One of the axioms of bankruptcy is that a bankruptcy will discharge unsecured debt. Unsecured debt is that which is not backed up with some type of collateral.
Typical unsecured debt consists of credit cards, medical bills, promises to pay bills without a promissory note secured by a deed of trust, etc.
A controversial question arose 30 years ago, which became more acute during the Great Recession (aka, the Financial Crash or the Housing Crash). That question has been, with regard to residential real estate, where the mortgage debt exceeds the fair market value of the property, may those mortgages be reduced to correspond to that fair market value? This proposition, of reducing or eliminating such debt in Chapter 7 bankruptcy, is referred to as “lien stripping.”
For example, if a home is worth $600,000, and the senior (first) mortgage is $400,000, and the junior (second) mortgage is also $400,000, then the first is fully secured. That is to say, if the house were sold, the property has enough value to fully pay off the first mortgage. However, with regard to the junior mortgage, the house is undersecured, because if the house were sold, it would yield only $600,000, meaning that $200,000 of the junior mortgage would go unpaid.
As another example, if the fair market value of the same home is $600,000, and the first mortgage is $800,000, then the first is undersecured by $200,000, but the second is unsecured, because a foreclosure sale of the home would yield nothing to the lender of that second mortgage.
So, the owner of such a home, should he or she file for Chapter 7 bankruptcy, might argue that the debt, for purposes of the proceedings, should be reduced (stripped) down to the fair market value of the home. Otherwise, the homeowner would argue, he or she is being penalized with a hopelessly “underwater” property.
Unfortunately, despite the logical appeal of this argument, the US Supreme Court rejected this approach, affirming decisions of the bankruptcy court and the US Court of Appeals. The reasoning appears to be, as long as the homeowner retains title, at least in Chapter 7 cases, the homeowner owes the full amount of all mortgage debts, regardless of property value.
Although this situation became acute in the Great Recession, the SCOTUS laid down the marker for its approach to these cases in the late 1980’s, long before the 2008 Financial Crash. The Dewsnups, a bankrupt debtor couple, sought to have the bankruptcy court reduce (“strip down”) the mortgage debt from the original loan value of $120,000, to their property’s fair market value of $39,000.
The US Supreme Court rejected this argument, based on Sec. 506 of the Bankruptcy Code:
“The practical effect of [the debtor’s] argument is to freeze the creditor’s secured interest at the judicially determined valuation. By this approach, the creditor would lose the benefit of any increase in the value of the property by the time of the foreclosure sale. The increase would accrue to the benefit of the debtor, a result some of the parties describe as a “windfall.”
“We think, however, that the creditor’s lien stays with the real property until the foreclosure. That is what was bargained for by the mortgagor and the mortgagee. The voidness language sensibly applies only to the security aspect of the lien and then only to the real deficiency in the security. Any increase over the judicially determined valuation during bankruptcy rightly accrues to the benefit of the creditor, not to the benefit of the debtor and not to the benefit of other unsecured creditors whose claims have been allowed and who had nothing to do with the mortgagor-mortgagee bargain.”
Dewsnup v. Timm, 502 U.S. 410, 112 S.Ct. 773. Argued Oct. 15, 1991; Decided Jan. 15, 1992 [emphasis added]
Some District Courts and Courts of Appeal were not satisfied with this analysis. Particularly in light of the drop in home values during the Financial Crash, there were many properties whose value was far less than the outstanding mortgages. In fact thousands of people simply walked away from their properties, rather than pay mortgages that were far above the value of the homes they owned.
Naturally, the lending industry was keen to maintain the viability of Dewsnup. But in the Southeast, the US Circuit Court of Appeals for the 11th Circuit (Alabama, Georgia & Florida), pushed back on this disallowance of lien stripping in 2012, in a case in which the bankrupt debtor sought to fully strip an unsecured junior mortgage:
“That GMAC’s junior lien is both “allowed” under 11 U.S.C. § 502 and wholly unsecured pursuant to section 506(a) is undisputed.
“To determine whether such an allowed — but wholly unsecured — claim is voidable, we must then look to section 506(d), which provides that “[t]o the extent that a lien secures a claim against a debtor that is not an allowed secured claim, such lien is void.” See 11 U.S.C. § 506(d).
