When a creditor may not have a valid lien, Chapter 13 gives you a good way to defeat that disputed lien and the claim against your property.
Our last blog post dug into what happens when a creditor does not assert its rights in the lien it has against your property. Or it does so only after your Chapter 7 case is completed. We showed the advantages of dealing with this situation under Chapter 13.
But what if there’s a dispute about whether there is a valid lien? Today we’ll show how, again, Chapter 7 leaves you with some practical problems, while Chapter 13 provides a good solution.
The Creation of Liens on Your Property
There’s a big difference between a debt in which the creditor has a lien on your property and one in which it doesn’t. It’s the difference between the creditor having rights against that property and having none. It’s usually the difference between the creditor being able to take or repossess your property or not. In a Chapter 7 “straight bankruptcy” it’s the difference between having to pay part or all of the debt to keep your property vs. paying nothing.
Whether or not a creditor has a legally enforceable lien is not always clear. The laws about creating a lien differ radically for different kinds of property. For example, creating a lien on an appliance is very different from creating one on a motor vehicle. Plus the laws often differ in the details even for the same kinds of property from state to state.
And speaking of details, the laws about creating liens tend to be quite specific and strict. If the creditor does not precisely follow the procedures for creating a lien, no lien gets created.
The consequence of all this is that whether a creditor has a valid lien isn’t always clear. Yet whether or not the lien is valid makes a big difference.
A Questionable or Disputed Lien under Chapter 7
If you and your bankruptcy attorney believe that a creditor’s claim to a lien is not legally enforceable, you are in an awkward position if you file a Chapter 7 case.
You would treat the debt as an unsecured debt in your bankruptcy documents. Then one of two things would happen. The creditor could assert its lien in your property either during the Chapter 7 case, or do so only afterwards.
The Creditor Asserting a Lien during the Chapter 7 Case
First, the creditor may contact you or your lawyer during the Chapter 7 case asserting its lien on your property. To dispute that lien you’d essentially have to file a lawsuit against the creditor in the bankruptcy court. At least you have a lawyer representing you who can give you advice about the lien’s legal enforceability. And you are already in the midst of a legal proceeding, with a court familiar with such matters readily available
Nevertheless such a lawsuit is not a normal part of a Chapter 7 case. It would significantly increase the cost of your case. If the property with the disputed lien is not worth a lot, it could be cheaper to just settle with the creditor and pay part or even all of the debt. That’s not a good solution if the creditor really doesn’t have a valid lien.
The Creditor Asserting a Lien Only after the Chapter 7 Case
Second, the creditor might not contact you or your lawyer during the Chapter 7 case asserting a lien. Instead it may do so only after the case is over. That’s even worse for three practical reasons.
1) You don’t have an attorney then currently representing you to advise you about the legal validity of the creditor’s claims.
2) As expensive as litigating a disputed lien may be in bankruptcy court, it would be likely significantly more so in regular state court.
3) Perhaps most important, after a Chapter 7 case is completed you no longer have the “automatic stay” protection against repossession. The creditor could potentially just repossess the property in which it claims a lien. Depending on the type of property, that’s often not likely. But still it’s a risk in certain circumstances.
The Chapter 13 “Adjustment of Debts” Solution
Filing a Chapter 13 case fixes these problems.
At the beginning of your case you and your bankruptcy lawyer put together a formal payment plan which clearly states how you intend to treat each of your secured debts—those with liens on anything you own. You also list all your secured creditors in Schedule D and all unsecured creditors in Schedules E and F.
Your plan either explicitly or implicitly asserts that a creditor’s potential lien is not valid. In some jurisdictions the plan language may include an explicit statement along those lines. Or else that creditor would be listed in Schedule F as an unsecured creditor, with no reference to it in the Chapter 13 plan, clearly implying that there is no valid lien.
Either way, all your creditors have the opportunity to object to how you propose to treat them in the plan. If a creditor with a questionable lien does not object on time, to some extent it is bound by that.
Most likely the creditor would be stuck with the debt being treated as unsecured during the course of the case. That means that the creditor could not assert a lien during the 3-to-5-years that the case would likely last. It could not ask the bankruptcy court for permission to repossess the property. The debt would be paid like all other “general unsecured” debts—only to the extent you have leftover money after paying living expenses and other higher priority debts. “General unsecured” debts are often paid only a small percentage of the debt, sometimes nothing at all.
After Completion of the Chapter 13 Case
Once you finish the Chapter 13 case successfully, the creditor may or may not be allowed to assert its lien at that point. Whether or not it would still have that right depends on:
- exactly how your payment plan and other court documents referred to the debt (that is, what notice you gave the creditor of your assertion that it did not have a valid lien);
- whether the creditor addressed this issue with the bankruptcy court during the case, and if so how it did so;
- other facts specific to your case; and
- the attitude of your local bankruptcy court and of your specific judge about this.
Even if the creditor still does have the right to assert that it has a lien against your property after your Chapter 13 case is over, at that point in most cases the property will have depreciated so much that the creditor would be wasting its time if it pursues its rights.
Chapter 13 enables you to treat a disputed lien as invalid during the life of the case. Then, depending on the facts of the case and on local laws and practices, the creditor may or may not assert the lien after the case is over. It’s not likely to if the property with the alleged lien is no longer worth the trouble.