Understanding Lien Avoidance in Bankruptcy

February 16, 2012 by  Filed under: Bankruptcy 

To truly understand the effect of filing bankruptcy you must know the difference between a debt and a lien. A debt is when someone owes money. Sometimes debts are secured by property. When the person who owes the money defaults on the debt, the creditor can seize the property so that it can be liquidated and applied against the amount owed. These types of debts are called secured debts. The mechanism that attaches the debt to the property is called a lien.

In most instances, bankruptcy discharges debt but has no effect on the lien itself. For example, if someone files bankruptcy and discharges their mortgage, the lender cannot sue the debtor for money damages, but they may still foreclose on their house. However, there are two instances where a bankruptcy case not only discharges the debt but also removes the lien from the property.

The process of removing a lien from property in bankruptcy is referred to as avoiding the lien. The first type of lien that can be avoided is the judicial lien. Judicial liens are created when a creditor sues a debtor, receives a judgment, and then attaches that judgment to the debtor’s property in the form of a lien. Most judicial liens can be removed simply by filing a motion with the court. The Bankruptcy Code makes an exception for judicial liens resulting from a domestic support obligation, such as child support, alimony or spousal maintenance. These types of judicial liens cannot be avoided.

The second situation where a lien can be avoided in bankruptcy applies to a very specific type of lien. First, the lien must be nonpossessory, meaning the lender is not in possession of the collateral. Second, the lien must not be a purchase-money security interest in household goods. A purchase-money security interest arises when the loan is made for the purpose of purchasing the collateral. Household goods is a broadly defined term referring to household furnishings, clothing, appliances, books, and about ten other types of collateral listed in section 522(f)(1) of the Bankruptcy Code. If the debtor is in possession of the collateral and the loan was not made for the purpose of purchasing the collateral, then the debtor should be able to avoid the lien. One notable exception to this rule is that liens attached to motor vehicles generally cannot be avoided.

The ability to avoid a lien seems to be a powerful tool available to bankruptcy debtors. In practice it doesn’t come up that much. Most lenders offering secured loans use vehicles or real property as collateral and these types of liens cannot be avoided.

Nathan S. Graham is an attorney with The Wright Firm, LLP. Nathan represents individuals and debtors in Chapter 7 and Chapter 13 bankruptcy cases. The Wright Firm, LLP, has offices in Dallas, Denton, Lewisville, and Frisco.

For more information about Nathan Graham visit the Wright Firm’s web site at http://www.northtexas-bankruptcy.com or read Nathan’s blog at http://www.northtexas-bankruptcy.com/blog/.

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