The Supreme Court has ruled that bankruptcy courts cannot void a second lien because it exceeds the value of the collateral.

The case involved two homeowners who had their second mortgages voided in Chapter 7 because they were underwater, but it is also being closely watched in the corporate loan market. The Bank of America, the lender, was seeking a reversal.  

B of A’s case relied heavily on a 1992 ruling by the Supreme Court in Dewsnup vs. Timm, which barred debtors in Chapter 7 bankruptcy from voiding a partially underwater second mortgage down to its market value. This ruling has not always been applied to second liens that are wholly underwater.

The debtor’s counsel steered clear of Dewsnup; instead of asking justices to reverse it, he arguing instead that an underwater loan is not an allowed claim under the bankruptcy code.

In an opinion published today, the Supreme Court sided with B of A. “The reasoning of Dewsnup dictates that a debtor in a Chapter 7 bankruptcy proceeding may not void a junior mortgage lien under 506(d) when the debt owed on a senior mortgage lien exceeds the current value of the collateral. The debtors here have not asked us to overrule Dewsnup, and we decline to adopt the artificial distinction they propose instead. We therefore reverse the judgments of the Court of Appeals and remand the cases for further proceeds consistent with this opinion.”

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