Dewsnup Needs to be Overturned: It’s Out of Touch and Based on a Bizarre Foundation (But U.S. Supreme Court Passes)

By: Donald L. Swanson

The U.S. Supreme Court’s Dewsnup v. Timm opinion (502 U.S. 410 (1992)) was wrongly decided and needs to be overturned.

Unfortunately, that’s not going to happen any time soon, since the U.S. Supreme Court denied certiorari on Tuesday (February 19, 2019) in the case of Ritter v. Brady, Supreme Court Case No. 18-747.

I’ll try to demonstrate how out-of-touch the Dewsnup rationale, from nearly three decades ago, actually is!

Dewsnup: The Question

The question decided by the U.S. Supreme Court, in Dewsnup v. Timm, is this:

May a debtor “strip down” a creditor’s lien on real property to a judicially-determined value of the collateral, under 11 U.S.C. § 506(d)?

11 U.S.C. § 506(d) provides in part (emphasis added):

(d) To the extent that a lien secures a claim against the debtor that is not an allowed secured claim, such lien is void.

Dewsnup: The Facts

On June 1, 1978, Timm loaned $119,000 to Dewsnup, secured by a Deed of Trust on two parcels of Utah farmland. Dewsnup defaulted on the loan.

Dewsnup filed Chapter 7 bankruptcy and sought to “avoid” the under-secured portion of Timm’s lien under § 506. The Bankruptcy Court found the amount of the secured debt to be $120,000 against a collateral value of $39,000.

Dewsnup: The Bankruptcy Court Decision and Appeals

The Bankruptcy Court refused Dewsnup’s avoidance request, based on a side issue: it reasoned that the Chapter 7 Trustee had abandoned the property under § 544; so, the property could not be subject to § 506, which applies only to “property in which the estate has an interest.” Dewsnup appealed.

The United States District Court summarily affirmed, without a supporting opinion. Dewsnup appealed again.

The Tenth Circuit Court of Appeals also affirmed—on two side issues. First, it specifically approved the Bankruptcy Court’s abandonment rationale. Then, it declared that a contrary result would be inconsistent with a debtor’s limited rights of redemption under § 722 of the Bankruptcy Code. Dewsnup appealed to the U.S. Supreme Court, which granted certiorari.

Dewsnup: The Supreme Court’s Ruling and Rationale

The Supreme Court addresses the § 506 issues head-on and affirms. Here is the essence of its affirming rationale.

It begins by analyzing the language of § 506 and reaching these conclusions:

Section 506 and other provisions of the Bankruptcy Code “embrace some ambiguities”;

“Were we writing on a clean slate, we might be inclined to agree” that “the words ‘allowed secured claim’ must take the same meaning in 506(d) as in 506(a)”; but

Because of ambiguities in the text, we must follow the pre-Code rule that “liens pass through bankruptcy unaffected.”

In describing pre-Code law, the majority declares propositions that, in today’s world, seem awkward—even bizarre!

Consider these four propositions of law declared in the Dewsnup v. Timm majority opinion as the basis for its ruling.

–First Proposition – No “Windfall” Permitted

A contrary ruling would “freeze the creditor’s secured interest at the judicially determined valuation,” so the secured creditor “would lose the benefit” of any future increase in value of the collateral by the time of a foreclosure sale—a potential “windfall” for the Debtor; and

The secured creditor should receive what it “bargained for,” despite § 506(d)’s “voidness” language;

–Second Proposition – Looking to Pre-Code Law

“Under the Bankruptcy Act of 1898, a lien on real property passed through bankruptcy unaffected.”

–Third Proposition – Enforcing Pre-Code Law

The Bankruptcy Act of 1898 did not permit an “involuntary reduction of the amount of a creditor’s lien for any reason other than payment on the debt”;

In Louisville Joint Stock Land Bank v. Radford, 295 U.S. 555 (1935), for example, the Supreme Court invalidated a Bankruptcy Act amendment that scaled-down a secured debt “to the present value of the property”—it invalidated the amendment under the “Takings Clause” in the U.S. Constitution’s Fifth Amendment; and

“Congress must have enacted” the 1978 Bankruptcy Code “with a full understanding of this practice.”

–Fourth Proposition – Ambiguity & Legislative History Control

When Congress amends the bankruptcy laws, it does not write “on a clean slate”;

The Court is “reluctant to accept arguments” creating “a major change” from practice under the Bankruptcy Act of 1898 without “at least some discussion in the legislative history,” unless “the language is unambiguous”; and

The lien stripping remedy proposed by debtor cannot be accepted, (i) because it is “contrary to basic bankruptcy principles,” and (ii) due to ambiguity surrounding § 506.

Dewsnup: A Bizarre Foundation & Out of Touch

If you want to read a rationale that’s bizarre, consider the Fifth Amendment “Takings Clause” rationale from the Supreme Court’s Louisville v. Radford opinion [Note: such rationale is a foundation for Dewsnup’s majority opinion].

Louisville v. Radford declares “void” (under the Takings Clause) an amendment to the Bankruptcy Act of 1898 that stripped down an under-secured claim to the collateral’s value. Here’s what the Supreme Court said:

“private property shall not be thus taken even for a wholly public use without just compensation”;

taking property of a mortgagee to further the “public interest” and to “relieve the necessities of individual mortgagors” requires “proceedings by eminent domain”; and

that’s because “the burden of the relief afforded in the public interest” must be “borne by the public” through “taxation.”

Such a rationale is . . . well, it’s bizarre in today’s bankruptcy world. There’s no other way to describe it:

• In today’s world, under-secured liens are stripped down to present value in a variety of bankruptcy contexts; and
• Bankruptcy courts and their appellate overseers have, simply, refused to extend Dewsnup beyond its limited context.

So, a bizarre rationale is the foundation . . . the cornerstone . . . the bedrock . . . for the Supreme Court’s Dewsnup v. Timm ruling. That needs to change.

Conclusion

Dewsnup v. Timm is based on a bizarre foundation and is out of step with today’s bankruptcy world.

It needs to be overturned.  Unfortunately, the U.S. Supreme Court passed, two days ago, on a perfect opportunity to do so.

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