[authors: J. Ellsworth Summers, Jr., Scott St. Amand]
Prior to the real estate market crash in 2008, homeowners routinely borrowed against the equity in their homes, in turn, granting lenders second or even third mortgages. However, once the market crashed, their equity vanished, and millions of Americans were left with debts that exceeded the value of the homes that secured them. Unable to bear their financial burdens, each day thousands of individuals file for bankruptcy, but until the recent decision in McNeal v. GMAC Mortgage, a chapter 7 debtor who wanted to keep his home remained responsible for the repayment of his homestead loans, even those with no real underlying security.
McNeal allowed a chapter 7 debtor to “strip off” a wholly unsecured junior mortgage lien because the value of the senior mortgage exceeded the fair market value of the collateral. In so doing, the Eleventh Circuit departed from the other circuits that have addressed this specific issue. As a result, the debtors and lenders of America, and the attorneys who represent them, are faced with a split in the circuits and little time to consider its implications.
An analysis of the Eleventh Circuit’s decision in McNeal begins with the Supreme Court’s decision in Dewsnup v. Timm.
Dewsnup, a chapter 7 debtor, owned farmland secured by a single deed of trust, that far exceeded the property’s fair market value. Dewsnup filed an adversary proceeding to avoid the unsecured portion of the lien, and the Supreme Court, on appeal from the Tenth Circuit, certified the issue of “whether a debtor may ‘strip down’ a creditor’s lien on real property to the value of the collateral, as judicially determined, when that value is less than the amount of the claim secured by the lien.”
Dewsnup argued that the lien securing the property should be reduced to its value because of “the interrelationship of the security-reducing provision of § 506(a) and the lien-voiding provision of § 506(d).” The Court summarized the debtor’s argument:
Under § 506(a) (“An allowed claim of a creditor secured by a lien on property in which the estate has an interest…is a secured claim to the extent of the value of such creditor’s interest in the estate’s interest in such property”), respondents would have an “allowed secured claim” only to the extent of the judicially determined value of their collateral. And under § 506(d) (“To the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void”), the court would be required to void the lien as to the remaining portion of respondents’ claim, because the remaining portion was not an “allowed secured claim” within the meaning of § 506(a).
The crux of the debtor’s argument was whether the language in § 506(a), which defines secured and unsecured claims, applied to § 506(d), which voids liens to the extent the lien secures a claim that is not “an allowed secured claim.” If the description of “secured claim” in § 506(a) is to be read together with the phrase “allowed secured claim” in § 506(d), then, the debtor argued, such lien should be voided to the extent that the claim exceeded the value of the property.
In a 6-2 decision, the Supreme Court rejected the debtor’s argument, finding instead that the language in § 506(d) was independent from the language in § 506(a) and holding that the debtor was prohibited from “stripping down” a creditor’s lien when the value of the collateral is less than the amount of the creditor’s claim. The Court reasoned that the phrase “allowed secured claim” contained in the lien-voiding language of § 506(d) should be read “term-by-term,” i.e., that “allowed secured claim” refers “to any claim that is, first, allowed, and second, secured.” Importantly, the Court held that the determination as to whether the claim is “secured” for purposes of § 506(d) is not made by reference to § 506(a), which the Court acknowledged was “not a definitional provision.” By decoupling § 506(a) from § 506(d), the Court construed § 506(d)’s lien-voiding language as applying only to disallowed secured claims. The Court concluded that the claim was both “allowed” and “secured,” though not by reference to § 506(a); rather, the claim was secured because it was “secured by a lien with recourse to the underlying collateral.”
The Dewsnup Court acknowledged the inconsistency in construing the words “allowed secured claim” to have different meanings within the same statute, but attributed such a reading to Congress unclearly expressing its intention whether to depart from the pre-Code rule that liens pass through bankruptcy unaffected. Moreover, in support of its statutory interpretation, the Court reasoned that a creditor’s rights to the benefit from any increase in property value ran with the property until foreclosure, and that by allowing the debtor to “strip down” liens to the value of the collateral, the Court would potentially provide the debtor with a windfall, thereby violating the bargained-for exchange between the mortgagor and mortgagee. The Court stated that § 506(d) did not alter the pre-Code law’s prohibition on “involuntary reduction of the amount of a creditor’s lien for any reason other than payment on the debt.”
