Lien Avoidance - Reducing or Eliminating Liens in a Chapter 7 Bankruptcy
The lien is the interest that a creditor or other entity has in specific property, where ownership of the property is evidenced by a legal title document and can also apply to property described in a contract for a loan, where the lender exchanges a lien on the property for the loan, even if the loan was not used to buy the property. A recording and perfecting of the lien on the title document can prevent the conveyance of a clear title to another, preventing the sale of the item. This means you will not be able to sell the item until the debt is paid and the lien is removed.
Many liens can, and should, be eliminated in a Chapter 7 bankruptcy. But whether you can eliminate or reduce the lien depends on the type of lien and may also depend on the exemptions that you are claiming. Furthermore, if your unencumbered equity is significantly greater than your exemption amount, then the trustee may take it and sell it, pay you your exemption amount, the lienholders their lien amount, and use the rest to distribute to your unsecured creditors.
Consensual Liens — Security Interests
A consensual lien (aka voluntary lien) is one you consented to by agreement or contract. If you miss payments, the creditor has the right to take possession of the collateral and sell it.
Purchase-money security interests secure loans where the money is used to purchase the security interest. Mortgages and auto loans are the most common examples of this type of secured loan. If you default on the payments, the lender has the right to take possession of the property and sell it.
These liens cannot be removed or reduced by a Chapter 7 bankruptcy. You can keep this property if you are not behind on the payments by simply continuing the payments. However, if you are behind, then you must surrender the property, redeem the property by paying a lump sum, or sign a reaffirmation agreement. (See Secured Debts for more info.)
Nonpurchase-money security interests are loans that are secured by an item that the borrower already owns. If the borrower keeps the item while it serves as collateral, then this is called a nonpossessory loan. Liens on property for nonpossessory loans can be eliminated if the collateral is exempt.
A possessory loan is obtained by giving the collateral to the lender in exchange for the loan. Pawnshops are a common example of this type of lender. The liens for possessory loans cannot be eliminated in bankruptcy.
How Liens Can Be Eliminated or Reduced in Chapter 7 Bankruptcy
While a Chapter 7 bankruptcy can eliminate your liability for the debt secured by property, it doesn't eliminate any liens on the property unless you take the required steps that may be taken to reduce or eliminate the liens. Some liens you won't be able to either eliminate or reduce, but many you can.
Since the lien is attached to the property, it can be eliminated simply by surrendering the property — allowing the creditor to pick it up. You list the property on the bankruptcy Form B-8, Chapter 7 Individual Debtor's Statement Of Intention, then send a copy to the creditor within 45 days of your bankruptcy filing date.
The creditor then must contact you to arrange a time to pick it up. The creditor must pick it up within 30 days of the creditors' meeting; otherwise the property will be considered abandoned, and it will be yours to keep, free of any debt or liens. Creditors will often abandon property if it is not very valuable and difficult to sell. This is especially true for furniture or other items where the cost to pick it up, store it, then sell it is more than what the property is worth. Hence, this is an effective method of eliminating liens on property with little resale value, but you have to be prepared to lose it. A creditor might take it back just to cause you inconvenience.
Another method of reducing a lien is by redemption, which is done by paying the creditor what the item is worth rather than what is owed on the debt. Unfortunately, you must pay the amount within 30 days of the creditors meeting, but if the item is worth much less than the loan and you really want it, this is an effective method.
However, you and the creditor must agree on the value of the property; otherwise, you may have to go to court to set its value. One method that may allow you to accurately assess the value of the property is by looking it up on the many available resources on the Internet, such as eBay, where almost any item in various conditions can be found for sale at the auction site. This is a very objective way of assessing the value of almost any property.
To use redemption, the property must serve as security for a consumer loan, not a business loan, and it must be tangible property, which is property that can be held or touched. It can't be real estate and it can't be intangible, such as financial accounts or instruments, such as stocks or bonds. The property must also be property that you are claiming as an exemption or that the trustee has abandoned. The trustee usually abandons property that doesn't have significant value over and above the sum of all the liens plus your exemption amount for the property.
