Amicus Curiae Brief — Bank of America, N.A. v. Toledo-Cardona, 135 S. Ct. 677 (2014) (No. 14-163)

[Supreme Coun, US

FILEO

FEB 2 4 2015

OFFICE OF THE CLERK

Nos. 13-1421, 14-163

3n the Supreme Court of the Anited States

BANK OF AMERICA, N.A.,

Petitioner,

v.

DaviD B. CAULKETT,

Respondent.

BANK OF AMERICA, N.A.,

Petitioner,

Uv.

EDELMIRO TOLEDO-CARDONA,

Respondent.

On Writ of Certiorari to the

United States Court of Appeals for the Eleventh Circuit

BRIEF OF BANKRUPTCY LAW PROFESSORS

ROBERT M. LAWLESS, BRUCE A. MARKELL,

AND JOHN A. E. POTTOW AS AMICI CURIAE IN

SUPPORT OF AFFIRMANCE

PETER CONTI-BROWN

DEEPAK GUPTA

Counsel of Record

GuPTA BECK PLLC

1735 20 Street, N.W.

Washington, DC 20009

(202) 888-1741

deepak@guptabeck.com

ae

QUESTION PRESENTED

Should Dewsnup v. Timm, 502 U.S. 410

(1992), be extended to exempt a completely

underwater second mortgage from lien avoidance

under section 506(d) of the Bankruptcy Code?

ii-

TABLE OF CONTENTS

I IN cecceceitesniiiinicciientaccnstinsiiniiicianiontiiiesiiiiiiniatd i

aici ciecncvnstihnceiodscmanssdonsntenipebteriebpinsiutensiaiiene iv

I EE Is GO iicesidnnictitncricsieinsiniacanterontiinaninmncineniin 1

eG Br i icciedccirsiintiticieticecisntininniscc inclined 2

I pecieciiciisnecicnistslincbdintiniinbcliatiinnbsindatiiniitaaseniteeteniionas 5

I. The Bankruptcy Code already provides more

benefits to junior creditors than they would

TOSS CRN RID DIIIT onccccccncscscccsscscscscnnsccesconsosons 5

A. Bank of America’s lien under state law

METERS RAR SIP Cena Oe PLE eUN 5

B. The Code already protects Bank of

pS ee 7

II. Bank of America asks the Court to grant it

“hostage value” for its otherwise worthless

BE sscccncdecessonstninbeiinmanaiaieiieaibaupsiecanicnasessehinieussians 9

III. This Court’s precedents do not support the

view that “liens pass through bankruptcy”...... 13

A. Liens do not pass through bankruptcy;

they pass through bankruptcy only if

the Code permits them to stay in place..... 13

B. This Court’s key “liens ride through”

precedent—Long v. Bullard—does not

actually hold that liens ride through

I eicsitirstnsensiicicimntanesinrtiimpemnnees 15

-jii-

TABLE OF CONTENTS—Continued

C. Liens have always been subject to

alteration in bankruptcy. ...............:cccceeree 17

D. Whether liens sometimes rode through

bankruptcy is ultimately irrelevant........... 19

IV. This Court should overrule Dewsnup ..........-.... 21

NEA MER EN MORITA MER Oe ae Ao: EE TM 26

-lV-

TABLE OF AUTHORITIES

CASES

Bank of America National Trust & Savings

Association v. 203 North LaSalle Street

Partnership,

ee To oan aieieionspnseniaidimadedionnads 24

Bullard v. Long,

a csassuiecnsaediiscniadeuelmassiesuaciaied 16

Butner v. United States,

TPIT nc icnb cesta stcscshscdahecciannkasapiisnbbmiadssbiiaseranians 8

Dewsnup v. Timm,

Be is Se scessnksncasencciiioicchintnndesonsinssoscamnins passim

Folendore v. U.S. Small Business Administration,

if § .g:)) fe» eee 3

Hubbard v. United States,

BI a IN III cescsccebi stiadienctbadiiaiisieesktideiasiabdiolaalubls 25

In re Ahlers,

ec ee Ne Ga BOO eritactieestrncnsicanescmsesccbevicaseten 20

In re Lewrs,

Oe ee Ge Gee FD vecsirsnseccsnsicseinessssossveceosonresares 20

In re Pence,

be §) of, Le 8.0) 15

In re Toledo-Cardona,

566 F. App’x 911 (11th Cir. 2014)................sssscessessesees 3

Long v. Bullard,

RE Cele EF CRUD sssinssesncumsbeesicocoresasonnseneninconsses 16, 17, 21

-V-

TABLE OF AUTHORITIES—Continued

Nobelman v. American Savings Bank,

a 23

United Savings Association v. Timbers of Inwood

Forest Associates,

484 U.S. 365 (1992)......... ssciocebbasenasiinusaeDiasnidieitssiadesnlectoaaes 14

STATUTES

a ae We aI cepa ddaaitennstanicchaninds scaselathcnasinntens ee obese 12

Be Se OF Biches cliddlentatecnbabeunssinudeadbuendinaitins 12, 13, 14

Re ee Be Aihara nad tard seein eons ior ae 13, 14

LE oo ys MANS EARS SESS PEE AA EA Rt on ts SOLE. 14

ee A OS Ae Sea cochaientesaaleiartidiatiarnsuiediathaptomeaucgets 13, 14

gh tek gp. Wess Srmtheeer sitet sab arennt selarsia ie ater 8

ge Tee Be Maint aie ES Oy Ale SRI 14

kT | Race Bee a ese eae ay MR nek Milks Sh passim

ges Sky fen aia Noe eS aN dal apie neem ata 2 14

PRE ee 1 isditatadssentisdece tara rats 14

Be Cae OF, We icechoesneentbdeitiaciotanicadetainbnecemiinnaeetincicidiocteaaees 14

OE ais OF | EN acceenapasinted vnchienniooneipsliicanbeiiesnaseesinansnaniionusmeiaies 14

