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Issue  20  Article  46
Published:  3/1/1997

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Bankruptcy Judgements and Liens - 11 U.S.C. Sec. 522(f) Lien Avoidance
Ed Urban, Vice President and Corporate Legal Counsel

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, as we wrote in our May 1996 and July 1996 Newsletter and Legal Memorandum articles. This article is a revision of those two articles.

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(c)(1).

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."

Note that under G.S. 1C-1604(a), while the exemption exists, the debtor’s interest in the property is free of the enforcement of a judgment lien; the property is not free of the lien entirely. Therefore, if A owns property; J dockets a judgment (not excepted by G.S. 1C-1601(e)) against A; A properly obtains an exemption under G.S. 1C-1601(a)(1); A gives a deed of trust to T for M which is recorded; and A conveys the title to the property to B, it would seem arguable that, pursuant to G.S. 1C-1604(a), A’s exemption ceases and J can enforce his judgment by execution with priority over M’s deed of trust. Additionally, the language in G.S. 1C-1604(a) which states, "but a transfer in satisfaction of, or for the enforcement of, a security interest is a conveyance" triggering the end of the exemption clearly includes a deed in lieu of foreclosure and may include a foreclosure of a mortgage or deed of trust.

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."

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." "Judicial lien" does not include, and "statutory lien" includes, a federal tax lien. 4 Collier on Bankruptcy, Paragraph 522.11[1] (15th Ed. Rev.).

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).

The usefulness of 11 U.S.C. Sec. 522(f) seemed 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 court stated that 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, according to the court, 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.

However, the case of In Re Opperman, 943 F. 2d 441 (4th Cir. C.C.A. 1991), should be noted. In this case, the outstanding balances secured by the first and second mortgages were, respectively, $40,274.84 and $2,262.50. Opperman had equity of $2,462.66 which she claimed exempt under G.S. 1C-1601(a)(1). Subordinate to the two mortgages was Wachovia’s pre-bankruptcy judgment lien of $3,721.74. Opperman moved to avoid the judgment lien in its entirety under then existent 11 U.S.C. Section 522(f)(1). Wachovia argued that this should not occur since North Carolina’s exemption is contingent upon the debtor’s continued ownership and use of the property, as discussed above. The court cited Owen vs. Owen, 59 U.S.L.W. 4486, 24 C.B.C. 2d 850 (1991), as controlling, wherein the court, according to In Re Opperman, emphasized that the phrase "exemption to which the debtor would have been entitled" in 11 U.S.C. Section 522(f) included either 11 U.S.C. Section 522(d)’s federal exemption or the state’s exemption which applies due to the state’s "opting out" of the federal exemption. Therefore, G.S. 1C-1604(a)’s limitation on duration of the exemption does not apply to an 11 U.S.C. Section 522(f) avoidance procedure, according to In Re Opperman. According to the court "such a lien may be avoided if it impairs the debtor’s exemption, either an actual exemption under the state statute or," in, to say the least, interesting statutory interpretation, "the hypothetical federal exemption where the state has opted out of the federal scheme." Thus, in the Fourth Circuit, the issue of duration of the avoidance has been answered definitively, if not persuasively.

In In Re Opperman, the court noted that the creditor’s judgment lien was less than the amount of the homestead exemption so, the issue of whether the amount of the lien vs. the amount of the exemption affected whether the lien could be avoided in its entirety was not before the court. But the court stated: "The Court is left with one concern that requires clarification: whether a lien will be avoided entirely in this situation. To answer this, we need look no further than the statute itself. Section 522(f) states that ‘the debtor may avoid the fixing of a lien on an interest of the debtor in property to the extent that such lien impairs an exemption . . . .’ (Emphasis added). A lien larger in amount than the exemption available to the debtor does not impair that exemption. Thus, only that part of a lien which actually interferes with the debtor’s homestead exemption may be avoided. (Citations omitted)."

