Chapter 7 vs. Chapter 13–Debts Secured by Your Previously Owned Household Goods and Tools of Trade

What happens to the personal possessions and tools of trade that you gave as collateral on a loan?

 

Liens Usually Survive Bankruptcy

When you agree to give collateral to a creditor to secure a debt, you are giving the creditor a lien on the collateral, as long as the appropriate legal steps are taken to create that lien. That lien gives the creditor a right to the collateral if you don’t pay the loan. The lien—this right to the collateral—generally survives your bankruptcy. This means that although your obligation to pay the loan is discharged in bankruptcy, the creditor’s right to the collateral continues. This means that if you want to keep the collateral, you would have to pay the debt, or at least part of it, in either a Chapter 7 or Chapter 13 case.

Some Liens Can Be Voided in Bankruptcy.

There’s an exception that applies to a A) certain category of liens on B) certain kinds of collateral C) under certain conditions.

A) The category is “nonpurchase money” liens. This simply means the debt was not incurred for the purpose of purchasing the collateral. The lien might be able to be voided—erased—if it is a “nonpurchase money” lien.

B) The kinds of collateral with liens that CAN be voided include two main sets of them:

1) household goods and furnishings, clothing, appliances, books, animals, and jewelry for household use, BUT including no more than 1 radio, 1 TV, 1 VCR, and 1 personal computer, AND excluding works of art, antiques worth more than $500, jewelry worth more than $500 (other than wedding rings);

2) tools of trade, including farm animals and crops worth $5,000 or less.

C) “Nonpurchase money” liens in these kinds of collateral can be voided under conditions that need some explanation. These kinds of assets—if they were not collateral on the debt but rather you owned them free and clear—would often be protected through property exemptions. Property exemptions allow you to keep certain assets from creditors and the bankruptcy trustee. To the extent that a “non-possessory” lien impinges on a property exemption to which you would have been entitled, that lien can be voided.

Let’s illustrate with a simple example. Assume your state entitles you to a tool of trade exemption of $3,000, you own such tools worth $2,500, which are subject to a “non-purchase money” lien partially securing a  $5,000 loan. The entire $2,500 worth of tools is protected by the $3,000 tool of trade exemption, so the entire lien impinges on the tool of trade exemption, and can be entirely avoided.

Voided “Nonpurchase-Money” Liens in Chapter 7

In the example, after the lien on the tools of trade is avoided, the $5,000 loan no longer has any collateral securing it. That loan will be very likely be discharged in the Chapter 7 bankruptcy case (unless it was incurred through fraud or fits some other exception), and the creditor would have no right to the tools of trade. In other words, a debt with a voided lien under Chapter 7 is treated like any other unsecured debt.

Voided “Nonpurchase-Money” Liens in Chapter 13

Same thing under Chapter 13. After the lien on the tools of trade is avoided, the related debt would be treated as unsecured, with that unsecured debt simply adding to the pool of your other unsecured debt. In most cases that would just reduce what the other creditors would receive, without increasing what you have to pay. And here as well, your creditor would have no right to your tools of trade.  

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