CAE To Bet nei Bos Pe abe SONI Ce Balak. 14

eas We ee caitsioletsnciedaisanieioningedalanipmriaciiteaunaasiaaindinieeniati 21

-vi-

TABLE OF AUTHORITIES—Continued

ye RR EME TS RRs Pea ds ak WN Te am. Sd 5

LEGISLATIVE MATERIALS

Bankruptcy Act of Apr. 4, 1800, ch. 19, 2 Stat. 19.......... 19

Bankruptcy Act of Aug. 19, 1841, ch. 9, 5 Stat. 440....... 19

Bankruptcy Act of July 1, 1898, ch. 541, 30 Stat. 544... 18

Bankruptcy Act of Mar. 2, 1867, ch. 176, 14 Stat. 517... 18

Be SU WN: I pietenesrbiinest ienatantadecbtesabdaaikadeabaces 20, 23

RULES

Federal Rules of Bankruptcy Procedure 3012................. 7

BOOKS AND ARTICLES

Vicki Been, Howell Jackson, & Mark Willis, Sticky

Seconds—-The Problems Second Liens Pose to the

Resolution of Distressed Mortgages, 9 N.Y.U.J.L.

4) ye gf Bae tthe a ie i eS eS 10

David Gray Carlson, Bifurcation of Undersecured

Claims in Bankruptcy, 70 Am. Bankr. L.J. 1

Anthony T. Kronman, Contract Law and the State of

Nature, 1 J. L. ECON & ORG. 5 (1985)..............ccceeceeeees 9

Lynn M. LoPucki & Elizabeth Warren, SECURED

ge Sa a ier oe SRR tn ot AIR )

-Vii-

TABLE OF AUTHORITIES—Continued

Lawrence Ponoroff & F Stephen Knippenberg, The

Immovable Object Versus the Irresistible Force:

Rethinking the Relationship Between Secured

Credit and Bankruptcy Policy, 95 Mich. L. Rev.

SAR AREAL RRR ERG ARIE ER MINE be Malerba 22

RESTATEMENT (THIRD) OF PROPERTY (MORTGAGES)

*

INTEREST OF AMICI CURIAE'’

Amici curiae are three leading scholars of

bankruptcy, commercial, and business law who have

been teaching, researching, and writing about

bankruptcy law for decades. They seek to provide the

Court with a fuller description of the legal rules, history,

and policies affected by this case.

Robert M. Lawless is the Max L. Rowe Professor at

the University of Illinois College of Law and is an

elected member of the American Law Institute, a

conferee of the National Bankruptcy Conference, and a

fellow of the American College of Bankruptcy. He is also

co-author of a leading casebook on secured credit.

Bruce A. Markell is a former bankruptcy judge and

currently the Jeffrey Stoops Professor of Law at Florida

State University and co-author of four casebooks in

bankruptcy, contracts, secured transactions, and

securitization. He is a member of the Board of Editors of

Collier on Bankruptcy, and an elected member of the

American Law Institute, a conferee of the National

Bankruptcy Conference, and a fellow of the American

College of Bankruptcy, where he currently serves as its ,

Scholar in Residence.

John A. E. Pottow is the John Philip Dawson

Collegiate Professor of Law at the University of

Michigan Law School, a member of the International

* Respondents have filed with this Court a blanket consent to

amicus briefs. Petitioner has furnished a written consent to the

filing of this brief, and a copy of that consent has been filed with this

Court concurrently with the filing of this brief. No counsel for a

party authored any part of this brief. No person, other than amici

and their counsel, has made a monetary contribution toward the

preparation or submission of this brief.

2.

Insolvency Institute, and a co-author of a leading

textbook on bankruptcy law.

SUMMARY OF ARGUMENT

When debtors can’t pay their bills, state law allows

their creditors to grab their assets in an uncoordinated

and chaotic manner. What few assets there are go to the

swift, while the uninformed and cautious take nothing.

This process destroys asset value, which not only hurts

debtors, but the debtors’ other creditors as well.

Congress enacted the Bankruptcy Code to address this

imbalance and potential for waste. Through its

operation, the Code seeks to maximize returns to all

creditors, not just the aggressive, and to offer debtors a

better chance to pay their debts and rehabilitate their

finances.

To achieve these goals, the Code treats secured

creditors and unsecured creditors differently. Secured

creditors are those whose loans to the debtor come with

collateral. In the event the debtor cannot repay the debt,

the secured creditor can look to that property for

repayment. A mortgage provides exactly this kind of

secured claim. If the debtor defaults on the debt, the

secured creditor (mortgagee) can secure payment on the

debt by foreclosing on the debtor's home. Unsecured

creditors, on the other hand, don’t have this option. They

are paid only if anything is left after the secured

creditors have liquidated their collateral. The Code’s

entire apparatus is designed to ensure fairness in

dividing the debtor’s property among these secured and

unsecured creditors.

In this case, Bank of America wants to turn that

careful balance upside down. The bank asks this Court to

create a valuable asset that the market and the Code

ae

regard as worthless. The bank is a junior lienholder on

an underwater mortgage, meaning that the value of the

home does not even cover the secured claim of the senior

creditor. The Code’s plain language treats junior

lienholders in this situation, like Bank of America, as

unsecured creditors. 11 U.S.C. § 506(a).

Bank of America asks this Court to redefine the

nature of its claim. The bank wants its lien to be an

“allowed secured claim,” id, that survives. the

bankruptcy process. The only conceivable reason for

seeking such legal alchemy is so the bank can extract

value from the debtor and other creditors by impeding

the orderly financial resolution that the Code is

specifically designed to provide. The bank argues that

the Court’s decision in Dewsnup v. Timm, 502 U.S. 410

(1992), compels this result.

