How Liens Are Created

• Jurisdiction: Maryland

B. HOW LIENS ARE CREATED

There are three mutually exclusive types of liens relevant to bankruptcy proceedings as delineated in Title 11 of the U.S. Code: security interests, judicial liens, and statutory liens. The Bankruptcy Code and case law have imposed specific restrictions and limitations on each of these three types of lien, which will be addressed here.

1. Security interests

Security interests are defined by 11 U.S.C. § 101(51) as being a "lien created by an agreement," otherwise known as a consensual lien.³ In this circumstance, a debtor voluntarily enters into an arrangement with a creditor in which the payment of a debt is secured through the creditor's possession of a legal right to the debtor's property. When considered in the context of bankruptcy cases, security interests must be distinguished from executory contracts, which entail obligations from all involved parties, such as a tenant's agreement to pay rent in exchange for the landlord's obligation to provide quiet enjoyment of the premises and maintenance of the building. Under 11 U.S.C. § 365, a debtor who declares bankruptcy can be compelled to assume or reject an executory contract by a set date, either proving the ability to continue obeying the terms of the contract exactly ("assuming" the contract, which may be difficult for a debtor in bankruptcy to do) or relinquishing the asset ("rejecting" the contract, which in most circumstances places an undue burden on the debtor, such as the necessity to relocate from an apartment to another residence). If a debtor does not choose one of these options, the bankruptcy estate is liable to a breach of contract claim from the creditor, as well as all associated costs. Security interests, on the other hand, are treated as secured debts in bankruptcy which, as discussed in Chapter II.F.6.b, supra, are only accessible by creditors up to the market value of the asset and not liable for damages arising from a breach of contract claim. In short, "unlike the situation where an executory contract is assumed, a secured claim is fixed at the value of the collateral and does not expose other creditors and the estate to the risk of post-assumption breach."⁴

A security interest may be granted by a debtor to a lender against assets which the debtor already owns and of which the debtor continues to retain possession. This is known as a "non-possessory, non-purchase money" lien because the debtor, and not the lender, has possession of the collateral, and the lender's funds were not used to purchase the collateral. Such non-possessory, non purchase money liens may be granted, perhaps even surreptitiously, by the mere placing of an "x" in a box on one of multiple pages of an 8" × 14" loan document—usually for the in terrorem effect of threatening repossession of the collateral if the debtor fails to repay the loan as contractually agreed.

A non-possessory, nonpurchase money lien can also be granted in combination with the consensual granting of other security interests. A classic example is the debtor's purchase money financing a vehicle and the debtor's execution of a security agreement pledging the purchased vehicle as collateral— to be repossessed if not timely and fully paid, which security agreement could also contain a provision with an "x" in a box granting a lien against the debtor's household goods and furnishings, none of which were purchased with the funds that were used to purchase the vehicle. Every such a non-possessory, nonpurchase money security interest lien is avoidable in every chapter of the Bankruptcy Code by the filing of a motion to avoid the lien⁵ pursuant to 11 U.S.C. §§ 522(f)(1) and 522(f) (2)(A).⁶

The two most common types of security interests are deeds of trust, which grant liens and encumbrances securing the repayment of promissory notes that create personal liability, and mortgages granted against real estate. Both are instruments of both lien encumbrance and personal liability, combined in one document. Courts have held that similar agreements, such as land installment sales, also fall under the category of "security interests." Land installment sales differ from mortgages in that they often require a single lump payment after a certain number of monthly installments, rendering them similar to a lease-and-purchase agreement. In In re Johnson,⁷ debtors Bruce and Sharon Johnson had such a land installment sale agreement with their vendors, and as part of their bankruptcy plan, set out to pay off the amount they owed on the property before filing for bankruptcy—more than $60,000—over the course of forty-eight months. The vendors objected, demanding the entire payment at once or relinquishment of the property. The Bankruptcy Court sided with the vendors, ruling that the new payment plan violated the terms of the parties' initial agreement and holding that "the interest of a vendor in real property subject to a land installment contract is like that of a mortgagee . . . in real property."⁸

Similar to land installment contracts, courts have held other agreements resembling leases, such as "rent to own" transactions in which a purchaser makes small, repeated payments until an item is paid off, are also in fact security interests.⁹

This issue was addressed in In re Crummie,¹⁰ where a debtor who filed a Chapter 13 case had entered into a payment plan for an automobile. The payment plan, much like the land installment contract in Johnson, supra, provided that there was a balloon payment due on the forty-eighth and final month after signing, and that if a buyer could not pay it, he or she could sell the automobile back to the creditor and have the amount of sale credited to the debt. The creditor argued that this contract amounted to an executory contract and, under 11 U.S.C. § 365(d)(2), moved to compel Crummie to either pay the amount due...