“Several courts have determined that the United States Supreme Court’s decision in Dewsnup v. Timm, 502 U.S. 410, 112 S.Ct. 773, 116 L.Ed.2d 903 (1992) — which concluded that a Chapter 7 debtor could not “strip down” a partially secured lien under section 506(d) — also precludes a Chapter 7 debtor from “stripping off” a wholly unsecured junior lien such as the lien at issue in this appeal. See, e.g., Ryan v. Homecomings Fin. Network, 253 F.3d 778 (4th Cir.2001); Talbert v. City Mortg. Serv., 344 F.3d 555 (6th Cir.2003); Laskin v. First Nat’l Bank of Keystone, 222 B.R. 872 (9th Cir. BAP 1998). But the present controlling precedent in the Eleventh Circuit remains our decision in Folendore v. United States Small Bus. Admin., 862 F.2d 1537 (11th Cir.1989). In Folendore, we concluded that an allowed claim that was wholly unsecured — just as GMAC’s claim is here — was voidable under the plain language of section 506(d).
“A few bankruptcy court decisions within our circuit — including the decision underlying this appeal — have treated Folendore as abrogated by Dewsnup. See, e.g., In re McNeal, No. A09-78173, 2010 Bankr.LEXIS 1350, at *9-12 (Bankr.N.D.Ga. Apr. 9, 2010); In re Swafford, 160 B.R. 246, 249 (Bankr.N.D.Ga.1993); In re Windham, 136 B.R. 878, 882 n. 6 (Bankr.M.D.Fla.1992). But Folendore — not Dewsnup — controls in this case.
“Under our prior panel precedent rule, a later panel may depart from an earlier panel’s decision only when the intervening Supreme Court decision is `clearly on point.’” Atl. Sounding Co., Inc. v. Townsend, 496 F.3d 1282, 1284 (11th Cir.2007). Because Dewsnup disallowed only a “strip down” of a partially secured mortgage lien and did not address a “strip off” of a wholly unsecured lien, it is not “clearly on point” with the facts in Folendore or with the facts at issue in this appeal.
“Although the Supreme Court’s reasoning in Dewsnup seems to reject the plain language analysis that we used in Folendore, “`[t]here is, of course, an important difference between the holding in a case and the reasoning that supports that holding.’” Atl. Sounding Co., Inc., 496 F.3d at 1284 (citing Crawford-El v. Britton, 523 U.S. 574, 118 S.Ct. 1584, 1590, 140 L.Ed.2d 759 (1998)). “[T]hat the reasoning of an intervening high court decision is at odds with that of our prior decision is no basis for a panel to depart from our prior decision.” Id. “As we have stated, `[o]bedience to a Supreme Court decision is one thing, extrapolating from its implications a holding on an issue that was not before that Court in order to upend settled circuit law is another thing.” Id. In fact, the Supreme Court — noting the ambiguities in the bankruptcy code and the “the difficulty of interpreting the statute in a single opinion that would apply to all possible fact situations” — limited its Dewsnup decision expressly to the precise issue raised by the facts of the case. 112 S.Ct. at 778.”
In re: Lorraine McNEAL, Debtor. Lorraine McNeal, Plaintiff-Appellant v. GMAC Mortgage, LLC, 735 F.3d 1263 (11th Circuit, issued May 11, 2012)
Although the 11th Circuit had valid reasons for its decision, the SCOTUS was not friendly to this trend of pushing back on Dewsnup. Eventually the issue came back before The Supreme Court. In 2015, the Supreme Court restated its Dewsnup ruling, in the context of property value severely affected by the Housing Crash. The Court would overrule the reasoning of the 11th Circuit:
“The Code suggests that [Bank of America’s] claims are not secured. Section 506(a)(1) provides that “[a]n allowed claim of a creditor secured by a lien on property . . . is a secured claim to the extent of the value of such creditor’s interest in . . . such property,” and “an unsecured claim to the extent that the value of such creditor’s interest . . . is less than the amount of such allowed claim.” (Emphasis added.) In other words, if the value of a creditor’s interest in the property is zero—as is the case here—his claim cannot be a “secured claim” within the meaning of §506(a). And given that these identical words are later used in the same section of the same Act—§506(d)—one would think this “presents a classic case for application of the normal rule of statutory construction that identical words used in different parts of the same act are intended to have the same meaning.” Desert Palace, Inc. v. Costa, 539 U. S. 90, 101 (2003) (internal quotation marks omitted). Under that straightforward reading of the statute, the debtors would be able to void the Bank’s claims.
“Unfortunately for the debtors, this Court has already adopted a construction of the term “secured claim” in §506(d) that forecloses this textual analysis. See Dewsnup v. Timm, 502 U. S. 410 (1992). In Dewsnup, the Court confronted a situation in which a Chapter 7 debtor wanted to “ ‘strip down’ ”—or reduce—a partially underwater lien under §506(d) to the value of the collateral. Id., at 412–413. Specifically, she sought, under §506(d), to reduce her debt of approximately $120,000 to the value of the collateral securing her debt at that time ($39,000). Id., at 413. Relying on the statutory definition of “ ‘allowed secured claim’ ” in §506(a), she contended that her creditors’ claim was “secured only to the extent of the judicially determined value of the real property on which the lien [wa]s fixed.” Id., at 414.
