The U.S. Supreme Court has agreed to hear two appeals by Bank of America concerning an important and frequently recurring question of bankruptcy law: whether a chapter 7 debtor can “strip off”-that is, void-a junior mortgage lien on a debtor’s house when the debt owed to a senior lienholder exceeds the current value of the house. This would resolve a split of authority in the circuit courts.

In the cases before the Supreme Court, the Eleventh Circuit held that a debtor may strip off such a junior lien in Bank of America v. Caulkett, 13-1421, and Bank of America v. Toledo-Cardona, 14-163. The Fourth, Sixth and Seventh Circuits have previously held that the reasoning in Dewsnup v. Timm, 502 U.S. 410 (1992), precluded such a strip off.

If the Eleventh Circuit’s decisions are upheld, chapter 7 debtors may not only discharge their personal liability on second mortgage loans, but leave the mortgage-holder without the right to foreclose on the property even if the value of the property subsequently increases.

The issue before the Supreme Court is framed as:

Whether, under § 506(d) of the Bankruptcy Code, which provides 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,” a chapter 7 debtor may “strip off” a junior mortgage lien in its entirety when the outstanding debt owed to a senior lienholder exceeds the current value of the collateral.

In Desnup, the Supreme Court held that section 506(d) does not permit a chapter 7 debtor to “strip down” a mortgage lien to the current value of the collateral. The mortgage lien in Desnup was partially secured, not wholly unsecured as in the cases on appeal.

Bank of America argues that consistent with the holding in Desnup, that a mortgage is underwater matters only to the treatment of the claim under section 506(a) (secured vs. unsecured), and has no effect on the treatment of the lien under section 506(d). Rather, under well-established bankruptcy practice, liens pass through bankruptcy unaffected unless the underlying claim is disallowed, and any increase over the judicially determined value during the bankruptcy accrues to the benefit of the creditor.