The U.S. Court of Appeals for the Eleventh Circuit

disagreed, concluding that Dewsnup did not apply. Jn re

Toledo-Cardona, 556 F App’x 911, 912 (11th Cir. 2014)

(unpublished opinion). Dewsnup held that in cases where

the value of the underlying home covers some but not all

of a lien, the undersecured creditor can still retain its

legal claim on the property after bankruptcy. Creditors

whose lies are completely devoid of value, the lower

court held, cannot receive the same treatment. /d.

(following Folendore v. U.S. Small Bus. Admin., 862

F.2d 1537 (11th Cir. 1989)).

Bankruptcy law scholars Robert M. Lawless, Bruce

A. Markell, and John A. E. Pottow, file this brief to urge

the Court to affirm the lower court’s sensible conclusion.

They explain why Bank of America’s arguments are

inconsistent with the Code’s plain language, history, and

fundamental! policies.

ois

To reverse the reasoning of the judgment below—

that holders of mere allowed unsecured claims cannot

bootstrap into becoming treated as secured creditors—

would subvert essential elements of the Code’s basic

architecture, namely: (1) enforcing the secured creditor’s

bargain that it must look to the value of the collateral for

repayment, (2) ensuring equal treatment of all

unsecured creditors, (3) minimizing the potential for

holdout and hostage value to derail voluntary debt

adjustments inside and outside bankruptcy, and (4) in

consumer cases, according debtors finality in resolving

their financial distress and a fresh start through

discharge. Dewsnup should not be extended to bring

about this result. Alternatively, Dewsnup should be

overruled outright as a long-overdue error correction in

bankruptcy jurisprudence.

-5-

ARGUMENT

I. The Bankruptcy Code Already Provides More

Benefits to Junior Creditors Than They Would

Receive Under State Law

A. Bank of America’s Lien Under State Law Is

Worthless

Bank of America holds a junior lien against

Respondent Caulkett’s home. Because the value of his

home has fallen substantially since the loan was issued,

the value of the junior lien is zero. The home’s value isn’t

even enough to pay back Caulkett’s senior creditor. If

that senior creditor foreclosed on the house tomorrow in

response to Caulkett’s default, Bank of America would

receive nothing. More importantly, the senior creditor’s

decision to foreclose would wipe out Bank of America’s

lien, forever extinguishing its (worthless) claim on the

collateral RESTATEMENT (THIRD) OF PROPERTY

(MORTGAGES) § 7.1. (1997).

Bank of America knows this. Because “the present

value of the collateral is less than the amount

outstanding on senior mortgages, if the houses were sold

today, Bank of America would obtain no recovery.” Pet.

Br. 26. But the bank and its supporting amici argue that

affirming the lower court somehow presents Caulkett a

windfall that deprives the bank its due.* The bank argues

that the Code requires it to retain its lien and hopes that

the market correction that rendered its lien worthless

* The “windfall” argument only applies to an individual debtor; a

corporate debtor—such as a commercial real estate owner—can

never have a windfall because it gets no discharge in liquidation. 11

U.S.C. § 727(a)(1).

6-

will somehow, some day, correct itself sufficiently for the

bank to recoup some of its investment. In the meantime,

the bank’s worthless lien should continue to cloud the

property's title, preventing the senior lienholder and

Caulkett from reaching any settlement.*

State law cuts off Bank of America’s desire to play

the market. Under state law, junior lienholders get

nothing if a foreclosed property’s sale price leaves a

senior creditor undercompensated. This is why junior

lienholders charge much higher interest rates. The

benefit of the bargain for junior lienholders like Bank of

America is that in exchange for charging more for the

second mortgage, the junior lienholder has a higher risk

of ending up without a security interest in the property

in the event it is wiped out at foreclosure. Under state

law, a junior lienholder is subject to the whims of the

market, and, perhaps more importantly, the contro] of

the senior lienholder. If the debtor defaults under the

senior lien, the senior lender has a categorical night to

foreclose; the junior lender has no say in the matter.

* The Loan Syndications and Trading Association (LSTA),

amicus in support of Bank of America, contends in passing that

these liens are not economically worthless because there is “a

secondary market” where LSTA members “frequently purchase

debt” that is “often secured by a secondary lien.” Brief for Loan

Syndications and Trade Association at 1. Amici law professors do

not dispute that there are secondary debt markets; amici argue

only that there is no evidence that there is a market for underwater

liens, the kind at dispute in this case. Worthless loans—without

“value” in the parlance of the Code—-might conceivably trade in

some jurisdictions where they have been sanctioned, but they could

only trade in the majority of others (where they have not been

sanctioned) by only the most risk-tolerant speculators willing to

take the chance their liens will not be avoidable under a binding

judicial interpretation of section 506(d).

x

Even if the junior lienholder feels that a foreclosure

occurs during an inopportune dip in the housing market,

there is no recourse under state law. Once the senior

lienholder forecloses, the junior lien is gone, and title is

cleansed.

B. The Code Already Protects Bank of America’s

Junior Lien

Bank of America and its amici argue that affirming

the lower court’s decision would somehow use

bankruptcy to deprive Bank of America of its legal

property rights created under state law. This claim is

mystifying, because the Code is much more generous to

underwater junior lienholders than applicable state

foreclosure law discussed above.

The key lies in the valuation of the collateral. Under

state law, value is determined subject to the mechanistic

process for foreclosure, where the junior lienholder has

effectively no input in the process. Not so in bankruptcy.

To value the junior lienholder’s interest, the debtor must

bring a motion, and the bankruptcy judge will perform a

valuation that avoids the often punishing fire sale

valuations that occur in foreclosures. Fed. R. Bankr. P.

3012. This bankruptcy valuation process can include

expert testimony and provides ample space for a junior

lienholder to argue that a forced liquidation would

undervalue the home, and that the “true” value would

render part of the secondary lien secured for purposes of

the Code. /d.

In other words, although section 506—the section at

issue in this case—separates secured from unsecured

claims, the process by which those claims are separated

differs dramatically from the regimented strictures of

state law. The parties in bankruptcy court, including the

-8-

junior lienholder, can litigate their claims in a way that

the foreclosure process does not accommodate.

