If a creditor gets a judgment against you and the debt is dischargeable in a Chapter 7 bankruptcy, filing for bankruptcy will wipe out a creditor's ability to collect. However, a creditor with a judgment can place a lien on your property.
Because liens don't go away in bankruptcy automatically, it's possible to wipe out a lawsuit judgment in bankruptcy and remain obligated to pay the lien. When you don't have a strong defense, you can often avoid this problem by filing for bankruptcy before a lawsuit judgment is entered against you.
A lawsuit judgment enhances a creditor's ability to collect a debt, but you can't always eliminate that power in bankruptcy. That's not to say bankruptcy can't get rid of a lawsuit judgment against you, but eliminating the lawsuit judgment itself isn't always enough to avoid responsibility for paying a debt.
This article takes you step-by-step through this challenging area, covering key areas you'll need to understand, including the following:
Not many. Most bills, like credit card balances, medical bills, rental contracts, and personal loans, aren't "secured" by collateral, such as a home or vehicle the creditor can take if you don't pay your bill. Also, the law doesn't allow most unsecured creditors to place a lien on your property when you don't pay what you owe (although some have this right, the IRS being a well-known exception).
Without a money judgment, collateral, or a lien on your property, your credit card company, the local gym owner, or another unsecured creditor can't do much if you stop paying your debt. They can ask you to pay it, but that's about it.
Yes. An unsecured creditor who wants to use more aggressive means to force you to pay can get the right to take your property without your consent. But these creditors must sue you in court first.
In court, the creditor must prove the balance owed to the court's satisfaction. If successful, the court will award the creditor a money judgment. The money judgment protects you by ensuring the creditor uses the tactics explained in the next section to collect what's owed, not more.
Once the creditor has a money judgment, the power shifts. The money judgment gives the creditor tools that can strip you of assets. Specifically, a creditor with a money judgment in hand can do the following:
A money judgment also allows the creditor to attach a "lien" to your property. A lien gives a creditor an ownership interest in the property until you pay the debt (more below).
In some states, a judgment automatically gives a creditor a lien right to all your property. Other states require the creditor to file the money judgment with the recorder's office, state secretary, or a similar office first.
With the lien in place, the creditor can do one of two things:
Creditors usually place a lien on a home or other real property because it's often the person's most valuable asset. But selling real estate can be expensive and complicated, so many creditors wait for the debtor to sell it. The debtor must pay off the lien before transferring the title to the new buyer.
If you'd like more details, read How Creditors Enforce Judgments.
Assume the trial is over, the creditor won, and the judge awarded the creditor a money judgment. If the money judgment is for a debt you can discharge, like a credit card balance, and didn't involve fraud, and the judgment creditor hasn't placed a lien on your property, Chapter 7 bankruptcy will provide a quick and easy solution, allowing you to wipe your hands of the entire matter and pay nothing.
You might benefit from bankruptcy if the judgment creditor already placed a lien on your property, but you'll have extra work ahead. If the judgment involves fraud, bankruptcy could help if luck is on your side. If the judgment involves a nondischargeable debt, there's likely no reason to file unless you'd benefit by erasing other debt or paying the judgment over time in Chapter 13 bankruptcy.
Keep reading to learn more about each potential outcome.
The simplest way to start your analysis is by determining whether bankruptcy will wipe out the debt. If the underlying debt is nondischargeable, like those below, you won't be able to erase it in bankruptcy:
If you have one of these debts and need time to repay it, consider filing for Chapter 13. You can force the creditor into a five-year repayment plan while simultaneously handling other financial issues. Another benefit? The creditor won't be able to garnish your wages, levy your bank account, or seize property while you pay into your Chapter 13 plan.
Learn more about debts a bankruptcy discharge won't eliminate.
Don't assume you're off the hook if the judgment doesn't fall into a nondischargeable category. Other debts can also be declared nondischargeable by a bankruptcy judge if a creditor asks. The most common debts that can be made nondischargeable include the following:
Are you confused about why these debts differ from the debts discussed above? If so, you're not alone. Here's the critical difference.
If the debt falls under one of these categories and the creditor doesn't object, you can discharge the lawsuit judgment. Therefore, if the judgment creditor does nothing, your responsibility to pay will be erased with other qualifying debts.
However, if the creditor objects by asking the bankruptcy court to declare the money judgment debt nondischargeable, the bankruptcy court will likely rely on the underlying judgment and declare the debt nondischargeable.
