Liens in bankruptcy have an uncertain fate.
While most liens survive a bankruptcy discharge, some liens get wiped out.
Think of mortgages, tax liens, and judgment liens.
Each of them is a lien, but some get different treatment in bankruptcy.
Some liens can even be reduced or eliminated .
Lien basics
A lien gives the creditor holding the lien an interest in the debtor’s property, real or personal. With that interest comes the right to compel a sale of the property to pay the debt secured by the lien.
Liens come in three varieties: voluntary, judicial, and statutory.
Ordinarily, the lien must be paid off before any of the value in the collateral goes to the owner of the property.
And while you’re stuck with some liens after bankruptcy, some can be whittled down to size, and some can be eliminated altogether when you file bankruptcy.
But first, we’ve got to know which kind of lien we’re dealing with.
Voluntary liens
Voluntary liens are ones that you agree to create in favor of a creditor. A mortgage is a classic example, as is the lender’s lien on your car.
In business, a lender often insists on a lien on business assets to secure repayment of a loan. The lien puts the lender ahead of other unsecured creditors in the fight to be paid.
Judicial liens
Judicial liens are, not surprisingly, created by judges. They result from court judgments or orders creating temporary liens during the course of a lawsuit.
State law determines whether a judgment automatically becomes a judicial lien. In California, the winning party must take an additional step of recording an abstract of judgment to create a lien on real estate in that county.
Statutory liens
Statutory liens are created by law. Tax liens are ones we encounter most frequently.
Provisions of the tax statutes say that unpaid taxes become a lien on all the taxpayer’s assets.
Bankruptcy changes the rules
A cornerstone proposition in bankruptcy law says that a lien is only a “secured claim” to the extent that there is value in the asset for the lien to attach to.
A creditor may have a lien with a face value of $100,000. But if the property it attaches to had only $15,000 of available equity, the lien holder has a secured claim for $15,000 and an unsecured claim for $85,000.
Another cornerstone of bankruptcy law says that, without additional proceedings in bankruptcy court, liens survive bankruptcy as a charge on the property they attach to.
So, we really want to know which liens are vulnerable to being voided or whittled down by a proceeding in bankruptcy and in which chapter of bankruptcy those proceedings can be brought.
Judicial liens lose to exemptions
In any chapter of bankruptcy, the debtor can avoid (invalidate) a judicial lien that impairs an exemption to which the debtor is entitled. 11 USC 522(f).
Depending on the numbers, the lien can be eliminated altogether if there is not enough value in the asset to pay the exemption and have anything left for the lien. Or, the judicial lien may be reduced as required so there is value to fund the exemption.
This works only for judicial liens. Exemptions don’t protect assets from voluntary or statutory liens.
Chapter 13 smites worthless liens
Lienholders are at risk in Chapter 13, where the debtor is reorganizing his financial affairs, in ways they are not in Chapter 7.
Liens that aren’t secured claims ( that is, that don’t attach to value equal to the lien) can be voided at the completion of the payment plan.
With two exceptions, even voluntary liens, which are usually beyond altering, can be stripped down to collateral value. The exceptions are
- voluntary liens on a principal residence where the lien attaches to some value, and
- purchase money liens created within 910 days of a bankruptcy filing to buy a vehicle.
In all other situations, a lien is worth only the value of the collateral that secures it.
So, huge tax liens get cut down to the value of the available collateral, and wiped out at plan’s end. Totally unsecured deeds of trust or mortgages can be avoided.
You gotta appreciate the power of Chapter 13.