Individualized judicial valuation hearings in bankruptcy

give the junior lender a much fairer shot at capturing

any value than a state-law foreclosure.

Bank of America thus can already protect itself

through the bankruptcy valuation process if it believes

the market is undervaluing its underwater lien. And in

fact, if it believes the bankruptcy valuation process itself

is insufficient, it can go further. It can purchase an asset

that it believes the market and the bankruptcy court

have both undervalued by offering to buy it in

bankruptcy for more than the determined aggregate

value of the allowed secured claims. 11 U.S.C. § 363°(f).

Any trustee would jump at the deal.

But, of course, acquiring real estate is risky. Prices

go down as well as up. And here is the essential problem

of Bank of America’s position: it wants this Court to

allow it access to a risk-free investment. If the price goes

up, it still has its nondischargeable lien. If it goes down,

the trustee or the debtor—not Bank of America—takes

the hit. What the junior lienholder could not secure in

the market, and what it could not secure through the

bankruptcy valuation process, it wants to receive by

rewriting the Code.

A fundamental principle of bankruptcy law is that the

Code should not alter state law entitlements absent a

necessary bankruptcy law purpose. See Butner v. United

States, 440 U.S. 48 (1979) (refusing to craft a special rule

for mortgagees in bankruptcy to give them a right to

rents they do not have under state law). According a free

option to a junior lienholder does not just deviate from

state law, it is antithetical to the purposes of bankruptcy

law.

-9-

Il. Bank of America Asks the Court to Grant It

“Hostage Value” for Its Otherwise Worthless

Liens

One might wonder why an underwater second

lienholder would fight to protect a worthless lien. The

answer is not in the lien’s intrinsic market value, which is

zero. Instead, it lies in indirect value. Even a worthless

lien can allow its holder to derive some value from the

property. This is the lien’s “hostage value,” which is both

economically inefficient and inconsistent with the aims of

the Code.

A leading secured credit casebook clarifies the

distinction between market value and hostage value.

“The usefulness of property as collateral will ultimately

depend on (1) how much value the creditor can extract

from it after default (will it bring anything at resale?),

and (2) how much leverage the creditor can derive from

its ahility to deprive the debtor of the property (how

much will the debtor be willing and able to pay to keep

it?).” Lynn M. LoPucki & Elizabeth Warren, SECURED

CREDIT 22-23 (7th ed. 2012). As explained above, the

first factor in this case has already been determined:

zero. Bank of America and all other junior lienholders on

underwater properties must therefore rely on this

second factor—the lien’s ability to make the debtor or

other creditors buy its holder off to clean title to the

property.

This second type of value is called a property’s

“hostage” or “holdout value.” See Anthony T. Kronman,

Contract Law and the State of Nature, 1 J. L. ECON &

ORG. 5, 15-18 (1985). Many secondary liens provide their

holders substantia) hostage value over homeowners and

their primary creditors notwithstanding the lack of

market value. Homeowners face real costs associated

-10-

with the disruptions of losing their homes, such as

moving expenses and employment relocation, and so will

pay a ransom to avoid these costs. The sentimental

attachment many homeowners have to their homes

would only magnify the effect of this distortion.

The ability of a secondary lienholder to force a

foreclosure, post-bankruptcy—even though a successful

foreclosure will bring it absolutely no economic

benefit—enables it to extract payment from a

homeowner who wants to prevent that foreclosure. In a

sense, the junior lienholder on an underwater mortgage

is simply playing an expensive game of chicken. The

disproportionate value that homeowners attach to

staying in their homes is exactly the target for these

junior lienholders. Such lienholders, who don’t really

want to incur the costs of foreclosure, are simply hoping

the homeowner will blink first.

The debtor’s other creditors also suffer from the

worthless liens that remain attached to a property,

clouding the property’s title and stymieing alternative

arrangements between the senior lienholder and the

homeowner. See generally Vicki Been, Howell Jackson,

& Mark Willis, Sticky Seconds—The Problems Second

Liens Pose to the Resolution of Distressed Mortgages, 9

N.Y.U. J.L. & Bus. 71 (2012) (discussing underwater

junior lienholders’ pernicious role in workouts). This

reality stems from the fact that even the most worthless

junior lien can prevent deeds in lieu of foreclosure and

short sales—two commonly used mechanisms to reach

out-of-court resolutions of distressed mortgages—from

taking place.

A deed in lieu of foreclosure allows a homeowner (the

mortgagor) to convey property to its lender in full

satisfaction of the debt without going to court. That is,

x) ©

the homeowner turns over the keys (and the deed), and

the lender no longer seeks to recover from the loan. If a

home is worth less than the senior mortgage, a deed in

lieu of foreclosure can be an efficient, cost-effective

method for satisfying the senior lender and relinquishing

the debtor’s claim to title. But the deed in lieu of

foreclosure is essentially a private transaction between

borrower and lender and as such cannot eliminate other

liens on the property besides the one held by the

primary lender. RESTATEMENT (THIRD) OF PROPERTY

(MORTGAGES) § 8.5 cmt. B (1997). Although a junior

lienholder can get nothing and have its lien erased in a

formal foreclosure, it can still prevent the easier option

of an out-of-court deed in lieu of foreclosure simply by

saying “no” (or, more accurately, demanding a payment

to say “yes”’).

Similarly, a short sale occurs when the lender agrees

that the homeowner can sell the property to a third

party for less than the amount owing on the mortgage

free of the lender’s claim. In short sales, the lender

avoids the delay and costs of foreclosure and gets the

market price the short-sale purchaser is willing to pay.

The homeowner gains a complete or partial release from

any deficiency, and title to the property is again cleare‘.

