Are Windfalls Part of a Fresh Start Avoidance of Judicial Liens Under 11 U.S.C. 522(f)

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May 2002

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When can debtors avoid judicial liens impairing their bankruptcy exemptions in a
homestead? Does state law have an effect? Does it make a difference when the debtor
acquired an interest in the property? These and other questions were thoroughly
discussed in the Spring 2001 ABI Law Review.<a href="#1" name="1a">1</a> However, recent cases demonstrate
that debtor "windfalls" are still at issue. Once the exemption claim is effective,
the homestead is no longer property of the estate and is not subject to pre-petition
claims except for those listed in <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… USC §522(c)</a>. The extent to which the
debtor can avoid those judicial liens that impair the homestead exemption assists in
achieving the policy of a "fresh start" while frustrating creditors who won the "race
to the courthouse."

<h3>Section 522(f) Overview</h3>

After adoption of the Code, courts were divided as to (1) when judicial liens
impaired an exemption and (2) whether a judicial lien could be avoided entirely or
only up to the exemption amount. In the Bankruptcy Reform Act of 1994,
§522(f)(2) was adopted, laying out a formula to calculate the amount by which
a lien impairs an exemption.

Bankruptcy Code §522(f)(2) provides:

<blockquote>
(2)(A) For the purposes of this subsection, a lien shall be considered
to impair an exemption to the extent that the sum of—

<blockquote>
(i) the lien,

(ii) all other liens on the property; and 
(iii) 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.
</blockquote>

(B) In the case of a property subject to more than one lien, a lien that
has been avoided shall not be considered in making the calculation under
subparagraph (A) with respect to other liens. 
(C) This paragraph shall not apply with respect to a judgment arising out of
a mortgage foreclosure.
</blockquote>

The legislative history of this section clearly states that cases requiring the debtor
to have equity in the property in order to avoid a judicial lien were overruled.
Instead, Congress wanted a simple arithmetic test. H.R. Rep. No. 835,
103rd Cong., 2nd Sess., 52-54. The courts have followed that legislative
policy. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Freeman, 259 B.R. 104 (Bankr. D. S.C. 2001)</a>,
and Lingo v. Curcio, 2001 Bankr. Lexis 154 (Bankr. D. Del.
2001). However, since §522(f)(2) requires the debtor to have an "interest"
in the property claimed exempt, courts are split on whether judicial liens can be
entirely avoided.

<h3>The Bright-line Test</h3>

The Eighth Circuit BAP literally followed the statutory formula, avoiding the
full amount of a judicial lien on a homestead. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Kolich, 273 B.R. 199
(BAP 8th Cir. 2002)</a>. Affirming that the debtors were entitled to avoid
a judicial lien although they had no equity in the property, the BAP found that
the bankruptcy court failed to apply the plain-meaning doctrine. Concluding that the
1994 amendments "created a federal definition of impairment," the BAP adopted a
"congressionally mandated bright-line formula" and avoided the entire judicial lien
citing the majority view supported in <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Freeman, 259 B.R. 104,
108-10 (Bankr. D. S.C. 2001)</a>.

The "bright line" formula is set forth in the case law as follows:

<ol>
<li>Determine the value of the property upon which the judicial lien is sought
to be avoided.
</li><li>Deduct the amount of all liens not to be avoided from (1).
</li><li>Deduct the debtor's allowable exemptions from (2).

</li><li>Avoid all judicial liens results unless (3) is a positive figure.
</li><li>If (3) results in a positive figure, do not allow avoidance of liens,
in order of priority, to that extent only.
</li></ol>

<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Brantz, 106 B.R. 62, 68 (Bankr. E.D. Pa. 1989)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…
v. Owen, 500 U.S. 305, 313 N.5, 114 L.Ed. 350, 111 S.
Ct. 1833 (1991)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Piersol, 244 B.R. 309 (Bankr.
E.D. Pa. 2000)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Bank v. The Vessel "Harbor Light," 260
B.R. 694 (D. N.J. 2001)</a>.

<h3>Denying Debtor a Windfall</h3>

The minority position takes a dim view of allowing the debtor a windfall and attacks
the literal application of the statutory formula. These cases "look beyond the plain
language of a statute if applying the plain language would produce an absurd result."
<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Lehman, 205 F.3d 1255 (11th Cir. 2000)</a>; <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. Scala,
192 F.3d. 32 (1st Cir. 1999)</a>. Creditors have otherwise been
unsuccessful in arguing that §522(f) is an undertaking in violation of the <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=….
Constitution. In re Snyder, 231 B.R. 437 (Bankr. D. Mass. 1999)</a>.

In taking their "look beyond," these cases utilize the net equity the debtor
has in the property, rather than the property value, to determine the debtor's
interest. One court frames the validity of this approach in terms of not going
beyond the legislative intent of entitling debtors to their exemptions. These courts
hold that to do so would distort priorities between creditors. In re Ware,
2001 Bankr. Lexis 1825 (Bankr. D. S.C. 2001). Another court
insists that the plain meaning of §522(f)(2) mandates only a partial lien
avoidance. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Cisneros, 257 B.R. 332 (Bankr. D. N.M.
2000)</a>. Finally, these cases also conclude that full avoidance of a judicial
lien is inconsistent with the language and intent of the 1994 amendment. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…
re Falvo, 227 B.R. 662 (6th Cir. BAP 1998)</a>.

So much for plain meaning! Plain meaning under §522(f) seems to turn, at
least in one case, on the phrase "...to the extent that...," which is read by
that court to mandate partial lien avoidance as opposed to an all-or-nothing
conclusion. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Vokac, 273 B.R. 553 (Bankr. N.D. Ill. 2002)</a>.
Ignoring both the formula and §522(f)(2) entirely, another court recently limited
the lien avoidance to the amount of the available exemption. In re DeBarros,

2002 Bankr. Lexis 165 (Bankr. D. Md. 2002). Given all of the
judicial maneuvering in these cases, it is safe to say that there will be a number
of instances where appeals to the various circuits will result. As succinctly stated
in the ABI Law Review, at page 461, congressional intent, when construed by
the Supreme Court, should be difficult to ignore.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> Prescott, George M. Jr.,"Amphisbena! How 11 USC §522(c) Expands and Contracts State Law Exemptions in Bankruptcy,"
9 Am. Bankr. Inst. L. Rev. No. 1, p. 435, 2001. <a href="#1a">Return to article</a>

Journal Authors

Timothy D. Moratzka

Journal Date

Wednesday, May 1, 2002 - 12:00

Bankruptcy Rule

2002