Using FTC Credit Practices Rule to Invalidate Liens

April 13, 2006

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The Federal Trade Commission's (FTC) Credit Practices Rule can be used to invalidate certain types of liens against household property. Remember, an invalid lien can be eliminated whether it is attached to exempt or nonexempt property.

Under the Rule, certain non-purchase-money, non-possessory security interest liens are invalid: specifically, liens attached to household necessities and goods.

This provision affects only consumer goods and not liens on business property. Most importantly, because consumer goods often would be entitled only to limited protection as exempt assets, the rule can offer real protection.

A non-purchase-money security interest lien arises where the proceeds from the debt were not used to purchase the property. In other words, this type of lien arises when you already own some type of property and put it up as collateral for a loan, the proceeds of which are used for some other purpose. Loans involving purchase-money security interest liens (where the creditor finances the purchase of the asset that is the collateral for the loan) are more common, and are not invalid under this rule.

The lien must also be non-possessory to be invalid. This means that the debtor, as opposed to the creditor, has possession of the property. In contrast, an example of a possessory lien would be a pawn shop loan, where the creditor holds the collateral. Possessory liens in these types of property also remain valid under this rule.

The rule's definition of household goods includes household necessities such as clothing, appliances and linens, and some items of little economic value but of unique, personal value to the owner. These may include items such as family photographs, personal papers, the family Bible, and household pets.

The following types of property are excluded from the definition of household goods: works of art, electronic entertainment equipment (except one television and one radio), items acquired as antiques (more than 100 years old), jewelry (except wedding rings), pianos or other musical instruments, boats, snowmobiles, bicycles, and cameras. Liens on these types of property remain valid.

In practice, most commercial lenders and merchants will steer clear of liens that come under this rule because they are aware the liens would be invalid. However, some lenders who are either unscrupulous or ignorant of the rule may try to attach a lien to these assets. Therefore, you should be aware that liens that fall within the rule are invalid, and thus cannot impair any exempt or nonexempt assets.

Non-purchase-money, non-possessory liens on household items and certain other property can be eliminated in some bankruptcy proceedings as well.