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Chemical Bank v. James

354 N.J. Super. 1, 803 A.2d 1166 (App. Div. 2002)

LIENS; BANKRUPTCY— Even though a property is abandoned by a trustee, If a judgment lien against it could have been discharged in bankruptcy, a New Jersey Statute allows the lien to be cancelled and discharged when more than a year passes after the bankruptcy without a levy against the abandoned property.

A bank docketed a judgment against the owner of a one-half interest in a condominium. The judgment debtor filed a Chapter 7 Bankruptcy Petition listing the bank as an unsecured creditor. A schedule to the petition listed the market value of the property, subject to the mortgage lien, as approximately $115,000. Although the judgment attached to the interest in the condominium, the bank did not levy or execute upon its judgment prior to the bankruptcy proceeding or within one year after the discharge of bankruptcy. “Prior to the discharge, the trustee in bankruptcy filed a notice of proposed abandonment with respect to [the debtor’s] interest in the condominium, stating ‘there is no equity which could be realized for the benefit of the estate[,]’ in light of [the debtor’s] one-half interest in the condominium being encumbered by a [first] mortgage in the amount of $130,000.” No opposition was interposed and the abandonment became effective.

About six and half years after the Bankruptcy Court ordered the discharge, the debtor sought to have the bank’s judgment canceled and discharged of record as a lien on the property pursuant to N.J.S.A. 2A:16-49.1. That statute provides that when more than one year elapses since a discharge in bankruptcy, the debtor is entitled to an order directing that the judgment be canceled and discharged of record. On the other hand, “[w]here the judgment was a lien on real property owned by the bankrupt prior to the time he was adjudged a bankrupt, and not subject to be discharged or released under the provisions of the Bankruptcy Act, the lien thereof” may not be discharged and may be enforced. Consequently, the question before the Court was whether the lien was extinguished by the discharge of bankruptcy or remained viable “because of the trustee’s abandonment of the property prior to discharge.”

The debtor argued that because the bank did not object to the discharge, it no longer had the right to seek the relief it was seeking. The Court held that the bank “had no affirmative duty to preserve its lien during the debtor’s bankruptcy except to defend against the debtor’s or trustee’s demands to avoid the lien.” The debtor also argued that because the bank failed to execute a levy on its judgment, “its lien was subject to the avoidance powers of the bankruptcy trustee, and was in fact voided by the discharge in bankruptcy.” The lower court found that argument to be misplaced because once the trustee gave notice to abandon and then abandoned the property, the bank’s lien was no longer subject to being discharged or released under the provisions of the Bankruptcy Act. According to the lower court, “the abandonment by the trustee operated in favor of [the bank] and not against it.” It further opined that when abandonment occurs under Chapter 7, “the property reverts to the debtor as if no bankruptcy petition had been filed and it ceases to be part of bankrupt’s estate. Therefore, lienors are free to proceed against the property just as they normally would under applicable state law.” The lower court based its holdings on a 1994 Third Circuit case where an earlier court “held in similar circumstances that the plain language of 11 U.S.C. Section 522(f)(1) limited judgment lien avoidance following abandonment to the value of the debtor’s equity in the property at the time of the bankruptcy filing and in a 1992 District Court case “wherein the court held that the debtor could not avoid a judicial lien when after accounting for unavoidable liens and mortgages he had no equity in the property and, therefore, no interest on which to avoid a judicial lien.” According to the lower court, under the facts of the present case, when the trustee abandoned the property, the debtor had no determinable equity in it to which his exemption could attach.

On appeal, the Appellate Division reversed, beginning with the understanding that even though the debtor was discharged of the personal obligation by virtue of his bankruptcy discharge, the lender’s docketed lien remained. Consequently, the bankruptcy itself had no effect on the judgment lien. On the other hand, the intent of the New Jersey statute “is to provide the bankrupt debtor with an ancillary remedy within [the New Jersey] state system to assure that judgments intended to be discharged under federal bankruptcy law will not continue to cloud the marketability of title to property owned by the debtor.” If a judgment was not subject to discharge in bankruptcy, then the lien cannot be shed. Consequently, the issue was whether the lender’s “docketed judgment lien was ‘subject to be discharged or released under the provisions of the Bankruptcy Act,’” despite the trustee’s abandonment of the debtor’s real property during the bankruptcy proceeding. If the debtor could have obtained a discharge of the lien, then the lien was “subject to be discharged or released,” even though it may not in fact have been discharged in the federal bankruptcy proceedings. “A lien on the real estate enforced by levy, as opposed to the underlying judgment or indebtedness by defendants for a deficiency, is not subject to discharge or complete avoidance under the provisions of the Bankruptcy Code. If unperfected, however, [the bank’s] lien was subject to avoidance under the Code and therefore may now be discharged of record.” Here, the bank’s lien was unperfected because the bank failed to levy either prior to the filing of the petition or within one year after the discharge in bankruptcy. Consequently, according to the Appellate Division, the lower court “erroneously concluded that the trustee’s abandonment of the subject property during the bankruptcy proceedings had the effect of precluding [the debtor] from seeking relief pursuant to [the applicable New Jersey statute] because [the bank’s] judgment lien was no longer ‘subject to be discharged or released under the provisions of the Bankruptcy Act[.]’” According to the Court, such an interpretation failed to effectuate the legislative purpose of the statute. When the trustee abandoned the property, the bank could levy against the subject property within the one year period after the discharge. The Court stated that it found “nothing unfair or inequitable with this result. Our Legislature has provided an ancillary remedy for the benefit of our bankrupt citizens.”

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