“The Court rejected her argument. Rather than apply the statutory definition of “secured claim” in §506(a), the Court reasoned that the term “secured” in §506(d) contained an ambiguity because the self-interested parties before it disagreed over the term’s meaning. Id., at 416, 420. Relying on policy considerations and its understanding of pre-Code practice, the Court concluded that if a claim “has been ‘allowed’ pursuant to §502 of the Code and is secured by a lien with recourse to the underlying collateral, it does not come within the scope of §506(d).” Id., at 415; see id., at 417–420. It therefore held that the debtor could not strip down the creditors’ lien to the value of the property under §506(d) “because [the creditors’] claim [wa]s secured by a lien and ha[d] been fully allowed pursuant to §502.” Id., at 417. In other words, Dewsnup defined the term “secured claim” in §506(d) to mean a claim supported by a security interest in property, regardless of whether the value of that property would be sufficient to cover the claim. Under this definition, §506(d)’s function is reduced to “voiding a lien whenever a claim secured by the lien itself has not been allowed.” Id., at 416.
“Dewsnup’s construction of “secured claim” resolves the question presented here. Dewsnup construed the term “secured claim” in §506(d) to include any claim “secured by a lien and . . . fully allowed pursuant to §502.” Id., at 417. Because the Bank’s claims here are both secured by liens and allowed under §502, they cannot be voided under the definition given to the term “allowed secured claim” by Dewsnup.”
BANK OF AMERICA, N. A. v. CAULKETT & BANK OF AMERICA, N. A. v. TOLEDO-CARDONA, No. 13–1421 (2015)
There are signs that there is continued discontent with the Dewsnup construction. But for the moment, it remains the law. At this time, as housing values have continued to climb in the pandemic, those who own homes are apparently not in danger of losing the full value and being underwater, the way home owners were between 2008 and 2012.
However, we know that markets are volatile, and that business cycles are just that, and eventually, the Supreme Court will have to look again at whether consumers should be forced to pay back loans far in excess of their property’s value, when their disposable income has drastically decreased.
QUOTATIONS FROM COURT OPINIONS ARE PRESENTED AS PART OF COMMENTARY BY THE AUTHOR, AND THUS CONSTITUTE “FAIR USE” UNDER FEDERAL LAW.
THIS POST DOES NOT CONSTITUTE LEGAL ADVICE, AND READING IT DOES NOT CREATE AN ATTORNEY-CLIENT RELATIONSHIP. PLEASE CONSULT YOUR ATTORNEY IF ANY QUESTIONS!!
#bankruptcy #mortgages #lienstripping #dewsnup
BANKRUPTCY LAW (Homestead Exemption): In a recent case, the federal Second District Court of Appeal (NY, NJ, Connecticut) held that any “residence” in which the debtor has an interest is eligible for application of the homestead exemption. The court adopted the “minority rule,” which holds that “residence” includes a non-primary residence (e.g., a vacation home, or a property in which a spouse or child lives), and thus federal, controls the application of the homestead exemption.
As a result, a debtor may seek to have the homestead apply to her non-primary residence, if the federal courts in that state have taken a position on the application of the federal defeinitions of “homestead” and “residence.”
Notably, California law allows a debtor to assert a homestead exemption as to property in which the debtor’s spouse or former spouse lives. Calif. Code of Civil Procedure Sec. 704.720(d).
The Maresca court said:
“When a debtor files for bankruptcy, she may “exempt” certain interests from her “estate,” thus removing them from the pool of assets available to satisfy her creditors. 11 U.S.C. § 522(b)(1); see also id. § 541(a)(1) (defining property of the estate to include “all legal or equitable interests of the debtor in property as of the commencement of the [bankruptcy] case”). With some exceptions not relevant here, a debtor may also “avoid the fixing of” judicial liens on encumbered property that would otherwise be subject to an exemption. Id. § 522(f)(1)(A); see Owen v. Owen, 500 U.S. 305, 311-13, 111 S.Ct. 1833, 114 L.Ed.2d 350 (1991).
“[T]he bankruptcy court adopted what it called the “minority ‘plain meaning’ approach,” [under] which the term “residence” is interpreted, using traditional canons of construction, to include primary and non-primary residences. See, e.g., In re Demeter, 478 B.R. 281, 286-92 (Bankr. E.D. Mich. 2012).