Tip. Consider filing for bankruptcy soon after being served with a lawsuit containing fraud allegations. You could come out ahead. If your quick action deprives the creditor of a money judgment, the creditor will be forced to prove the fraud allegations at a bankruptcy trial rather than simply asking the bankruptcy judge to declare the debt nondischargeable based on the fraud judgment from the previous court. This is where luck enters the picture. Sometimes creditors assume the matter will be erased in bankruptcy and do nothing, or don't think they'll be able to collect if you're bankrupt and don't want to exert the time and money necessary to pursue a lawsuit.
Liens can be problematic because, in many cases, they survive bankruptcy. Obtaining a bankruptcy discharge won't matter much if the creditor's lien is still attached to your assets, such as your house.
Here's the typical scenario.
You allow a credit card lawsuit to go to judgment without appearing in court because you didn't have a viable defense. The court issues a money judgment against you for a dischargeable credit card debt, and you file for bankruptcy soon after. However, the creditor used the money judgment to file a lien against your house before you could file for bankruptcy.
You knew that your bankruptcy filing wiped out the money judgment and eliminated the creditor's ability to garnish your wages or take money out of your bank account. However, you didn't realize the bankruptcy did not affect the lien until years later, when you sold the house. You had to pay the lien in full before transferring ownership to the new buyer.
As the example demonstrates, if the lien remains, the creditor will retain a right to sell the property after the bankruptcy case's conclusion or wait until you sell it to take its share, even if you wiped out the money judgment in bankruptcy. If you don't understand this, many years later, you could discover you still owe a creditor for a debt you thought was erased in bankruptcy.
The good news is that you might be able to remove the lien in bankruptcy. The bad news is even if you can remove the lien, it will only be to the extent that you could have "exempted" or protected the property in bankruptcy.
You can eliminate some or all of a judgment lien in bankruptcy through "lien avoidance." Here's what you'll need to prove:
To avoid a judgment lien, you must follow bankruptcy procedures, and it's best to act quickly. However, if you forget to handle the lien, most courts will allow you to file a motion to avoid a lien after your bankruptcy case closes.
You must have the right to keep or "exempt" the property in bankruptcy. If the judgment lien gets in the way of this right, the court will likely agree to avoid it so that you maintain clear property ownership.
If you aren't entitled to exempt the asset, or if the lien is another type, such as a voluntary lien given when purchasing a house or car, the lien will remain in place.
Example 1. Henry can exempt $5,000 in equity in a car. His vehicle is worth $4,000, allowing him to protect it in a Chapter 7 bankruptcy. However, in his state, a creditor with a judgment automatically gets a lien against all of the debtor's personal property, including a car (and Henry has a money judgment against him). His attorney files a motion asking the court to avoid the lien. Because Henry can entirely exempt the vehicle, the court agrees.
Example 2. Tiffany's credit card company obtained a judgment for $25,000 and filed it with the Stoney County recorder's office, giving the credit card company a lien on all of Tiffany's real estate in the county. An exemption doesn't cover Tiffany's cabin. Even though she can wipe out the credit card debt in a Chapter 7 bankruptcy because the property is nonexempt (and located in the county), the court won't remove the lien. After the bankruptcy, the credit card company can sell the cabin (or wait for Tiffany to do so) and recover the lien amount.
For more details, see What Happens to Liens in Chapter 7 Bankruptcy?
You'll want to claim your property's exempt status in your bankruptcy paperwork and file a timely motion with the court. Remember that if you have more equity than what you can exempt, your creditor will likely argue that the lien is valid only up to the exemption amount. Whether you file for Chapter 7 or Chapter 13 will determine how problematic this issue could be for you.
For instance, the trustee might still sell the property in Chapter 7 bankruptcy and return the exempt portion to you. In Chapter 13, you'd likely be better off. You could keep the property by paying an amount equal to the nonexempt part through the Chapter 13 repayment plan.
For more information, read Getting Rid of Judgment Liens in Bankruptcy.
Lien removal is a tricky area of bankruptcy law, and complexities exist beyond this article's scope. To protect valuable property to the best of your ability, you should meet with a bankruptcy lawyer for a thorough case assessment.
Did you know Nolo has made the law accessible for over fifty years? It's true, and we want to ensure you find what you need. Below, you'll find more articles explaining how bankruptcy works. And don't forget that our bankruptcy homepage is the best place to start if you have other questions!
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