McNeal Resuscitates Folendore
On May 11, 2012, in an unpublished decision, the Eleventh Circuit Court of Appeals narrowly construed Dewsnup to apply only in cases in which a chapter 7 debtor sought to “strip down” a partially secured mortgage lien. Although the McNeal Court’s permitting a Chapter 7 debtor to “strip off” a wholly unsecured lien pursuant to § 506(d) works a sea of change in Chapter 7 law in the Eleventh Circuit, practitioners may be surprised to learn that the panel in McNeal was merely relying on “settled circuit law,” namely, the Eleventh Circuit’s pre-Dewsnup decision in Folendore v. United States Small Business Administration. Although no court expressly recognized that it had been abrogated, many bankruptcy courts within the Eleventh Circuit treated Folendore’s interpretation of § 506(d) as though it had been overruled by Dewsnup, and, therefore, the decision in Folendore had lain fallow for twenty years.
The Folendore court held that the SBA’s junior lien was unsecured under § 506(a), because two senior liens secured a debt greater than the collateral. The bankruptcy court denied the debtors’ motion to avoid the SBA’s lien under § 506(d), and the district court affirmed. The Eleventh Circuit reversed, holding that the “plain language” of § 506(d) allowed the debtors to void the lien of an allowed claim that was “unsecured” by application of § 506(a). In so holding, the Eleventh Circuit adopted the pre-Dewsnup majority view, which rejected the argument that § 506(d) operates to void a lien only if the claim is disallowed. Instead, the Eleventh Circuit read § 506(d) to void a lien if either the claim was disallowed or not secured within the meaning of § 506(a).
As detailed above, this interpretation was subsequently rejected by the Supreme Court in Dewsnup, which held that the lien-voiding provision of § 506(d) applies only to disallowed claims that are secured by a lien. Moreover, Folendore conflicts with the foundation of Dewsnup’s holding that § 506(d) does not alter the pre-Code rule that liens pass through bankruptcy unaffected. Nevertheless, the Eleventh Circuit’s opinion in McNeal is not, by the court’s analysis, in derogation of Dewsnup, because the McNeal court opined that the Supreme Court, “noting the ambiguities in the bankruptcy code and the difficulty of interpreting [§ 506] in a single opinion that would apply to all factual situations,” limited Dewsnup “expressly to the precise issue raised by the facts of the case.” The McNeal court held that Dewsnup disallowed only a “strip down” of a partially secured mortgage lien and did not address the “strip off” of a wholly unsecured lien. Therefore, the McNeal court reasoned, Dewsnup was not “clearly on point” with the facts in Folendore or McNeal.
Perhaps anticipating criticism for its very narrow reading of Dewsnup, the court stated that “[a]lthough the Supreme Court’s reasoning in Dewsnup seems to reject the plain language analysis that we used in Folendore, there is, of course, an important difference between the holding in a case and the reasoning that supports that holding.” Ever adamant, the court further stated that it would not “upend settled circuit law” by trying to extrapolate “a holding on an issue that was not before [the Supreme Court].” Although the Supreme Court cautioned a broad reading of Dewsnup,such a narrow tailoring renders Dewsnup inapposite in many chapter 7 proceedings. Such a distinction between “strip downs” and “strip offs,” not the holding in Folendore or Dewsnup, ultimately drove the Eleventh Circuit to rely on Folendore’s analysis, because under the Eleventh Circuit’s prior panel precedent rule, “a later panel may depart from an earlier panel’s decision only when the intervening Supreme Court decision is ‘clearly on point.’”
It is significant, however, that the McNeal decision is unpublished and therefore is not binding precedent. This leaves open the possibility that another panel of the Eleventh Circuit may see the issue differently, although it may ultimately require a hearing en banc if subsequent panels apply the prior panel rule as strictly as the McNeal panel.
“Strip Offs” in the Circuit Courts
A small number of courts have noted that Dewsnup specifically addressed only “strip downs” (reducing an under-secured lien to the fair market value of the collateral), and did not address “strip offs” (eliminating a wholly unsecured junior lien). However, the Fourth and Sixth Circuits and the Ninth Circuit BAP have applied Dewsnup equally to prohibit both “strip downs” and “strip offs” of a wholly unsecured junior lien in a chapter 7 proceeding.
The Fourth Circuit found there to be no substantive distinction between “strip offs” and “strip downs” such that the court would be required to construe § 506(d) differently than the Court in Dewsnup. The Sixth and Ninth Circuits found that to permit a “strip off” of a wholly unsecured junior lien would be contrary to the pre-Code common law rule that liens pass through bankruptcy unaffected, which the Supreme Court cited in Dewsnup. In so holding, these three circuit courts formed a micro-majority by extending Dewsnup’s prohibition against “strip downs” to the “strip off” avoidance of wholly unsecured junior liens. McNeal deviates from this micro-majority.
