July 24, 2017

After Bankruptcy: Debts Die, Liens Live

There is a saying among bankruptcy attorneys:  “debts die, liens live.”  People can discharge most debts in a bankruptcy case, meaning that they are released from their personal liability for discharged debts. Creditors cannot take any action to collect a discharged debt from a debtor.

But what happens to liens or mortgages on property owned by the debtor?  There are a few common scenarios to consider.

Personal property that is financed on an installment plan

Many individuals in bankruptcy have a car payment, and perhaps also payments on furniture, appliances, jewelry, or computers.  In these situations, the Chapter 7 debtor has two options:  (1) surrender (give up) the financed property and discharge the debt, or (2) sign a new contract in the bankruptcy case (called a reaffirmation agreement), agreeing to continue making payments to the creditor who has the lien against the property, in exchange for keeping the property.  Reaffirmation is not required for debts secured by real estate (land and buildings). This reaffirmation agreement provides that this one debt is taken out of the bankruptcy case, leaving the creditor with the option of repossessing the property and suing the debtor for the balance owed in the event that the debtor defaults on the new contract.

It should be noted that in many instances creditors with security interest on items purchased from or financed by them (such as furniture or jewelry) will not attempt to enforce the lien by taking the property. Also, liens on household goods not purchased from or financed by the creditor cannot be enforced.

Chapter 13 debtors have similar options:  (1) surrender the property and discharge the debt in accordance with the Chapter 13 payment plan (this creditor would be paid at the same rate as other unsecured creditors, such as credit card companies) or (2) keep the property and make the required payments as part of the Chapter 13 payment plan.  Again, it should be underscored that reaffirmation agreements are neither required nor advisable for debts secured by real estate.

Judicial liens

Judicial liens, judgments, do not constitute liens on personal property until the property is seized by the sheriff. The judgment becomes a lien on real property when it is recorded in the county in which the property is located.

We have previously discussed the concept of exempt property.  A properly recorded judgment operates as a lien against all personal and real property owned by the debtor in the county in which the lien is recorded.

For example, if the debtor lives in Mecklenburg County, owns a house located in Mecklenburg County, and has a judgment recorded against him in Mecklenburg County’s courts, that judgment is, in effect, a mortgage on the house.  North Carolina’s homestead exemption (N.C.G.S. 1C-1601(a)(1)) allows a debtor to exempt the first $35,000.00 in his primary residence located in North Carolina.

If, at the time the bankruptcy case is filed, there is less than $35,000.00 in equity in the residence, then the judicial lien can generally be avoided (cancelled) by the bankruptcy court.  

Tax liens

In some circumstances, an individual’s income tax liability can be discharged in a bankruptcy case.  However, even where the debtor’s personal liability is discharged, a tax lien remains in place and enforceable, against all property that the debtor owned on the date of the bankruptcy filing and the proceeds of that property.  Debtors with tax debt should consult with bankruptcy counsel on the effects of such tax liens.

 Mortgages on real estate

One of Charlotte’s former bankruptcy judges often said, “If you want to stay, you have to pay” – meaning that if a debtor wants to continue to own and enjoy financed real property, he or she must continue to pay the mortgage both during and after bankruptcy.

Further, in cases where the property will be surrendered in the bankruptcy case and then foreclosed, the mortgage company cannot seek to collect the debt from the debtor, but can enforce its lien and sell the property.

Bankruptcy protection is a powerful tool that helps people and businesses get a new start. A bankruptcy attorney knows how to maximize this tool.