The case of In Re McQueen (U.S.D. Ct., Eastern D., Western Div., No. 5: 94-CV-631-BR 1996), should be noted. The facts of In Re McQueen are as follows. The debtors owned their residence which was subject to over $898,000.00 in voluntary liens and over $400,000.00 in involuntary liens, one of which was a judicial lien to BB&T in the amount of $350,000.00 which is the subject of the case. The debtors had no equity in their residence, and they flied a motion to avoid the judgment lien. The motion was denied at a bankruptcy hearing "on the ground that the debtors have no equity in their residence and that an exemption is impaired only to the extent that the debtor has equity in the property." The court, in overruling the bankruptcy court’s decision, held that 522(f) was originally intended to provide a debtor the opportunity to avoid a judicial lien on a residence without regard to the debtor’s monetary interest in that residence; therefore, the debtors should have been allowed to avoid BB&T’s judicial lien in its entirety, as partial avoidance is not in line with the original intent of 522(f).

It should be noted that In Re McQueen construed 11 U.S.C. Sec. 522(f) before that section’s amendment by the Bankruptcy Reform Act of 1994. However, the court noted that the legislative history to the amendment indicated that the intent of former 11 U.S. C. Sec. 522(f) was to be construed as in In Re McQueen. The court noted that the legislative history cited in the October 4, 1994 Congressional Record (which is also reproduced in the annotation to 11 U.S.C. Sec. 522) states that the current version of 522(f) overrules decisions which do not allow complete lien avoidance in such a case. It is noted that In Re McQueen dealt with the issue of whether lack of equity above the amounts of liens prior to BB&T’s judicial lien precluded relief under 522(f).

In sum, what the In Re McQueen court might be saying is that, regardless of the limitations in North Carolina’s homestead exemption law, the debtor can obtain complete lien avoidance under 522(f) regardless of the fact that subsequently, the debtor or a dependent might cease to use the property as a residence or cease to own the property. That does appear to be the point of In Re Opperman. If a procedurally valid 522(f) order is entered stating that the lien is avoided in its entirety and the order is not appealed, we can rely upon the order. Any timely appeal taken must uphold the order. The bankruptcy docket should contain notation of the order and appeals, etc. Bankruptcy Rule 5003(a). The clerk is required to keep a correct copy of every final judgment or order affecting title to or a lien on real property. Bankruptcy Rule 5003(c).

The legislative history and comment indicates that complete judicial lien avoidance can be obtained when (1) a mortgage prior to the lien causes there to be no equity above the amount of the mortgage and (2) the total of the liens on the property and the amount of the debtor’s exemption exceeds the fair market value of the property. In Re Jakubowski, 196 B.R. 262 (Bankr. N.D. Ohio. 1996); In Re Allund, 196 B.R. 402 (Bankr. N.D. Ill. 1996). Once the lien is avoided it does not reattach to property to reach any future increase is value. 4 Collier on Bankruptcy, Paragraph 522.11[3] (15th Ed. Rev.). However, the commentators feel that if the property value exceeds the total of the judicial lien to be avoided, all other liens on the property and the maximum exemption amount, then the judicial lien is not impairing the exemption and cannot be avoided. 4 Collier on Bankruptcy, Paragraph 522.11[3]; 11 U.S.C. Sec. 522(f)(2)(A).

An interesting issue regarding contents of the order seems somewhat unresolved. If a debtor moves to have a lien avoided under 522(f) in circumstances that would allow complete lien avoidance (under the above cases), but the pleadings and order refer, or only the order refers, to the lien being avoided "to the extent it impairs the exemption" instead of the lien being avoided "in its entirety" as suggested in the preceding paragraphs, can the order be relied upon as an order avoiding the lien in its entirety? It would seem that the answer should be "yes." However, given the considerable confusion, and litigation generated thereby, regarding 522(f), we are reluctant to rely upon an order that sounds so equivocal. At the very least, such an equivocal sounding order would necessitate investigation as to the underlying circumstances. It does not seem too much to ask for the order, at least, to state that the lien is avoided in its entirety and is therefore subject to record cancellation by the clerk of superior court.

Incidentally, the U.S. Supreme Court has held that 11 U.S.C. Sec. 522(f) cannot be used unless the debtor possessed the encumbered interest in the property prior to the attachment of the lien. Farrey v. Sanderfoot, 500 U.S. 291, 111 S. Ct. 1825, 114 L. Ed2d 337 (1991).

It would seem that 11 U.S.C. Sec. 522(f) could be made more concise and straight forward if In Re McQueen and In Re Opperman are correct. 522(f) could have been changed in 1994 to clearly state that an order permanently avoiding and cancelling the lien can be entered. Let us hear from you or your bankruptcy law partners or associates regarding this confusing area.

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