Bankruptcy

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In this article, you can discover…

• The differences between a secured and an unsecured debt.
• The various kinds of liens that exist and their impact on bankruptcy.
• The process and implications of reaffirmation for personal debt.

What Is The Difference Between An Unsecured Debt And A Secured Debt?

The primary difference between unsecured and secured debt is whether or not the debt is secured by collateral.

Secured Debts

A secured debt is secured by a specific asset that serves as collateral. If you default on the payments, the creditor can repossess the asset. Common examples include car loans and home mortgages. If you fail to make the car loan payments, the lender can repossess the vehicle. Similarly, if you default on the mortgage, the lender can foreclosure on your home.

Unsecured Debts

These debts are not backed by any tangible asset. If you default, the creditor cannot repossess any asset. Examples include credit card debt, student loans, and medical bills. Unlike secured debts, creditors holding unsecured debts rely on legal measures like lawsuits to recover the money owed.

This distinction also affects how debts are treated in bankruptcy. Creditors holding secured debts are treated better than unsecured creditors because they have special rights attached to the collateral. As a consequence, unsecured creditors rarely recover the full amount owed.

What Is A Lien, And Do Liens Need To Be Recorded?

A lien is a legal claim against an asset that serves as the collateral securing a debt. However, the creditor fails to record the lien, the lien is unperfected, which means the debt is treated as unsecured. For a creditor to have an enforceable security interest, it must record the lien with the appropriate governmental entity, such as the County Recorder’s Office for real estate, or the Department of Motor Vehicles for vehicles.

Types of Liens

Consensual liens are liens associated with an agreement between the lender and you. When you take out a mortgage, you agree to allow the lender to record a lien against your home. The lien grants the lender the right to foreclose if you fail to make payments. When you borrow money to buy a car, you give the lender a lien against the vehicle.

Nonconsensual liens are imposed without the property owner’s agreement. They are created because some legal or statutory authority gives the creditor the right to record the lien. There are several types of nonconsensual liens, including:

• Judgment liens: If a creditor successfully sues you and obtains a judgment, it can record a lien against your property. This type of lien is also called a judicial lien.
• Mechanic’s liens: Contractors or workers who are unpaid for services or materials can record a lien on your property. This type of lien is a statutory lien because it is based on a California statute.
• Tax liens: The IRS and state tax authorities can impose liens for unpaid taxes. Taxing authorities frequently will record tax liens. However, some tax liens, such as secret liens held by the IRS, arise automatically by statute without requiring formal recording.
• HOA liens: Homeowner’s associations can record liens for unpaid dues, as authorized under specific statutes.

Statutory liens are liens authorized by state or federal statutes, such as mechanic’s liens, tax liens, and HOA liens. They don’t require an agreement but are enabled by law.

Finally, there are floating liens. These are common in business settings, especially with inventory or merchandise financing. A floating lien attaches not to a specific item, but to a stream of assets, such as inventory purchased and sold regularly. If payments aren’t made, the creditor can claim the unsold merchandise or funds from its sale.

Other than a secret tax lien outside of bankruptcy, recording a lien is critical for creditors because it establishes their priority over other claims in case of default or bankruptcy. An unrecorded lien will leave the creditor with no enforceable claim on the asset, reducing its ability to recover the debt.

Will My Personal Liability Associated With A Lien Be Discharged In Bankruptcy?

Whether your personal liability tied to a lien is discharged in bankruptcy depends on the type of liability and the specifics of the bankruptcy case.

On the one hand, in rem claims are claims against the collateral securing the debt. On the other hand, in personam claims are claims against you personally. For example, if you finance a car and default, the lender can act on its in rem claim, repossess the car, and sell it. If the sale doesn’t cover the loan balance, the lender can act on its in personam claim and pursue you for the post-resale deficiency.

With some exceptions, in personam claims are typically discharged in bankruptcy. For example, if you default on a car loan and then file for bankruptcy protection, the lender cannot pursue you for any deficiency after selling the car. On the other hand, in rem claims are not discharged in bankruptcy; so if you default, the creditor can still repossess the asset.

However, if the creditor successfully challenges the discharge of the debt you have to it, perhaps under a theory of fraud, the in personam claim will survive the bankruptcy discharge.

How Can I Deal With A Judgment Lien In Bankruptcy?

In bankruptcy, you can avoid a judgment lien to the extent that it impairs your exemption. (This is a somewhat unusual use of the word avoid. In this context it means rendering the lien null and void.) Here’s an overview of how the process works:

Exempt vs. Nonexempt Assets

Exempt assets are those you can keep after a Chapter 7 bankruptcy. Nonexempt assets may be liquidated in a Chapter 7 bankruptcy to pay creditors. We determine the exempt status of an asset by appealing to one of two exemption tables: one is for homeowners with equity in their principal residence, and the other is for everyone else.

Calculating Impairment

To determine if a lien impairs an exemption, add:

• The balance on the lien you want to avoid.
• The balances on all other liens against the property, including mortgages.
• The exemption value you would be entitled to in the absence of any liens.

To the extent that this sum exceeds the fair market value of the property on the date you filed your bankruptcy petition, the lien is impaired and can be avoided.

