Bankruptcy

Homestead Exemption In Chapter 7 Bankruptcy Cannot Avoid Creditor's Judgment Lien Obtained Before Debtors' Moved Into Home: Unless Bankruptcy Preference Rules Apply

By Jonathan Alper

Here?s a common situation of Chapter 7 bankruptcy debtors. Husband and wife own two properties, both of which are upside down. They live in one property and rent the other as an investment property. They cannot afford the mortgage on their residence, but they think they can afford to carry the rental. They have substantial credit card debt incurred as they were trying to carry both properties and also pay living expenses. So, they decide to abandon their current residence and move into what is now the rental property (assume no tenant leases). Then, the couple would file bankruptcy, wipe out the credit card debt, and preserve as exempt homestead what is now their rental house.

The plan goes awry when, prior to the couple taking occupancy of the rental home, one of the credit cards sues and receives a judgment which is promptly recorded. The recording of the judgment automatically gives the credit card company a judgment lien on the homestead. Subsequently moving into the rental and declaring it homestead doesn?t solve the problem. Because the judgment preceded occupancy as a primary residence the judgment will remain on the new homestead property.

Soon after moving into the rental house the couple files a joint Chapter 7 bankruptcy and declares their new home as exempt homestead. The home will be exempt from the joint unsecured creditors and the bankruptcy trustee, but the credit card judgment will remain a lien on the homestead throughout the bankruptcy for the same reason that the judgment preceded occupancy. Declaring the homestead exempt in bankruptcy will not avoid this judgment lien.

There is one thing the couple could try in the bankruptcy proceeding. Assuming the bankruptcy is filed no later than 90 days after the credit card company obtained its judgment, these debtor could try to avoid the lien as a "bankruptcy preference." Bankruptcy law does not permit one unsecured creditor to improve its position compared to other unsecured creditors within 90 days of a Chapter 7 bankruptcy. If the judgment lien is declared an improper preference the court may avoid the lien leaving the debtors with their exempt homestead free and clear of the credit card judgment.

Full post as published by Florida Bankruptcy Law on April 02, 2010 (boomark / email).