The source of this particular issue is the Supreme Court's 1992 decision in Dewsnup v. Timm, in which the Court held that section 506(d) of the Bankruptcy Code does not permit chapter 7 debtors to reduce the amount of a partially unsecured lien to the judicially determined value of the collateral. The Court's reasoning in Dewsnup focused on its determination that Congress, in enacting the Bankruptcy Code, did not intend to depart from the pre-Code rule that liens generally pass through bankruptcy unaffected. Additionally, the Court was hesitant to modify the prepetition contractual rights between secured lenders and debtors. Accordingly, Dewsnup made clear the chapter 7 debtors could not strip down partially unsecured liens using section 506(d). Dewsnup did not address, however, the related issue of whether section 506(d) permits chapter 7 debtors to void entirely those liens that are wholly unsupported by the value of the collateral. Lower courts nationwide have struggled with this issue ever since.
Although not every federal circuit court has addressed this issue, the majority of those that have ultimately determined that the reasoning in Dewsnup extends to the strip off issue, prohibiting debtors from using section 506(d) to eliminate wholly unsecured junior liens. Courts in the Eleventh Circuit, however, have continually relied on a pre-Dewsnup decision, In re Folendore, that permitted strip off in chapter 7. The Eleventh Circuit reaffirmed this decision post-Dewsnup in In re McNeal. In essence, courts in the Eleventh Circuit permit chapter 7 debtors to strip off wholly unsecured junior liens because they interpret Dewsnup as not being clearly on point, leaving In re Folendore as controlling precedent.
While the Second Circuit has not yet spoken on this issue, the United States District Court for Eastern District of New York has, and in Wachovia Mortgage v. Smoot held that section 506(d) of the Bankruptcy Code does not permit chapter 7 debtors to strip off wholly unsecured liens, relying on the reasoning of the Supreme Court's decision in Dewsnup.
The lasting effect of the Supreme Court's denial to hear Slinkfield is that this issue will remain open to interpretation until either Congress or the Court offers a definitive answer.