But here, as with deeds in lieu of foreclosure, the junior

lienholder can prevent a short sale entirely. The result is

that the junior lienholder can extract payment from

either the senior lienholder or the debtor to facilitate the

short sale by threatening to prevent this expedited

disposition of the underwater home by refusing to

convey clean title to the purchaser.

Thus, the underwater junior lienholder acts as a sort

of nuisance plaintiff who files a frivolous claim and must

be bought off by the senior creditor if the costs of

-12-

requiring full foreclosure instead of deeds in lieu of

foreclosure, short sales, or even refinancings with the

debtor exceed the payoff demanded by the gadfly to go

away. Exploitation of this hostage value harms both

debtors and senior lenders alike. Both suffer rent

extractions to junior lienholders that the Code is

designed to prevent.‘

One reason the Code evinces such hostility to..ard

hustage value is the multi-party nature of bankruptcy

proceedings. Consider a commercial firm with vital

machinery that has been tailored to its own purposes. On

a secondary market, this machinery will have little value.

But if the debtor loses its machinery, it loses much more

than the resale value. It may indeed lose the value of the

entire enterprise. A lienholder could extract an

extravagant premium from the debtor to prevent

repossession and concomitant factory shutdown.

Outside bankruptcy, that hostage value is simply

unpleasant for the debtor—simply a product of the

contracting parties’ negotiation. If the debtor grants a

lien on the specialized machinery to get cheap credit, so

be it. But in bankruptcy, the threat of hostage value is

devastating. Every dollar a debtor pays to satisfy a

lienholder’s hostage value is a dollar that does not go to

pay other creditors. The Code aims to neutralize, even

eliminate, these kinds of zero-sum contests. For exactly

this reason, the Code mostly protects only the

“objective” value of the collateral itself, not the hostage

os

* Hostage value is the liquidation bankruptcy cousin to the bane

of reorganization bankruptcy: holdout value. The Code combats

that related economic impediment to bankruptcy goals by allowing

the vote of a creditor class to bind all ciass members to a

reorganization plan. See 11 U.S.C. §§ 1126(e), 1129.

mie

value premium of a “subjective” excess. Section

1129(b)(2)(A), for example, allows secured creditors to

receive the “value of [the secured creditor’s] interest” in

the debtor’s property, not the subjective value of the

asset to the debtor. See also 11 U.S.C. § 1225(a)(5)(B)

(secured creditor receives the amount of the “allowed

secured claim”); 7d. § 1325(a)(5)(B) (same). Doing so

carefully balances the rights of secured creditors with all

other claimants in the debtor’s estate.

Ill. This Court’s Precedents Do Not Support the View

that “Liens Pass Through Bankruptcy”

A. Liens Do Not Pass Through Bankruptcy; They

Pass Through Bankruptcy Only if the Code

Permits Them to Stay in Piace

Bank of America argues that it is entitled to its

economically disruptive, inefficient, and atextual reading

of the Code because of a supposedly overarching and

ancient principle of bankruptcy law that “liens, including

underwater liens, ride through chapter 7 bankruptcy

unaffected.” Pet. Br. 44. For support, it cites the Court’s

decision in Dewsnup, 502 U.S. at 417-18.

Although Dewsnup announced its understanding of

historical practice as favoring a policy that allowed liens

to survive bankruptcy, id. at 418, this conclusion is only

partially true and dangerously misleading, especially so

when quoted as a general aphorism.

In fact, liens are altered, capped, subordinated, and

even wholly avoided in bankruptcy proceedings all the

time. The list of Code provisions that alters liens is

dizzying. The automatic stay of section 362 stops a

secured creditor from enforcing its lien, and the secured

creditor is not compensated for the delay in realizing on

-14-

its collateral. United Sav. Ass’n v. Timbers of Inwood

Forest Assocs., 484 U.S. 365 (1992). Under

section 364(d), a bankruptcy court can under some

circumstances award a lender who lends to the debtor

after the filing of the bankruptcy petition a

“superpriority” lien that trumps existing liens on

property of the estate. A lien can be avoided as a

preference under section 547 or a fraudulent transfer

under section 548. Section 522(f) allows debtors to avoid

some liens that impair exemptions on certain assets. The

trustee might avoid a lien under the “strong-arm

powers” of section 544. The trustee can avoid some

statutory liens under section 545. These provisions

apply generally to all bankruptcy debtors, regardless of

the chapter under which they have filed a petition. The

list goes on.

Additionally, in a chapter 11 reorganization plan, a

secured creditor can be crammed down and have its lien

altered over its objection. If a cramdown happens to a

secured creditor, that creditor receives the value of its

collateral, not the full amount of its lien. See 11 U.S.C.

§ 1129(b)(2)(A). Similarly, the baseline rule in chapters

12 and 13 is that secured creditors receive only the value

of their collateral, 11 U.S.C. §§ 1225(a)(5)(B)(i),

1325(a)(5)(B)(ii). Where Congress wanted to depart from

that baseline rule it wrote specific exceptions. See 11

U.S.C. §§ 1322(b)(2), 1325(a) (unnumbered paragraph)

(requiring payment of full allowed claim, not capped

valuation at allowed secured claim, for some debts owed

on primary residences and new cars). It is also incorrect

that a creditor can stand aloof from a bankruptcy

proceeding and have its liens survive unscathed. Section

501(c) allows the bankruptcy trustee or the debtor to file

a proof of claira on behalf of a creditor who does not file

one, lien or no lien.

a 8

Thus, the misleading “liens ride through bankruptcy”

half-truth invoked in Dewsnup and pushed by Bank of

America here might be more correctly reformulated as

“liens ride through bankruptcy wnless affected by the

Bankruptcy Code.” Cf In re Pence, 905 F.2d 1107, 1109

(7th Cir. 1990) (“These cases actually stand for nothing

more than the proposition, now codified in 11 U.S.C.

§ 506(d), that unless action is taken to avoid a lien, it

passes through a bankruptcy proceeding.”) Reduced to

this proper form, the saying devolves into tautology.