Evidence Needed:

You will not succeed in avoiding the lien if you fail to attach as exhibits the following evidence to your lien avoidance motion:

• An appraisal establishing the property’s market value on the date you filed your bankruptcy petition. The appraiser must sign a declaration under penalty of perjury attesting to the accuracy of the appraisal. Otherwise, the appraisal is hearsay.
• Certified copies of all liens, and any other documents necessary to verify balances.

Potential Litigation

Occasionally a creditor may contest the lien avoidance by challenging the property valuation. However, most lien avoidance actions proceed without opposition.

Is There Any Way To Deal With A Consensual Lien In Bankruptcy?

The simplest option is to pay the lien off entirely, but that might not be feasible if the outstanding balance is large. However, if a second mortgages is wholly unsecured, it can be removed in a Chapter 13 or Chapter 11 bankruptcy. For example, during past downturns in the housing market, it was possible to remove second mortgages that were entirely unsecured. Of course, in today’s real estate market we don’t see this happening. But if, in future, the market drops the way it did during the 2007 crash, we may see some of these cases again.

Let’s say your home is worth $500,000, and you have a first mortgage with a balance of $600,000. You also have a second mortgage with a balance of $100,000. Under these circumstances, the second mortgage is wholly unsecured because the property value is entirely consumed by the first mortgage. There’s no equity behind the second mortgage, making it effectively unsecured debt.

In such cases, you can strip off the second mortgage in a Chapter 13 bankruptcy. While this doesn’t make the debt disappear outright, it converts it into unsecured debt, which gets treated like other unsecured debts, like debt from a credit card in your Chapter 13 repayment plan. For instance, if your Chapter 13 plan pays unsecured creditors 10% of what they’re owed, you’d only pay $10,000 on a $100,000 second mortgage, and the remaining balance would be discharged upon completion of the plan.

This can be an appealing strategy, but it’s only available when the second mortgage is completely unsecured. With current housing market trends, these types of opportunities are rare, but markets can shift unexpectedly. If property values drop again, there may be future opportunities to strip off wholly unsecured second mortgages.

What Are My Other Bankruptcy Options For Dealing With Secured Debts?

As mentioned above, if you’re able, you can always pay your secured debts off entirely.

Another option is to negotiate with your creditors. When negotiating, remember this key to success: you need to convince your creditor that your proposal is in their best interest. Appealing to compassion or asking for help rarely works; instead, focus on demonstrating why your offer is the best deal the creditor is likely to get.

Point out the costs they’ll face if you don’t pay—such as those associated with repossessing, holding, and selling the asset—while also factoring in delays caused by the automatic stay in bankruptcy. Presenting a practical solution in terms that benefit your creditor may allow you to restructure the debt without adhering strictly to the original terms of the agreement. However, any negotiated deal must be approved by the bankruptcy judge assigned to the case.

What Is Reaffirmation?

Reaffirmation involves reinstating your personal liability on a debt, after filing for bankruptcy. The simple example of a car loan will illustrate the idea.

When you finance a car purchase, the creditor gets an in rem claim against the car. If you don’t make your payments, the creditor can repossess the car, and if the resale price doesn’t cover what you owe, it can pursue you for the remaining balance.

In bankruptcy, however, your in personam liability is typically discharged, meaning you personally owe nothing if the creditor repossesses the car and sells it for less than what’s owed. While the creditor retains a claim against the vehicle, it cannot come after you for any deficiency.

Creditors don’t like this, so they paid a lot of money to amend the Bankruptcy Code to permit them to require you to reaffirm your personal liability as a condition of your keeping the car. If you refuse to reaffirm the debt, the creditor can repossess the vehicle, unless you either redeem the car by paying the fair market value in one lump sum, or surrender the vehicle.

California law, however, has recently changed. Now, if you are current on your car payments, creditors cannot repossess the car, even if you have discharged your personal liability. Since the Bankruptcy Code only allows a creditor to appeal to applicable nonbankruptcy law if you fail to reaffirm, redeem, or surrender, and since the applicable California law forbids repossession unless you have defaulted, you probably don’t have to reaffirm unless you are behind on the payments.

How Does Reaffirmation Work?

Once you file for bankruptcy, creditors cannot contact you directly due to the automatic stay. Instead, they send reaffirmation agreements to your attorney. If you sign the agreement, your attorney will send it back to the creditor for its representative’s signature, who then files it with the court.

The judge assigned to the case will then schedule a hearing on the agreement. Most judges are hesitant to approve reaffirmation agreements unless there is an overwhelmingly compelling reason—such as a significant improvement in loan terms. Without court approval, the reaffirmation agreement is void, and there is no personal liability.

Alternatives

If the creditor sends a reaffirmation agreement, your attorney can negotiate more favorable terms. For instance, in one of my recent cases involving a title loan with unreasonable terms, I negotiated a dramatic improvement on the loan by greatly reducing the interest rate and the monthly payments.

Creditors may also agree to a ride and pay arrangement, where you continue making payments without reaffirming the debt. This can be a practical option if the creditor agrees, as it allows you to keep the car without reinstating personal liability.

Still Have Questions? Ready To Get Started?

For more information on Bankruptcy, an initial consultation is your next best step. Get the information and legal answers you are seeking by calling (562) 777-9159 today.