The Supreme Court dealt financially ailing Americans a setback on Monday in a decision that narrows their ability to erase mortgage debts in bankruptcy.
The Court ruled unanimously that David Caulkett and Edelmiro Toledo-Cardona, who each had two mortgage liens on their respective houses, cannot void a mortgage held by Bank of America that is subordinate to the other mortgage, even though both borrowers owe more on their first mortgage than the property is worth.
Both debtors filed for Chapter 7 bankruptcy, which allows a trustee appointed by the court to sell off the debtor’s assets and discharge any remaining debts, in 2013.
At the debtors’ urging, the bankruptcy court, acting pursuant to a provision of the law that allows debtors to strip away rights to repayment held by creditors who would receive nothing if the house were sold, voided Bank of America’s liens. That rendered the bank unable to foreclose on the loans even if the houses’ values later rose. The 11th Circuit Court of Appeals affirmed the rulings.
The Court disagreed. A secured claim, as defined by the bankruptcy code, means “a claim supported by a security interest in property, regardless whether the value of that property would be sufficient to cover the claim,” wrote Justice Thomas, who added that the debtors had not asked the Court to overrule a decision from 1992 on which the Court based its ruling but instead “request that we limit that decision to partially—as opposed to wholly—underwater liens,” a characterization that Justices Kennedy, Breyer and Sotomayor did not endorse despite joining the ruling.
The decision means that Americans who find themselves in financial distress may remain liable for second mortgages notwithstanding bankruptcy. To cite one example, 23% of Florida’s roughly 1.3 million homes that are worth less than the debt they secure have more than one mortgage, according to the Times.
If a house is worth less than the amount a borrower owes on the first mortgage—a situation known as the home’s being underwater—the second mortgage is worth nothing in a foreclosure.
The debtors’ contention—that a wholly underwater mortgage can be voided but a partially underwater mortgage cannot—would lead to an “odd” result, according to Justice Thomas. Under their approach, he explained, “if a court valued the collateral at one dollar more than the amount of a senior lien, the debtor could not strip down a junior lien under [the relevant precedent], but if it valued the property at one dollar less, the debtor could strip off the entire junior lien.”
“Given the constantly shifting value of real property, this reading could lead to arbitrary results,” Thomas added.
Last year more than 700,000 individuals and couples filed for Chapter 7 bankruptcy. Lenders cheered the ruling, which they say will help to make second mortgages affordable.
Others termed the decision an erosion of rights for vulnerable consumers. “Since 1992, the financial industry has chipped away at [bankruptcy law] to give protections to property regardless of the value of the claim,” David Dayen wrote last March about the appeal in The New Republic. “Now they want to chip away some more.”