Jeremy J. Cobb, Esq. [1]

This article discusses Minnesota law relating to the removal (“discharge") of judgments following a judgment debtor’s bankruptcy.

Introduction

Many debtors in bankruptcy come to counsel with preexisting judgments. They are judgment debtors. In recent years, it has become more common for unsecured creditors, such as, bank card issuers or former lienholders with unsecured deficiency claims (such as an automobile lender after repossession or junior mortgage lender after foreclosure), or their successors in interest, such as debt buyers or parties acquiring rights pursuant to a credit default swap (CDS) instrument, to file suit against debtors, thereby reducing the obligation to judgment and paving the way for the judgment creditor to employ powerful state-law collection remedies such as garnishment, attachment, execution, and levy. In addition, taxing authorities have many of the same modes of collection available to them with no requirement for antecedent judicial involvement. It is frequently the threat of garnishment of wages or funds held in deposit accounts at financial institutions that motivates the debtor to seek bankruptcy protection.

One remedy available to judgment creditors is the attachment of the judgment to certain property of the debtor, commonly a judgment lien on real property titled to the debtor. Many debtors—and more than a few attorneys—imagine that bankruptcy can transport the debtor back in time so as to remove such liens. This belief is unfounded and contrary to settled law.

Federal Bankruptcy Law

Liens Pass Through Bankruptcy Unaffected . . . Except That Most of the Time They Can’t Be Enforced

A fundamental mischaracterization of the nature of a bankruptcy discharge pervades the bankruptcy bar. Rather than eliminating debts per se, a discharge merely eliminates a bankrupt’s personal liability for discharged obligations. A bankruptcy discharge extinguishes a bankrupt’s in personam liability only; in rem liability remains. [2] Therefore, a creditor’s remedy to bring an action in rem against property of the debtor survives the debtor’s bankruptcy, subject to the automatic stay during the pendency of the case. [3]

Accordingly, it is settled law that a preexisting lien against property of the debtor passes through bankruptcy unaffected. “It is hornbook law that a valid lien survives a discharge in bankruptcy unless it is avoidable and the debtor takes the proper steps to avoid it." [4] Thus, “a creditor’s right to foreclose . . . survives or passes through the bankruptcy," [5] except when it doesn’t.

Bankruptcy Discharge Under § 524 Voids Judgments to the Extent That Enforcement Is Predicated Solely on the Debtor’s Personal (In Personam) Liability

Section 524 of the Bankruptcy Code reads in pertinent part:

A discharge in a case under this titl e . . . voids any judgment at any time obtained, to the extent that such judgment is a determination of the personal liability of the debtor with respect to any debt discharged [pursuant to chapters 7, 9, 11, 12, and 13], whether or not discharge of such debt is waived[.] [6]

The effect of a discharge is to void any judgment determinative of a debtor’s personal liability. This codifies the rule in Long v. Bullard, 117 U.S. 617 (1886). [7] Thus, prepetition judgments cannot be enforced post-petition against property of the debtor (the automatic stay operates to prevent post-petition but pre-discharge attachment). Such judgments do not survive discharge and are void by operation of law, rather than merely voidable.

Exempt Property Is Not Subject to Post-Petition Enforcement of Pre-Petition Debts (With Exceptions, Naturally)

Section 522(c) reads in pertinent part:

Unless the case is dismissed, [exempt] property is not liable during or after the case for any debt of the debtor that arose . . . before the commencement of the case, except—

(1) for [certain taxes and custom duties and for domestic support obligations];

(2) [for] a debt secured by a lien that is [not avoided by the debtor as impairing an exempt property interest of the debtor; not avoided by the trustee exercising certain statutory powers; and not void as securing a debt that is not an “allowed secured claim"];

(3) [for certain debts related to misconduct by a financial institution]; or

(4) [for certain fraudulent educational debts]. [8]

Thus, except for certain kinds of debts, a creditor may not enforce a pre-petition lien in rem against property of the debtor unless the debtor or trustee has failed procedurally to avoid the lien or the lien is of a kind that the debtor or trustee may not avoid.

Unless state law prohibits it, [9] the debtor may generally avoid any lien on otherwise-exempt property of the debtor, [10] notwithstanding any putative contractual waiver given by the debtor to the contrary. This rule applies both to judicial liens—except those enforcing a “domestic support obligation"—and to nonpossessory, nonpurchase-money security interests in household goods, [11] tools of the trade, prescribed health aids, and other property ordinarily exempt under state law. [12]

An important limitation is that a debtor may not avoid a mortgage, since it does not fall within any of the applicable categories of liens subject to avoidance. [13] Nor may a debtor avoid the fixing of a lien in connection with a “judgment arising out of a mortgage foreclosure." [14]

[1] Mr. Cobb graduated from the University of Minnesota Law School in 2001, where he was an editor for the Minnesota Journal of Law, Science & Technology and named to the dean’s list. He earned a bachelor of science in chemical engineering from the University of Michigan, Ann Arbor, cum laude, in 1995. He was a Regents-Alumni Scholar and earned Class Honors. He is a principal at Judson Cobb LLC and devotes a large portion of his practice to bankruptcy.

[2] 11 U.S.C. § 524(a)(1) (2006); Johnson v. Home State Bank, 501 U.S. 78, 84 (1991) (“Rather, a bankruptcy discharge extinguishes only one mode of enforcing a claim—namely, an action against the debtor in personam—while leaving intact another—namely, an action against the debtor in rem.").

[3] 11 U.S.C. § 362 (2006).

[4] Arruda v. Sears, Roebuck & Co., 310 F.3d 13, 21 (1st Cir. 2002).

[5] Johnson, 501 U.S. at 83 (citing Long v. Bullard, 117 U.S. 617 (1886) (“The setting apart of the homestead to the bankrupt under . . . did not relieve the property from the operation of liens created by contract before the bankruptcy."), 11 U.S.C. § 522(c)(2) (2006), and H.R. Rep. No. 95-595 (1977)). The rule in fact, goes back even further.

[6] 11 U.S.C. § 524(a)(1).

[7] Johnson, 501 U.S. at 83.

[8] 11 U.S.C. § 522(c).

[9] Id. § 522(f)(3).

[10] Exempt under id. § 522, that is.

[11] “Household goods" is defined in id. § 522(f)(4).

[12] For example, compare Minnesota’s exemptions in Minn. Stat. § 550.37 (2012).

[13] 11 U.S.C. § 522(f)(1).

[14] Id. § 522(f)(2)(C).