A lien is defined by the Federal Bankruptcy Code as a “charge against or interest in property to secure payment of a debt or performance of an obligation” owed by a debtor to a creditor. Generally speaking, a bankruptcy case discharges, or wipes out, debt owed to creditors but does not eliminate a creditor’s lien held against the debtor’s property.
This means, in many cases, although the creditor many not take any collection actions against the debtor (i.e. bringing a lawsuit or enforcing a court judgment against the debtor) they still may repossess the collateral, or remain legally entitled to payment upon sale of the property, to secure payment of the debt. However, there are some exceptions to this general rule and, in some circumstances, liens can be “avoided,” meaning eliminated or reduced, by a bankruptcy case.
Types of Liens That Cannot Be Eliminated by Bankruptcy in MN
Typically, liens to which the debtor voluntarily consents cannot be eliminated by bankruptcy. These liens include mortgages, car loans, and other types of loans in which the debtor borrows money from the creditor in exchange for granting the creditor a lien on the debtor’s property to secure payment of the loan (aka a security interest in the property). Although these types of “secured creditors” retain a lien on the debtor’s property, and thus, a right to repossess the property or receive payment in the event the property is sold, the debtor almost always is allowed to retain the property after a bankruptcy so long as they continue to make regular payments on the debt.
Consensual Liens
An exception to the rule that consensual liens cannot be eliminated in bankruptcy, is in the circumstance where the creditor has a “non-possessory, nonpurchase-money security interest” in the property. Such a debt refers to a loan that was not granted to purchase the property upon which the lien is attached and the creditor does not have possession of the property.
An example would be a debtor taking out a personal loan from a creditor to buy Superbowl tickets and granting the creditor a lien in their home furniture to secure the loan. The furniture is not in the possession of the creditor and the borrowed money was not used to purchase the furniture.
To the extent the property to which the lien is attached (i.e. the collateral) is “exempt”, or legally protected under the law from creditors, the lien may be avoided by the debtor. This means the debtor may reduce or eliminate this type of lien against the property to the value to which the property is exempt. However, only liens on certain types of property may be avoided as a non-possessory, nonpurchase-money security interest.
The property to which the lien is attached must fall into the category of being a household good (i.e. furniture, appliances, clothing, pets and jewelry), health aid, or a tool of the trade used for the debtor’s business. To remove this type of lien the debtor must file a motion with the court claiming that the exempt property meets the above requirements, and if such requirements are met, the court will wipe out the lien.
A Nonconsensual Lein in Minnesota
When the lien on the property is nonconsensual, meaning the debtor did not intentionally agree to the lien, the debtor may also be able to avoid the lien in some circumstances. A common nonconsensual lien is a “judgement lien” which occurs when a creditor sues the debtor on an unpaid debt and gets the court to enter a judgement declaring that the debt is valid and legally owed by the debtor. The judgment automatically creates a lien against any real estate owned by the debtor located within the County in which the judgement was entered.
The creditor can also take additional steps to attach the judgment against other real and personal property owned by the debtor and the creditor may even be able to garnish the debtor’s wages and money from the debtor’s bank account. In Minnesota, judgement liens can be eliminated through bankruptcy. After the debtor receives their discharge, they can simply file an application with the State District court in which the judgment was entered and the court will remove the judgement, and the lien with it.
It is notable that certain nonconsensual liens, such as tax liens and judgment liens for certain nondischargeable debts (i.e. child/spouse support and debt incurred from fraud) cannot be removed.
"Cramming" Down
There are also a few options that debtors have to reduce or eliminate liens in a chapter 13 case that are not available in a Chapter 7 case. Debtors have the option of “cramming down” certain secured loans by including them in their chapter 13 repayment plan. The way this works is that the secured loan is paid in the plan, but only up to the amount of the value of the secured property.
For example, if the debtor has a car worth $2,000, and the loan on it is $4000, the debtor can include the car in the plan and will only have to pay $2,000, rather than $4000. If the debtor pays the entire $2,000 value of the car in the plan, they will end up with the car free and clear of the lien after their chapter 13 repayment plan is done, and the remaining $2,000 loan balance is discharged.
Cram downs are usually done with vehicle loans but can apply to other secured debts, such as second mortgages. Original first mortgages cannot be crammed down, and in order for vehicle loan to be crammed down, the loan must have been taken out, at least, 910 days prior to the bankruptcy filing.
Lien Stripping in Minnesota
Another way to eliminate a lien, which is uniquely done only in chapter 13 bankruptcies, is through a process called “lien stripping.” If a debtor has a second or third mortgage, they can actually eliminate those liens on their home if the home is insufficient equity in the home for those mortgages to be paid.
An example of this type of situation would be if someone owned a home that is only worth $100,000 with a first mortgage of $120,000 and a second mortgage of $20,000. Since sale of the home would not even be enough to satisfy the first mortgage, the second mortgage creditor would not receive any money from the sale either. Therefore, the debtor could file a motion asking the court to “strip.” or remove the second mortgage, and the lien, on the property, which would likely be granted by the court in this scenario.
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This is a generalized overview of how liens can be avoided by a debtor in a bankruptcy case and is not designed to be a comprehensive discussion of the subject. To see how exactly how a bankruptcy will impact liens on your property, and to learn more specifically what your options are for reducing or eliminating the liens, you should consult with an experienced bankruptcy attorney. See us at LifeBackLaw.com!
