If a creditor holds a judgment lien against a debtor arising from a claim based on fraud, it stands to reason, does it not, that the debtor cannot avoid the judgment lien under Section 522(f) as an impairment of the debtor’s homestead exemption?

According to an opinion by Bankruptcy Judge David T. Thuma of Albuquerque, N.M., it does not stand to reason. The Supreme Court held in Law v. Siegel, 571 U.S. 415 (2014), that equitable powers do not permit the bankruptcy court to deny an otherwise valid homestead exemption.

A couple filed a chapter 13 petition that was converted to chapter 7. Before bankruptcy, two creditors obtained judgments against the debtors totaling about $400,000. Both judgments were based on fraud. Both creditors recorded the judgments, creating judgment liens against the debtors’ home.

Asserting that the equity in the home above the mortgage was fully covered by the state homestead exemption, the debtors filed motions under Section 522(f) to avoid the judgment liens as impairments of their homestead exemption. Both creditors objected. In his December 2 opinion, Judge Thuma described the creditors as contending “that [the] Debtors should not be allowed to use § 522(f) to avoid judicial liens that secure claims arising from fraud.”

Ruling after a preliminary hearing on the debtors’ motions, Judge Thuma described Section 522(f) as permitting “a debtor to avoid a judicial lien if it impairs a homestead exemption” under state law. The only requirements for lien avoidance, he said, “are those found in § 522(f).”

Citing the Supreme Court, Judge Thuma said that the debtors would satisfy Section 522(f) by proving “the existence of a judicial lien; that the lien impairs their homestead exemption; and that they possessed the homestead property when the lien attached.” Allowing the liens to remain in place “effectively would deny Debtors their right to the homestead exemption,” he said.

Judge Thuma said that the creditors “do not cite any statutory or case law support for such a fraud exception.” The Supreme Court, he said, “addressed a similar argument in” Law v. Siegel and held “that the Bankruptcy Code does not confer ‘a general, equitable power in bankruptcy courts to deny exemptions based on a debtor’s bad-faith conduct.’ Id. at 425.”

Judge Thuma also cited a nonprecedential opinion from the Tenth Circuit, Clabaugh v. Grant (In re Grant), 658 Fed. App’x. 411, 414 (10th Cir. 2016). The Tenth Circuit quoted Law v. Siegel for the proposition that “federal law provides no authority for bankruptcy courts to deny an exemption on a ground not specified in the Code.” Law v. Siegel, supra, 571 U.S. at 416.

Citing several other circuits to the same effect as Clabaugh, Judge Thuma held that denying the “Debtors’ § 522(f) motions because the subject judicial liens allegedly secure debts procured by fraud would run afoul of Siegel and Clabaugh.” The caselaw, he said, prohibits the court from using “its § 105 powers to create an equitable exception to § 522(f) not found in the Code.”

For the creditors, all is not lost. Judge Thuma said that “defrauded creditors (secured and unsecured) have the right under § 523(a)(2) to have their debts declared nondischargeable.”

Without ruling on the merits of the debtors’ motions to vacate the judicial liens, Judge Thuma denied the creditors’ motion to deny the debtors’ motion to vacate the liens.

Questions

Assume that Judge Thuma avoids the judicial liens. Next, assume that Judge Thuma later rules that the (now unsecured) debts are nondischargeable. What then?

It doesn’t seem as though the creditors could again obtain a judgment lien against the home. Would the creditors be limited to a supplemental proceeding attempting to locate and attach assets other than the home?

This writer is interested in knowing how readers believe it will work out.