I. General Comments
In our November, 1995 newsletter, Chris Burti, Regional Vice President and Counsel, wrote an article entitled "Beware of Pre-Bankruptcy Judgments." In addition to the issues discussed in that article, we have been asked to consider the impact of 11 U.S.C. Sec. 522(f)'s provisions pertaining to avoiding "the fixing of a lien... to the extent that [the] lien impairs an exemption..." To the extent 11 U.S.C. Sec. 522(f) applies, Bankruptcy Rules 4003(d) and 9014 (contested matters by motion) govern procedure. The exact impact of 11 U.S.C. Sec. 522(f) is unclear.
II. Brief Overview Of North Carolina Exemption Law
A. Statutory exemptions
G.S. 1C-1601(a)(1) sets out a $10,000 in value "residence" exemption for each individual debtor. G.S. 1C-1601(a)(2) provides each individual debtor with another $3,500 in value exemption less whatever is used of the exemption in
G.S. 1C-1601(a)(1). "Value" means fair market value of the individual's interest in the property, less valid liens superior to the judgment lien sought to be enforced. G.S. 1C-1601(b).
The exemption can be waived or lost only pursuant to G.S. 1C-1601(c). One of the three methods of waiver is by transfer of property allocated as exempt.
G.S. 1C-1601(e) provides a list of claims to which the statutory exemptions are inapplicable. The list includes claims (1) of the United States or its agencies as provided by federal law (this would seem to include federal tax liens); (2) of the State or subdivisions for taxes; (3) of a lien for labor performed for the person claiming the exemption or for a mechanic for work done as it affects the improved real property; (4) for purchase money obligations; (5) for contractual security interests in property; (6) for statutory liens on the property affected other than judicial liens; and (7) for child support, alimony or distributive awards under Chapter 50 of N.C.G.S.
G.S. 1C-1603 sets forth the lengthy procedure for setting aside exempt property. If the property is set aside as exempt, an order is entered designating exempt property. G.S. 1C-1603(e)(9) and (10). This is noted by the clerk on the judgment docket opposite the judgment. G.S. 1C-1603(f).
G.S. 1C-1604 sets forth the effect of the exemption. G.S. 1C-1604(a) states that the property is free of the enforcement of claims of creditors for indebtedness incurred before or after the exempt property is set aside, subject to G.S.
1C-1601(e)'s exceptions, "for so long as the debtor owns it."
G.S. 1C-1604(a) also provides that: "When the property is conveyed to another, the exemption ceases as to liens attaching prior to the conveyance. Creation of a security interest in the property does not constitute a conveyance within the meaning of this section, but a transfer in satisfaction of, or for the enforcement of, a security interest is a conveyance. When exempt property is conveyed, the debtor may have other exemptions allotted."
G.S. 1C-1604(b) states that: "Exempt property which passes by bequest, devise, intestate succession or gift to a dependent spouse, child or person to whom the debtor stands in loco parentis, continues to be exempt while held by that person. The exemption is terminated if the spouse remarries, or, with regard to a dependent, when the court determines that dependency no longer exists."
And relatively new G.S. 1C-1604(a1) provides as follows: "The statute of limitations on judgments is suspended for the period of exemption as to the property which is exempt. However, the statute of limitations is not suspended as to the exempt property unless the judgment creditor shall have, prior to the expiration of the statute of limitations, recorded a copy of the order designating exempt property in the office of the register of deeds in the county where the exempt real property is located."
Applicable case law is discussed below.
B. Constitutional Exemptions
G.S. 1C-1602 makes reference to the fact that each individual debtor can elect the exemptions, including the homestead exemption, provided in Article X of the North Carolina Constitution instead of G.S. 1C-1601's exemptions. These constitutional exemptions include the "homestead exemption" in Article X, Sec. 2(1) of the Constitution as follows: "Exemption from sale; exceptions. Every homestead and the dwellings and buildings used therewith, to a value fixed by the General Assembly but not less than $1,000, to be selected by the owner thereof, or in lieu thereof, at the option of the owner, any lot in a city or town with the dwellings and buildings used thereon, and to the same value, owned and occupied by a resident of the State, shall be exempt from sale under execution or other final process obtained on any debt. But no property shall be exempt from sale for taxes, or for payment of obligations contracted for its purchase."
