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Can I Avoid Liens In Bankruptcy?

There are instances when a lien can be avoided and today we’re going to talk about NPMSI. NPMSI which stands for “Non-purchase money security interest loans” that occur when a borrower already owns property that is used as collateral for a loan.

For instance, as a borrower, you may take a loan from a finance company and use household goods and/or jewelry for example, as collateral for the loan. The bankruptcy law allows the person in debt (herein called the ‘debtor’) to exempt (up to a certain amount) household goods and jewelry, so the NPMSI loan can be avoided (i.e. stripped off) to the extent that the loan impairs the legal exemption.

The reference in the Bankruptcy Code

Bankruptcy Code section 522(f) states that a debtor may avoid a lien in property if the lien impairs a legal exemption and the lien is a judicial lien or a NPMSI in:

  • (i) household furnishings, household goods, wearing apparel, appliances, books, animals, crops, musical instruments, or jewelry that are held primarily for the personal, family, or household use of the debtor or a dependent of the debtor;
  • (ii) implements, professional books, or tools, of the trade of the debtor or the trade of a dependent of the debtor; or
  • (iii) professionally prescribed health aids for the debtor or a dependent of the debtor.

OK I need an example

For example, let’s say that you take a loan from a finance company for $500 and secure it with your television worth $400. If you apply a legal household goods exemption to protect the full value of your television ($400), the finance company’s loan impairs an exemption in your household goods.

After the bankruptcy court grants your Motion to Avoid Lien, the television is fully protected under the exemption, the lien is avoided, and the creditor is left with an unsecured loan.

In many states a judgment can become a lien against your real property in the county of the judgment or any other county where the judgment has been transcribed into the official records. A “judgment lien” or “judicial lien” is often effective both with respect to property owned at the time of the judgment, as well as property acquired after the judgment.

How will a discharge affect me?

A bankruptcy discharge will void the future application of a judgment, and thus prevent it from attaching to property acquired after bankruptcy, but the discharge does not automatically get rid of an existing judgment lien.

A creditor with an existing judgment lien could seek to foreclose or repossess the property after bankruptcy (this link defines a judgement lien).

The primary method used to attack a judgment lien is via a motion to avoid as a lien impairing exemptions, under section 522(f)(1)(A) of the bankruptcy code.

A judgment lien may either be completely avoided or partially avoided, in which case the amount of the lien is reduced. It works this way: first add up the exemption amount, the judicial liens, and all other liens, like mortgages. This sum is then compared to the value of the property.

What if the value of the lien is greater than the value of the property?

If it is greater than the value of the property, the judicial lien impairs the exemption and may be partial or completely avoided. If the sum is less than the value, there is no impairment of the exemption and section 522 does not provide a means to avoid the judgment lien.

Below is an example:

  • Value of the property: $100,000
  • First mortgage: $50,000
  • Second mortgage: $30,000
  • Amount of exemptions: $20,000
  • Judicial lien: $10,000

The amount of all of the encumbrances against the property, plus the available exemptions is $100,000, which is equal to the value of the real property. As a result the judicial lien is not actually secured by anything, and the bankruptcy court can order the lien avoided and the entire $10,000 judgment debt discharged with other unsecured debts.

A second example shows how a judicial lien can be reduced when it impairs a legal exemption:

  • Value of the property: $105,000
  • First mortgage: $50,000
  • Second mortgage: $30,000
  • Amount of exemptions: $20,000
  • Judicial lien: $10,000

The amount of all of the encumbrances against the property plus the available exemptions is $100,000, which is $5,000 less than the value of the real property.

As a result the judicial lien can be reduced by $5,000 by the bankruptcy court and the remaining $5,000 discharged with other unsecured debt.

What if there are multiple judgement liens?

Lien avoidance under section 522(f)(1) can also apply to situations where there are multiple judgment liens. Lien avoidance can also work when the judgment lien is the only lien of any kind on the property, although the value of the property compared to the exemption becomes very important.

Section 522(f) is not generally available for avoiding a NPMSI in a personal motor vehicle. However, lien avoidance may be available if the vehicle is used in business. Many courts permit application of section 522(f) to a motor vehicle if that vehicle qualifies as a “tool of the trade.”

But before you think that every vehicle used to commute to work will qualify as a tool of the trade, take a look at In re Cardwell, BK 13-40623, a recent bankruptcy court ruling (2013) from the United States Bankruptcy Court for the District of Nebraska.

In Cardwell, the bankruptcy court held that a debtor must prove that a vehicle claimed exempt under the tools of the trade exemption was reasonable necessity in the debtor’s trade or business, and regularly used as a tool for the business. The court specifically stated that a vehicle used solely for commuting to work is not a tool of the trade under federal bankruptcy law. I guess we could in this case suppose that the judge in the matter figure that if he couldn’t use a car to get to work, he could use the train.

The take home

Although the bankruptcy law is clear, ever case is different. If you’re dealing with liens in bankruptcy, speak with a bankruptcy specialist in order to get your case sorted out through an appropriate representative.