Bankruptcy Treatment of a Security Interest in an Insurance Policy

It is common knowledge that when a person or business files for bankruptcy, the end result is typically a discharge of debts.  The bankruptcy debtor will no longer be personally responsible for payment of the outstanding debts.  However, a security interest in real property remains, such as a lien created by a mortgage on a home.  But what happens to a security interest in something more intangible, like insurance proceeds?

A discharge in bankruptcy eliminates the debtor’s personal liability for payment of certain debts.  Specifically, it can void judgments and stop pending or future collection activities on debts forever.  Once a debt has been discharged, the creditor can never go after the debtor for payment of that debt in the future.  For more detailed information pertaining to the discharge of debts in bankruptcy, please review the Federal Bankruptcy Code.

So what happens to a lien on property when the monetary debt is discharged?  The answer is simply: nothing.  The lien on the property remains in place.  This is clear when the property is a tangible item, such as real estate or a vehicle.  But the issue becomes more complicated when the security interest is in something like the proceeds from a life insurance policy that have not yet become ripe for payment.  Even though a lien on an insurance policy may not seem the same as an interest in real property, the treatment of that security interest is the same.

The bankruptcy courts have made clear that a security interest in a life insurance policy created by the assignment of the policy to a creditor survives discharge.  “[D]ischarge does not prevent the Bank from collecting its lien on the proceeds of the policy assigned to it as collateral for a debt, to the extent of the unpaid balance of the debt.”  Jennings v. The Prudential Insurance Company of America, 402 So.2d 1367, 1369 (1st FL DCA 1981).

The moral of the story here is to remember that a lien on property survives a discharge in bankruptcy.  Do not be fooled by a debtor requesting a satisfaction of lien because that lien stays in place.  There are circumstances where a lien may be stripped, but that’s a tale for another day.