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. Judgments, however, can create a lien on your property. And liens don't go away in bankruptcy automatically. So it’s possible to wipe out a judgment in bankruptcy and remain obligated to pay the lien.
Before determining whether you can use bankruptcy to get out from under a judgment entirely, you’ll need to learn:
Lien removal is a tricky area of bankruptcy law that could require professional help. If you’d like to ensure that you protect valuable property to the best of your ability, it's prudent to seek the advice of a knowledgeable bankruptcy attorney.
Learn about lawsuits you can’t stop by filing for bankruptcy.
Unless a creditor required you to put up collateral—for instance, a home or vehicle—a creditor can’t do much other than ask you to pay your bill. And most bills, like credit card balances, medical bills, rental contracts, and personal loans, aren’t secured by property.
So if you stop paying your bill and your credit card company, local gym owner, or another unsecured creditor wants to use more aggressive means to force you to pay, the creditor must sue you in court first. The creditor must prove that you owe the money to the court’s satisfaction before getting a money judgment.
Once the creditor has a money judgment, however, the power shifts. The money judgment lets the creditor do the following:
A money judgment also allows the creditor to attach a "lien" to your property. A lien works by giving a creditor “dibs” on the property until you pay the debt. With the lien in place, the creditor can do one of two things:
Creditors usually choose to put 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 most wait for the debtor to sell it. Why? Because the debtor must pay off the lien, with interest, before transferring title to the new buyer.
In some states, a judgment automatically gives a creditor a lien right to all of your property. Other states require the creditor to file the money judgment with the recorder's office, state secretary, or a similar office first.
If you'd like more details, read How Creditors Enforce Judgments.
It can be a complicated process, so if a creditor served you with a collection lawsuit but it hasn’t gone to judgment yet, meet with a bankruptcy attorney soon. Bankruptcy might stop the suit and erase the debt automatically, saving you significant time and money. However, if the judge already issued a decision and the creditor has received a money judgment, here’s what you’d do in bankruptcy.
When determining whether bankruptcy will wipe out a judgment, start by asking whether the underlying debt is nondischargeable. Nondischargeable debts include the following:
If the judgment doesn't fall into a nondischargeable category, don't assume that you're off the hook just yet. Other types of debts might be nondischargeable if the creditor files an objection—most notably, obligations related to fraud. The creditor's process to ask the court to find a debt nondischargeable is to file an adversary proceeding. The following types of debts often trigger an adversary proceeding filing:
If the judgment doesn't relate to these categories, and the creditor doesn't object to your discharge, you can discharge the lawsuit judgment in Chapter 7 bankruptcy. But a lien still might remain—which means you'd still end up losing the property or paying an amount equivalent to the owed amount unless you have the lien removed.
For more information, read Nondischargeable Debts in Chapter 7 Bankruptcy.
Obtaining a bankruptcy discharge will give you little comfort if the creditor's lien is still attached to your assets, such as your house. 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.
However, there is a way that you can get rid of the judgment lien in your bankruptcy. It is called lien avoidance. Here are the three conditions you’ll need to prove to qualify for lien avoidance:
To avoid a judgment lien, you must follow bankruptcy procedures, and it's best to act quickly (although most courts will allow you to file a motion to avoid a lien after your bankruptcy case closes). Learn more about the different types of property liens.
When you file for bankruptcy, you're allowed to keep or "exempt" a certain amount of property. 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. Keep in mind 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.
Sometimes a lien avoidance motion doesn't get filed during a bankruptcy. If you (or your attorney) failed to do so, don't panic. Most courts will allow you to handle the issue after the closure of the case.
Complexities exist that are beyond the scope of this article. You should seek legal counsel for an assessment of your particular case. For more information, read Getting Rid of Judgment Liens in Bankruptcy.