Creditors sometimes assist debtors who are struggling to meet their obligations by refinancing their debt. This could be a good collection strategy, and it could also be a good plan to keep the debtor out of bankruptcy. In doing "workouts", however, be careful not to jeopardize your lien.
As we have previously discussed, debtors may avoid non-purchase money security interests under Bankruptcy Code §522(f). Remember, this Code Section provides that debtors may avoid a creditor's interest in personal property subject to homestead exemption if such interest is not a purchase money security interest.
Example #1: A debtor borrows $5,000.00 to purchase a car from a seller. Debtor executes the lender's promissory note which designates the debtor's car as security for the loan. A valid lien is then perfected on the vehicle title.
Question: Can the debtor avoid the lender's security interest? Answer: No. The lender's interest is a purchase money security interest.
Example #2: A debtor borrows $5,000.00 to pay off old loans. The debtor executes the lender's promissory note which designates the debtor's existing car as security for the loan. A valid lien is then perfected on the vehicle title.
Question: Can the debtor avoid the lender's security interest? Answer: Yes. Since the security interest was not for the current purchase of goods and/or services, the interest is not a purchase money security interest.
When a lien is "reworked", the purchase money security interest is extinguished according to some courts, thus transferring it into an ordinary security interest whose priority is determined according to the time of filing or perfection. Thus, if the debtor files bankruptcy within 90 days of the refinance, the creditor may loose his lien.
Keep this in mind when doing "workouts". Sometimes you can feel comfortable that the debtor will not file bankruptcy due to your efforts - most times you cannot be sure.