Avoiding or Reducing Liens Created by Nonpossessory Nonpurchase-Money Security Interests
A nonpossessory nonpurchase-money security interest is a property interest used to secure a loan that was not used to purchase the property nor does the lender possess it. Although these liens can be reduced or removed without paying anything, the property to which it can be applied is restricted, both in type and amount. Furthermore, the property must be exempt and the exemption amount is also usually limited.
The pledged collateral for which lien avoidance is available is restricted mostly to household items with insignificant value. The collateral pledged must be for personal, family or household use and be in one of the following categories:
- clothing and linens
- furniture and appliances
- china, crockery, and other kitchenware
- 1 radio, TV, VCR, and computer and peripherals
- musical instruments and jewelry for household use
- medical equipment and supplies
- the first $5,000 of the lien can be avoided for:
- animals or crops for household use
- implements and books used in your or a dependent's trade
Loans based on real estate or motor vehicles as collateral do not qualify. However, if a motor vehicle is necessary in the actual performance of work — and not just as a means of commuting — then up to $5,000 of the lien can be avoided as equipment used in your trade. For instance, a van used for a cleaning service, where tools and equipment are transported from 1 cleaning site to another would probably qualify.
Nonconsensual liens are liens imposed on titled property without your consent. Because these liens are not effective unless legal ownership is evidenced by a title, these liens are generally restricted to real estate and automobiles, or any other item where ownership is established by title. While the lienholder is usually entitled to sell the property, if necessary, to pay toward the debt, usually the lienholder will simply add the lien to the title, which will prevent you from transferring a clear title to anyone else until the debts are paid. There are 3 major types of nonconsensual liens: judicial, tax, and statutory liens.
- A judicial lien is recorded by someone who has won a money judgment against you in court.
- Tax liens are imposed by tax authorities for delinquent taxes.
- Statutory liens are liens created when work is done on the property on which the lien applies, and the workers are not paid in full for their work, such as when a handyman works on your house, and doesn't receive payment.
Only judicial liens can be reduced or eliminated by using lien avoidance in bankruptcy.
Removing Judicial Liens on Exempt and Oversecured Property
You may be able to eliminate or reduce judicial liens on exempt property that is oversecured, where the total of all liens exceeds the value of the property. Here, only bankruptcy law matters, not state law. Judicial liens have the lowest priority of all liens, regardless of when the liens were perfected. (Normally, under nonbankruptcy law, perfected liens have chronological priority, with earlier liens having priority over later liens.)
Use this procedure for calculating how much of the judicial lien can be avoided:
Remainder = Property Value - Consensual Liens - Tax Liens – Statutory Liens - Exemption Amount
- If Remainder <= 0, then the judicial lien can be avoided completely.
- If Remainder > Judicial Lien, then the lien cannot be avoided at all.
- If Remainder < Judicial Lien, then the amount of the judicial lien that can be avoided = Judicial Lien Amount - Remainder.
Chapter 13 and Chapter 20 Bankruptcy
If you have property that you want to keep, but are unable to use the techniques discussed above, then you may want to consider filing Chapter 13, which will allow you to keep all of your property by paying over a period of 3 or 5 years.
Some debtors use what is called a Chapter 20 bankruptcy, where the debtor first files for Chapter 7 to eliminate those debts that are dischargeable under Chapter 7, then immediately after the discharge, files for Chapter 13 to pay secured debt. However, since the debtor cannot get a Chapter 13 discharge until 4 years have elapsed since his Chapter 7 discharge, his Chapter 13 must last at least that long.
The main disadvantage to Chapter 20 bankruptcy is the amount of time that it will take before the debtor can begin a fresh start and to reestablish credit. Filing fees and legal fees will also be greater.