There are different types of debt that are treated differently by the court in Chapters 7 and 13 bankruptcies. It’s important to understand the distinction as you are making decisions about filing bankruptcy.
Secured Debt—Is this debt secured?
To determine whether an individual is eligible for Chapter 13, you have to know the total amount of the secured debt. To know what rights a creditor may have in the debtor’s property in any type of bankruptcy, you have to know whether the creditor has a lien attached to an asset you own (that is, whether the creditor is secured). How do you tell if a debt is secured?
Some kinds of secured debts are familiar to all of us. The most common are home mortgages, home equity lines of credit and car loans. These debts involve liens created by agreement between you and the creditor who holds the lien and are described in the papers you have signed.
There are several other kinds of debts that are secured by liens on your property, sometimes without you even realizing it.
Purchase money security interests
There is a security interest, created by a retail installment agreement, when you borrow the purchase money for consumer goods from a store that allows you to pay over time on a store account. The lien can be created by a specific written agreement or may happen automatically when the purchase is financed on the seller’s revolving credit plan or store credit card. This kind of lien does not have to be recorded by the filing of additional paperwork. In theory, if the buyer discharges his personal liability on the debt through bankruptcy, the seller retains the right to reclaim the goods. The usual Sears, Good Guys, Circuit City and Zales credit plans give the company a security interest in the goods purchased.
On the other hand, if you buy the same goods using a Visa or MasterCard (credit provided by a lender other than the seller), there is no retail installment agreement and you get clear title to the goods. Even if you discharge your liability on the credit card debt, the goods you purchased when you charged with the card are yours, free and clear of any security interest in favor of the seller or the credit card issuer.
Purchase money security interests can be avoided or stripped down to the present value of the goods you purchased only in Chapter 11, 12 and 13. See The Power of 13.
It is our experience that creditors with purchase money security interests in consumer goods almost never take the action required to enforce their interest in the goods. They are not really interested in the used goods. They rely on the debtor’s fear of repossession to “encourage” debtors to pay for things with little present market value.
Generally, a judgment in and of itself does not give the creditor holding the judgment a lien; the judgment creditor in some cases must take an additional step of filing or recording the judgment with a designated agency to create a lien on the judgment debtor’s property. Check the laws of your state to determine how judgment liens come into effect. Get a report of liens on file with the secretary of state to know what liens are effective against your property, and which liens come first, before the other liens.
In analyzing a debtor’s situation for bankruptcy planning it is important to know if judgment debts have become a lien on your property since secured debts are totaled separately from unsecured debts in calculating the debtor’s eligibility for Chapter 13. Judgment liens may be avoided if they conflict with exemptions in your property. In Chapter 13, judgment liens and other liens can be stripped down to the value of the assets to which the lien attaches. More on avoiding liens and Chapter 13.
When a notice of federal tax lien is recorded, it creates a lien on all of the taxpayer’s property, real (land) and personal (everything else). Federal and state tax liens are statutory liens and cannot be avoided as a lien impairing an exemption under § 522(f). However, a tax lien can be stripped off in Chapter 13 if there is no equity in the property for the lien to attach to. It may attach even to retirement savings and 401(k) plans that are beyond the reach of other creditors.
Blanket security interests
This is not a lien on your blankets: it refers to the term in most secured bank or SBA loans by which the borrower gives the lender a security interest in all the borrower’s personal property. The lien “blankets” all the borrower’s assets. (Personal here means everything but real estate, NOT “personal” as opposed to “business” assets.) Even intangibles like accounts receivable and intellectual property like patents, copyrights, and software may be subject to a blanket security interest. The agreement may also give the creditor a lien on assets acquired after the security agreement is signed. Since the borrower agreed to give the lender a security interest in the property described in the security agreement, the lien cannot be avoided on the grounds it impairs an exemption (the lien is not a “judicial lien”). In Chapter 11 or Chapter 13, the lien may be stripped down to the value of the property at the time the bankruptcy is filed. Since the lender has rights in the items themselves and in any proceeds from their sale, the borrower may not be free to sell the asset and pocket the proceeds or even spend the proceeds paying other business debts. Spending the sales proceeds without the lender’s permission may be a legal violation creating a debt which is not dischargeable in bankruptcy under 11 U.S. C. 523.
Lien stripping in bankruptcy
Liens can be removed or “stripped off” of the debtor’s assets in Chapter 11, 12 or Chapter 13 when there is not enough equity in the asset, after deducting senior liens from the property’s current market value, to secure the unsecured in whole or in part, or where the lien exceeds the value of the debtor’s property. Section 506 of the Bankruptcy Code acknowledges that a lien is only a secured claim to the extent there is value in the asset to which it attaches. To the extent that the claim exceeds the value of the collateral, that portion of the claim is unsecured. In Chapter 11, 12 or Chapter 13, even voluntary liens, such as mortgages and security interests, can be stripped down to the value of the collateral, with the exception of voluntary liens secured only by the debtor’s residence. Congress is currently considering changes to bankruptcy law allowing the modification of home mortgages.
Tax liens can be stripped off in reorganization proceedings (Chapters 11, 12 and 13) to the extent that the lien does not attach to equity in property. Tax liens can’t be avoided in Chapter 7 on the grounds that they impair exemptions; if the tax is dischargeable in the Chapter 7, the bankruptcy court can determine the amount of the lien that is secured at the time of the filing. Payment of that sum entitles the debtor to the release of the lien.
Dealing with secured debts in Chapter 7
When a debt is secured against property, the creditor has rights in the property (or collateral) in addition to the rights against the debtor. The debtor’s personal liability may be discharged in Chapter 7 while lien rights in the collateral pass through bankruptcy unaffected unless they are avoided or stripped down.
More on avoiding liens.
When the lien cannot be avoided, the debtor gets choices about how to provide for the creditor’s rights in the collateral.
Long term secured debt like mortgages or other home loans pass through the bankruptcy with their lien unaffected by the discharge. Most creditors secured in real property are happy to continue receiving payments on the debt, so long as you are current. For more on home mortgages after bankruptcy. See Chapter 13 for using that chapter to cure defaults in long term secured debts.
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