Nonetheless, the tautology provides insight into

places where the Code is silent. Amici do not dispute the

idea that the Code leaves liens in place unless a provision

of the statute operates otherwise. In other words, if the

Code does not independently adjust the rights of a

lienholder, the bankruptcy process leaves those rights

untouched. But beyond that general statement of how to

treat silence in the Code, the slogan “liens ride through

bankruptcy” does not help answer questions such as the

one at issue in this appeal. The contest here is precisely

whether section 506(d) is one of those many instances

where the Code alters liens. Bank of America’s

misleading incantation that “liens ride through

bankruptcy” skips the very analysis that the bank is

asking this Court to perform.

B. This Court’s Key “Liens Ride Through”

Precedent—Long v. SBullard—Does_ Not

Actually Hold that Liens Ride Through

Bankruptcy

Not only is the naked statement that “liens ride

through bankruptcy” misleading on its face, it stems

from a misunderstanding of the case usually invoked as

the venerable authority for the proposition, Long v.

-16-

Bullard, 117 U.S. 617 (1886). See Pet. Br. 23, 28, 31, and

35. A careful review of the facts of that case clarifies that

the primary legal issues involved the interaction between

state property law and federal bankruptcy law.

Long, a debtor, had claimed a homestead exemption

in his federal bankruptcy proceeding and argued that

that exemption defeated a state law mortgage. All this

Court held was that claiming the homestead exemption

under federal bankruptcy law did not act to eliminate the

mortgage on the underlying real estate. /d. at 621. The

question the Court decided was only whether the

debtor’s right to claim a homestead exemption in

bankruptcy somehow invalidated the lien the creditor

claimed as a mortgage. The Court announced no broad

principle of liens and bankruptcy law. (Tellingly, the

aphoristic phrase appears nowhere in the opinion.) On

the contrary, the case was chiefly concerned with

federalism and issue preclusion in determining the

validity of the mortgage.

Without detouring too deeply into the facts of a 130-

year-old case, the main issue in Long arose more from

the idiosyncratic nature of the mortgage in question than

it did from sweeping principles of bankruptcy law.

Creditor Bullard loaned money at usurious rates to

debtor Long, secured by a deed to Long’s house. Long

then went through bankruptcy and discharged his debts.

When Bullard later came to foreclose on the mortgage,

Long successfully challenged Bullard’s underlying loan

aS usurious and therefore invalid under state law,

requiring the mortgage to be set aside. Bullard

countered that at the time of the original loan, an

equitable mortgage arose to the extent the loan was non-

usurious. The state courts agreed with Bullard. Bullard

v. Long, 68 Ga. 821 (1882).

-17-

In this Court, the case became one about the ability

of the federal courts to revisit state-law determinations

regarding when the equitable mortgage arose under

state law. Because the state courts had decided the

mortgage arose at the time of the original loan, this

Court concluded that there was no space for federal

courts to say otherwise. As Chief Justice Waite

concluded: “The dispute. was as to the existence of the

lien at the time of the commencement of the proceedings

in bankruptcy. That depended entirely on the state laws,

as to which the judgment of the state court is final and

not subject to review here.” Long, 117 U.S. at 620-21

(emphasis added). The case was not a_ solemn

pronouncement of the general treatment of liens under

federal bankruptcy law, as the subsequent mythology

appears to have it. Instead, the parties were litigating

the boundary lines between state and federal law in

bankruptcy. The Court’s conclusion that it was bound to

respect state courts’ determinations of the existence and

timing of state-law property rights had nothing to do

with broad principles of bankruptcy.

Long v. Bullard is often associated with the notion

that “liens ride through bankruptcy.” This is legal

mythology. Like the children’s game of broken

telephone, the idea has been repeated so many times

that its original meaning has long been lost. The actual

holding of Long v. Bullard is much narrower than the

hailf-truth that “liens ride through bankruptcy.”

C. Liens Have Always Been Subject to Alteration

in Bankruptcy.

Amici for Bank of America include the erroneous

recitation of the Long v. Bullard mythology. See Brief

for Loan Syndications and Trading Association at 12-16

-18-

(“LSTA Brief”). But those amici seem to make another

historical argument: independent of Long, the principle

that liens cannot be violated in bankruptcy has been a

constant principle of federal bankruptcy law.

This is incorrect. There are of course cases holding

that particular facts do not trigger lien-avoiding

provisions of the Code. Again, amici here agree with

amict for Bank of America that the bankruptcy

discharge does not, without more, erase an otherwise

legal lien. LSTA Brief at 12, 16. The extensive history

cited in the LSTA Brief demonstrates precisely this view

that all parties can endorse. Liens sometimes survive

bankruptcy, except when they do not.

But this proposition is obvious and unhelpful. Despite

the historical examples offered by LSTA, previous

versions of the bankruptcy law routinely allowed courts

to avoid liens for reasons “other than payment on the

debt.” Dewsnup, 502 U.S. at 418-19. For example,

section 14 of the Bankruptcy Act of 1867 allowed the

avoidance of any judicial lien obtained within four

months of the bankruptcy. Bankruptcy Act of Mar. 2,

1867, ch. 176, 14 Stat. 517 § 14 (repealed 1878) (“1867

Act”). Section 67 of the Bankruptcy Act of 1898 did much

the same thing. Bankruptcy Act of July 1, 1898, ch. 541,

30 Stat. 544, § 67 (repealed 1978). Under these laws,

creditors who obtained liens as an impermissible

preference did not survive bankruptcy. Similarly, liens

that were obtained for less than reasonably equivalent

value have been avoidable as fraudulent transfers. See,

€.g., id.

