Bankruptcy makes it possible to cancel, or strip off, liens on the debtor’s assets.
Which liens can be stripped depends on
- the kind of lien in question,
- the chapter the case is filed under and
- the value of the asset to which the lien attaches.
There are different rules for different combinations of chapter and lien.
Kind of lien
Voluntary liens are mortgages, deeds of trust, and home equity lines of credit; a borrower typically grants a lien to secure a loan.
Judicial liens arise from judgments in law suits.
Statutory liens are created by a statute in the law; tax liens and property tax liens are the most common statutory liens.
The only liens that can be stripped in Chapter 7 are judicial liens that impair an exemption the debtor is otherwise entitled to.
In Chapter 13, a reorganization chapter, every kind of lien can be reduced to the value of the collateral to which it attaches. There is an exception protecting mortgage liens on principal residences. See more about lien stripping on a home.
Value of collateral
The power to strip liens in bankruptcy is designed to ensure that the debtor gets a measure of exempt property and that liens that are really worthless at the filing of the case are eliminated.
The value of the lien looks at the market value of the property (real or personal) to which it attaches, and the amount of any liens that attached to the property before the lien being evaluated for stripping.
There’s a jingle describing the order of payment for multiple liens on the same asset:
first in time, first in right
That is, the first lien to attach is the first to get paid.
So, the value of the lien is the market value of the collateral minus the payoff amount of any liens senior to it.
Limits on lien stripping
The Bankruptcy Code prohibits the stripping of voluntary liens secured only by the debtor’s residence.
Thus under- secured mortgages on the debtor’s home cannot be reduced to the present value of the property as can liens on some vehicles, etc.
The circuit courts of appeal are split on whether a voluntary lien on the debtor’s residence that is not secured by any value (that is, the senior liens equal or exceed the value of the property) can be stripped.
In the 9th Circuit, which includes California, liens on personal residences can be stripped if there is no value at all securing the mortgage sought to be stripped.
Everywhere, the bankruptcy amendments of 2005 limited the debtor’s ability to strip or cram down liens on personal vehicles bought within 910 days of a bankruptcy filing.
Getting rid of liens that impair exemptions
Would bankruptcy work for you?
Image courtesy of Flickr and Toni Castillo.