Can the Court Rescue Drowning Homeowners?
Critics of the Supreme Court's conservative wing like to say it’s instinctively pro-business. The justices on Tuesday will test that proposition in a fascinating case about whether bankruptcy law instructs judges to void liens on underwater properties. On one side lie the interests of Bank of America, which is the petitioner and doesn't want the loans to be “stripped off,” that is, voided. On the other side is the plain statutory text, which says they should be. The poetic twist is that, in a very similar 1992 case, the Supreme Court ignored the plain text and held in favor of the banks -- over the forceful dissent of one Justice Antonin Scalia.
The facts of the case are simple, and reflect a common situation post-2008. In each of two consolidated cases, a debtor had two mortgage liens on a property, one subordinated to the other. The property lost so much value that the debt on the first mortgage was greater than the value of the house -- in common terms, the house was underwater. Given that this was so, the second, subordinated lien, owned by Bank of America, was completely underwater. When filing for bankruptcy, the debtor asked that the second lien be eliminated under the federal Bankruptcy Code.
On the surface, the law is as straightforward as the facts. Section 506(d) of the code says that if “a lien secures a claim against a debtor that is not an allowed secured claim, such lien is void.” That in turn should cause us to ask what makes an “allowed” claim count as “secured.” Section 506(a) of the same code -- in essence, earlier in the same paragraph -- provides what sounds like an answer. It says that
An allowed claim of a creditor secured by a lien ... is a secured claim to the extent of the value of such creditor's interest in such property ... and is an unsecured claim to the extent that the value of such creditor's interest ... is less than the amount of such allowed claim.
Because the creditor's interest is less than the judicially assessed true value of the property, the lien should be void.
Case closed, right? If only it were so simple. The U.S. Court of Appeals for the 11th Circuit held that the lien should be void, relying on the statutory language. But most of the other courts of appeals that have considered the issue held to the contrary -- and the Supreme Court agreed to hear the case to resolve that split among the circuits.
So what were those other courts thinking? The answer lies in an otherwise obscure 1992 bankruptcy decision by the Supreme Court with the truly mellifluous name of Dewsnup v. Timm. In Dewsnup, the Rehnquist court considered almost the same question with regard to a partially secured mortgage lien, as opposed to one that had become wholly unsecured. Voiding such a partially secured lien is called “stripping down,” rather than “stripping off.” (I have no idea why bankruptcy experts like this rather risqué language, but maybe a reader can enlighten me.)
In an opinion by Justice Harry Blackmun, the court rejected the plain meaning of the Bankruptcy Code. It offered various rationales, including the observation that bankruptcy law before the enactment of the code in 1978 protected liens against being stripped down. The court then offered an economic explanation. It said that if it voided the lien based on the judicial valuation of the property, “the creditor would lose the benefit of any increase in the value of the property by the time of the foreclosure sale.” This would be a windfall for the debtor, the court said. Because the creditor is always a bank, this explanation came very close to saying that it would be wrong to allow bankruptcy courts to deprive banks of every nickel they might be able to glean from the defaulting debtor.
Scalia, joined only by Justice David Souter, who was then new to the court, wrote a devastating dissent. The court “replaces what Congress said with what it thinks Congress ought to have said,” Scalia observed. And he dismissed the court's invocation of pre-Bankruptcy Code practice as “deus ex machina” invoked without logic to save its preferred interpretation.
Scalia’s position surely explains why the 11th Circuit deviated from its sister circuits in declining to apply Dewsnup in the closely related context of stripping off. Justices Scalia and Anthony Kennedy (who was on the other side) are the only justices left who voted in the 1992 case. (Justice Clarence Thomas was recused for reasons unknown.) Since 1992, textualism has been rising. And the textualist opinion with a dissent from Scalia is a prime candidate for being overturned. The 11th Circuit was gambling that the Bank of America case would be an opportunity to undo Dewsnup -- with happy results for underwater debtors.
Today's conservatives will have plenty of ammunition if they want to reject textualism in favor of a pro-business outcome. They can say, with some justice, that after Dewsnup, the creditor and debtor alike must have bargained in the expectation that there would be no stripping of any kind. But they would have to do it in the same term as the Obamacare case, King v. Burwell, where Scalia at oral argument was making a strong textualist stand. As for the liberals, they may be torn between the interests of debtors and their general doubts about textualism; nevertheless it would be nice for them to vote as textualists when the stakes for them were relatively low.
No one wants to be in bankruptcy -- but this time, at least, there's some hope for the debtor.
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