Chapter 7 Bankruptcy: Failure to Discharge Judgment Liens Can Be Costly Error

A case decided by the Bankruptcy Appellate Panel of the Sixth Circuit, In re: McCoy, No. 15-8056 (6th Cir. 2016), illustrates why New Jersey attorneys representing debtors filing a Chapter 7 or Chapter 13 Bankruptcy Petition diligently do their “homework” before filing.

If a bankruptcy debtor owns New Jersey real property, one example of necessary pre-filing “homework” is obtaining a complete public record search of judgment and all other liens on the property.  Even if all the judgment liens are known and listed on the debtor’s bankruptcy petition, McCoy illustrates the failure of an attorney who represented a Chapter 7 Bankruptcy debtor, who was a homeowner, to make full use of the rights and remedies available to the debtor during the proceedings before the Bankruptcy Court.

McCoy’s Bankruptcy Case

In McCoy, an Ohio Chapter 7 bankruptcy debtor “listed pre-petition judgment liens held by Asset Acceptance LLC, Capital One, Forum Health, LVNV Funding LLC, Palisade Collections, and Troy Capital (“creditors”), albeit on Schedule E, incorrectly.”  In Ohio, as in New Jersey,  “judicial liens” (i.e. judgments entered by creditors) are liens on real estate and a bankruptcy discharge alone does not “discharge” the lien on the property.

Under the Bankruptcy Code, a debtor may avoid (i.e. remove) a  judicial lien on real estate (or other property) if it “impairs” their allowed exemption in the property.   For example, a New Jersey Debtor who used the federal homestead exemption, 11 U.S.C. §522(d)(1), can currently protect $23,675 of equity in their principal residence.   The exemption amount is doubled for married couples.

To avoid the lien, a Bankruptcy debtor must file a motion to avoid the judgment liens which impair the homestead exemption.  In Chapter 7 bankruptcy cases, this Motion is filed after the bankruptcy case is filed with the Court.   In Chapter 13 bankruptcy cases, motions to avoid judicial liens must be filed separately or made a part of a Chapter 13 Plan.

McCoy’s attorney failed to file the motion(s) during the bankruptcy case.  As a result, when, nearly four years later, McCoy attempted to refinance the mortgage on his home, he was unable to complete the refinance without paying off the judgment liens at the close.

McCoy’s Motion to Reopen in Bankruptcy Court

McCoy’s attorney, who admitted his negligence to the Court, then filed a motion to reopen the bankruptcy case under 11 U.S.C. §350(b) so that the judicial liens on McCoy’s home could be discharged.  Section 350(b) provides that “[a] case may be reopened in the court in which such case was closed to administer assets, to accord relief to the debtor, or for other cause.”

Although none of the judgment creditors objected to the Motion, the Bankruptcy Judge denied the Motion to reopen.  The bankruptcy court held, with little reference to the Bankruptcy Code or any case law, that the motion would be denied as McCoy “failed to state cause to reopen this case, which has been closed for more than three and one-half years.”

The bankruptcy judge made a clear point to McCoy’s lawyer when he stated:  “Maybe you’re going to suffer. You could end up with a malpractice claim for all I know, unless the debtor was the one who made the decision not to go forward with avoiding those liens. And if he did, he’s going to have to live with that decision.”

The Appellate Court Decision

Bankruptcy Appellate Panel of the Sixth Circuit (“BAP”) reversed the decision of the Bankruptcy Court and granted McCoy’s Motion to Reopen the case.   The BAP rejected the punitive intent of the bankruptcy judge toward the Debtor and his attorney and found that reopening the case, even four (4) years after it had been filed, did not prejudice McCoy’s judgment creditors who had not objected to the Motion.

The Appellate Panel properly viewed McCoy’s Motion, and the non-restrictive terms of Section 350(b), in light of the intent of a Chapter 7 Bankruptcy to provide McCoy with relief.  The Court noted that, “(w)hen determining whether to reopen, many courts consider the equities of each case with an eye toward the principles which underlie the Bankruptcy Code.” Citing In re Kapsin, 265 B.R. 778, 780 (Bankr. N.D. Ohio 2001).   It also acknowledged the well established principle that “avoidance of a judicial lien falls within the ambit of ‘cause’ to reopen a case, because it presents the potential for relief to the debtor.” Citing In re Oglesby, 519 B.R. 699, 703 (Bankr. N.D. Ohio 2014).

Lessons of McCoy

We strongly advise that any Chapter 7 Bankruptcy client who owns a residence – or other real property –  in New Jersey absolutely pursue motions to avoid judicial liens if they have had judgments entered against them prior to the filing of a bankruptcy case and these liens impair their allowed exemptions.

Where, in some cases, this may increase the cost of their case, McCoy serves as a stark reminder of the minimal cost compared to the prejudice, time, and cost of seeking to reopen a bankruptcy case to accomplish this goal.  McCoy and/or his attorney dodged a bullet and reminded attorneys and clients that, in the practice of law, like many other human endeavors, an ounce of prevention is worth a pound of cure.