In East Cambridge Savings Bank v. Silveira (In re Silveira), 141 F.3d 34 (1st Cir. 1998), the First Circuit Court of Appeals decided that 11 U.S.C. §522(f)¹ permits only partial avoidance of judicial liens in situations where a debtor has equity in excess of his or her exemption in real property. The First Circuit is the only court of appeals to decide this issue since §522(f)(2)(A) (which provides a formula for determining whether a lien impairs a debtor's exemption) was added to the Bankruptcy Code by the Bankruptcy Reform Act of 1994.

The Silveira debtor owned real property with a value of $157,000, which was encumbered by a mortgage in the amount of $117,680 and a judicial lien in the amount of $209,500. The debtor moved to avoid the judicial lien on grounds that it impaired his $15,000 exemption in the property. The sum of the judicial lien, the mortgage and the debtor's exemption was $342,180, which exceeded the value of the property by $185,180. Thus, according to the formula prescribed by §522(f)(2)(A), because that sum exceeded the value of the property, the judicial lien impaired the debtor's exemption. Both the bankruptcy court and the district court ruled that, once impairment was found, the lien was avoided in its entirety.

The First Circuit Court of Appeals reversed the decision, stating that the plain language and the purpose of §522(f) mandated only partial avoidance. Therefore, the debtor could avoid only $185,180 (the amount of the impairment) and the $24,320 remainder would continue to be secured by the judicial lien.

The court based its holding on Congress's use of the phrase "to the extent that" in both §522(f)(1) (debtor may avoid a judicial lien "to the extent that" it impairs exemption) and §522(f)(2)(A) (lien impairs debtor's exemption "to the extent that" the sum of all liens and the exemption would exceed debtor's interest in property absent any liens). It reasoned that had Congress intended an "all-or-nothing" result, it would have used the word "if" instead of the phrase "to the extent that" in drafting both subsections. In the court's view, the phrase "to the extent that" serves a dual purpose: It functions as both a condition and a measure of a debtor's avoidance power. The court's analysis demonstrated how a $1 difference in either the amount of the judicial lien, the value of the property, or the sum of all other liens could yield an unfair and arbitrary result if total lien avoidance was mandated upon a finding of impairment. For example, a debtor with property valued at $100,000 that was encumbered by a $55,000 mortgage and $30,000 judicial lien, subject to an exemption of $15,000, could not avoid the judicial lien because the sum of the encumbrances and the exemption equals, and therefore does not exceed, the value of the property. Whereas, if either the amount of the judicial lien or all other liens on the property increased by $1, or if the value of the property was decreased by $1, then impairment would be found and total avoidance mandated. In the court's opinion, this outcome was absurd.

The Silveira court rejected the notion expressed by the district court that partial avoidance of an impairing lien frustrates the Bankruptcy Code's "fresh start" policy. Instead, the court emphasized that a debtor is entitled only to the amount of his or her exemption. In other words, the courts below had effectively given the debtor a "super" exemption, contrary to the Code's exemption limits. The court held that the judicial lien should attach to the equity exceeding the debtor's exemption, up to the value of the property. In this way, the lien is fixed at the amount representing the excess equity, and any subsequent appreciation accrues to the debtor's benefit.

The Court of Appeals noted that the Bankruptcy Appellate Panel (BAP) for the First Circuit had likewise concluded that §522(f) permits only partial lien avoidance in situations where a debtor has equity in excess of his or her exemption. See Federal Deposit Insurance Corp. v. Finn (In re Finn), 211 B.R. 780 (1st Cir. BAP 1997). According to the BAP, partial avoidance preserves the debtor's exemption in property, and thus is consistent with the fresh start goal of bankruptcy. Moreover, partial rather than full lien avoidance promotes "certainty and definiteness," neither of which existed prior to the enactment of §522(f)(2)(A). Previously, some courts had held that a judicial lien would attach to future appreciation in the property. Under Silveira and Finn, any future appreciation accrues to the benefit of a debtor, enhancing his or her fresh start.

Prior to Silveira and Finn, it was unclear whether excess equity resulting from total avoidance of an impairing lien accrued to the benefit of a debtor, or to his or her bankruptcy estate. And while the partial avoidance rule adopted by Silveira and Finn diminishes the possibility that §522(f) could result in a "super" exemption for the debtor, or unsecured creditors trumping the rights of a judicial lienholder, it does not eliminate this possibility.

Specifically, anomalous results may persist in situations where a debtor co-owns property with a non-debtor, and there are liens exclusive to the non-debtor. For example, suppose a debtor and non-debtor are equal owners of real property valued at $100,000, encumbered by a $20,000 judicial lien against both owners. Further, suppose that there is a second lien against the non-debtor only, in the amount of $100,000. The language of the statute indicates that only the debtor's interest is considered in determining whether an impairment exists, but that all liens are included in the lien avoidance formulas.² Assuming a $16,125 exemption for the debtor, the sum of both liens and the debtor's exemption ($136,125) exceeds the value of the debtor's interest in the property ($50,000) by $86,125—which is the amount of the impairment. Since the amount of the impairment is greater than the amount of the lien to be avoided (i.e., $86,125 > $20,000), the lien is avoided in its entirety.

