What Happens to Owners in Bankruptcy or Foreclosure
Purpose of this article is to try to clear some of the apparent confusion we see on this site re what happens to debts & liens in BK filing/discharge and foreclosure (trustee's)sale.
Let's start with debts..
What happens to any debt in a Ch 7 BK?
Except for IRS debt*, and certain specified NON dixchargeable debt, such as Judgment finding fraud by debtor, or criminal sentence ordering restitution for criminal conduct, or payment of fines, or court costs, other debt is normally** effectively discharged and barred upon filiing of Ch 7 BK.
The purist & moralist will object that our moral obligation to repay those debts is NOT really discharged, only the legal obligation.
I'm not going to discuss that now.
Well, OK, you say, but what about the liens? Say a 2d mortgage on the house?
That lien is attached to the RE, and even though the underlying debt is barred and its collectability closed out, the lien is NOT removed, deleted or changed in any way...and any such lien stays on the RE's title and may have to be paid off before it's released.
Of course, it it's a subordinate lien, such as a 2d or 3d mortgage or deed of trust secured debt, it's likely to be eliminated when the property is foreclosed by the 1st mortgage holder.
Let's look at a very normal Ch 7 filing, which is frequently done a day or two ahead of a Deed of Trust foreclosure auction date.
The very filing of the Ch 7 absolutely bars or "stays" the D/T auction from passing any kind of title or rights, and normally, when a trustee is aware of the Ch 7 filing, that calendared auction is immediately scrubbed, as it CANNOT accomplish anything.
And remember this: Even though that particular debt or debtor was NOT even mentioned in the Ch 7 petition, it is still barred ! i.e., the debtor might have deliberately omitted listing that debt so that debtor might miss its filing, and show up in BK court to contest the debt's discharge.
But Fed BK law clearly states that even though the debt was omitted in the list of debts and debtors, it is still barred along with all those that the debtor did list.
You should also understand that the debtor is NOT free to make subsequent arrangements, without the BK Court's permission, to go ahead and pay one or two of those debts.
What? Huh? Come again...why would the debtor do such a thing?
Having mis-spent a fair amount of my professional time in BK court and having heard lots of debtor's testimony at their discharge hearings, I've heard lots of debtors tell the Court that they've made special arrangments to pay some debt or other...whereupon the court asks why? And then proceeds to tell the debtor that such an agreement is NOT binding on the debtor and the debtor certainly does NOT have to do that.
Although I can't recall hearing any BK Court order the debtor not to pay such, I've heard the Court come very close to it.
OK, but what about the bank's right to foreclose its 1st mortgage?
Well, they can and do, despite the filing of the Ch 7, and here's how: A few weeks after the BK's filing, the bank will have its lawyer file a Motion to Lift Stay, meaning it's asking the Court to remove the automatic "stay" that was applied to the foreclosure when the Ch. 7 was filed.
And the court will then, pretty automatically, so order, lifitng the "stay" and allowing the foreclosure to proceed.
So whle the BK debtor can succeed in delaying the foreclosure, he cannot normally
stop or kill the foreclosure, and it will happen, just later than it was originally scheduled.
So in summary, just remember this rule of thumb: A debt is discharged by BK, but not a lien. And liens are eliminated by foreclosure, but not debts.
The lien being foreclosed is thereby converted into title for the foreclosing creditor, and the secondary, or subordinate liens are thereby eliminated.
The debtor should clearly understand that the other debts are NOT discharged or eliminated by foreclosure of one of the liens...and those creditors can still come after the debtor, although their security is now gone by the foreclosure process.
In some states the foreclosing lien holder can still sue and obtain a "deficiency" Judgment against the debtor, in the event the foreclosure auction doesn't net the creditor as much as his total debt, including P, I, and costs....yet in other states, once the foreclosure has taken place, the creditor cannot pursue the debtor with a deficiency J.
*IRS debt cannot be discharged until it's some years old, as I recall, maybe incorrectly, it's 10 years from date of filing of the tax return. Please correct me if this is not right.
**Although most debt is immediately discharged upon filing of Ch 7 petition, any creditor is able to immediately contest that discharge, and with legal grounds, such as criminal or fraudulent, or some other statutory exception, perhaps succeed in having that debt declared NOT discharged or dischargeable and kept alive....but my personal experience, with clients whose business concerned me as far as possible criminal complaints, or some old J against them for fraud, is that about 90-95% of the time, those creditors don't even show up, and ALL the debt is discharged.
Hope this has added some light in the tunnel, rather than adding to the murky dark.
John Merchant
What about County Tax Liens?
I though they were "protected" against discharge? I had heard that the interest may not be protected, but that the tax lien itself is.
You're right, in that NO lien is itself discharged, and although debts are discharged, liens hang on...liens are against the RE & are NOT discharged, only the debt...and normally property taxes are not pursued as debts against the debtor, but just handled as liens against the RE.....and are not released until paid.
So even after the BK debtor is, himself, discharged, those liens have to be dealt with.
The subordinate ones are wiped out by foreclosure of the 1st Mtg lien, but the IRS liens may be redeemed for a certain short term FOLLOWING the foreclsosure.
Hi,
I filed a chapter 7 bankruptsy a few years ago. I was able to keep my home [it was never involved in the bankruptsy] and the bankrupsy was completed about a year ago. I re morgaged my home for renovations a few months ago and now that it is time for a closing there are 2 utility liens on the property-one of which is bogus but I do not have clear title and can not get them removed so I am possibly going to loose my mortgage approval as the lawyers will not set up a closing date due to the liens. Your article gave me some insight but there must be a way to discharge the liens as they were part of the bankruptsy. My lawyer says that the bankrupsy must be re opened - any opinion?
If the utility liens are from pvt utility cos. and not government (water usually is gov. agency) you might be able to deal with and negotiate to pay them at discount.
And if the refi is OK except for these liens, you can get pvt loan to pay them, then repay the pvt loans with the big refi proceeds. Your pvt loan could be secured by 2d, and lots of investors would do that deal.
By the way, bankruptcy is misspelled in the title, and every time I see it it bugs me. But bankruptcy is right way.
I believe this utility is private.
Their lawyer told me I needed to file certain papers with the district court to get the lien dropped and the District Court is saying to me that the utility company needs to file papers with them in order to get a release on the liens.
No one except for the mortgage company [credit union] is saying it needs to be satisfied or dropped.
My lawyer is stating that he is re opening the bankruptcy and within 30 days these liens will be released - is this a fallacy? He has told me I have to pay for new re filing costs.
I do not have any time to waste or I will loose everything I've put into this.
One of the liens is not correct and I was going to file a complaint this weekend with the Land Court in Boston. If I have to pay these liens then it should only be for the amount owed.
Anyway I appreciate your input-it gives me a different avenue to take on Monday and it seems to be the only one making any sense at this time.
Sorry for the misspelled word.
John
This article is excellent. It is straight forward and easy to understand. Great work, and thank you for taking your time to do this
Sam