United States: Mortgage "Strip Off" In Chapter 7: Dewsnup Fails To Prevail – Go Figure

Last Updated: February 11 2014
Article by Vicki Harding

McNeal v. GMAC Mortgage, LLC (In re McNeal), 735 F.3d 1263 (11th Cir. 2012) –

A chapter 7 debtor sought to "strip off" the second mortgage lien on her home.  The bankruptcy and district courts declined, and the debtor appealed to the 11th Circuit.

The debtor contended that the fair market value of her home was ~$141,500, and it was subject to a first priority lien of ~$176,500 and a second priority lien of ~$44,500.  (These facts were not disputed.)  Consequently, the debtor argued that (1) under Section 506(a) of the Bankruptcy Code the second mortgage claim was a secured claim only to the extent of the value of the creditor's interest in the property – in other words $0 (since the claim was totally underwater), and (2) consequently the second mortgage was not an allowed secured claim and its lien should be voided under Section 506(d).

Although the argument that a lien should be voided under Section 506(d) to the extent that the amount exceeds the value of the collateral (e.g. is not a secured claim under Section 506(a)) can be supported by a plain language reading of Section 506, as discussed in other blog posts, various courts have interpreted the U.S. Supreme Court decision in Dewsnup v. Timm, 506 U.S. 410, 112 Sup. Ct. 773, 116 L. Ed. 2d 903 (1992) to preclude this interpretation of Section 506(d) on the basis that Congress did not intend to change pre-Bankruptcy Code common law to the effect that liens ride through bankruptcy.

Dewsnup held in a Chapter 7 case that a partially underwater lien could not be "stripped down."  The McNeal case dealt with the question of whether a totally underwater mortgage lien could be "stripped off."  Recognize that the only difference between a "strip down" and a "strip off" is that the mortgage is only partially underwater in the first case (i.e. the deficiency claim is less than the full amount of the claim), and is totally underwater in the second case (i.e. the deficiency claim is equal to the entire claim).

While acknowledging decisions by other courts (including the 4th, 6th and 9th Circuits) that a chapter 7 debtor could not strip off a totally underwater lien given the U.S. Supreme Court's decision in Dewsnup, the 11th Circuit concluded that a pre-Dewsnup 11th Circuit panel decision controlled.  In that decision, the 11th Circuit determined that a lien securing a claim that was wholly underwater was voidable under the plain language of Section 506(d).

The court asserted that an earlier panel decision is abrogated by an intervening Supreme Court decision only if it is "clearly on point."  According to the court, since Dewsnup addressed only a strip down and not a strip off of a lien, it was not clearly on point.

While also acknowledging that the reasoning of Dewsnup would lead to a reversal of the prior 11th Circuit decision, the court emphasized that there is a distinction between the holding in a case and the reasoning that supports the holding:  "[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 court law is another thing."

Consequently, the 11th Circuit reversed the lower court decisions and determined that the second mortgage lien was voidable under Section 506(d).

As discussed in prior blog posts, the courts have struggled to reconcile the Supreme Court's Dewsnup decision with the plain language of Section 506.  (See for example:  Mortgage Liens: Can Liens Be "Stripped Off" (vs. "Stripped Down") in a Chapter 7 Case?; Mortgage Liens: Can Liens Be Stripped Off in a Chapter 13?; Underwater Liens: Can A Federal Tax Lien Be Stripped Off In A Chapter 13?; Untimely Secured Proof of Claim: Ghost of Dewsnup May Save the Day.)

Some courts have been inclined to limit Dewsnup to Chapter 7 cases and/or to a strip down (as opposed to a strip off) of a lien, while others have been more inclined to take the case to its logical limits.  Towards one end of the spectrum is McNeal, where the 11th Circuit declined to apply Dewsnup to the strip off of a Chapter 7 lien (distinguishing Dewsnup as applicable only to a strip down).  Towards the other end is Woolsey, where the 10th Circuit reluctantly applied Dewsnup to preclude the strip off of a Chapter 13 lien. (See Mortgage Liens: Can Liens Be Stripped Off in a Chapter 13?)  Until the Supreme Court provides additional guidance, the status of undersecured liens will remain difficult to predict.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Vicki Harding
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