Recently Served with a Lawsuit? Another Reason to File Bankruptcy Before Your Creditor Gets a Judgment Against You

File Bankruptcy in California Before Creditor Obtains JudgmentGetting served with a collections lawsuit by a credit card company, auto lender, or any other creditor will certainly ruin anyone’s day. Often it’s the last straw that finally motivates many of my clients to come see me for a free consultation about filing personal bankruptcy here in the Bay Area. The trouble is, many prospective clients procrastinate after being served with a lawsuit before they consider the options of Chapter 7 or Chapter 13 bankruptcy. They wait until after the creditor who sued them has already obtained a judgment by default. When a creditor files a collections lawsuit in California, the defendant has just 30 days to file a formal Answer in the court. Consumers are all too often confused by the papers served on them because this 30 day deadline is printed in tiny print on the face of the summons, while another date is given on something called a Notice of Case Management Conference. That CMC date is irrelevant if no Answer is filed within 30 days because by then the creditor plaintiff has already obtained a default judgment against the debtor.

I’ve written before on this blog that just because a creditor already has a judgment against you, does not meant that you cannot discharge this debt in bankruptcy. Provided that you are eligible for either Chapter 7 or Chapter 13, and that the debt was not incurred through some fraudulent act or other reason that might bar it from being discharged under Bankruptcy Code section 523(a), the judgment debt can be discharged in bankruptcy just the same as it could have been before the creditor ever sued.

However, and this is the point of this blog post, there are some very good reasons why a consumer who has been sued in California should consider filing bankruptcy before the creditor obtains a judgment against him or her. If the debtor owns a home, a judgment creditor can record a lien against that home by recording an Abstract of Judgment. The judgment creditor can also garnish the debtor’s wages and levy his or her bank accounts. The Automatic Stay in bankruptcy can stop wage garnishments and prevent further bank levies, but it does not automatically remove a judgment lien from the debtor’s home.

There is a procedure in bankruptcy law to avoid a judicial lien against the debtor’s home under Bankruptcy Code Section 522(f)(1). However, this requires a special motion to be filed by the debtor’s bankruptcy attorney, and the Court will only grant the motion to remove the judgment lien to the extent that the lien “impairs” the debtor’s homestead exemption. In English, this means that only if the bankruptcy debtor had equity in the home at the time she filed bankruptcy, and only if she claimed the homestead exemptions (California CCP 704 exemptions) to protect that equity, only then can a judgment lien be removed or “avoided” in bankruptcy. If there is no equity in the home at the time of filing, she may still be able to avoid the judicial lien pursuant to the formula contained in Section 522(f)(2)(A).

However, the problem is that if the debtor had no equity in her home at the time of filing a Chapter 7 bankruptcy, and she wants to avoid the judicial lien, then she will have to forego utilizing the California CCP 703 “wild card” exemptions and thereby forego protecting other potentially valuable assets such as a second car or non-retirement savings. Even if the lien is not removed by the bankruptcy, personal liability for the debt itself will still be discharged in the bankruptcy, but the lien will remain. This means that although the creditor cannot collect the discharged debt by any other means (such as garnishing wages), the homeowner will still not be able to sell or refinance that home without satisfying the judgment or negotiating a settlement with the creditor to get them to voluntarily remove the lien.

This may not matter if the home is so far underwater that the bankruptcy debtor intends to eventually walk away from the home. But if the long term plan is to keep that underwater home, then it is critical that the homeowner seek advice about bankruptcy immediately upon being served with a lawsuit and before the creditor can obtain a judgment. This is just another reason why anyone with substantial debts, and in particular, if his creditors are starting to sue on those debts, should get a consultation with an experienced bankruptcy lawyer.

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