A relatively common misunderstanding of the effect of discharge under Sec. 524 of the Bankruptcy Code (11 U.S.C. 524) can lead to a serious omission on a title opinion. The purpose of this article is to attempt to help point out the issues that should concern a title examiner when a closed bankruptcy case is discovered in the chain of title.
The basic principle underlying the effect of bankruptcy on judgments is that, once docketed, a judgment forms the basis of two liabilities. The first is the personal liability of the judgment debtor to satisfy the debt by payment. The second is the in rem liability of the lien which attaches to all real property owned or subsequently acquired by the judgment debtor while the judgment remains unsatisfied and in full effect. It is this second liability that survives the discharge since Sec. 524 only provides relief from the first, the personal obligation of the debtor to pay the judgment debt.
Bankruptcy essentially treats a pre-filing judgment as a secured debt in the nature of a deed of trust. Even though the debtor may not have any further obligation to make payment the property remains available to satisfy the secured debt to the extent that the debtor has equity in it in excess of any available exemption. Therefore, unless the property is disposed of free of the lien in the bankruptcy proceeding, the lien remains attached and enforceable against the property even though the underlying debt is no longer enforceable against the debtor.
It should be noted that Sec. 523 provides certain exceptions to discharge which in most, but not all, cases relevant to title examination must be raised prior to discharge. See particularly Sec. 523(c). Since a discharged debt is no longer enforceable personally against the debtor any prefiling judgment lien will not attach to property acquired after the bankruptcy. The significance of sec. 523 to a title examiner lies primarily in cases where a pre-filing judgment debt is not discharged and therefore the lien would attach to after-acquired property.
The vast majority of bankruptcy cases involving real estate usually dispose of the property through: a sale free of liens, relief from stay and foreclosure, or are filed prior to any judgments being docketed and therefore pre-bankruptcy judgment concerns are cut off. The foregoing discussion becomes very pertinent in those rare cases where a debtor owns property with judgment liens attached prior to filing bankruptcy. Typically it is encumbered by a secured indebtedness senior to the judgments, with little or no equity, and the lender and debtor work out an arrangement to pay the debt and retain the property. The property continues to be vulnerable to execution (an in rem proceeding) for the life of the judgment.