Consider also that if a sale of the property were to occur after the lien was avoided, first the liens common to both owners would be deducted from the gross proceeds and then the interests of the respective owners would be determined. Next, the amount of liens and encumbrances against each co-owner would be deducted from that particular owner's share of the remaining proceeds. In the above fact pattern, if a chapter 7 bankruptcy trustee were to sell the real property for the full value of $100,000, he or she would have no liens common to both owners since the $20,000 judicial lien was avoided as to the debtor's interest. Therefore, the proceeds would be equally split between the debtor's estate and the non-debtor. The $20,000 judicial lien against the non-debtor's interest and a portion of the $100,000 lien exclusive to the non-debtor would be paid from the non-debtor's proceeds. The debtor's estate would receive $50,000 in proceeds, from which the trustee would pay the debtor his or her $16,125 exemption, leaving $33,875 in net proceeds available to the bankruptcy estate.

A similar anomaly results when a debtor and non-debtor are jointly liable on a mortgage debt. The statute requires us to consider only the debtor's interest in the property, but to include the full amount of the mortgage debt in determining the amount of the impairment. For example, suppose that you had the same scenario as above, except that rather than a $100,000 lien against the non-debtor, there is a $50,000 mortgage against both owners. If the lien is avoided (as it would be upon application of the lien avoidance formulas) and the trustee sells the property for $100,000, then the mortgage would be satisfied in full from the gross proceeds. The remaining $50,000 in proceeds would be split, and the debtor's exemption would be paid from his $25,000 in proceeds, leaving $8,875 as the remaining non-exempt equity in the debtor's estate.

Section 522(f) does not contemplate the economic reality of a sale of real estate and disbursement of proceeds. While ownership interests are established and partitioned accordingly, the encumbrances against the property are not apportioned or otherwise allocated to the particular owner against whom the lien applies. If the strict language of §522(f) is applied, then all encumbrances are included in the lien avoidance formula. In a situation where obligations would be satisfied either partially or exclusively from the proceeds of a non-debtor's interest, then, upon a sale of the property, a bankruptcy trustee would realize proceeds for the estate in excess of the debtor's exemption, after avoidance of the judicial lien.

Lien avoidance is an important issue to debtors and lienholders alike. While Silveira and Finn³ help to ensure a fair result, there remains the potential that in certain cases of co-ownership of property between or among debtor and non-debtor parties, a judicial lien would not attach to a debtor's surplus equity.⁴ In such a case, a trustee could sell the property and recover the surplus equity for the benefit of unsecured creditors. And if the trustee elects not to sell the property, or is otherwise precluded from doing so, then the debtor would obtain an inflated exemption. In these situations, courts should analyze a debtor's motion to avoid a judicial lien according to a hypothetical sale of the property in order to prevent unfair and seemingly unintended results.

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Footnotes

¹ Section 522(f) provides, in relevant part, the following:

(1) Notwithstanding any waiver of exemptions but subject to paragraph (3), the debtor may avoid the fixing of a lien on an interest of the debtor in property to the extent that such lien impairs an exemption to which the debtor would have been entitled under subsection (b) of this section, if such lien is—

(A) a judicial lien, other than a judicial lien that secures a debt....

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(2)(A) For the purposes of this subsection, a lien shall be considered to impair an exemption to the extent that the sum of—

(i) the lien,(ii) all other liens on the property; and (iii) the amount of the exemption that the debtor could claim if there were no liens on the property;exceeds the value that the debtor's interest in the property would have in the absence of any liens. 11 U.S.C. §522(f)(1), (2)(A)(emphasis added). Return to article

² The variables used in the avoidance formulas articulated in Silveira are: A = value of debtor's interest; B = allowed exemption; C = amount of lien to be avoided; D = all other liens on the property. The Silveira avoidance formulas are:

amount of impairment (I) = [A-(B+C+D)]
if I > C, then retained lien = C - I
if I < C, then lien avoided in its entirety. Return to article

³ The BAP for the Ninth Circuit has also held that §522(f) limits avoidance to the extent necessary to preserve the debtor's exemption, and that the statute does not mandate total avoidance of impairing liens. Bank of America National Trust and Savings Association v. Hanger (In re Hanger), 217 B.R. 592 (9th Cir. BAP 1997). Return to article

⁴ See In re Pascucci, 225 B.R. 25 (Bankr. D. Mass. 1998)(unambiguous statutory language prohibits apportioning debts between debtor/non-debtor co-owners even though the debtor receives an enhanced exemption. Return to article