This session of the Supreme Court decide a bankruptcy dispute that was widely watched by bankruptcy attorneys: Caulkett v. Bank of America.
In Caulkett v. Bank of America, Justice Clarence Thomas and his Supreme Court colleagues unanimously decided that underwater homeowners cannot use the chapter 7 bankruptcy process to remove second mortgages that are entirely unsecured. The court rejected the debtor’s attempt to create an exception to the rule created in the 1992 case Dewsnup v. Timm. That case upheld the standard that partially unsecured mortgages pass through the bankruptcy unaffected. The debtor is Dewsnup’s home was worth more that the first mortgage. The second mortgage in that case was not completely unsecured. He tried and ultimately failed at removing or “stripping” the unsecured portion of the second mortgage on his property.
The debtor in Caulkett, however, had a home that was worth less than his first mortgage. He argued that his situation was different and an exception should be created to the Dewsnup rule. Namely, that he should be able to remove the second mortgage on his property, because his mortgage was one hundred percent “underwater.” Furthermore, such a large encumbrance is seen by many to be contrary to the intent of the “fresh start” provided by chapter 7 bankruptcy.
From the debtor’s perspective, it would be quite beneficial to the debtor to exit bankruptcy without the additional burden of an “underwater” second mortgage. Lending institutions, however, argued that they should be able to maintain their secured position in the additional mortgage in case the property’s value goes up. They should not be prejudiced because a debtor’s property value is depressed. Unfortunately for consumers, the Supreme Court sided with mortgage lenders. This decision is a victory for lenders because they will not have to relinquish these potentially valuable mortgages.
Homeowners, it should be noted, can still possibly strip underwater second mortgages through the process of chapter 13 bankruptcy. However, the chapter 13 bankruptcy process is more challenging and complicated that a chapter 7 bankruptcy. In this scenario, the first mortgage has to exceed the value of the home, making the second mortgage “underwater.” If the debtor is successful in removing the second mortgage lien in the chapter 13 bankruptcy, the secured debt gets reclassified as unsecured debt. How much of the now unsecured second mortgage debt the debtor ultimately has to pay back will vary depending upon the debtor’s income, expenses, and, if applicable, means test results. The debt would be paid back over a three to five year payment plan that is overseen by the Bankruptcy Court. Most importantly, a chapter 13 debtor must be able to afford his or her plan payments. For many debtors, this is not a realistic option.
If you have any questions about second mortgages or any of the issues presented in this article, please contact the Law Offices of David I. Pankin, P.C. at 888-529-9600.