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Issue  55  Article  115
Published:  2/1/2000

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Entireties, Bankruptcy and the Attachment of Judgement Liens
Chris Burti, Vice President and Legal Counsel

A recent Maryland bankruptcy case has been decided by the 4th Circuit and may be helpful in sorting out the issues concerning pre-petition judgment liens. Birney v. Smith, No. 98-2479, U.S. 4th Circuit Court of Appeals, December 29, 1999 concerns the attempt by a judgment creditor to execute on a judgment on real property in Maryland. The property was originally owned by the debtor as tenants by the entireties with his wife who died after the filing of the petition in bankruptcy.

Birney and his wife owned real property located in Cecil County, Maryland as tenants by the entireties. In 1984, Smith obtained a judgment against Birney individually in state court. In Maryland, as in North Carolina, a judgment lien against individuals does not attach to entireties property held by debtors with their spouses. In May of 1995, Birney filed a voluntary Chapter 7 bankruptcy petition. Birney listed the property as exempt because it was jointly owned as tenants by the entireties by the debtor and his non-filing spouse. In June of 1995, the trustee notified the creditors that the case was a no-asset case and filed a report of no distribution in August of 1995. In October of 1995, Birney’s wife died. The trustee determined that the estate could not acquire these assets and he filed a second report of no distribution in December of 1995. In January of 1996, a discharge was issued and the case was closed without objection to the claimed exemptions or the trustee's reports.

Smith then attempted to execute on the property, claiming that he acquired a lien on the property upon Mrs. Birney's death. In April of 1996, Birney reopened the bankruptcy case seeking a determination by the court that no lien attached to the property and that Smith's claim against Birney had been discharged in the bankruptcy proceedings. The Bankruptcy Court granted Birney's motion for summary judgment, finding that Mrs. Birney's death did not void the property exemption. The District Court affirmed the Bankruptcy Court's order, finding that the property was never captured by the bankruptcy estate and therefore could not be reached by the creditor who then appealed.

The 4th Circuit ruled that the creditor could not reach the property directly through the debtor. During the period prior to the debtor’s bankruptcy petition, the lien could not attach to the property because the spouse was still alive. During the period between the bankruptcy filing and the discharge, no lien could attach because of the automatic stay imposed by 11 U.S.C. 362(a)(5). This section prohibits ‘any act to create, perfect, or enforce against property of the debtor any lien to the extent that such lien secures a claim that arose before the commencement of the case under this title’. The creditor contended that his lien on the property arose by operation of law upon the death of the spouse. He argued that attachment of the lien did not fall under the 362(a) prohibition since it did not involve an "act" to create or perfect the lien. The Circuit Court determined that this contention was incorrect under the holding of In re Avis v. Trustee, 178 F.3d 718 (4th Cir. 1999).

In Avis, the 4th Circuit held that the attachment of a tax lien, arising by operation of law to post-petition property, is an "act" within the meaning of 362(a). Attachment is, therefore, prohibited during the time that the automatic stay is in effect. The Court rejected a narrow interpretation of the term "act" and concluded that the attachment of a lien is itself an "act" that is prohibited by 362(a)(5), even when the attachment occurs automatically by operation of law. Id. at 722- 23.

The automatic stay imposed by 362(a)(5), therefore, prohibits the attachment of Smith's post-petition lien because it is still an "act". The automatic stay remained in effect until January of 1996, when Birney was granted a discharge. Smith's lien could not attach from the time Birney filed his bankruptcy petition until the time he was granted a discharge. After discharge, no lien could attach to the property because the discharge extinguished the debt upon which the lien was based, as the debtor was no longer liable for the judgment debt.

The creditor also cannot reach the property through the bankruptcy estate. He contended that upon the spouse's death, the basis for exempting the property from the bankruptcy estate lapsed, and that therefore the property should become part of the estate and made available to satisfy the claims of creditors. The court ruled that the basis for the debtor's exemption of the property was in fact extinguished upon the spouse's death citing In re Cordova, 73 F.3d 38 (4th Cir. 1996). Cordova held that an exemption for property owned as tenants by the entireties lapsed when the joint tenancy was extinguished by operation of law following a divorce that occurred post-petition. Termination of the exemption after the filing of the petition does not, by itself, bring the property into the bankruptcy estate. There must also be some applicable statutory mechanism by which the estate "captures" the post-petition property. Section 541(a) provides the only statutory basis having potential for bringing the property into the bankruptcy estate.

This section defines as part of the estate

" Any interest in property that would have been property of the estate if such interest had been an interest of the debtor on the date of the filing of the petition, and that the debtor acquires or becomes entitled to acquire within 180 days after such date --

(A) by bequest, devise, or inheritance;

(B) as a result of a property settlement agreement with the debtor's spouse, or of an interlocutory or final divorce decree; or

(C) as a beneficiary of a life insurance policy or of a death benefit plan."

In these limited circumstances, the statute allows the estate to "capture" property acquired by a debtor within 180 days after filing the bankruptcy petition. Such property becomes part of the bankruptcy estate only if the property was obtained as a result of the events contained in subsections (A) through (C). Upon Mrs. Birney's death, less than 180 days after filing his bankruptcy petition, Birney became the sole owner of the property. A tenant by the entireties does not "inherit" the co-tenant's interest in the property. The survivor continues in full ownership of the property alone. As a result, the debtor did not receive a fee simple interest in the property by "bequest, devise, or inheritance." Nor did he obtain the property in a divorce settlement or as an insurance beneficiary. As a result, the creditor could not reach the property through the estate.

This case presents an excellent opportunity to remind title examiners of the potential problem that arises from pre-petition property subject to a pre-petition judgment lien. Discharge in bankruptcy only discharges the personal obligation to pay the debt as noted above. The lien of a pre-petition judgment is not voided or discharged when the debtor retains the pre-petition property after the bankruptcy. The discharge operates to prevent the creditor from executing on the lien as long as the debtor retains the property. Once the debtor conveys the property after discharge, the creditor may execute on the lien against the new owner. This is also a problem in the lending context. Subjecting the property to a deed of trust or mortgage is not a conveyance giving rise to a right on the creditors part to execute. Foreclosure of the instrument, by the lender, terminates all legal and equitable rights of the debtor but does not cut off the lien of the prior judgment. There are, at least, two exceptions to this principle. Obviously, if the judgment has expired due to an applicable limitations period, it may not be enforced. In addition, if the debtor obtained an order of lien avoidance, after due notice, under Section 522(f) of the Bankruptcy Code, the creditor is cut off from the right to execute on the lien.

If the title examination discloses judgments of record that have attached to property owned at the time of a discharge in bankruptcy, the examiner should report the facts to the title insurer for underwriting review. It is not unusual to require re-opening of a bankruptcy proceeding in order to obtain a lien avoidance order in such cases, but these situations do not arise very often.

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