How Unperfected and Perfected Liens Work in Bankruptcy
Liens refer to secured property where the property is used as collateral for loans. To perfect a lien, the lender must file it with the correct legal authority. For example, a car dealership must file the lien with the Department of Motor Vehicles or whichever authority in the dealership’s particular state handles the filing of car liens. In the case of a mortgage lender, the lender usually files the mortgage deed of trust with the office of the county recorder, Secretary of State or land records office for that county or municipality.
By filing liens, lenders gain protection from other third parties making claims against the property. A perfected lien gives the lender priority in the event that the borrower fails to make payments on the property, whether a car, house, boat, or whatever the property may be.
An unperfected lien is a lien that the lender has not filed with the proper authority. As a result of not perfecting the lien, other creditors can claim the property. Lenders may fail to perfect their liens because they simply forget to record their statement of financing after making the loan, or they delay too long and other parties make claims against the property before they perfect it. Also, a lender may discover that another party has already filed a lien on the property. An example of this is searching a chain of title against a piece of real estate property and discovering the title is not clear because of a lien on the property.
…And the creditor?
In bankruptcy a creditor with a perfected lien takes priority as far as being paid for the secured debt. Also, when creditors do not have perfected liens, the trustee can claim the property as part of the bankruptcy estate, sell it, and divide the proceeds among creditors. Unperfected liens create disadvantages for both borrowers and lenders. It denies the borrower the opportunity to pay off the property loan over an extended period of time. For example, the borrower may want to keep a car and continue making payments to the creditor. The creditor with an unrecorded lien could lose its priority status as a secured creditor. The debtor could lose the property to the bankruptcy trustee who stands to make a commission off the sale and use the proceeds to pay all unsecured debts a pro rata share of the proceeds, after the trustee’s fees and costs.