Supreme Court To Rule on Stripping
Good morning, if this headline got your attention, get your mind out of the gutter. Think in bankruptcy parlance. A “strip off” occurs when a court cancels a lien that is wholly unsecured.
On Monday, the Supreme Court decided to hear an important case to answer this question: can a court overseeing a Chapter 7 Bankruptcy cancel a junior lien on a residential mortgage where the value of the property is so low that there is no equity with which to pay back the subordinate lien holder? The Supreme Court decided to consolidate two cases from the 11th Circuit (Bank of America v. Caulkett and Bank of America v. Toledo-Cardona). Both cases deal with residential mortgages that tumbled in value once the Great Recession hit. The homes tumbled so much in value, in fact, that there wasn’t enough money in either house to pay back the holder of the principle mortgage, let alone the holders of home equity lines of credit taken out on the properties.
Most courts that have addressed this issue in other jurisdictions have concluded that a subordinate lien survives bankruptcy regardless of the amount of equity left in the residential property. In New York, for example, the leading case is Wachovia Mortgage v. Smoot, 478 B.R. 555 (E.D. NY 2012). The court provided an excellent explanation of why subordinate liens survive Chapter 7 Bankruptcy. In addition, at least three other circuit courts have reached the same conclusion.
In contrast, the 11th Circuit, which includes Florida, has reached the opposite conclusion. In the consolidated cases to be decided by the Supreme Court, the Florida homeowners were successful in getting their subordinate liens cancelled. Why does this matter? In depressed housing markets, it may not make much of a difference, but in states like New York, where it may take several years to foreclose on a property, a homeowner could see a sharp rise in his property value between the time when they declare bankruptcy and the time a house is foreclosed on. They could end up pocketing money to which the subordinate lien holder would otherwise be entitled. The Court will be issuing a decision in this case by June.