Eliminating Liens

April 13, 2006

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When battling liens against you, the ability to eliminate judgment liens on exempt assets can be highly significant to the small business owner.

John Smith forms an LLC to operate his business. Smith's major supplier allows him to use an open account, but requires that he personally guarantee his LLC's contract on the account.

After two years, John experiences serious financial difficulties and defaults on the open account. At that time, the balance on the account is $80,000.

Let's say John's LLC, at this time, has no assets. His only personal asset is his residence, which has a value of $100,000 and a first mortgage with a balance of $40,000.

The supplier sues John personally based on his guarantee, receives a judgment of $80,000, and places a judgment lien on John's residence in this amount.

However, John's home state allows an asset exemption for a residence in the amount of $125,000. Thus, Smith's residence is an exempt asset. The judgment lien cannot be enforced.

Generally, a lien can be eliminated only if three conditions are met:

The lien is against a class of assets known as exempt -- Determine whether the asset is exempt, under the state's post-judgment asset exemptions or under the federal bankruptcy exemptions, as the situation dictates (the state and federal governments allow debtors to keep certain property in such situations, so as not to completely ruin a person beyond financial repair). In a bankruptcy proceeding, compare the federal and state exemptions, unless the state has opted out of the federal exemptions.
The lien is a type of lien that can be eliminated -- If the asset is exempt, determine whether liens against the asset are of a type that can be eliminated. Remember, most judgment liens can be eliminated, while consensual and statutory liens, provided that they are valid, usually cannot be eliminated. In addition, as discussed later, the federal bankruptcy code allows for additional liens to be eliminated beyond what state laws allow.
The amount of the lien impairs the exemption -- Calculate the amount of liens that cannot be eliminated. This amount is equal to the value of the asset less the amount of the exemption. Under this calculation, liens subject to elimination can always be discharged in their entirety if the asset is the object of an unlimited exemption, because the value of the asset equals the exemption amount. When the asset exemption is limited, or the value of the asset is much larger than the exemption, the amount of the liens that cannot be eliminated will be significant, so that any new liens added to the property, such as judgment liens, cannot be eliminated. There are ways to calculate what portion, if any, of a lien can be eliminated.