What Happens to Owners in Bankruptcy or Foreclosure: JohnMerchant

Purpose of this article is to try to clear some of the apparent confusion we see on this site re what happens to debts & liens in BK filing/discharge and foreclosure (trustee's)sale.

Let's start with debts..

What happens to any debt in a Ch 7 BK?

Except for IRS debt*, and certain specified NON dixchargeable debt, such as Judgment finding fraud by debtor, or criminal sentence ordering restitution for criminal conduct, or payment of fines, or


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court costs, other debt is normally** effectively discharged and barred upon filiing of Ch 7 BK.

The purist & moralist will object that our moral obligation to repay those debts is NOT really discharged, only the legal obligation.

I'm not going to discuss that now.

Well, OK, you say, but what about the liens? Say a 2d mortgage on the house?

That lien is attached to the RE, and even though the underlying debt is barred and its collectability closed out, the lien is NOT removed, deleted or changed in any way...and any such lien stays on the RE's title and may have to be paid off before it's released.

Of course, it it's a subordinate lien, such as a 2d or 3d mortgage or deed of trust secured debt, it's likely to be eliminated when the property is foreclosed by the 1st mortgage holder.

Let's look at a very normal Ch 7 filing, which is frequently done a day or two ahead of a Deed of Trust foreclosure auction date.

The very filing of the Ch 7 absolutely bars or "stays" the D/T auction from passing any kind of title or rights, and normally, when a trustee is aware of the Ch 7 filing, that calendared auction is immediately scrubbed, as it CANNOT accomplish anything.

And remember this: Even though that particular debt or debtor was NOT even mentioned in the Ch 7 petition, it is still barred ! i.e., the debtor might have deliberately omitted listing that debt so that debtor might miss its filing, and show up in BK court to contest the debt's discharge.

But Fed BK law clearly states that even though the debt was omitted in the list of debts and debtors, it is still barred along with all those that the debtor did list.

You should also understand that the debtor is NOT free to make subsequent arrangements, without the BK Court's permission, to go ahead and pay one or two of those debts.

What? Huh? Come again...why would the debtor do such a thing?

Having mis-spent a fair amount of my professional time in BK court and having heard lots of debtor's testimony at their discharge hearings, I've heard lots of debtors tell the Court that they've made special arrangments to pay some debt or other...whereupon the court asks why? And then proceeds to tell the debtor that such an agreement is NOT binding on the debtor and the debtor certainly does NOT have to do that.

Although I can't recall hearing any BK Court order the debtor not to pay such, I've heard the Court come very close to it.

OK, but what about the bank's right to foreclose its 1st mortgage?

Well, they can and do, despite the filing of the Ch 7, and here's how: A few weeks after the BK's filing, the bank will have its lawyer file a Motion to Lift Stay, meaning it's asking the Court to remove the automatic "stay" that was applied to the foreclosure when the Ch. 7 was filed.

And the court will then, pretty automatically, so order, lifitng the "stay" and allowing the foreclosure to proceed.

So whle the BK debtor can succeed in delaying the foreclosure, he cannot normally
stop or kill the foreclosure, and it will happen, just later than it was originally scheduled.

So in summary, just remember this rule of thumb: A debt is discharged by BK, but not a lien. And liens are eliminated by foreclosure, but not debts.

The lien being foreclosed is thereby converted into title for the foreclosing creditor, and the secondary, or subordinate liens are thereby eliminated.

The debtor should clearly understand that the other debts are NOT discharged or eliminated by foreclosure of one of the liens...and those creditors can still come after the debtor, although their security is now gone by the foreclosure process.

In some states the foreclosing lien holder can still sue and obtain a "deficiency" Judgment against the debtor, in the event the foreclosure auction doesn't net the creditor as much as his total debt, including P, I, and costs....yet in other states, once the foreclosure has taken place, the creditor cannot pursue the debtor with a deficiency J.

*IRS debt cannot be discharged until it's some years old, as I recall, maybe incorrectly, it's 10 years from date of filing of the tax return. Please correct me if this is not right.

**Although most debt is immediately discharged upon filing of Ch 7 petition, any creditor is able to immediately contest that discharge, and with legal grounds, such as criminal or fraudulent, or some other statutory exception, perhaps succeed in having that debt declared NOT discharged or dischargeable and kept alive....but my personal experience, with clients whose business concerned me as far as possible criminal complaints, or some old J against them for fraud, is that about 90-95% of the time, those creditors don't even show up, and ALL the debt is discharged.

Hope this has added some light in the tunnel, rather than adding to the murky dark.

John Merchant

Word Cloud:
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What Happens to Owners in Bankruptcy or Foreclosure

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