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Bankruptcy's Effect on Liens

 

Possibly the single greatest misconception among lawyers today is the idea that a personal discharge in bankruptcy serves to discharge liens. The discharge of the debtor (or bankrupt) serves merely to discharge his or her personal obligation to pay the debt which the judgment or other lien secures; it does not affect the lien itself. This is because the bankruptcy proceeding, in and of itself, does not affect the nature and quality of the title of the debtor's real estate. So if the debtor's realty is burdened by certain liens or encumbrances at the time he files a bankruptcy petition, and no affirmative action is taken to remove those liens or encumbrances during the course of the bankruptcy proceeding, the liens and encumbrances will still exist at the time the case is concluded. 11 U.S.C. §727(b). Borromeo v. DiFlorio, 409 N.J. Super. 124 (App. Div. 2009) (“... a statutorily created judgment lien survives the debtor’s discharge in bankruptcy ...”).

 

Nevertheless, the law affords a remedy to a debtor whose realty remains encumbered by liens after his or her bankruptcy discharge. N.J.S.A. 2A:16-49.1, which was originally intended to cover only after-acquired property, Furnival Machinery Co. v. King, 142 N.J. Super. 251 (App. Div. 1976), has been judicially expanded to address liens encumbering pre-acquired property; i.e., realty owned by the debtor at the time the bankruptcy petition was filed. See Associates Commercial Corp. v. Langston, 236 N.J. Super. 236 (App. Div. 1989).

In order to prevail in an application under N.J.S.A.2A:16-49.1 to avoid a judgment which was a lien against pre-acquired property, the debtor must demonstrate that (a) one (1) year has elapsed since the discharge of the bankrupt; and (b) the debt or lien was scheduled in the bankruptcy petition; and (c) the debt is dischargeable; and (d) the judgment lien could have been avoided during the bankruptcy proceeding. Thus, the statute may not be used successfully in every case. See, e.g., Party Parrot v. Birthdays & Holidays, 289 N.J. Super. 167 (App. Div. 1996), wherein the court declined to set aside a judgment lien because it probably could not have been avoided during the pendency of the bankruptcy.
More recently, in Gaskill v. Citi Mortgage, 428 N.J. Super. 234 (App. Div. 2012), the Appellate Division had occasion to construe the first prong of the

four-part test statutory set forth above. In that case, the debtors alleged that the judgment lien was subject to avoidance under the statute because the creditor had failed to levy prior to debtorsfiling of a bankruptcy petition or within one year of discharge of the underlying debt.
The creditor, Citi Mortgage [“Citi”] had recovered a default judgment against the debtors [the Gaskills] in 1997. The debtors had filed a Chapter 7 petition in 2001, but erroneously listed the law firm which had represented Citi, rather than Citi itself, as a creditor. The Gaskills were discharged in 2002. In 2005, the debtors filed suit against Citi in the Chancery Division, seeking cancellation of the judgment lien under N.J.S.A. 2A:16-49.1. The trial court held that the judgment was subject to cancellation because Citi had failed to levy within one year of the debtors’ discharge. Yet it would be inequitable to cancel the judgment in this case, because Citi had not received notice of the bankruptcy proceeding, owing to the debtors’ error. Hence the court determined that Citi would have one year from the closing of the Chancery Division case to levy on the debtors’ realty.
On appeal, the Appellate Division affirmed the holding below. It began its analysis by quoting the decision in Party Parrot, supra, which reminds us that a discharge in bankruptcy serves only to discharge debts, and not liens. After reviewing the record, the panel concluded that the Chancery Division properly exercised its equitable powers in tolling the one-year period “under the unique circumstances of this case”.
The court noted that “...the discharge in bankruptcy only discharges the personal liability incurred by the debtors. Unless avoided or released during the bankruptcy proceeding, the judgment remains enforceable against the real property owned by the debtor, and the ...creditor has one year to levy against that property”. 428 N.J. Super. at 243 (emphasis added). Thus, the Appellate Division adopted the view that the one-year period is intended to allow a judgment creditor a reasonable period of time after discharge to enforce its lien. But others have understood the one-year period to refer to the time within which a debtor’s discharge may be revoked under 11 US.C. §727 (e). In any event, the opinion serves as a reminder that a discharge of personal liability does not, in and of itself, operate as a discharge of a lien on which such liability is based.
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