Avoiding liens can be an important part of the bankruptcy “fresh start.” There is a variety of methods of lien avoidance in bankruptcy cases. We will here discuss lien avoidance under two code sections, Section 506(d) and 522(h). Under Section 506(d), liens securing disallowed claims are not valid. There are some exceptions to this rule, however.
One exception deals with domestic support obligations; a second exception deals with liens securing claims of codebtors or guarantors; and a third exception deals with situations where a claim was never filed in a case.
Section 506(d) is commonly used in Chapter 13 cases to “strip” or remove wholly unsecured second or third mortgages on a debtor’s primary residence. While this remedy is not available under Chapter 7, it is available in Chapter 13 or Chapter 11 cases. Under 506(d)(2), a lien securing an unfiled claim survives the bankruptcy even if the debtor’s personal liability for the unfiled claim is discharged. The proper remedy in this situation is simply to reopen the case and file the necessary paperwork to avoid the lien.
If a debtor notices that a creditor is not filing a claim and the claims filing deadline is approaching, one solution is for the debtor to file his own claim on behalf of the creditor, and then object to its allowance, or file some other proceeding in the bankruptcy court to avoid the lien. Liens can be avoided under Section 506(d) by adversary proceeding, by motion, and in some cases, by the plan confirmation process of Chapter 13 or Chapter 11, as long as proper notice is given of the intent to avoid the lien. In Re Pence, 905 F.2d 1107 (7th Cir. 1990).
Section 522(h) of the Code deals with avoiding nonconsensual liens on exempt property. A debtor has a right to avoid such liens and other involuntary transfers of interests in his exempt property. This right is in addition to the rights a debtor has under Section 522(f) of the Code. Section 522(h) also permits a debtor to claim exemptions on property recovered by the Trustee if the debtor did not voluntarily transfer the property and did not hide the existence of the property. A Trustee is unlikely to go through the trouble of recovering property that ends up being exempt property of the debtor. If the debtor can exempt even a portion of the property sought to be recovered by avoiding the lien, then the debtor may avoid the lien. When this happens, the excess value of the recovered property may remain subject to the lien unless the balance of the lien is avoided by the Trustee.
Basically, a debtor will need to meet these requirements to avoid a lien or other transfer under Section 522(h):
- The transfer must not have been voluntarily made by the debtor
- The debtor must not have concealed the existence of transferred property in the bankruptcy case
- The Trustee must not have acted to avoid the transfer in question, and it must be avoidable by him under the Code or be recoverable as a setoff
- The debtor must be able to use an exemption on the transferred property, if recovered.
These requirements are relatively straightforward. In practice, it can be difficult to determine whether a transfer was done voluntarily or involuntarily. Many transfers that appear to be voluntary may in fact be, upon scrutiny, not so voluntary. Creditors frequently use coercion, threats, and duress when collection issues arise. We should look to the essence of the transfer, not on what someone names it.
The burden of proof is on the debtor to show that he or she ws unduly coerced or harassed, or threatened. Like much else in the law, if a debtor desires to act under this Section, he or she should move quickly to do it. Failing to act in a timely fashion to reclaim property in this situation may mean that the debtor will not prevail. Courts have an interest in seeing property disputes resolved in a timely fashion. The doctrine of “laches” holds that a party which sleeps on its rights may lose its right to do something that was able to do.
Protocol may differ from court to court and from judge to judge, but the standard procedure for avoiding liens under Section 522(h), and for recovering the property in question, is the filing of an adversary proceeding using F.R. Bankr. 7001. It is also a good idea for a petitioning debtor to request that the court preserve the avoided transfer, since such transfers are not automatically preserved for the debtor. 11 U.S.C. §522(i)(2). Such transfers are automatically preserved for the Trustee, but not for the debtor without a request having been made and granted.