Can bankruptcy help if I pledged my household goods as collateral?

Sometimes, a financing company will ask a borrower to sign papers pledging various household property (such as furniture, televisions, and appliances) as collateral to secure a new loan. Done properly, the creditor then has a legal right to demand turnover of the existing household property if the loan goes unpaid.

The general rule in bankruptcy is that secured liens survive bankruptcy, and the creditor retains the right to repossess even if the debt was discharged in a bankruptcy case. When the collateral is household goods pledged to secure a new debt, 522(f) lien avoidance can get rid of the lien and allow the debtor to keep the goods.

The law does not favor creditors obtaining pledges of household goods as collateral. Household goods are much more valuable in the possession of their owner than being sold to pay a debt. For this same reason, North Carolina has exemption laws that prevent a creditor from collecting a money judgment by selling basic household goods. A "voluntary" lien agreement gets around this exemption law by giving the creditor a "voluntary" security interest in the property, which a creditor could in theory repossess. Bankruptcy law recognizes that this type of transaction gets in the way of basic property exemptions, and provides a mechanism to avoid a lien in certain personal property.

The statute, 11 U.S.C. 522(f)(1)(B), allows debtors to avoid liens in particular household property, trade tools, and health aids that get in the way of the debtor's exemption rights. Note the lien must be a "nonpossessory, nonpurchase-money security interest;" i.e. possessory liens cannot be avoided and purchase-money security interests (PMSIs) cannot cannot be avoided under this statute. An example of a possessory lien is a pawn shop loan. Purchase-money security interests are when the money that was borrowed was used to buy the collateral pledged. When a lender loans money to enable someone to buy goods (like a couch or a TV), if they take a security interest in the goods, 522(f) doesn't provide a tool to avoid the lien.

Avoiding a lien under exemption theory requires proper planning prior to filing a bankruptcy case and motion after the case is filed.