DD 12/1/05 Can state law dismiss judgment liens post discharge beyond bankruptcy impact?

Daily Development for Thursday, December 1, 2005
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
dirt@umkc.edu

BANKRUPTCY; HOMESTEAD; JUDGMENT LIENS; DISCHARGE: Under Wisconsin statute, which is not preempted in bankruptcy, debtor can obtain a post-discharge state court order satisfying a pre-petition judgment lien, even though the debtor's property interest exceeded the exemption claim to which debtor was entitled in bankruptcy.

Megal Development Corp. v. Shadof, 2005 WI 151 (2005)

Homeowners filed Chapter 7 petition for bankruptcy and listed in debtors' schedule of unsecured creditors a creditor that obtained a judgment in the amount of $52,714. During the bankruptcy proceeding, the judgment creditor filed an objection to debtors' claim for exempt homestead property, but the bankruptcy court set aside the objection as premature, because debtors had not sought to avoid any portion of the judgment lien. After discharge, debtor filed application with state court pursuant to a Wisconsin statute, Sec. 806.19(4), Wis. Stats., seeking an order satisfying the judgment. Creditor objected on the ground that the net equity in the property exceeded the maximum homestead exemption of $40,000

The state court held that the debtors were not entitled to an order satisfying the judgment, where the property's value exceeded the applicable exemption. Wisconsin Court of Appeals certified the matter to the Wisconsin Supreme Court.

The Supreme Court reversed, upholding the complete release of the judgment lien claim.

The court determined that the Wisconsin statute provided a post-discharge mechanism through operation of state law for a debtor to obtain, where the judgment creditor's claim was discharged in bankruptcy, satisfaction of a judgment and a judgment lien that had, by operative statute, attached to debtor's real estate. The language of the statute, regardless of any state or bankruptcy exemption limits, mandates that the clerk shall satisfy each judgment described in the applicable, upon which the judgment shall cease to be a lien on any real estate owns or later acquires.

The Wisconsin Supreme Court then examined the state statute in the context of federal bankruptcy law. It held that the Wisconsin statute is not preempted by the Supremacy Clause of the United States Constitution, because a state statute that permits a state court to satisfy post-discharge a judgment and extinguish a judgment lien reflects policy decisions of the legislature to provide additional protections to Wisconsin residents at the conclusion of bankruptcy, and does not interfere with the Bankruptcy Code. The state statute does not create an exemption, nor does it limit the powers of the bankruptcy trustee during bankruptcy. The statute simply does not operate during bankruptcy at all, but is dormant until the conclusion of the federal bankruptcy proceeding, and thus does not conflict with the Code. For states that do not, like Wisconsin, have such a statute, 11 U.S.C. Sec. 522(f) provides a similar mechanism to avoid liens through the federal bankruptcy code. Fina!

lly, t
he Wisconsin statute does not deprive judgment creditors of a property right without due process of law. The judgment lien, which is nothing more than a mechanism for the enforcement of an in personam money judgment, does not constitute or create an estate interest or right of property

Comment: I asked bankruptcy expert Paul Hoffman, of the Stinson, Morrison firm here, to comment. He responded in some length as follows. Note that Paul assumes that the Wisconsin statute is a rarity. Is this really true? DIRT would like to know.

Here are Paul’s comments:

Hypothetical 1: Debtor has home worth $160,000, subject to first and second mortgages in the aggregate amount of $100,000 and a judgment lien for $50,000. The relevant state law homestead exemption is $40,000. Debtor files Chapter 7 and gets a discharge. Under 522(f) of the Bankruptcy Code, the debtor has $60,000 in "equity" (above the mortgages) and is entitled to "avoid" $30,000 of the $50,000 judgment as "impairing" her entitlement to a homestead exemption of $40,000. However, the $20,000 balance of the judgment lien "survives" and should be enforceable against the homestead after the automatic stay is terminated. As noted in the Dewsnup case, the discharge only affects the debtor's personal liability for the judgment, not the in rem lien created by the judgment.

522(f) exists to "avoid" the in rem lien "to the extent" that it impairs an exemption. There is no need for 522(f) if the discharge otherwise eliminates the in rem lien.

Hypothetical 2: Same facts, except home is worth $250,000. Debtor has $150,000 in equity above the mortgages, and is entitled to a $40,000 exemption.

The debtor cannot avoid any part of the judgment lien because it does not "impair" her exemption. Accordingly, the lien "survives" the discharge and can be foreclosed if not satisfied (most debtors in this circumstance will arrange to sell or refinance the home to eliminate the judgment lien). Moreover, the trustee sees "equity" above all the liens and the exemption in the amount of $60,000 and will arrange to sell the home (or negotiate with the debtor about refinancing or selling the home to pay this estimated equity to the trustee) to capture that non-exempt equity in the bankruptcy case. This is a highly unusual situation because most debtors with this much equity in their home do not need to file bankruptcy.

3. Now consider the above examples under this Wisconsin case:

In hypothetical 1, above, the debtor gets to deem the judgment "satisfied" under Wisconsin law upon getting a discharge. This means the debtor will then get to keep $60,000 in equity in the homestead instead of the $40,000 permitted under the homestead statute and the Bankruptcy Code. Under the Bankruptcy Code, this $20,000 should have gone to the judgment creditor, as argued in the case. Query whether the trustee can now argue that this $20,000 should go to the estate based on this interpretation of the Wisconsin statute.

Wisconsin law applied to hypothetical 2, above, results in an even more egregious consequence. The debtor gets to deem the entire $50,000 judgment lien "satisfied" and keep $90,000 in equity above the mortgages.

Readers are encouraged to respond to or criticize this posting.

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