The most that can be said regarding the historical

practice of liens in bankruptcy under prior statutes was

that provisions expressly protecting liens were included

in the Bankruptcy Acts of 1800 and 1841. And the

-19-

Bankruptcy Act of 1867 allowed for protection outside

the four-month window mentioned above. See

Bankruptcy Act of Apr. 4, 1800, ch. 19, 2 Stat. 19 § 63

(repealed 1803); Bankruptcy Act of Aug. 19, 1841, ch. 9,5

Stat. 440 § 2 (repealed 1843); 1867 Act § 14. To that

limited extent, then, it is true that some liens under some

prior versions of the federal bankruptcy law “rode

through” bankruptcy by explicit congressional

command. But at that level of generality, the proposition

is unremarkable.

D. Whether Liens Sometimes Rode Through

Bankruptcy Is Ultimately Irrelevant

All this historical discussion reduces to two general

points: (1) liens sometimes rode through bankruptcy

under prior, repealed versions of the bankruptcy laws,

and (2) sometimes they did not under those same laws.

But it is a strange argument to insist that 200-year-old

statutes, since abrogated in their entirety by an

intentionally comprehensive overhau! of the bankruptcy

system, should count as anything other than a historical!

curiosity.

To decide whether Congress’s innovations to the

rights of secured creditors were intentional or

inadvertent in 1978 should require focus on what that

Congress, not prior Congresses, said. And there, the

House Judiciary Committee’s report explained the

reasons for the changes in section 506, and is worth

quoting in full.

One of the more significant changes [wrought by

the Bankruptcy Code} is the treatment of

secured creditors and secured claims. The

distinction becomes important in the handling of

-20-

creditors with a lien on property that is worth less

than the amount of their claim, that is, those

creditors who are undersecured.

Throughout the bill, references to secured claims

are only to the claim determined to be secured

funder Section 506(a)], and not to the full amount

of the creditor’s claim. This provision abolishes

the use of the terms “secured creditor” and

“unsecured creditor” and substitutes in their

place “secured claim” and “unsecured claim.”

H.R. Rep. No. 95-595, at 180-81, 356.

The opinion in Dewsnup mistakenly contends there is

no evidence in the “annals of Congress,” 502 U.S. at 420,

that section 506 was meant to deviate from the opinion’s

understanding of bankruptcy history. But the opinion

did not cite that history, even as other, pre-Dewsnup

circuit courts had done. See In re Lewis, 875 F 2d 53, 55

(3d Cir. 1989); In re Ahlers, 794 F 2d 388, 394 n.5 (8th

Cir. 1986), rev'd on other grounds, 485 U.S. 197 (1988).

The existence of the committee report's clear

explanation of congressional intent behind section 506

further undercuts Dewsnup’s claim that Congress was

inadvertently abrogating a historical practice of lien

protection in bankruptcy law.’

* Amici appreciate that the Court believed the historical

bankruptcy practice illuminating in Dewsnup, 502 US. at 418-19,

but the brief discussion there (relied upon heavily by Bank of

America) oversimplified the history. As just discussed, provisions of

pre-Code law frequently invalidated liens for reasons other than

payment. But see id. (“Apart from reorganization proceedings, see

(Continued...)

-21-

IV.This Court Should Overrule Dewsnup

Amici believe that Dewsnup need not be overruled to

affirm the judgment below. In Dewsnup, the lien in

question still had market value: it was merely worth less

than the debt owed on the lien. At least in those factual

circumstances, an undersecured creditor retains the

incentive to reach out-of-bankruptcy settlement. But, as

argued above, liens such as Bank of America’s that

retain no market value give the holder no incentive to do

anything but impede the orderly resolution of a

homeowner’s financial distress. Thus, amici urge the

Court to uphold the lower court’s decision.

A cleaner way, however, for the Court to reach the

same result would be to overrule Dewsnup once and for

all and return the plain meaning to the text of

section 506(d) that Dewsnup upended. Whether this

case presents the best vehicle to do so is something on

which amici express no opinion. Amici are certain,

though, that the opinion is deeply flawed and should be

abandoned.

Dewsnup is a short and thinly-theorized precedent

that almost no bankruptcy scholar defends. The

principal problem is one of statutory interpretation. The

opinion is almost completely irreconcilable with the plain

language of the Code and effectively concedes as much.

11 U.S.C. §§ 616(1) and (10) (1976 ed.), no provision of the pre-Code

statute permitted involuntary reduction of the amount of a

creditor’s lien for any reason other than payment on the debt.”).

And, Long v. Bullard was about much more than the bankruptcy

discharge’s effect on liens. But see id. at 419 (“In Long v. Bullard,

117 U.S. 617, 620-621 (1886), the Court held that a discharge in

bankruptcy does not release real estate of the debtor from the lien

of a mortgage created by him before the bankruptcy.”).

mm

Id. at 417 (“Were we writing on a clean slate, we might

be inclined to agree with petitioner that the words

‘allowed secured claim’ must take the same meaning in

§506(d) as in § 506(a)”). This tension has led to the

widespread—near-unanimous—criticism of that opinion

by bankruptcy scholars. See, e.g., David Gray Carlson,

Bifurcation of Undersecured Claims in Bankruptcy, 70

Am. Bankr. L.J. 1, 16 (1996) (characterizing Dewsnup’s

assignment of different meanings to “allowed secured

claim” in §§506(a) and (d) as “overt interpretive

violence”); Lawrence Ponoroff & FF. Stephen

Knippenberg, The Immovable Object Versus the

Irresistible Force: Rethinking the Relationship Between

Secured Credit and Bankruptcy Policy, 95 Mich. L. Rev.

2234 (1997) (“Dewsnup was not only a historical anomaly

in terms of the Supreme Court’s_ established

methodology in its approach to bankruptcy cases, but

also an untenable exception in the ever-more-clearly

emerging course of bankruptcy jurisprudence under the

Code.”).

As a matter of textual interpretation, Dewsnup could

most charitably be described as problematic. Section

506(d) provides, in relevant part, that “[t]o the extent

that a lien secures a claim against the debtor that is not

an allowed secured claim, such lien is void.” 11 U.S.C.

