Lien Stripping
Liens can be stripped off of the debtor's assets in Chapter 11 or Chapter 13 when the equity in the asset is less than the amount of the unsecured portion of the lien, after deducting senior liens from the property's current market value.
There is a special exception to this concept that limits lien stripping when the lien is a voluntary lien, like a mortgage, on property that is the debtor's principal residence. Under this exception, voluntary liens on a home can be stripped off only if there is no equity in the property at all after totaling the senior liens, to which the lien in question could attach.
Unfortunately, Congress has thus far failed to change bankruptcy law to allow the modification of home mortgages by reducing the amount of the lien to the current value of the property.
Section 506 of the Bankruptcy Code acknowledges that a lien is only a secured claim to the extent that there is value in the asset to which it attaches. To the extent that the claim exceeds the value of the collateral, that portion of the claim is unsecured.
Contrast this procedure to lien avoidance pursuant to section 522, where only judicial liens such as judgment liens (or voluntary liens on household goods) can be avoided if the property would otherwise be exempt.
Liens secured by vehicles
The most common application of lien stripping is the reduction of car loan liens to the present value of the car. Thus, a lender holding a $12,000 claim secured by a car now worth $10,000 has a secured claim of $10,000 and an unsecured claim for $2,000. Two thousand dollars of the lien may be stripped off the asset (the car) in the reorganization of the loan. The plan must provide for payment in full of the secured portion of the debt; the unsecured portion can be paid partially or not at all, along with other unsecured claims.
Recent changes to the bankruptcy law attempt to limit lien stripping on vehicles purchased within 910 days of the bankruptcy filing. The amendment says that "section 506 does not apply" to such vehicles. The intent is to compel full payment of car loans made within two and two-thirds years of the filing, despite the fact that the collateral is often worth thousands of dollars less than the debt it secures.
Tax liens
Tax liens can be stripped off in reorganization proceedings (Chapters 11 and 13) to the extent that the lien does not attach to equity in property. Tax liens cannot be avoided in Chapter 7 on the grounds that they impair exemptions because they are statutory liens, not judicial liens.
If the tax underlying the lien is dischargeable under Chapter 7, the bankruptcy court can determine the amount of the lien that is secured at the time of the filing. Payment of that sum entitles the debtor to the release of the lien.