“[Para.] When a debtor files for bankruptcy, she may “exempt” certain interests from her “estate,” thus removing them from the pool of assets available to satisfy her creditors. 11 U.S.C. § 522(b)(1); see also id. § 541(a)(1) (defining property of the estate to include “all legal or equitable interests of the debtor in property as of the commencement of the [bankruptcy] case”). With some exceptions not relevant here, a debtor may also “avoid the fixing of” judicial liens on encumbered property that would otherwise be subject to an exemption. Id. § 522(f)(1)(A); see Owen v. Owen, 500 U.S. 305, 311-13, 111 S.Ct. 1833, 114 L.Ed.2d 350 (1991).
“[Para.] The federal exemption at issue in this case, referred to as the “homestead” exemption, allows the debtor to exempt—and thereby avoid a judicial lien upon—her “aggregate interest, not to exceed [$23,675] in value, in real property or personal property that the debtor or a dependent of the debtor uses as a residence.” Id. § 522(d)(1) & (f)(1)(A); see 4 Collier on Bankruptcy ¶ 522.09.”
In re Melissa Maresca, 982 F.3d 859 (2020)
Argued: October 22, 2020.
Decided: December 14, 2020 When representing clients, attorneys rely on the words of the law (a “statute”) and ask the court to implement the plain, obvious meaning of its words. When it comes to federal statutes, however, it is easy to overlook the “comments” by the lawyers for the Congressional committees that draft the statutes, or the agencies which implement them.In a recent unanimous 9th Circuit decision by the Honorable Mary M. Schroeder, the comments to a consumer lending statute were critical to holding a bank accountable.In Gilliam v. Levine, Case No. 18-56373 (9th Circuit, 2020), the court recounts that the borrower obtained a loan as trustee for a family trust. The purpose of the loan was to make home repairs. the home itself was the sole asset of the trust. Another family member, who occupied the home, with the trust beneficiary.
The home, i.e., the asset of the family trust, secured the loan.
The borrower later discovered that the due date for the final loan payment was 1 year earlier than she had been led to believe. The borrower was alarmed, and sued to cancel (rescind) the loan under federal law, Truth in Lending Act (TILA), 15 U.S.C. § 1601, et seq., and the Real Estate Settlement Practices Act (RESPA), 12 U.S.C. § 2601. The borrower also asserted a claim under California’s Fair Lending Law [Rosenthal Act], 1788.1(b) of California’s Rosenthal Act, California Civil Code §§ 1788.1(b).
This relief is only available where the borrower is a consumer. 15 U.S.C. § 1635(i)(4); 12 U.S.C. § 2606(a); Cal. Civ. Code § 1788.2(e). The trial court, Hon. Philip Gutierrez, concluded that because the loan went to the trust, it was not a consumer loan. The trial court dismissed the case.
The 9th Circuit reversed the trial judge. The appellate court noted federal Consumer Financial Protection Bureau’s Official Staff Commentary to Regulation Z (mortgage loans), which suggested the opposite result in this case. The Commentary, for example, stated that “[c]redit extended for consumer purposes to certain trusts is considered to be credit extended to a natural person rather than credit extended to an organization.” 12 C.F.R. pt.1026, Supp. 1, § 1026.3 Comment 3(a)-10.
The “certain trusts” that fall under the rubric of “natural persons,” entitled to protection for loans made to benefit a natural person, and not an organization, include the trust in this case, which was formed for tax or estate planning purposes [which benefit people]. As a result, where individuals invest assets in the trust, the regulation thus effectuates TILA’s definition of consumer credit transactions. 12 C.F.R. pt.1026, Supp. 1, § 1026.3 Comment 3(a)-10.
The trust in question was “primarily for personal, family, or household purposes.” 15 U.S.C. § 1602(i). The borrower was the aunt (as Trustee); the niece was the beneficiary; and the trust property was a private home. As a result, the loan was a “consumer credit transaction,” which was subject to the Fair Lending Laws. And the Comment makes the point: Look to the substance of the transaction. Here it was to benefit a consumer, not a company. 12 C.F.R. pt. 1026, Supp. 1, and § 1026.3 Comment 3(a)-10.i.
For as much as it has been vilified by certain political interests, the CFPB remains in force, and fortunately, it remains a source of protection for consumers. It will be interesting to see if the case if appealed to the Supreme Court (quite likely), and whether it will be upheld.
WARNING: THIS POST DOES NOT CONSTITUTE LEGAL ADVICE; PLEASE CONSULT AN ATTORNEY