New Supreme Court Case of Bank of America N.A. v Caulkett: A “Tempest in a Tea Pot” or New Opportunity for Secured Creditors?

June 2, 2015
Client Alert:
From: Spencer Scheer
To: All SLG Clients and Affiliates

New Supreme Court Case of Bank of America N.A. v Caulkett: A “Tempest in a Tea Pot” or New Opportunity for Secured Creditors?

The recent opinion of the Supreme Court case of Bank of America, N.A. v Caulkett (United States Supreme Court, Docket # 13-1421, decided June 1, 2015), denied claims by a debtor that a wholly unsecured second position lien could be avoided/stripped in a Chapter 7 proceeding. The holding in the Caulkett case was an extension of a prior holding by the Supreme Court in the case of Dewsnup v. Timm, 502 U.S. 410 (1992). The difference in Caulkett and Dewsnip was that in Dewsnup the debtor attempted to have a partially secured first position lien reduced/stripped to the actual value of the property, which was denied. Debtor advocates in the Caulkett case thought they might get “another bite at the apple” by taking aim at junior liens which obviously had no equity to support the lien. However, this attempt was denied by the Court in Caulkett, which in essence reaffirmed the principle that valid liens pass through bankruptcy unaffected.

At first glance, the ruling may appear to be a “tempest in a teapot”, just extending the holding in Dewsnip that you can’t reduce/strip off a mortgage lien in a Chapter 7. However, a closer reading of the holding in Caulkett may allow creditors to challenge lien strips/cramdowns in Chapter 13 cases when a loan is solely secured by the debtor’s principal residence. This protection was previously taken away from creditors in jurisdictions such as the 9th Circuit, which includes California, but was not decided by the Supreme Court.

Under the ruling of the case of In re: Lam, 211 B.R. 36 (B.A.P. 9th Cir. 1997), courts in the 9th Circuit took away anti-loan modification protections allowed to lenders under 11 U.S.C. §1322(b)(2) and 11 U.S.C. §1123(b)(5). Simply stated, the bankruptcy code provides that loans solely secured by debtor’s principal residence could not be modified/stripped in a Chapter 13 or Chapter 11 case. To get around this, courts in the 9th Circuit (via Lam and its progeny, see e.g. Zimmer v. PSB Lending Corp. (in Re Zimmer), 313 F.3d 1220 (9th Cir. Cal. 2002))found that this protection only applies if the lien has equity or value supporting it. If there is no equity, then the anti- modification provisions don’t apply and the Debtor can remove or strip the lien. This is often referred to as a “cramdown.” It happens all the time in the bankruptcy courts in the Ninth Circuit and is often a result of economic swings to the downside, which can provide a debtor with a windfall if the property regains value.

With the recent holding in Caulkett it appears that secured creditors can now argue that there is no basis to remove a lien that is entitled to the anti-modification protections allowed in the bankruptcy code, as long as the lender’s claim is “allowed” and “secured”. The Supreme Court clearly did not go this far in its holding and did not address whether the anti-modification provisions protect against cramdown/lien stripping even if there is no equity supporting the claim, but the implication is there. While debtor proponents will argue that the Supreme Court’s holding is “apples and oranges” in respect to the anti -modification provisions in the Lam case, I believe that someone will raise the argument, asserting that the Supreme Court decision in Caulkett does impact the Lam decision overturning the anti-modification protections given to Lenders. The holdings in Lam and its progeny were never validated one way or another by the Supreme Court. I think this will happen soon.

Accordingly, whether the Caulkett case is a “Tempest in a Tea Pot” or will be extended to recapture ground taken away from secured creditors by Lam, is an issue to keep an eye on.