Posting for

Monday, October 5, 1998

by: Bert Rush

brush@firstam.com

BANKRUPTCY/JUDGMENT LIENS/TAX LIENS

One of the least understood aspects of bankruptcy law is the effect of a discharge in bankruptcy on preexisting liens against the debtor's real property.

Michael operated a construction business in Richmond, Virginia, known as "Stewart E. Turner Construction."

In 1989 Michael found himself on the losing end of several lawsuits. During February 1989 a judgment was entered against Michael in favor of a Mr. and Mrs. Roy for $77,500--which judgment was docketed and became a judgment lien against Michael's Richmond home on February 27, 1989.

Later a judgment was entered against Michael in favor of Roper Bros. Lumber Co. in the amount of $11,702, plus attorney's fees of $2,925. This judgment was docketed and became a judgment lien against Michael's home on May 22, 1989.

With the wolf at his door, Michael filed a chapter 7 bankruptcy. The Roys responded by filing an adversary proceeding in the bankruptcy, in which they objected to discharge of their debt as a personal obligation of Michael's. The usual grounds for such an objection are fraud on the part of the debtor in connection with creation of the debt.

Michael, through his attorney, agreed to a compromise and settlement of the Roys' adversary proceeding. By the terms of this settlement, Michael agreed that the Roys should have a non-dischargeable judgment against him in the amount of $25,000, but that enforcement of the judgment would be stayed, and the judgment would be satisfied in full, if Michael paid the Roys $200 per month for 36 months, for a total of $7,200. These terms were memorialized in a "Consent Judgment Order" filed in Michael's bankruptcy in April 1990.

Michael's remaining debts were discharged and his bankruptcy case was closed.

In late 1992 Michael contracted to sell his home to one John. A First American agent handled the transaction.

The agent relied on an independent contractor to search the Chesterfield County records and provide an abstract of title. The abstractor turned up the two judgment liens--but somehow between the abstractor and the agent's office it was decided the liens no longer affected the property because of Michael's subsequent discharge in bankruptcy. A "clean slate."

So in December 1992 our new owner's policy was issued to John, in the policy amount of $99,950, without exception for either of the two liens. Meanwhile, Michael paid the $7,200 to the Roys and went on with his life.

In 1996, when John listed the home for sale, the judgment liens came to light and threatened to hold up the sale.

For, as experienced title people know, a discharge in bankruptcy operates to free the debtor from personal liability for debts, but it does not operate to release judgment or tax liens which have been perfected against the debtor's real property prior to the commencement of bankruptcy. Whoever believed otherwise, causing our policy to be issued providing coverage against these liens, was in error.

First American agreed to take care of the liens--and John went on to sell the property and move away.

The Company got a release of the Roper Bros.' judgment lien by paying $12,000. But the Roys' lien was another matter.

The Roys' attorney insisted that the judgment lien had not been cleared because it was not considered or mentioned in the bankruptcy court's "Consent Judgment Order"--and he probably also thought it a shame that the Roys should be held to have bargained away their $77,500 lien for only $7,200.

But after much legal wrangling a state court agreed with our in-house counsel Jim DeBoer that the "Consent Judgment Order" operated as an accord and satisfaction, replacing Michael's liability to the Roys for the $77,500 judgment in all respects. So the state court ordered the Roys' lien to be released (and ordered the Roys to pay attorney's fees of $1,349). The Roys ultimately settled by paying $675.

First American paid legal expenses of $33,472 in the successful defense of its insured owner.

MORAL: Well--it's been said. A discharge in bankruptcy operates only to discharge debts as the personal obligation of the debtor; by itself the discharge does not release liens perfected against the debtor's real property before the commencement of bankruptcy.

And, this is an area of bankruptcy law commonly misunderstood by title and escrow/closing folk--and by more than a few attorneys.

This is also another example of some no-nonsense claims handling on the part of in-house counsel Jim DeBoer. The facts of a claim as first presented are like the first half of play--and Jim's good in the fourth quarter.

Questions, comment, argument? Just press the "reply" button....