A judgment lien is one of the most powerful tools in the creditor’s arsenal, but its effect can be severely curtailed by a bankruptcy filing. This article explores the impact of bankruptcy on judgment liens and the limited state court remedies which may remain after a bankruptcy discharge.
CREDITOR’S JUDGMENT LIEN ON THE DEBTOR’S REAL ESTATE
A judgment lien is easily established. As stated in Teaman v. Wilkerson (1997) 59 Cal.App.4th 1259, 69 Cal.Rptr.2d 705, “A judgment lien on real property is created by recording an abstract of a money judgment with the county recorder. (CCP § 697.310, subd. (a)). Unless satisfied or released, the judgment lien continues until 10 years from the date of entry of the judgment, after which it may be renewed. (CCP § 697.310, subd. (b)).”
The lien attaches to any real property owned or acquired by the judgment debtor in the recording county with one exception: “A judgment lien on real property does not automatically attach to real property on which a declaration of homestead has been recorded. (See CCP § 704.950, subd. (a)). Instead, under section 704.950, subdivision (c): ‘A judgment lien attaches to a declared homestead in the amount of any surplus over the total of the following: (1) All liens and encumbrances on the declared homestead at the time the abstract of judgment or certified copy of the judgment is recorded to create the judgment lien; (2) The homestead exemption set forth in Section 704.730,’” Teaman, supra. In other words, if the judgment debtor has recorded a homestead declaration before the creditor records a judgment, the judgment lien attaches only to any surplus in the debtor’s equity over and above the homestead exemption.
The practical effect of a judgment lien which has attached to real property is to force an owner/judgment debtor to pay off the lien in order to sell or encumber the real property, since he or she will be unable to obtain title insurance unless the lien is satisfied.
THE JUDGMENT DEBTOR FILES BANKRUPTCY
A judgment debtor’s bankruptcy filing can in some instances modify or eliminate the creditor’s judgment lien. If obtained shortly before the bankruptcy filing, the lien may be subject to avoidance as a preference. Under Section 547(b)(4) of the Bankruptcy Act, a transfer is preferential if made:
“(A) on or within 90 days before the date of the filing of the petition; or
(B) between ninety days and one year before the date of the filing of the petition, if such creditor at the time of such transfer was an insider.”
If the bankruptcy trustee or the debtor successfully attacks such a transfer, the effect is to eliminate the judgment lien and leave the creditor in the unsecured creditor class.
Judgment liens are also subject to avoidance under Section 522(f) of the Bankruptcy Act if they impair an exemption to which a debtor would otherwise be entitled.
LIEN AVOIDANCE UNDER BANKRUPTCY LAW
If a creditor’s judgment lien has attached to the bankruptcy debtor’s principal residence, the debtor, in order to obtain the benefit of the generous California homestead exemption, will likely seek to avoid all or part of the lien under Section 522(f) of the Bankruptcy Act (11 U.S.C. § 522(f)). Under that section, a judgment lien impairs an exemption, and may be avoided, “to the extent that the sum of (i) the lien; (ii) all other liens on the property; and (iii) the amount of the exemption that the debtor could claim if there were no liens on the property; exceeds the value that the debtor’s interest in the property would have in the absence of any liens.”
This provision can best be illustrated by an example such as that set forth in 2 Norton Bankruptcy Law and Practice 2d, Section 46:24 (updated December, 2006):
… if property worth $40,000 is encumbered by a $40,000 mortgage and a junior judicial lien, the lien is avoidable in its entirety even though no value is actually available for the homestead exemption. Similarly, if the property is worth $50,000 and is encumbered by a $40,000 mortgage and a $20,000 judicial lien, the debtor entitled to a $10,000 homestead exemption can avoid the entire judicial lien. Finally, if property worth $50,000 is encumbered by a $20,000 mortgage and a $60,000 judicial lien, the debtor entitled to a $10,000 homestead exemption can avoid $40,000 of the lien. That will create $10,000 of equity that the debtor can take as a homestead exemption, and leave in place the mortgage and a judicial lien of $20,000.
In other words, under the formula in Section 522(f), the judicial lien remains in place only to the extent that there is equity in the property over and above the amount of the homestead exemption. To the extent that the judgment lien exceeds the value of the debtor’s equity, it is unsecured. Songer v. Cooney (1989) 214 Cal.App.3d 387, 264 Cal.Rptr.; 11 U.S.C. § 506(a),(d).
Some debtors who are entitled to relief under Section 522(f) will bring their motion while their bankruptcy case is being administered. The Section 522(f) formula can then be readily applied using the lien amount, homestead exemption amount and equity valuation existing on the date of the bankruptcy filing. Other debtors may be living in their homestead with no present intention to sell or refinance. They may not wish to pay additional fees to their bankruptcy counsel to pursue the lien avoidance motion, or they may simply neglect to inform their counsel that a judgment lien exists. In such an instance, the judgment lien can sometimes remain in effect for several years, perhaps during a period of dramatic appreciation in real property value, before the discharged debtor seeks to transfer the property and is forced to deal with the judgment lien. A long time judgment creditor who appears to hold a valid lien against a valuable piece of real estate may receive a belated motion to reopen the debtor’s bankruptcy case in order to seek avoidance of that lien.
