Court Relies on, then Discusses Problems with, Dewsnup

Posted by NCBRC - April 21, 2020

Finding that the case was governed by Dewsnup, a bankruptcy court granted the lien creditor’s motion to dismiss the chapter 7 debtors’ complaint seeking to strip down its partially unsecured lien. Vasquez v. JPMorgan Chase Bank, No. 19-1841, Adv. Proc. No. 19-100 (Bankr. E.D. N.C. March 25, 2020).

The chapter 7 debtors initiated a challenge to the controversial decision in Dewsnup v.Timm, 502 U.S. 410 (1992), when they sought to strip down a partially underwater lien held by JPMorgan. Given that, in 1992, the Supreme Court prohibited chapter 7 lien stripping of partially secured liens, the bankruptcy court did the only thing it could do and dismissed the complaint. Acknowledging the problematic nature of the decision in Dewsnup, however, the court went on to examine that case more closely.

As an initial matter, Dewsnup’s four-page opinion seemed to invite minimization by recognizing that it was “not without its difficulty” and was limited to its facts. From there, the Court went on to an examination of section 506. Section 506(a)(1) provides that an allowed claim “is a secured claim to the extent of the value of such creditor’s interest in the estate’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.” Section 506(d) appears to instruct what happens once a claim is valued under section 506(a): “[t]o the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void.”

The Dewsnup Court reasoned that, to the extent the two paragraphs in section 506 appear to work in conjunction to permit lien stripping, they run counter to established law under which liens pass through bankruptcy unaffected. Because Congress did not make clear its intention to deviate from this established law, the Court found the statutory language to be ambiguous and attempted to divine Congress’s intent by reading section 506(d) as permitting lien stripping only where the lien is both not allowed under section 502, and not secured under section 506(a).

This strained reading prompted a scathing dissent by Justice Scalia who was offended by the majority’s willingness to interpret an allowed secured claim in paragraph (a)(1) of section 506, differently than the “allowed secured claim” referred to in paragraph (d) of the same section, stating: “When § 506(d) refers to an ‘allowed secured claim,’ it can only be referring to that allowed ‘secured claim’ so carefully described two brief subsections earlier.” Justice Scalia also disagreed that there was any ambiguity in this language to justify reliance on past history and the absence of congressional direction to alter it.

In addition to the strained statutory reading of section 506, the Dewsnup Court’s reliance on the rule of liens passing through bankruptcy unaffected has also come under fire. As many subsequent courts and scholars have noted, liens have always been subject to alteration or stripping in bankruptcy. Chapters 11, 12, and 13, all have been held to permit modification of liens under certain circumstances, notwithstanding application of the provisions of chapter 5, including section 506, to bankruptcy in general. In addition, those chapters and chapter 7 permit avoidance of liens that impair exemptions.

Many subsequent cases and articles have focused on the weaknesses in Dewsnup, but one particularly notable case is that of In re Woolsey, 696 F.3d 1266, 1274 (10th Cir. 2012), in which then Judge Gorsuch, now Supreme Court Justice Gorsuch, made clear his dissatisfaction with the Dewsnup Court’s reasoning and conclusion.

Unfortunately, there have been some near misses in getting the Court to revisit Dewsnup. In the 2015 case of Bank of America, N.A. v. Caulkett, 575 U.S. 790 (2015), the debtor sought to strip off a wholly unsecured lien in chapter 7, and the Court, relying on and expanding its holding in Dewsnup, prohibited lien stripping in that circumstance as well. However, in Caulkett, the Court specifically noted that it had not been asked to overturn Dewsnup, suggesting that had it been asked to do so, it might have given Dewsnup another look. This ray of hope was defracted in Ritter v. Brady, 139 S. Ct. 1186 (Mem.) (2019), when the Court declined certiorari in a case which would have offered the opportunity to revisit Dewsnup.

Not only has the Supreme Court not taken the opportunity to revisit Dewsnup, JPMorgan correctly noted that, despite decades to do so, Congress has not legislated against its holding.

The case is currently on appeal to the District Court for the Eastern District of North Carolina, No. 20-62.

Vasquez Bankr ED NC March 2020


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