Chapter 7 Effect on Liens
A lien is type of security interest in favor of a creditor to secure payment of a debt or performance of some other obligation. The liens with which most debtors in bankruptcy are concerned are: 1) a mortgage secured by the debtor’s residence or other real property, 2) the title to a motor vehicle, 3) a PMSI (Purchase Money Security Interest) in an item of personal property acquired on an installment plan such as a TV, appliance or furniture set. When the debtor files bankruptcy, the debtor can usually keep such assets, provided that the debtor continues to pay for the item and honor the original contract. In many instances, a creditor can demand either payment of the outstanding balance or a reaffirmation of the debt, which may offer substituted (and sometimes more favorable) repayment terms in exchange for the non-dischargeability of the outstanding obligation.
Liens Normally Survive Bankruptcy
Secured debts are treated differently in bankruptcy than unsecured debts. Under Chapter 7, liens normally pass through unaffected by the debtor’s discharge. This fundamental protection is part of why creditors are willing to extend credit in the first place.
Some liens are avoidable (removable) by the debtor in Chapter 7, but no lien is automatically terminated by the bankruptcy process. Lien avoidance is only available for some lien types, and only by taking specific affirmative action. The debtor bears the burden to prove all factors material to avoidance of any particular lien. Generally, liens can be avoided only to the extent of an exemption that the debtor is entitled to claim, and provided that the lien arose as a non-possessory, non-purchase money lien on certain kinds of the debtor's property. By non-possessory, non-purchase money, we mean the property pledged as collateral for the debt was not retained by the creditor (debtor still possesses the property), and the debtor owned the property independent of the debt giving rise to the lien. PMSI's are not avoidable, because the lien arises out of the debt incurred to acquire the property. A loan from a pawn shop, where the creditor retains possession of the collateral, are not avoidable.
Examples of avoidable liens include home equity loans, or personal loans where the borrower’s car is the collateral. A judgment lien is usually avoidable to the extent of the equity that would have been exempt in the absence of the judgment lien (as opposed to a voluntary mortgage which normally is not avoidable).
Statutory liens, such as tax liens and mechanic's liens, are not avoidable, and will survive the bankruptcy case unaffected.
Court Action Required
The debtor must seek avoidance by affirmative motion in the court. Absent the court's affirmative order avoiding a lien, the lien will remain in effect against the debtor's property and may be enforced by the creditor after the bankruptcy case is over and discharge is entered. This is true even if the debtor could have avoided the lien, but failed to take the necessary steps.
A debtor must file a motion to avoid each avoidable lien with bankruptcy court. There is then be a hearing (if requested by the creditor) to determine whether to reduce or eliminate the lien on the debtor’s exempt real or personal property. Liens are avoidable to the extent of allowable exemptions, so the result can be partial avoidance (amount of the lien is reduced) or complete avoidance, depending upon the value of the lien, the collateral, and available exemptions applicable to the property in question.
If an avoidable lien was overlooked during the bankruptcy case, the court may permit the debtor to reopen a closed bankruptcy case so that the debtor can pursue relief.