This is the first of a four part series on lien avoidance.  I developed these notes for a presentation I gave to the Central District Consumer Bankruptcy Attorney’s Association, Los Angeles, California.

A lien is a claim or legal right against assets that are typically used as collateral to satisfy a debt.  A lien serves to guarantee an underlying obligation.  If the underlying obligation is not satisfied, the creditor may can seize the asset that is the subject of the lien.  In essence, a lien creates an in rem claim against the assets of a debtor against whom the creditor has an in personam claim.

There are many types of liens.  The most common liens against the assets of an individual debtor in bankruptcy are tax liens, liens arising from loans, mechanics liens, HOA liens, and judgment liens.  For those who may be new to dealing with liens in bankruptcy, here is some vocabulary:

  • A consensual lien is one that is recorded with the consent of the debtor, and a nonconsensual one is recorded without the debtor’s consent.
  • A tax lien is typically authorized by statute (g., for the IRS: 26 U.S.C. § 6321), and grants the taxing authority a security interest in some, or all, of the debtor’s assets. In the case of § 6321, the lien extends to all of the debtor’s assets.  This type of lien is typically nonconsensual.
  • A loan lien is recorded against a specific asset, or assets, as part of a lending agreement — either for the purchase of the asset, or to secure a nonpurchase money loan. This type of lien is consensual.
  • A mechanics lien is a lien recorded by someone who has performed services for the debtor, but has not been paid for those services. Most such liens are nonconsensual.  Mechanics liens are authorized by statue.   Civ. Code § 8400, et seq.  The statute was designed to prevent a property owner from taking advantage of laborers.  See, e.g., Wm. R. Clarke Corp. v. Safeco Ins. Co., 15 Cal. 4th 882, 889 (1997) (“The mechanic’s lien is … to be liberally construed for the protection of laborers and materialmen.”).  A mechanics lien has priority over any subsequently recorded lien, mortgage, or trust deed.  Cal. Civ. Code §8450.
  • An HOA lien is recorded by an HOA against the property of a debtor who is delinquent on paying HOA assessments or dues. HOA liens are also authorized by statute.  Civ. Code § 5675.  HOA liens are usually nonconsensual.  An HOA lien has priority over any subsequently recorded lien, mortgage, or trust deed.  Cal. Civ. Code § 5680.  An HOA lien is secured only to the amount stated in the recorded lien.  See Highland Greens Homeowners Ass’n v. de Guillen (In re de Guillen), 604 B.R. 826 (9th Cir. BAP 2019).  Thus, assessments made after recordation are not secured by the lien.
  • A judgment lien, a.k.a. a judicial lien, is a lien recorded by a creditor who has obtained a judgment against the debtor. California judgments earn simple interest at 10% per annum.  Code Civ. Proc. § 685.010(a).

Under the right circumstances a debtor in bankruptcy can avoid judgment liens and consensual liens.  Judgment lien avoidance does not depend on the chapter under which the debtor filed; but consensual lien avoidance is not available to Chapter 7 debtors.

I.   Avoiding A Judgment Lien – § 522(f)(1)(A)

The enabling statute for avoiding a judgment lien is 11 U.S.C. § 522(f)(1)(A), which permits a debtor to avoid a judgment lien to the extent that it impairs the debtor’s exemption of the asset in question – most commonly, the debtor’s principal residence.  Since businesses cannot exempt assets, this sort of lien avoidance only applies in individual cases.

Practice Tip:  If the Court determines that the underlying debt is nondischargeable under § 523(c), then there is no point in avoiding the lien because after the Court closes the case the creditor can simply file another lien.

A.  Exemption Impairment

  1. The Formula

The $64,000[1] question is:  What does it mean for a lien to impair an exemption?  § 522(f)(2)(A) provides a simple arithmetic formula that answers the question:

a.  Add up the values of: (i) the lien to be avoided, (ii) all other liens on the property, and (iii) the value of the exemption the debtor could claim in the absence of any liens against the property.

b.  To the extent that the sum exceeds the fair market value of the property, the lien can be avoided.

  1. Applying The Formula

Obviously, you must establish the current balances of all the liens.  Do this by attaching as an exhibit documents showing current balances on each of the liens.  You must authenticate those documents with a declaration.  Although this sort of lien avoidance rarely provokes opposition, if you face opposition, you may need to do a motion to value the lien.

To establish the exemption claimed, attach a copy of Schedule C, with a declaration authenticating it.

The fair market value of the property must be determined as of the petition date.  11 U.S.C. § 522(a)(2).  Therefore, since housing prices have been increasing rather rapidly (though there are indications that that trend may soon reverse itself), get an appraisal as soon as possible after the petition date; or else use a forensic appraiser.  Include the appraisal as one of the exhibits in the motion to avoid the lien.  However, the appraisal by itself is not admissible evidence, so you must also include a declaration by the appraiser attesting to the accuracy of the appraisal.

Potential Problem:  If the value of the property exceeds the sum of the liens, you cannot avoid the lien using § 522(f).

You must serve copies of the motion (use Form F 4003-2.1; and in Chapter 13, also attach Form F 3015-1.04C to the plan) on all the lienholders, not just the holder of the lien to be avoided.  LBR 4003-2(c).

B.  Potential Problems

  • If you don’t serve all required entities, the Court will deny the motion. Therefore, it’s better to overserve rather than underserve.
  • If the numbers are such that there is no equity to exempt (unusual these days, but possible), you must manufacture an exemption á la In re Higgins, 201 B.R. 965, 967-68 (B.A.P. 9th Cir.1996) (“Congress has made it clear in amending Section 522 that a lien will be deemed to impair an exemption, even when there is no equity in the property, if the sum of all the liens on the property and the hypothetical value of the exemption without liens exceeds the value of the debtor’s interest in the property in the absence of liens.”).
  • If the value of the property as of the petition date is greater than the sum of the liens and exemption, you cannot avoid the lien. Therefore, do the numerical analysis very early in the case to determine whether the lien can be avoided.
  • If the lien is for domestic support, you cannot avoid it.

II.   Avoidance Of A Nonpossessory, Nonpurchase-money Lien On Personal Property – § 522(f)(1)(B)

Sometimes a debtor will put up personal property as collateral for a personal loan; so the loan is a nonpurchase-money loan.  With some exceptions, the lien on the property can be avoided to the extent that it impairs the exemption.  The process is analogous to avoiding a judgment lien.  Use Form F 4003-2.2.

Perhaps the most important exception is liens on motor vehicles (§ 522(f)(4)(B)(v)).  Unfortunately, abusive car title loans cannot be avoided using § 522(f).  However, in certain circumstances in a Chapter 13 or Chapter 11, a loan secured by a car can be bifurcated into secured and unsecured portions.  (Exception in Chapter 13:  The debtor incurred the debt on the car during the 910-day prepetition period.  See hanging paragraph after § 1325(a)(9).)  That leads us to § 506, which is the topic of the next post.

[1] With the rampant inflation we’re currently facing, the value of the question is a much larger dollar amount than it was on the old TV show.