Unfortunately for the creditor, the bankruptcy court will usually allow the debtor to reopen the bankruptcy case and file the lien avoidance motion unless the creditor can demonstrate prejudice [delay in itself usually not prejudicial to creditor, since creditor is in no different position than if motion had been brought at time of bankruptcy filing. In re Carroll, 258 B.R. 316, 45 Collier Bankr.Cas.2d (MB) 1000 (Bankr. S.D. Ga. 2001). Furthermore, the time for determining the debtor’s interest in the property is the date of the bankruptcy filing rather than the date of the motion. See, In re Orr, 304 B. R. 875 (Bankr. S.D. Ill. 2004); In re Hyman, 967 F.2d 1316 (C.A. 9 Cal., 1992). The creditor gets no benefit from either the interest which has accrued on the judgment or the appreciation in the property’s value. Furthermore, the amount of the homestead exemption, which under state law is determined as of the date the judgment lien is created (CPP § 703.050(a); Berhanu v. Metzger (1992) 12 CA4th 445, 15 CR2d 191), is, in a bankruptcy lien avoidance motion, determined as of the date the bankruptcy case was filed (In re Mayer, 167 B.R. 186 (BAP (9th Cir. 1994).
The net result of Section 522(f), whether debtor’s lien avoidance motion is brought either at the time of the initial case administration or after several years of appreciation in value, is that the creditor’s lien will be limited to the equity in the property over and above the applicable homestead amount calculated as of the time of the bankruptcy filing. If the case has been administered and the liened real property abandoned as an asset by the trustee, any post-petition appreciation will go to the debtor. Songer, supra, 214 Cal.App.3d 391.
CREDITORS MAY BE ENTITLED TO PRE-PETITION APPRECIATION
A surprisingly complex issue arises when a judgment lien is recorded on a California residential dwelling at a time when the debtor has no equity in the property. If the debtor files bankruptcy after the property has appreciated, one of the questions presented in a lien avoidance motion is whether the judgment lien ever became attached to the real property.
The first step in the analysis is to determine whether the debtor’s homestead exemption claim is based on the recorded declared homestead described in CCP § 704.920 or the “automatic” homestead exemption granted in CCP § 704.720. The difference is significant and is noted in Amin v. Khazindar (2003) 112 Cal.App.4th 582:
In California, a homestead exemption may be asserted two ways. First, a declaration of homestead may be recorded. (Code Civ. Proc., §§ 704.920.) A recorded homestead protects the property from execution by certain creditors to the extent of the amount of the homestead exemption. (In re Mulch (Bankr. N.D.Cal. 1995) 182 B.R. 569, 572 [applying California homestead exemption].) Because many California debtors failed to file homestead exemptions, the legislature in 1974 enacted legislation which created an “automatic” homestead exemption. (Code Civ. Proc., §§ 704.720.) This exemption need not be memorialized in a recorded homestead declaration in order to be effective. “The automatic homestead exemption is available when a party has continuously resided in a dwelling from the time that a creditors’ lien attaches until a court’s determination in the forced sale process that the exemption does not apply.” (In re Mulch, supra, at p. 572; Webb v. Trippet (1991) 235 Cal. App. 3d 647, 651 [286 Cal. Rptr. 742].)
As noted in In re Mulch, the two exemptions are distinct protections and they operate differently. The declared homestead provides greater rights than the automatic homestead. The declared homestead provides protection from a voluntary sale; judgment liens only attach to the equity in excess of consensual liens; and the protections of the declared homestead survive the death of the homestead owner. The proceeds from a voluntary sale may be reinvested within six months, thus allowing the debtor to invest in another residence. (In re Mulch, supra, 182 B.R. at p. 573.) On the other hand, the automatic homestead only entitles the debtor to protection from a forced execution sale. (Ibid.)
If the debtor seeking to avoid a judgment lien has not recorded a declaration of homestead and is instead relying upon the “automatic” homestead exemption of CCP § 704.720, the judgment lien will have attached itself to any pre-petition appreciation which occurred after the lien was recorded, and the judgment debtor will be entitled to the homestead exemption only upon a forced sale. If the debtor records a declaration of homestead after the judgment lien has been recorded, the result will remain the same, as the judgment lien will retain its priority. In either event, however, the judgment lien will be avoidable under Section 522(f) to the extent of the homestead exemption. Katz v. Pike, 243 B.R. 66, (9th Cir. B.A.P. (Cal.) 1999).
