowers argue that Dewsnup does not control this case as Dewsnup's scope is limited only to partially underwater liens, and here, a wholly underwater mortgage lien is at issue.

DOES DEWSNUP APPLY TO COMPLETELY UNDERWATER LOANS?

Bank of America asserts that this case is analogous to Dewsnup, even though Dewsnup involved a partially underwater lien rather than a completely underwater lien. According to Bank of America, nothing in the reasoning of Dewsnup prevents its holding from applying with equal force to completely underwater loans. For instance, Bank of America argues that “Dewsnup’s construction of § 506(d) admits no distinction between partially and wholly underwater liens.” Moreover, Bank of America contends that the value of the collateral was unnecessary in Dewsnup’s reasoning; rather it matters only in the treatment of the creditor’s claim for purposes of distribution. Thus, Bank of America asserts, it is immaterial that a junior lienholder would not recover anything should a completely underwater home be foreclosed upon—the lien still remains a “real and valuable property interest.” Finally, Bank of America submits that “every court of appeals to address the question other than the Eleventh Circuit has concluded, that [Dewsnup’s] reasoning also applies to wholly underwater liens.”

In contrast, the borrowers contend that Dewsnup is unlike this case because the mortgage in Dewsnup was partially underwater and thus the mortgaged property had some value as well as a mixed secured and unsecured claim. The borrowers assert that, in contrast to the facts in Dewsnup, here the mortgage is wholly underwater and so no component of the mortgage is secured in bankruptcy. Moreover, the borrowers contend that the Court's holding in Dewsnup was difficult to reconcile with a natural reading of the text in §506, which on its face voids underscored parts of partially underwater liens; however, the Court did so with the limitation that Dewsnup's holding would not be extended to the issue of whether completely underwater second mortgages are secured claims. Additionally, the borrowers assert that the Court later decision in Nobelman v. American Savings Bank “confirms” that Dewsnup's scope only pertained to partially underwater liens; thus bankruptcy courts, while not allowed to eliminate partially underwater mortgage liens, can eliminate completely underwater liens. The borrowers also contend that all of the courts of appeals that had cases before them implicating this issue have held that Nobelman and § 506(a) authorize eliminating completely underwater second mortgage liens.

STATUTORY ANALYSIS OF § 506

Bank of America asserts that any ambiguity in § 506 is resolved in favor of not permitting the stripping off of liens that secure allowed claims. First, Bank of America argues that the phrase "secured claim" embedded in § 506(d) is referring to the standard English understanding of a claim secured by a guaranty, rather than the language in § 506(a). Second, Bank of America stresses that this interpretation is supported by pre-Bankruptcy Code history; before the enactment of the Bankruptcy Code, liens, no matter the value of the collateral backing them up, survived liquidation proceedings. Bank of America adds that the Court has stated that Bankruptcy Code should not be read to deviate from pre-Bankruptcy Code practice without Congress’s clear intent, and here Congress has provided no intent to do so. Third, Bank of America asserts that Congress has largely given states the authority to govern bankruptcy because bankruptcy involves state-law property rights, and thus, bankruptcy should not change state-law property rights unless it is necessary to meet a bankruptcy goal. Fourth, Bank of America contends that the drafting history of § 506(d) showed that a lien was not voided unless an individual in interest had objected to the claim at issue and the court had disallowed it; thus, a lien securing an allowed claim, as is the case here, cannot be voided based on the value of the collateral. Fifth, Bank of America argues that the structure of the Bankruptcy Code includes sections that “do permit debtors to strip down liens to the current value of the collateral” but those provisions only apply in rare circumstances and § 506(d) is not one of those provisions that apply. Lastly, Bank of America asserts that Congress has continually revised the Bankruptcy Code and § 506 and has never changed § 506(d) in regards to Dewsnup's holding; therefore, Congress has acquiesced to Dewsnup's interpretation of § 506(d).

In contrast, the borrowers argue that the Bankruptcy Code clearly eliminates fully underwater mortgage liens as § 506(a)(1) states that a completely underwater claim “is an unsecured claim,” and § 506(d) states that thus the claim's associated lien is void. The borrowers argue that “secured claim” means the part of a claim that is treated as "secured" for purposes of distribution under § 506(a). Borrowers stress that based on English grammar, a claim such as an underwater claim is not secured and is thus is void under § 506(d). Additionally, the borrowers assert that § 506(d) incorporates two phrases, “lien secures a claim” and “secured claim” that Bank of America considers analogous. However, the borrowers argue that these analogies are not accurate. The borrowers argues that the phrase, “lien secures a claim” refers to non-bankruptcy law rights, while “secured claim” is a “term of art” defined by bankruptcy law. Moreover, the borrowers claim that how the non-bankruptcy lien securing a claim is treated under § 506(d) varies on whether the claim is or is not an allowed secured claim in bankruptcy. The borrowers argue that Bank of America's interpretation that § 506(d)'s definition of secured claim requires only that the claim be secured by a lien in connection to the collateral regardless of whether the collateral's value is erroneous; they maintain that this is because Bank of America’s interpretation cuts against the terms of § 506(a), which states that secured status requires a determination of the value of the creditor's interest in their property. The borrowers also contend that if Bank of America was correct and every lien that secures a claim is a secured claim, then § 506(d)'s multiple “secured” words in the provision would be redundant and would have been eliminated as the Court must take into account every clause and word of the Bankruptcy Code. Additionally, the borrowers counter that Congressional legislative history does not support a Congressional intent to omit § 506(a) from operating on secured claims because if Congress had intended to remove § 506(a) from § 506(d), Congress would have specifically said so—as Congress did previously with other provisions. Finally, the borrowers also assert that Bank of America’s asserted pre-Bankruptcy Code history cannot overcome the clear statutory language and that past courts have, in fact, voided completely underwater junior liens.