Yale Law Clinic Seeks Relief for Homeowners Burdened with Underwater Second Mortgages

The Mortgage Foreclosure Litigation Clinic at Yale Law School, along with the Connecticut Fair Housing Center (CFHC), has filed an Amicus Brief with the Supreme Court of the United States in support of Respondents, David Caulkett and Edelmiro Toledo-Cardona, in Bank of America v. Caulkett. The case presents the question of whether wholly underwater second mortgages can be voided in bankruptcy as unsecured liens.

The question of second mortgages is especially pertinent in Connecticut. Hartford, Connecticut, holds the dubious distinction of being the “most underwater” city in the nation, with a negative equity rate of 56%*. Connecticut is also home to three other cities in the top one hundred towns with the highest negative equity in the country, including New Haven. The Supreme Court’s ruling in Caulkett has the potential to affect the many Connecticut residents with underwater second mortgages by providing a helpful alternative to foreclosure for resolving their mortgage troubles, according to the clinic.

The Mortgage Foreclosure Clinic provides legal assistance to individuals who cannot afford private counsel. The Clinic has been representing homeowners fighting foreclosure in Connecticut since 2008. The Clinic has also filed amici briefs with appellate courts in several states and its members have testified before the Connecticut legislature on foreclosure policy.

CFHC represents homeowners in foreclosure litigation and provides individualized advice and instruction to more than 1,800 homeowners each year. CFHC also trains and advises hundreds of attorneys, housing counselors, and government employees who work with homeowners facing foreclosure.

The Clinic and CFHC argue in their brief that investors holding second mortgages (generally large banks) often obstruct arrangements that would be beneficial for both homeowners and first mortgage holders. Allowing bankruptcy to strip off second mortgages that no longer contain any actual value will help more homeowners keep their homes.

The bankruptcy code allows people burdened by financial troubles get a fresh start. It also allocates the debtor’s assets by prioritizing certain secured loans, according to the clinic. Completely underwater second mortgages, though, are functionally no different from unsecured debt (such as credit card debt).

 “In the aftermath of the housing crisis, fully underwater second mortgage holders have often been able to use their hostage power to destroy workouts that would be beneficial for first mortgage lenders, homeowners, and surrounding communities,” says Alexa Milton ’16, a Yale law student intern in the Clinic. “The Bankruptcy Code is designed to prevent exactly this kind of collective action problem.”

Second mortgages do not effectively promote homeownership the way first mortgages do, student said. They argue that taking away unwarranted protection for underwater second mortgages, then, will not undermine the “American Dream” of homeownership.

“Second mortgages really play a peripheral role in a healthy housing market,” notes Beezly Kiernan ’16, another law student intern in the Clinic. “In fact, piggyback second mortgages contributed to an unhealthy housing market—as well as the financial crisis and subsequent recession—in the mid-2000s.”

The Connecticut General Assembly recognized and dealt with the second mortgage hold-out problem by passing Public Act 14-84, An Act Concerning an Optional Method of Foreclosure. The act allows homeowners and first mortgage holders to carry out short sales without requiring consent from second mortgage holders.

Unlike the Connecticut act, though, voiding second mortgages in bankruptcy would let many homeowners stay in their homes.  “From a policy standpoint,” states law student intern, Solange Hilfinger-Pardo ’17, “we see bankruptcy as a much better way to deal with the second mortgage hold-out issue, both for the homeowner and for the first mortgage holder.”

“Our students of course relish this opportunity to participate in Supreme Court litigation,” says clinical supervisor J.L. Pottenger, Jr. “Appellate briefs are a great addition to our usual trial-level motion practice on our client homeowners’ behalf.”

In addition to gaining valuable experience, the Clinic’s students also bring something new to the debate. “With their insight and research, the students introduced a fresh perspective to the case,” says Jeff Gentes, Managing Attorney, Fair Lending and Foreclosure Prevention at CFHC and the Clinic’s co-supervisor. “If the Supreme Court rules in the homeowners’ favor, thousands across the country will be able to thank the students for making a real difference in their lives.”

Oral arguments for Bank of America v. Caulkett (Case No. 14-10803) are scheduled for March 24, 2015, with a decision expected by late June.

*Haas Institute, Underwater America, U.C. Berkley (2014), 14.