Liens in Chapter 7

What happens to liens in Chapter 7 bankruptcy? Will your liens pass through bankruptcy unaffected by your filing? Or will you have an opportunity to remove or “avoid” liens on your property? People often file a Chapter 7 bankruptcy case with liens on various assets that they own. These liens might include—

• a 1st or 2nd mortgage on their home or other real estate

• a judgment lien filed by a creditor that affects their home or other property

• a lien on their cars created when they purchased the vehicles

• a title loan using a car as collateral (the lien “arose” after the purchase where the car was used as collateral for a loan)

• a security interest (lien) affecting some furniture and appliances

• property held by a pawnbroker

So let’s see what happens to these liens in Chapter 7, and let’s see which liens can be avoided by using the Bankruptcy Code to your advantage.

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Most Liens Pass Through Bankruptcy Unaffected

As a general rule, most liens will pass through bankruptcy and the creditor will “retain” their lien—unless there is some way for you to “avoid” the lien under the law. If a lien passes through your Chapter 7 bankruptcy case, then the creditor will eventually be allowed to “take back” or “repossess” their collateral. Of course, immediately after you file your petition, the automatic stay will stop any foreclosure or repossession of collateral. And if you are making your payments timely on a secured loan when you file bankruptcy, there may still be issues to deal with. For example, in order to keep collateral when a creditor insists that you “reaffirm” the debt, see: “Should You Reaffirm Debts To Keep Property?”, and “Reaffirmation Agreements.”

But when you are in default on a loan or other secured obligation, the protection from the automatic stay is temporary IF the lien is valid and IF you take no action to avoid or remove the lien. You will lose the protection of the automatic stay either when you receive your Chapter 7 discharge or possibly earlier if the creditor asks the Court for “relief from the stay” to repossess the collateral sooner.

Explain The Types Of Liens That Affect My Property

Liens that affect your property may be “voluntary” or “involuntary.” This distinction is important in bankruptcy because the law may give you ways to protect your property from “involuntary liens.” On the other hand, liens that arose because you voluntarily entered into an agreement to borrow money and use your property as collateral (such as home loan or car loan) will be usually be protected by law.

Another important distinction under the law is made between “purchase money security” and “non-purchase money security” interests. A “purchase money security interest” arises when you buy property (like a home or car). A “non-purchase money security interest” arises because a creditor either voluntarily or involuntarily gets a lien on some or all of your property.

The most common “voluntary” liens in bankruptcy cases are home loans (mortgages) and car loans (the title papers to your car) where money is still owed when you file bankruptcy. These types of “voluntary” liens are called “purchase money security interests” (including liens on furniture or appliances) when the liens came about because you bought an item or items of property. These forms of “voluntary” liens are found on items that you purchased and for which you have not finished paying. You may be able to keep the secured assets affected by these “voluntary” “purchase money” liens provided you are willing to make payments and honor the original contract.

Another type of “voluntary lien” is called a “non-purchase money” lien because it comes about by your choice, but the loan was not used to purchase the collateral that secures the loan. These loans may include so-called “title loans” on a car (short term loans where you put up your vehicle as collateral). Another example is the lien held by a pawnbroker who loans you money on an item that the pawnbroker then holds as collateral for repayment.

“Involuntary liens” come about where a creditor has taken some collection action against you and that action results in a determination that you owe money. These “collection actions” sometimes are taken to the next level by the creditor who gets a lien on specific property or possibly a general lien on all your property (often called an “abstract of judgment”). Other “involuntary liens” come about by law, such as an IRS or Franchise Tax Board (California state tax) lien.

Which Liens May Be Avoided?

Debtors are given the right under bankruptcy law to “avoid” or remove certain liens from their property. Your attorney may say these liens are “avoidable.” But removing these liens requires that some action be taken on your part—filing an action or motion in the Bankruptcy Court to remove the lien. And when taking these actions, the burden will be on you, the debtor, to prove the facts that will legally allow the Court to make an order to “avoid the lien.” These Court orders may also remove only part of a lien, depending on the facts and circumstances of your case.

Removing liens in Chapter 7 may depend on your allowed “exemptions” under the law, so you may want to review the section of our Get Out Of Debt Guide that explains exemptions. The liens that you may be able to avoid are liens that affect your exempt assets. This could include your home (California Homestead Exemption Law AB 1885), your furniture and appliances (household furnishings and personal effects), equity in a car and so on.

And the liens that are potentially avoidable are “involuntary liens” (such as judgment liens) and “non-purchase money liens” that are also “nonpossessory” (where you have kept possession of the collateral—such as with furniture and appliances). When the creditor has possession (such as the pawnbroker) or holds a title interest, your options will be very limited and you won’t be able to avoid the lien. You may have certain other options with a title loan on a vehicle, depending on the value of the car and depending on your ability to “buy back” the car for the current cash value of the car.

It will be very important to discuss these options and your rights with an expert bankruptcy lawyer BEFORE you file your bankruptcy case. Removing liens will require taking actions after you file your bankruptcy case and this may affect the planning that should be done by you and your lawyer before you file.

Examples Of Liens And What May Happen In Your Chapter 7 Case

A judgment lien. Judgment liens against your home may be avoided in your case. When? If you have a homestead exemption to protect in your bankruptcy case, we can protect the homesteaded equity in your home (the allowed amount of your homestead exemption) when the judgment lien “took away” this protected equity. To accomplish this, we must look at whether you had equity in your home (over and above your voluntary mortgage or mortgages) if the judgment lien did not exist. If there is equity that would have been exempt, you may be able to remove the judgment lien and protect your homestead equity amount.

Non-possessory, non-purchase money lien on home furnishings. If you borrowed money from a loan company and put up your home furnishings as collateral for the loan, you will most likely be able to avoid the lien. This assumes that your home furnishings (furniture and appliances) are exempt under the exemption law that applies to you. Since this kind of lien “impairs” or negatively affects your exemption, it may be avoided.

Jewelry held in pawn. This type of lien is not “avoidable” because the pawnbroker keeps possession of the jewelry until the loan is paid.

Statutory Liens. These liens are not “avoidable.” These are liens like IRS tax liens or a mechanic’s lien.

Avoiding A Lien Requires Action

When liens are “avoidable,” you must take action to remove them in your bankruptcy case. These liens do not go away on their own. Your lawyer will explain the process to you, but a separate action must be filed in the Bankruptcy Court. You will have to present proof of the relevant facts. And the Court must make a separate “order” that removes the lien. If you take no action, these liens stay in place and will continue to affect your property. After your case is closed, the creditor will be able to take action to enforce their lien and recover their collateral even if you could have removed the lien in your Chapter 7 case. So discuss the actions you need to take with your lawyer so that you protect your property.

Certain liens against exempt property are avoidable by the debtor, but the lien avoidance does not happen automatically. The debtor must take affirmative legal action in court to get a separate court order avoiding the lien. Unless the debtor takes these steps, the lien remains against the debtor’s property and can still be enforced by the creditor, after the case is closed. This is true even though that lien could have been avoided during the case.

Chapter 7 bankruptcy continues to offer excellent protection for your property, including the possibility that you may avoid some liens to protect your assets. Find out what will happen to liens in Chapter 7 in your financial situation and how it may save your assets from being taken by aggressive creditors. Call the Bankruptcy Law Center today to set up a FREE consultation at 1-(800)-551-7922.