The Supreme Court of the United States held in a unanimous decision announced today that a debtor in a Chapter 7 bankruptcy proceeding may not void a junior mortgage lien when the debt owed on a senior mortgage lien exceeds the current value of the collateral if the creditor’s claim is both secured by a lien and allowed under the bankruptcy code.

The ruling, which will benefit commercial lenders, says that bankruptcy courts may not “strip off” junior liens on property if the value of the property used as collateral is less than the amount the debtor owes to the senior lienholder — in other words, the junior mortgage lien is “completely underwater.”

In the case of Bank of America v. Caulkett, Bank of America asserted that junior liens should not be treated as unsecured loans, because the bankruptcy code only “strips off” claims from property that are disallowed and because the Supreme Court’s ruling in Dewsnup v. Timm, disallowing “stripping down” of primary liens to the value of the underlying property, should extend to this case. The defendants argued that second liens should be treated as unsecured, and hence disallowed.

The Court’s unanimous ruling impacts the right of junior lienholders to collect on loans in the event of a debtor’s declaration of bankruptcy and the treatment of previously secured, but subordinate, debt in bankruptcy proceedings.

From the ruling: