Most of the time when the term “avoid” comes up in New York bankruptcy it’s used in the context of preferential transfers to creditors. That is, the debtor transfers money to a creditor he or she likes more than the others, such as a relative, and the trustee chooses to nullify (“avoid”) the transfer. The other time avoidance comes up is with liens. In this situation, though, the debtor is the one trying to nullify something—the lien—to his or her benefit and not the bankruptcy estate’s. Note that avoiding a lien is not the same thing as “stripping” a lien as debtors sometimes try to do in chapter 13 or chapter 11.
So when is lien avoidance possible? When the lien “impairs” an exemption. The relevant statute is Section 522(f) of the Bankruptcy Code.
A lien impairs an exemption when it denies the debtor the benefit of that exemption. For example, let’s say a debtor owns a home somewhere in New York City worth $600,000 with a mortgage worth $450,000 and a $30,000 lien affixed to it. Subtracting the mortgage from the property’s value gives us $150,000 that would normally be exempt. However, because of the lien, the debtor can’t fully use the exemption. The law, then, avoids the lien, releasing the debtor from having to pay it once the bankruptcy is concluded, so the debtor can keep the exempt equity.
A lien can also be avoided partially. For instance, if the mortgage was worth only $440,000, then the debtor’s equity would be $260,000. However the exemption plus the lien is still a greater amount, $270,000. In this situation, the lien is avoided to the extent that the debtor can claim the full value of the exemption, so it would be reduced to $10,000.
It’s very important to point out that not all liens can be avoided. The statute only protects debtors from two types of liens: judicial liens (except those for domestic support obligations), certain “nonpossessory, nonpurchase-money security interests,” and, in chapter 13 only, tax liens when they’re greater than the secured asset’s value. Liens on “nonpossessory, nonpurchase-money security interests” attach to pieces of the debtor’s personal property not because they have significant market value but because they’re valuable to the debtor. Examples include appliances, books, animals, musical instruments, jewelry, tools of trade, and health aids that are pledged in exchange for a loan.
If a creditor recovers an item protected by a lien, debtors can take advantage of Section 522(h) and avoid the transfer to the creditor under the same principles that the trustee can if the trustee does not do so. This way, the debtor can benefit from an exemption even if he or she no longer holds the property.
Due to its high homestead exemption, debtors in New York have an easier time avoiding liens than debtors in other states. It’s a significant advantage the Bankruptcy Code gives them, and an experienced New York bankruptcy lawyer can help a debtor move the bankruptcy court to avoid a lien.
For answers to more questions about liens, bankruptcy, the automatic stay, effective strategies for dealing with foreclosure, and protecting your assets in bankruptcy please feel free to contact experienced New York bankruptcy attorney Bruce Weiner for a free initial consultation.