If you’re considering Chapter 11 or Chapter 13 bankruptcy, it’s possible that you’re dealing with multiple liens against your home or other property. This could be in the form of a second mortgage on your primary residence, but could also relate to investment properties, business equipment or other instances where you incur debt against specific collateral. Depending on the kind of bankruptcy you file, you may be able to discharge some of this debt. However, it depends on the specifics of your case.
Secured Vs. Unsecured Debt
One of the main distinctions to keep in mind when discussing bankruptcy is secured versus unsecured debt. Secured debt is analogous to a mortgage — you take on the debt, with the understanding that you could forfeit the real estate you’re buying if you don’t pay back the mortgage. Unsecured debt is more analogous to credit cards — debts you incur without putting up collateral to incur them.
Generally speaking, bankruptcy allows you to discharge most types of unsecured debt. However, liens relate to specific assets, so they start out as secured debt by definition. Whether they remain that way throughout the bankruptcy process depends on if you’re eligible for a process called “lien stripping.”
Lien Stripping: Eligibility And Lien Priority
Lien stripping is the process of converting liens from secured debt to unsecured debt, which allows them to be removed in bankruptcy. For instance, suppose you took out a $100,000 loan to purchase some business equipment, and later took out a second loan of $25,000 against the value of the same equipment. The equipment is now worth $75,000. Because the total value of the liens exceeds the value of the equipment they’re attached to, lien stripping could allow a court to determine that some of the liens are now unsecured, and therefore dischargeable.
Which ones, though? This is where lien stripping becomes complicated and requires a thorough examination of all debt documents. Liens have priority in the order in which you took them on, and you pay the most senior liens first. In the example above, the $100,000 debt came first, so it’s partly secured by the present value of the equipment. The $25,000 debt came second, and since there’s no equity left over, a judge could reclassify it as unsecured and eligible for bankruptcy discharge.
As you can see, untangling a web of liens can quickly become a daunting task, so you’ll need the assistance of attorneys who are intimately familiar with the lien stripping process. However, the good news is that there are mechanisms in place to ensure that you can pay your debts while retaining as much freedom as possible.