§ 506(d). The Court in Dewsnup read “allowed secured

claim”—an expressly defined term of art in the Code—to

mean “allowed claim.” Dewsnup, 502 U.S. at 417-18.°

* Dewsnup attempted to redefine “allowed secured claim” in

section 506(d) as, effectively, “allowed claim that is at least in some

part secured.” An undersecured creditor's full allowed claim would

thus meet this definition, as it is both allowed and, to some extent,

secured.

(Continued...)

-23-

By so doing, the Court excised one of the most

important words in the Code from this section. In

bankruptcy, most everything hangs on whether a

creditor heids (or does not hold) a security interest. It is

one thing to read the same term in different parts of a

lengthy statute differently. It is quite another to do so

within the very same statutory section in which it is

defined, as Justices Scalia and Souter forcefully

observed in dissent. See Dewsnap, 502 U.S. at 422

(Sealia, J., dissenting) (observing the rule that identical

words used in different parts of the same statute take

the same meaning “must surely apply, a fortiori, to use

of identical words in the same section of the same

enactment.”)

Dewsnup’s error is not confined to section 506(d).

Rather, it destabilizes section 506(a)’s definition of

“allowed secured claim” in a way that casts doubt on the

vitality of its meaning. It is supposed to be a “term of

art,” Nobelman v. American Sav. Bank, 508 U.S. 324

(1993), that is used “throughout the Code,” H.R. Rep.

No. 95-595 at 356. Dewsnup’s rewriting of “allowed

secured claim” in one part of the Code means its

The problem with this special reading of “allowed secured

claim” is that section 506(d) is a provision that specifically voids

liens. Voiding liens can only apply to secured claims, because there

is no such thing as a lien on an unsecured claim. By definition, an

unsecured claim is a debt unsecured by a lien.

Dewsnup’s reading of section 506(d) to restrict lien avoidance

on liens that satisfy its two prongs—{1) allowed, and (2) to some

extent, secured—thus contains a redundant second prong, which

means the test collapses into the first prong only: liens are not

avoided on allowed claims. Thus, Dewsnup presents a textual

conundrum of reading “allowed secured claim” as “allowed claim,” a

concession Bank of America is forced to make. Pet. Br. at 19.

-24-

meaning in other sections is up for grabs for lenders and

debtors to litigate and bankruptcy, district, and

appellate courts to redefine with no burden of

consistency. Such uncertainty and inconsistency are

anathema to the spirit and letter of uniformity that

Congress wrought in the passage of the Code for the

hundreds of thousands of bankruptcy petitions

adjudicated annually. “The risks of relying on such

practice in interpreting the Bankruptcy Code, which

seeks to bring an entire area of law under a single,

coherent statutory umbrella, are especially weighty.”

Bank of America National Trust & Sav. Ass’n v. 203

North LaSalle Street P’ship, 526 U.S. 434, 461 (1999)

(Thomas, J., concurring).

Dewsnup has been subsequently criticized by

members of the Court as committing “methodological

error” in laying the grounds for this uncertainty. Jd. at

461; see also id. at 463 (“Regrettably, subsequent

decisions in the lower courts have borne out the

dissenters’ fears. The methodological confusion created

by Dewsnup has enshrouded both the Courts of Appeals

and, even more tellingly, Bankruptcy Courts, which

must interpret the Code on a daily basis.”) This

uncertainty lingers over the Code today and will

continue to do so until this Court abandons Dewsnup’s

faulty reasoning.

Amici are mindful of the doctrine of stare decisis,

and do not seek to portray themselves as experts

thereon. Whether this is the right vehicle to overrule

Dewsnup, or whether an overruling should be given only

prospective effect to future creditors, are questions that

-25-

likely exceed our areas of expertise.’ Amici note nothing

more than the fact that this Court can and does overrule

statutory precedents when appropriate circumstances

arise. See, e.g., Hubbard v. United States, 514 U.S. 695

(1995) (overturning previous statutory interpretation

and returning to the plain textual meaning). To the

extent helpful to the Court’s analysis, amici advise from

their perspective as bankruptcy experts that the

Dewsnup opinion is uniformly criticized, generally

wreaks havoc with the Code by injecting unwarranted

uncertainty, and is unlikely to have generated any

serious reliance interests by secured creditors according

to the best available empirical evidence.

* + +

Bank of America and other underwater junior

lienholders charge higher interest rates for their risky

investments. But they are not completely without

recourse in the event that their risky security becomes

worthless: the bankruptcy process allows them to

participate in the valuation of the property and, if

necessary, share in the estate as unsecured creditors.

What the bank now seeks, though, is something else,

something new: hostage value that will disrupt the

bankruptcy process and wreak havoc on debtors and

'There is only one stare decisis point amici wish to address

specifically. Bank of America contends congressional inaction

demonstrates acquiescence to Dewsnup. Pet. Br. 41. Amict think

this is unfair. Because the Court itself admitted it was contravening

the fairest reading of the text of section 506(d), it’s not clear how

Congress should have amended that text, other than adding “i.e., as

just defined in subsection (a),” right after “allowed secured claim,’

which would be a startling drafting requirement.

-26-

creditors alike. The Court should reject Bank of

America’s breathtaking suggestion that hostage value is

a central and time-honored policy of the Code. Reversing

the lower court would create an asset that gives comfort

only to those creditors who seek to shake down debtors

and senior creditors for a payment that neither the

market nor the Code would permit. This Court should

not play along with Bank of America’s attempt to enjoy a

leg up over other creditors and get a risk-free

investment at the expense of the bankruptcy process.

CONCLUSION

For the foregoing reasons, the decision of the court

of appeals should be affirmed.

Respectfully submitted,

PETER CONTI-BROWN

DEEPAK GUPTA

Counsel of Record

GUPTA BECK PLLC

1735 20th Street, NW

Washington, DC 20009

(202) 888-1741

deepak@guptabeck.com

Counsel for Amici Curiae

February 24, 2015