As a general practice it is difficult to prognosticate what impact, if any, an unpublished decision will have on the legal landscape. Nevertheless, only fourteen days after the Eleventh Circuit decided McNeal, the United States Bankruptcy Court for the Middle District of Florida published a new negative notice procedure, entitled “Motion to Determine Secured Status/Strip Lien on Real Property” in chapter 7 cases, which was implemented “[i]n light of the Eleventh Circuit Court of Appeal’s recent decision in In re McNeal.”
Unquestionably, as it stands, the McNeal decision greatly expands a debtor’s opportunity for a “fresh start” following emergence from a chapter 7 proceeding. Debtors located in circuits that have not resolved the “strip off” issue at the appellate level may be able to cite McNeal and refer to pre-Dewsnup, circuit-specific case law that supports a plain language reading of § 506(d), as in Folendore. In addition, with the effective limitation of Dewsnup to its specific facts, and the resulting circuit split, McNeal seems to have paved a clear path to the steps of the Supreme Court or Capitol Hill. Challenges to McNeal are imminent as lenders are now faced with the stark reality that current and potential chapter 7 debtors, who are upside down with multiple mortgages, may have been provided a proverbial golden ticket by the Eleventh Circuit. Time will tell whether McNeal marks a return of the practice of pre-Dewsnup “strip offs,” or whether the contrary circuit court decisions will remain the majority, preventing stripping of any sort.
McNeal v. GMAC Mortgage LLC (In re McNeal), 2012 WL 1649853 (11th Cir. May 11, 2012), petition for reh’g en banc filed June 1, 2012.
In re McNeal, 2012 WL 1649853, at *2.
Dewsnup v. Timm, 502 U.S. 410 (1992).
Justice Thomas did not participate in the decision.
Dewsnup,502 U.S. at 417.
 Id. (stating that “[t]his reading of § 506(d)…gives the provision the simple and sensible function of voiding a lien whenever a claim secured by the lien itself has not been allowed.”).
Id. at 417 (Emphasis added).
 In re McNeal, 2012 WL 1649853.
 862 F.2d 1537 (11th Cir. 1989).
See In re McNeal, 2010 WL 1753376 at *4 (Bankr. N.D.Ga. 2010); In re Swafford, 160 B.R. 246, 249 (Bankr. N.D.Ga. 1993); In re Windham, 136 B.R. 878, 882 n.6 (Bankr. M.D.Fla. 1992). Arguably the court inIn re Hoffman also considered Folendore to have been abrogated by Dewsnup as the court found “no clear precedent on this issue exists within this Circuit” and did not reference Folendore in its opinion. SeeIn re Hoffman, 433 B.R. 437, 438 (Bankr. M.D. Fla. 2010), aff’d by In re Armstrong,2011 WL 768080 (M.D. Fla. 2011).
Folendore, 862 F.2d at 1538
Id.; see also In re McNeal, 2010 WL 1753376, at *4(stating that Folendore made “no distinction between the terms ‘allowed’ and ‘secured’ for purposes of § 506(d), as Dewsnup requires”).
 In re McNeal, 2012 WL 1649853, at *2.
Id. (citing Crawford–El v. Britton, 523 U.S. 574 (1998)).
Id. at *5 (citing Atl. Sounding Co. Inc. v. Townsend, 496 F.3d 1282, 1284 (11th Cir. 2007)).
Unpublished opinions of the Eleventh Circuit are not considered “binding precedent” but are “persuasive authority.” 11th Cir. R. 36-2.
See In re Lavelle, 2009 WL 4043089 (Bankr. E.D. N.Y. 2009); In re Arrieta, 2009 WL 1789576 (Bankr. N.D. Ill. 2009); In re Howard, 184 B.R. 644 (Bankr. E.D.N.Y. 1995).
Talbert v. City Mortgage Servs., 344 F.3d 555 (6th Cir. 2003); Ryan v. Homecomings Fin. Network, 253 F.3d 778 (4th Cir. 2001); In re Laskin, 222 B.R. 872 (Bankr. 9th Cir. 1998).
Ryan, 253 F.3d at 782.
Talbert, 344 F.3d at 561; Laskin, 222 B.R. at 876.
Id.; see also Ryan, 253 F.3d at 779.
Negative Notice List Revised 5-25-2012,United States Bankruptcy Court Middle District of Florida, May 25, 2012, available at http://www.flmb.uscourts.gov/announcements (last visited June 1, 2012).
Summers, Jr., J. Ellsworth & St. Amand, Scott. "'Down' is Out, 'Off' is In: Stripping Liens in Chapter 7 after McNeal" American Bankruptcy Institute Journal July 2012: 42-43, 90.