The procedure in G.S. 1C-1603 applies. G.S. 1C-1602.
C. Use of North Carolina exemptions in bankruptcy
11 U.S.C. Sec. 522 is the exemption section of the Bankruptcy Code. By virtue of the interaction of 11 U.S.C. Sec. 522 and G.S. 1C-1601(f), North Carolina's exemptions and not the exemptions in 11 U.S.C. Sec. 522(d) are utilized in federal bankruptcies.
III. 11 U.S.C. Sec. 522(f)
11 U.S.C. Sec. 522(f) was amended by the Bankruptcy Reform Act of 1994, effective October 22, 1994.
Pursuant to 11 U.S.C. Sec. 522(f)(1)(A), the debtor may "avoid the fixing of a lien" on the debtor's interest in the property "to the extent that such lien impairs an exemption to which the debtor would have been entitled... "if such lien is a "judicial lien" other than judicial liens securing certain specific spouse-child-domestic relations awards. "Judicial lien" is defined in 11 U.S.C. Sec. 101(36) to include a lien obtained by judgment or other legal or equitable proceeding, which is not to be confused with "statutory lien" defined in 11 U.S.C. Sec. 101(53) to include, for example, a lien for labor, services or materials. 11 U.S.C. Sec. 101(53) expressly excludes a "judicial lien."
11 U.S.C. Sec. 522(f)(2)(A) provides that a lien shall be considered to impair an exemption to the extent that the sum of (1) the lien, (2) all other liens on the property and (3) 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. A lien that has already been avoided is not included in (2). 11 U.S.C. Sec. 522(f)(2)(B). When one runs examples through 11 U.S.C. Sec. 522(f)(2)(A)'s formula, one does not get a perfect fit with the math available under G.S. 1C-1601(a). Perhaps it is a fair interpretation of 11 U.S.C. Sec. 522(f)(2)(A) to state that it provides the highest extent to which an exemption cannot be impaired, implicitly subject to state law limitations on the value or amount of the exemption.
The usefulness of 11 U.S.C. Sec. 522(f) seems to be limited because of the reasoning in In Re Love, 42 B.R. 317 (Bankr. E.D.N.C. 1984). The debtor claimed her residence exempt under G.S. 1C-1601(a)(1) and moved to avoid the judicial (judgment) lien under then existent 11 U.S.C. Sec. 522(f)(1). The court ordered that the lien be avoided and cancelled "to the extent the lien impairs the Debtor's exemptions in this property." The debtor sought to modify the order to provide that the lien be cancelled without limitation. The court observed that this request depended upon the nature and extent of the North Carolina exemptions. The court refused the modification request since the exemption in G.S. 1C-1601(a)(1) is conditional; the property is free from the enforcement of the lien only so long as the debtor or a dependent uses the property as a residence. Once that use ceases, prohibition on enforcement ceases. 42 B.R., at 318. Cessation of ownership has the same result. 42 B.R., at 319. In either event, the judgment creditor can then enforce the lien. 42 B.R., at 319. It would seem that the effect of an order of exemption under North Carolina law is to merely exempt the property from execution to the extent of the exemption. G.S. 1C-1603(a); G.S. 1C-1603(e)(6), (9); G.S. 1C-1604(a). An order of modification under G.S. 1C-1603(g) is not required in order for an exemption to cease.
For these reasons, until the law is changed or clarified, title insurers are reluctant to rely upon avoidance under 11 U.S.C. Sec. 522(f) in order to "insure over" a judicial lien. We understand that in the Western District of North Carolina, there might be a different view of the effect of 11 U.S.C. Sec. 522(f). An interesting issue is, if a court unequivocally and totally cancelled a lien in disregard of the view in In Re Love, and the order was not appealed, would the order be binding? Certain attorneys have argued "yes." We invite your comments and especially those of your bankruptcy law partners and associates. We would like to highlight the comments that we receive in a future newsletter.