Strip Off of a Wholly Unsecured Second Mortgage Impermissible

By: Michael J. Casaceli

St. John’s University Law Student

American Bankruptcy Institute Law Review Staff

Joining a majority of courts, the New Jersey District Court, in Cook v. IndyMac Bank,[1] held that the debtor, Cook, could not use section 506(d) of the Bankruptcy Code (the “Code”) to “strip off” a wholly unsecured junior lien.[2]  Cook’s home was encumbered by a first and second mortgage.  Cook sought to strip off the second mortgage pursuant to section 506(d),[3] because the first mortgage exceeded the appraised value of the home.[4]  The court denied Cook’s attempted “strip off” because it would grant a windfall to debtors whose property unexpectedly sells for more than its appraised value.[5]  The court found that the only way to “strip off” a second mortgage is to contest its status as an allowed claim under section 502 of the Bankruptcy Code.[6]

In Dewsnup v. Timm,[7]the Supreme Court refused to allow a creditor to “strip down” a lien where the creditor was undercollateralized because it determined that Congress, in drafting the Code, had not intended to depart from the pre-Code rule[8] that liens on real property pass through bankruptcy.[9]  Whether a lien can be voided under section 506(d) turns merely on whether the claim secured by the lien is an “allowed” claim under section 502.[10]  Since Cook failed to contest the allowance of the junior lienholder’s claim, he was not entitled to void it under section 506(d).[11]  Cases allowing a “strip off” argue that the claim is not secured by a lien in those situations where it is wholly unsecured (i.e., there is no collateral value available to support the junior lien).[12]  The court found the debtor’s reliance on the Third Circuit’s McDonald v. Master Fin., Inc.[13] decision unpersuasive because McDonald expressly declined to decide whether Dewsnup’s applies to strip offs.[14]  McDonald distinguished strip offs from strip downs;[15] however, McDonald was a chapter 13 case concerned with the scope of 11 U.S.C. § 1322(b)(2) and not section 506(d).[16]

Justice Scalia, writing for the dissent in Dewsnup, contended that the Court, in ignoring the plain meaning of section 506(d), wasreplacing what Congress “said” with what it “thinks Congress ought to have said”.[17]  Read naturally and in accordance with other provisions of the statute, section 506(d) provides for the voiding of a wholly unsecured junior lien.[18]  While there has also been substantial scholarly criticism of the Court’s statutory interpretation in Dewsnup,[19] the Court has not revisited the issue and it does not appear that it will do so in the near future.  Cook joins the majority of lower courts that have held that Dewsnup’s reading of section 506(d) necessarily applies to both “strip downs” and “strip offs.”[20]

[20] In re Cook, 432 B.R. 519, 525 (Bankr.D.N.J. 2010) (citing Talbert v. City Mortg. Servs. (In re Talbert), 344 F.3d 555 (6th Cir. 2003) (prohibiting Chapter 7 strip-off);  Ryan v. Homecomings Fin. Network, 253 F.3d 778 (4th Cir. 2001) (prohibiting Chapter 7 strip-off);  In re Laskin, 222 B.R. 872 (9th Cir.BAP 1998) (prohibiting Chapter 7 strip-off)), aff’d, 449 B.R. 664.  Courts in the Eleventh, Seventh, Eighth and Second Circuits have also joined the majority. See, e.g., Armstrong v. Regions Bank (In re Armstrong), No. 6:10-cv-1316-Orl-31, 2011 WL 768080, at *2–3 (M.D.Fl. Feb. 28, 2011); Dhillon v. JP Morgan Chase Bank (In re Dhillon), Bankruptcy No. 10–41700 Adversary No. 11–4016, 2011 WL 2134051, at *4 (Bankr. S.D.Il. May 27, 2011); Tritch v. BAC Home Loans Servicing LP (In re Tritch), Bankruptcy No. 10–02695–als7 Adversary No. 10–30097–als, 2011 WL 846062, at *3 (Bankr. S.D.Ia. Feb. 11, 2011); In re Caliguri, 431 B.R. 324, 327 (Bankr. E.D.N.Y. Mar. 17, 2010).