By: Attorney Raymond C. Pelote | Partner

When debtors file Chapter 7 or Chapter 13 bankruptcy petitions, many lien creditors don’t pay attention to the filing, despite receiving notice, until such time as the creditor’s liens are in jeopardy. Debtors, in filing their bankruptcy petitions, designate certain property they seek to exempt. Typically, debtors seek to exempt their largest asset which is their real estate. The debtors, in Massachusetts and Rhode Island, have two (2) options. One, the debtor can claim their respective state exemption, which in Massachusetts and Rhode Island is currently $500,000.00. Two, the debtors can elect the federal exemption which is around $22,975.00. More often than not, debtors declare the state homestead exemption as it provides more of a protection for the debtor’s equity in the real estate.

When reviewing a debtor’s bankruptcy petition, it is important to thoroughly review all of the debtor’s schedules and other related documents filed by the debtor. Particularly, lien creditors should look at Schedule C which will display the debtor’s claimed exemptions. On this schedule, the debtor will list his or her real estate, among other properties owned by the debtor, and declare whether the debtor will select the state or federal exemptions. As I said before, more often than not, a debtor will elect his or her state exemptions in an effort to protect their real estate. If a lien creditor, after reviewing a debtor’s Schedule C, discovers that a debtor has elected his or her state homestead exemption, then it is important for the lien creditor to determine whether the creditor’s lien impairs the debtor’s claimed exemption. Typically, a creditor who holds a mortgage lien on a debtor’s real estate will not be affected by the debtor claiming a homestead exemption in his or her real estate. Typically, in a mortgage, there is a “waiver of homestead exemption” provision that protects a creditor who holds a mortgage interest in a debtor’s real estate.

The creditor who is mostly affected is the judicial lien creditor. This creditor obtained a judgment against a debtor in state court and recorded an execution against the debtor’s real estate. Unfortunately, a judicial lien does not contain a “waiver of homestead exemption” provision that is contained in a mortgage. As such, in almost all cases, a judicial lien will impair a debtor’s claimed homestead exemption on his or her real estate. In that regard, lien creditors should file an objection to a debtor’s claimed homestead exemption to protect its judicial lien. Before filing an objection, it is important to assess whether a lien creditor has a basis to object to a debtor’s claimed homestead exemption. For example, if the judicial lien is on the debtor’s residence and the residence is a one-to-four family residence, then the lien creditor may not have a sufficient basis to object to the debtor’s claimed homestead exemption. However, if the debtor resides in a mixed-use property which is predominately commercial, the lien creditor may be in a better position to object to the debtor’s claimed homestead exemption in the real estate. It is important to remember that the homestead exemption statute in Massachusetts and Rhode Island protects a debtor’s principal residence. However, the homestead statute is not designed to protect a debtor’s interest in commercial property. In light of same, a lien creditor may have a valid objection to a debtor’s claimed homestead exemption in mixed-use property where the property is predominately commercial.

Federal Rule of Bankruptcy Procedure 4003(b) provides that “a party in interest may file an objection to the list of property claimed as exempt within thirty (30) days after the meeting of creditors is held under Section 341(a) is concluded or within thirty (30) days after any amendment to the list or supplemental schedules is filed, whichever is later.” This means that a lien creditor must pay close attention to a debtor’s bankruptcy almost immediately as the notice that the court sends to all creditors provides information on the Section 341 meeting or the creditors’ meeting. Once the court schedules the Section 341 or creditor’s meeting, the deadline to object to claimed exemptions is established and creditors should object within that thirty (30) day period after the Section 341 or creditors’ meeting is completed.

However, if for some reason a creditor has not been paying close attention to a debtor’s chapter 7 or 13 bankruptcy case and the debtor seeks to avoid the creditor’s judicial lien, a creditor still has the ability to object or oppose the debtor’s motion to avoid lien. Again, the creditor must have a basis to object to a debtor’s motion. One basis, as discussed earlier, is that the debtor owns mixed-use property which is predominately commercial. So, the failure to file an objection as provided in Rule 4003(b) does not foreclose the possibility of objecting or opposing a motion to avoid a creditor’s judicial lien. Federal Rule of Bankruptcy Procedure 4003(d) provides that a “debtor [may] avoid a lien [ ] under Section 522(f) of the [bankruptcy] code [ ] by motion in accordance with Rule 9014.” Rule 4003(d) further provides that “[n]otwithinstanding the provisions of subdivision (b), a creditor may object to a motion filed under Section 522(f) by challenging the validity of the exemption asserted to be impaired by the lien.” As such , a Section 522(f) motion, otherwise known as a motion to avoid lien, may face an objection or opposition from a lien creditor despite the lien creditor not previously filing an objection to a debtor’s claimed exemption as indicated in Rule 4003(b). The key phrase of “notwithstanding the provisions of subdivision (b)” is controlling and limits the scope of Rule 4003(b) to apply only to unsecured creditors leaving the ability of a lien creditor to challenge the validity of the debtor’s claimed homestead exemption.

The ability of a lien creditor to still challenge a debtor’s claimed exemption despite not previously objecting to a debtor’s claimed exemption under Rule 4003(b) is important especially where lien creditors do not always pay close attention to a debtor’s chapter 7 or 13 bankruptcy case. In light of same, it is important for lien creditors to become active in a debtor’s chapter 7 or 13 bankruptcy case as soon as they can. However, it is also important to understand that if a lien creditor misses the 4003(b) deadline to object to a debtor’s claimed exemption and a debtor files a motion to avoid lien, that a lien creditor’s ability to object to the debtor’s claimed exemption is revived under Rule 4003(d). Essentially, lien creditors under Rule 4003(d) will receive a second chance to oppose or object to a debtor’s motion to avoid lien, provided that a lien creditor has a basis to object or oppose said motion.

Navigating bankruptcy in Massachusetts and Rhode Island can be challenging. If you have questions or would like assistance from an experienced attorney, please call Wynn & Wynn, P.C. 1.800.852.5211 or request a free consultation.