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U.S. Supreme Court Hears Opening Arguments in ‘Stripping Off’ Mortgage Cases

U.S. Supreme Court Stripping Off MortgagesIn the opening arguments on Tuesday morning for two cases in the U.S. Supreme Court to determine the legality of extinguishing, or "stripping off" an underwater second mortgage as unsecured debt for a debtor in bankruptcy, an attorney representing Bank of America contended that the high court should uphold a 1992 decision that outlawed stripping off, while attorneys representing the debtors argued that the decision is irrelevant to these two cases.

The nation's highest court began hearing arguments for the cases of Bank of America v. Caulkett and Bank of America v. Toledo-Cardona on Tuesday morning. The cases center on two Florida homeowners, David Caulkett and Edelmiro Toldeo-Cardona, who filed for Chapter 7 bankruptcy and had their second mortgages with Bank of America extinguished by a bankruptcy judge following the housing crisis of 2008 based on the fact that they were completely underwater. The SCOTUS blog describes the issue in the case of Bank of America v. Caulkett as "Whether, under Section 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."

Central to the Caulkett and Toledo-Cardona cases and often referred to in the Supreme Court in Tuesday's opening arguments was a ruling by the high court in the 1992 case of Dewsnup vs. Timm, which barred debtors in Chapter 7 bankruptcy from "stripping off" an underwater second mortgage down to its market value, thus voiding the junior lien holder's claim against the debtor. When Bank of America appealed the bankruptcy judge's ruling in the Caulkett and Toledo-Cardona cases, the 11th Circuit Court of Appeals went against the Dewsnup ruling in May 2014 by deciding in favor of the two homeowners, saying that the previous decision did not apply when the collateral on a junior lien (second mortgage) did not have sufficient enough value.

"We quote statistics in our opening brief that show that between 2012 and 2014, the number of underwater junior mortgages was cut in half from 4.2 million to 2.1 million," said Danielle Spinelli, an attorney representing Bank of America. "So houses are coming above water every day. And what Dewsnup held is that the lienholder, according to the basic nonbankruptcy bargain, is entitled to keep its lien until payment in full or until a lender decides to foreclose. . . the rule of law simply doesn't allow this Court in the typical situation to overrule a statutory interpretation decision in a case like this where Congress, over the past 25 years, has acquiesced in that decision."

Spinelli asserted that "there is simply no distinction that can be drawn between partially and completely underwater liens in this situation. Dewsnup held that a secured claim is a claim secured by a lien with recourse to the underlying collateral. That is equally applicable here. . .completely underwater liens are not valueless. Their value stems from the potential for appreciation in the collateral."

Stephanos Bibas, an attorney representing the defendant, David Caulkett, argued that precedent has been set with other cases to show that judicial valuations are both "workable" and "fairer to creditors" than the alternative, which is foreclosure.

"Present economic value is what this Court's cases have consistently focused on," Bibas said. "The value of the claim is equal to the value of the collateral, this Court has said, and that's the present value of the collateral. The statute uses the present tense in Section 506, whether it is or is not. It's not about forecasting or speculating into the future. That would be unworkable. But judicial valuations are workable."

When Bibas attempted to make a distinction between completely underwater mortgages and partially underwater mortgages, Justice Elana Kagan told the attorney that, "these distinctions that you are drawing between partially underwater and fully underwater are not terribly persuasive."

Bibas argued that the Dewsnup decision did not apply to the Caulkett and Toledo-Cardona cases because it "reserved the completely underwater hypothetical on the face of its opinion. It was exceptionally narrow, and the lawyers could read and see that it declined to reach this issue."

Attorneys representing both Bank of America and Caulkett, when reached by email, declined to comment beyond what was in the in-court transcript of the opening arguments. The Supreme Court is expected to make a ruling by June.

About Author: Brian Honea

Brian Honea's writing and editing career spans nearly two decades across many forms of media. He served as sports editor for two suburban newspaper chains in the DFW area and has freelanced for such publications as the Yahoo! Contributor Network, Dallas Home Improvement magazine, and the Dallas Morning News. He has written four non-fiction sports books, the latest of which, The Life of Coach Chuck Curtis, was published by the TCU Press in December 2014. A lifelong Texan, Brian received his master's degree from Amberton University in Garland.
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