Liens And Bankruptcy
A lien is an interest in property that secures a debt owed by the property owner to the holder of the lien. There are many types of liens, but the most common are consensual liens and judicial liens. Consensual liens, also known as security interests, are those created by contract, such as mortgages on real property or financing liens on vehicles. In New York, judicial liens, commonly known as judgment liens, are created when a judgment is entered against a debtor that owns real property.
Liens generally survive a debtor’s bankruptcy. That is, the debtor’s personal obligation to pay the debt is discharged, while the lien continues to attach to the debtor’s property. However, as explained below, liens can be avoided (removed) in bankruptcy under certain circumstances.
Judicial Liens in New York
Judicial liens, also known as judgment liens, arise out of court proceedings and result when a creditor obtains a judgment against the debtor. In New York, judicial liens attach to all real property owned by the debtor in the county or counties in which the judgment is entered. Judicial liens against real property can be avoided (removed) in bankruptcy when the judgment lien impairs an exemption in real property, to the extent that it impairs the exemption. A brief explanation is as follows:
Under New York State law, a debtor in bankruptcy is allowed an exemption in his or her principal residence, known as the homestead exemption (the exemption varies based on county of residence – from $102,400 to $204,825). Property that is exempt is retained by debtors in Chapter 7 and cannot be sold by a Chapter 7 trustee.
A judgment lien can be avoided to the extent that it impairs this exemption. For example, a debtor owns a home with $50,000 of equity. A $20,000 judgment lien would interfere with the debtor’s homestead exemption in that it attaches to the portion of the equity in the home that is exempt. In this scenario, the judgment lien can be avoided in its entirety.
Alternatively, a debtor in New York can utilize the federal exemptions provided for under the Bankruptcy Code. A debtor can claim the federal “wildcard” exemption, up to $15,425, in any property. This can include rental properties or investment properties. So a debtor can, under certain circumstances, avoid judgment liens in real property other than their primary residence.
In order to avoid a judicial lien in bankruptcy, it is necessary for the debtor to file a motion in the bankruptcy court, after the bankruptcy case is filed. The bankruptcy court must be presented with evidence of the value of the debtor’s home, i.e. an appraisal, or a written broker’s price opinion. If successful, the bankruptcy court then issues an order avoiding the lien. This order is then filed with the appropriate county clerk’s office so that the clerk’s records accurately show that the judgment lien has been removed from the property.
Avoiding judgment liens in bankruptcy will ensure that when the debtor later wants to sell or refinance the property, the judgment liens are no longer a problem. If the judgment liens are not avoided in the bankruptcy case, the liens must be paid off at the time of the sale of the property (although keep in mind that judgment liens in New York are valid for only ten years, unless renewed by the judgment creditor).
While a bankruptcy case can be reopened for the purpose of avoiding judgment liens, the Bankruptcy Court is not required to grant the request to reopen the case. It is always a good idea to avoid judgment liens when the case is initially pending, even in situations where no equity exists in the property. This is because the property could later increase in value, or the mortgage sufficiently paid down. In either case, the judgment liens would have to be paid out of the equity in the property. Or, the debtor may wish to have the property sold in a short sale at some point. Judgment liens will prevent a property from being sold in a short sale unless the purchaser is willing to pay off the liens.
Nonpurchase Money Security Interests
A nonpurchase money security interest is created when a debtor borrows money and a creditor takes a security interest in the debtor’s personal property. In this situation, the loan is not for the purchase of a particular item, such as a car. It is common for credit unions to take security interests in the debtor’s personal property when giving loans. Such nonpurchase money security interests can be avoided to the extent that the security interest impairs the debtor’s exemption for household goods and furnishings. See the property exemptions page for a more detailed discussion of exemptions.
The same analysis, as explained above under judicial liens, is performed to determine if the non-purchase money security interest impairs the debtor’s exemption. A motion must then be brought in the bankruptcy court to have the security interest avoided.
Treatment of Liens in Chapter 13 Bankruptcy
The Chapter 13 Cramdown
Secured claims, other than those secured only by a security interest in the debtor’s principal residence, can be "crammed down" in Chapter 13. This means that the Chapter 13 plan will pay the secured creditor the value of the property securing the loan, not the full amount owed to the creditor. This can substantially reduce the amount that must be repaid to the creditor through the plan. The plan must propose to repay at least the value of the collateral plus interest, unless the secured creditor agrees to the modification. The interest rate to be paid is based on the Supreme Court decision in Till v. SCS Credit Corp. – calculated by adding a risk factor to the prime rate of interest. The risk factor is usually between 1% and 3%.
If the final payment on a mortgage secured by the debtor’s principal residence will come due during the pendency of the plan, e.g. a balloon payment, then the claim can be modified. Also, the cramdown may be used to modify mortgages secured by real property that is not the debtor’s principal residence, such as rental properties and second homes.
The Chapter 13 cramdown is most commonly used with motor vehicle loans. However, the cramdown may not be used if the vehicle was purchased within the 910 days prior to the filing of the bankruptcy petition, and was purchased for the personal use of the debtor (i.e. if the vehicle was purchased for business use, the 910 day restriction does not apply).
The cramdown is also not available for any secured property for which the debt was incurred within one year preceding the bankruptcy filing.
If the debtor is successful in cramming down the lien on the vehicle or other property, then the balance of the loan above the value of the property is considered an unsecured debt, and will be treated in the same manner as other unsecured debts under the debtor’s Chapter 13 plan.
Junior Mortgage Liens in Chapter 13
The Chapter 13 cramdown may not be used for claims secured only by a security interest in the debtor’s principal residence. However, in Chapter 13, the debtor can avoid junior mortgage liens (e.g., second mortgages and home equity loans) on the debtor’s primary residence, if the value of the property is less than the balance due on the first mortgage. This is commonly known as a “lien strip” and can only be done when no equity attaches to the junior mortgage, i.e. it is “wholly unsecured.” The reason why this can be done is that when the balance owed on the first mortgage is greater than the value of the property, there is no equity left for the second mortgage to attach to.
Of critical importance is the value of the property. If there is even one dollar in equity above the first mortgage, then the second lien cannot be avoided. In order to have the bankruptcy court avoid a subordinate mortgage, the debtor must commence a separate proceeding in the bankruptcy case, or file a motion, depending on local practice. An appraisal will have to be performed to determine the value of the property.
If the debtor is successful in showing that the value of the property is less than the balance due on the first mortgage, then any subordinate mortgage liens will be classified as unsecured debts, and will treated in the same manner as other unsecured debts under the debtor’s Chapter 13 repayment plan. Upon the debtor’s successful completion of the Chapter 13 plan, the junior mortgage lien will be avoided, and the debtor will no longer be required to make payments on the junior mortgage.
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