Supreme Court to Decide on Lien Stripping in Chapter 7

The Eleventh Circuit is the only Circuit which permits Chapter 7 debtors to strip wholly unsecured mortgage liens.¹ All other circuits follow the Supreme Court's decision in Dewsnup v. Timm and do not allow it.² The Supreme Court of the United States recently agreed to hear an appeal of two of the Eleventh Circuit's recent cases permitting lien stripping in Chapter 7 to resolve the circuit split of opinions.³

In Dewsnup, A Chapter 7 debtor sought to void the unsecured portion of a mortgage lien on her residence. She argued that the unsecured claim was void by law. To get there, she first looked to §506(a)⁴  which states that an "allowed claim that is secured" by a lien is secured only to the extent of the value of the collateral. She then paired §506(a) with Section 506(d)⁵, which states "to the extent that a lien secures a claim…that is not an allowed secured claim, such lien is void". The crux of her argument was that the unsecured portion of the mortgage lien was void because it was not "an allowed secured claim".

The Supreme Court didn’t agree in large part because it found that Congress, when drafting the Code, did not intend to abandon the ancient bankruptcy maxim that liens pass through bankruptcy unaffected. The definition of an allowed secured claim in §506(d) is not the same as what defines a secured claim in §506(a).
  
An "allowed secured claim" in §506(d) is defined by §502⁶. Claims are "allowed" unless objected to, and §502(b) provides an exclusive list of grounds on which bankruptcy courts may disallow proofs of claims. Claims may not be disallowed simply because the lien is wholly or partially unsecured. Claims are "secured" if the underlying lien is valid under state law.
 
Therefore, an allowed secured claim under §506(d) is one that has a valid state law lien and has not been disallowed under §502. Liens are only void under §506(d) if the claim was disallowed under §502.
 
The Eleventh Circuit bases its allowance of voiding liens under §506(d) on a case it decided before Dewsnup⁷ and its own "prior panel precedent rule". That rule requires the court to follow its own precedent unless a Supreme Court decision that is "clearly on point" overrules it. Dewsnup was decided in the context of "stripping down" a mortgage, that is, it was an attempt to void the unsecured portion of a partially secured mortgage lien. The Eleventh Circuit's case permitted §506(d) to void a wholly unsecured mortgage, not a partially secured one, so that Dewsnup was not "clearly on point" and so that it is required to follow its own precedent.
 
The Supreme Court is being asked to decide whether §506(d) can be used to void wholly unsecured liens in Chapter 7. While it might appear that it will follow its own reasoning based on its premise that liens survive bankruptcy in Dewsnup, the Court is known to issue opinions that do surprise us. 
 

 ¹ The Eleventh Circuit consists of Alabama, Georgia and Florida.
 ² Dewsnup v. Timm, 502 U.S. 410 (S. Ct. 1992)
 ³ Bank of America v. Caulkett, 566 Fed Appx. 897 (11^th Cir. 2014) and Bank of America v. Toledo-Cardona, 556 Fed. Appx. 911 (11^th Cir. 2014)
 ⁴ 11 U.S.C.§506(a)
 ⁵ 11 U.S.C.§506(d)
 ⁶ 11 U.S.C.§502(a) and (b)
 ⁷ Folendore v. U.S Small Bus. Admin., 862 F.2d 1537,(11^th Cir. 1989).