The more interesting issue is presented when the homestead declaration is recorded prior to the judgment lien. In that instance, according to a literal reading of CCP § 704.950(a), if there is no equity above the amount of the homestead exemption, the judgment lien does not attach. This situation arises with some frequency because the exemption amount is at least $75,000, and in some circumstances can be as much as $175,000. As a result, it is not unusual for the judgment debtor’s equity to be less than the amount of the homestead exemption. When the property later appreciates to the extent that there is equity beyond the amount of the exemption, the court deciding a Section 522(f) motion must determine whether a judgment lien which did not attach when recorded can subsequently attach to later created surplus equity.
The resolution of this question has a complex history. Teaman v. Wilkerson (1997) 59 Cal.App.4th 1259, 69 Cal.Rptr.2d 705, supra, the California court which finally resolved this issue, describes the sequence of decisions as follows:
The Enforcement of Judgments Law does not address the potential enforceability of a judgment lien that has failed to attach because of lack of surplus equity, nor has any California case addressed the issue. However, it was the key issue in a bankruptcy matter that yielded a two-to-one decision from the Ninth Circuit Bankruptcy Appellate Panel in favor of the creditor (In re Jones (B.A.P. 9th Cir. 1995) 180 B.R. 575 (Jones I)) and a two-to-one decision in favor of the debtor when the matter was heard in the Ninth Circuit (In re Jones (9th Cir. 1997) 106 F.3d 923 (Jones II)).
The split Jones courts, construing California law, favored the bankrupt debtor in determining that if there was no equity at the time the judgment lien was recorded, the lien never became attached to subsequent surplus equity. The Teaman court rejected the Jones II decision, holding that, “…when an increase in value of the property creates or increases surplus equity, the judgment creditor is entitled to reach this appreciation in satisfaction of its judgment,” supra at 1267. See also, Smith v. James A. Merrill, Inc. (1998) 64 Cal.App.4th 94, 75 Cal.Rptr.2d 108, and Title Trust Deed Service Co. v. Pearson (2005) 132 Cal.App.4th 168, 33 Cal.Rptr.3d 311.
The resulting crumb for the creditor is that when the Section 522(f) lien avoidance formula is applied, the creditor’s judgment lien will have attached to any surplus equity (over and above the amount of the homestead exemption) which has arisen in the subject property after the lien was recorded and before bankruptcy, even if no surplus existed at the time of recording.
CREDITORS CAN ENFORCE SURVIVING LIENS
The first portion of this article describes the circumstances under which a judgment lien on residential property, or at least a portion of that lien, may remain after a bankruptcy debtor’s lien avoidance motion. First the lien must have been recorded prior to the bankruptcy preference period, and second, the amount of the lien will be limited to the amount of surplus equity remaining after consensual liens and the debtor’s homestead exemption. In other instances, the debtor may own real property, either non-residential or not his dwelling, which is not subject to the homestead exemption. Such a lien is not subject to Section 522(f) lien avoidance because it does not impair an exemption, and it survives the debtor’s bankruptcy. While the underlying debt is discharged, the real property remains subject to the judgment lien, and may be preserved and enforced. As stated in Songer v. Cooney (1989) 214 Cal,App.3d 387, supra at 392, “absent an order from the bankruptcy court avoiding the lien in its entirety the judgment [is] not vacated but remain[s] enforceable in rem to the extent necessary to support the lien.” The same rule is confirmed by In re Hermansen (B.C.D.C. Colo. 1988) 84 B.R. 729, 733 [18 C.B.C.2d 952],) cited by the Songer court:
Generally, valid, perfected judicial liens which precede bankruptcy survive and are enforceable after bankruptcy. … The bankruptcy discharge does not prevent post-petition enforcement of valid liens. The secured creditor may proceed to enforce the lien, as an in rem action, and is not barred by the injunctive terms of 11 U.S.C. §§ 524.
Furthermore, the creditor is entitled to obtain a writ of execution to enforce the judgment lien even though the debtor’s personal liability on the debt has been discharged. Songer, supra, at 393, and in a later unpublished decision, the same Second Appellate District, Division Six, confirmed that a creditor holding a post-discharge judgment lien could renew the judgment for the purpose of enforcement. Songer v. Bordan, 2002 WL 1904425 (Cal. App. 2 Dist. Aug 20, 2002).
A judgment lien on a bankrupt debtor’s personal residence will often be reduced or eliminated by a lien avoidance motion brought under 11 U.S.C. § 522(f) in order to preserve the debtor’s right to a homestead exemption. Any remaining lien, however, as well as any judgment lien on real property other than debtor’s homestead, will survive the bankruptcy and still be enforceable by the judgment creditor even though the underlying debt has been discharged.
Bruce W. Hogan is a partner in the Santa Barbara firm of Kingston, Martinez & Hogan. He specializes in commercial collection matters and has practiced in the Central Coast area, including Santa Barbara, Ventura and San Luis Obispo Counties, for over 30 years.