Bankruptcy & Litigation Series: #7 Foreclosures and Short Sales

Foreclosures are down for the sixteenth straight month in Massachusetts (Source: Massachusetts Real Estate: Foreclosure Activity down yet again).  Whether you credit government intervention programs, improvements in the economy, or something else, this is good news for most people.  However, not everyone will be able to avoid a foreclosure of their property.

Homeowners encounter serious problems when they cannot pay (and have not paid) the mortgage especially if they have negative equity in the property (meaning that the mortgage is more than the fair market value).

Whether you took on a mortgage payment that you could not afford - i.e., purchased "too much house" - or some other temporary situation has impacted your finances such as an unexpected medical expense, loss of a job or other significant interruption in income, the bank will begin threatening foreclosure when you get behind on payments.  At this point, you must weigh your options.

If you can afford your mortgage payment and have just gotten behind then you may be able to work out a mortgage modification directly with your bank, but if they are not willing or able to work with you then bankruptcy can forestall a foreclosure proceeding.  In a Chapter 7 bankruptcy, you will have to pay any mortgage arrears if you want to keep the property, but the foreclosure will likely be delayed partially during the process.  In a Chapter 13 bankruptcy, the mortgage arrears can be included in your payment plan so long as they will result in a full payoff of the arrears by the end of the plan.

If you can't afford the payments, and your financial situation does not permit a mortgage modification, then your options may include bankruptcy, short sale, or foreclosure, or some combination of those.

Short Sales:

In a short sale, the bank or mortgage lender agrees to discount a loan balance because of an economic or financial hardship on the part of the borrower. The home owner/debtor sells the mortgaged property for less than the outstanding balance of the loan, and turns over the proceeds of the sale to the lender. Borrowers are able to mitigate damage to their credit history, and partially control the debt. It does not extinguish the remaining balance unless settlement is clearly indicated on the acceptance of offer. The borrower must work directly with the lender to seek approval of the short sale by the bank, obtain a purchaser, and complete the transaction before any foreclosure proceedings are completed. (In some cases, the bank may have initiated foreclosure proceedings, in addition to contemplating consent for the short sale.) Timing is critically important, and the debtor is an important part of the short sale process.

However, if the individual does not then pay off the deficient portion of the mortgage (the unpaid portion of the mortgage after the short sale proceeds were applied to the balance), the lender can take further legal action against the debtor to collect the unpaid portion of the mortgage, which may include trustee process attachments, garnishments, or seizure of other assets, depending on the debtor's other property. The debtor may, after the short sale is complete, file for Bankruptcy upon completion of the short sale to discharge any deficiency and extinguish any further liability to the lender.  If the homeowner is already in bankruptcy, they will need the trustee or court's approval to transfer the property in a short sale.

Foreclosure and Bankruptcy:

A final option is to simply file for bankruptcy, and indicate that the debtor's intention is to surrender the property to the bank. Procedurally, the Bankruptcy case will progress through the Bankruptcy Court, and eventually the secured lender will seek permission from the Bankruptcy Court to be relieved of the automatic stay protections, and begin foreclosure proceedings. Regardless of whether the foreclosure auction is completed by the bank before or after the debtor's discharge (meaning they no longer owe certain debts, including the mortgage debt), any deficiency from the foreclosure auction is discharged by the bankruptcy court. From the debtor's perspective, the whole process is completed through the bankruptcy, and does not require any specific participation directly with the lender.

This option provides a swift resolution to the issue of past-due mortgage debt, the pending foreclosure on the property, and any mortgage deficiency all in one process that, in the case of a Chapter 7 bankruptcy, can be completed from filing to discharge in under six months. It is best utilized when the lender will not agree to a short sale, when there is insufficient time to arrange a short sale, or when the debtor's other financial concerns (such as collection actions on other debt) require immediate action. It also does not require the lender's permission or cooperation - provided you qualify for bankruptcy, the Bankruptcy Laws dictate the result, not the lender's business decision.

The credit implications of a foreclosure and bankruptcy (or in the context of bankruptcy) are more detrimental than a short sale followed by bankruptcy, if the debtor wants to obtain a mortgage again in the future.

Bankruptcy & Litigation Series: #6 Eviction - Tenant Bankruptcy

When one of the parties in a landlord-tenant relationship goes bankrupt, the result is very different depending on whether it is the landlord or the tenant.  As described in the previous post, when the landlord files for bankruptcy, the lease may continue even if the landlord abandons it to the trustee.  But what happens to a Landlord or Eviction Suit when the Tenant files for bankruptcy?

Just like a collection action, an Eviction proceeding is automatically stayed during the pendency of the filing.

The tenant can elect to assume or reject the lease.  If the tenant assumes the lease, any arrears must be brought current.  The landlord can file a motion for relief from stay to proceed with the eviction, but cannot pursue the debtor for pre-petition unpaid rents.   If the debtor assumes the lease, his financial obligations to the tenant must be either current, or in the case of a debtor in possession, must provide adequate assurances (in the form of money) that he can continue to afford his maintenance of the lease obligations.  Otherwise, the lease is deemed rejected.

Bankruptcy & Litigation Series: #5 Eviction - Landlord Bankruptcy

The tenant will receive a notice of bankruptcy.  A landlord can elect to assume (i.e., keep) or reject (i.e., end) a lease per 11 U.S.C. s. 365.

If the debtor-landlord elects to reject the lease, the terms of the lease can be administered by the trustee.  If the debtor assumes the lease, his financial obligations to the tenant must be either current, or in the case of a debtor in possession, must provide adequate assurances (in the form of money) that he can continue to afford his maintenance of the lease obligations.  Otherwise, the lease is deemed rejected.  If a tenant will be displaced by a debtor-landlord, he should file a proof of claim for his damages, and will be compensated pro-rata in the event that there are any bankruptcy assets.

Bankruptcy & Litigation Series: #4 Collections - Defendant Bankruptcy

When one of the parties in a collection action goes bankrupt, the result is very different depending on whether it is the defendant or the plaintiff.  As described in this previous post, when the Plaintiff files for bankruptcy, the suit may continue but becomes an asset of the estate.  But what happens to a collection suit when the Defendant files for bankruptcy?

Collection proceedings against a debtor are automatically stayed pursuant to 11 U.S.C. s. 362.  The debtor or debtor's counsel should file a Suggestion of Bankruptcy in the civil suit, but NOT filing a suggestion of bankruptcy does not have any prejudicial effect.

The Plaintiff should file a proof of claim if the case is filed under Chapter 11 or Chapter 13, or in a Chapter 7 where there are assets to distribute. The underlying debt will be included in the debtor's discharge, and should the Plaintiff pursue the case, will be in contempt of either the Order of Discharge or the Order of Automatic Stay, and face civil contempt penalties, including being forced to compensate the debtor for actual damages, attorney's fees and punitive damages.

What if there are multiple defendants?

In cases where there are multiple defendants, the case will be stayed as to the debtor, but the case WILL proceed as to the remaining defendants.  See 11 U.S.C. s. 362

Note that depending on the case, certain damages claimed in a civil or personal injury suit are not dischargable:

1. Money, property or services or an extension of credit obtained by false pretenses or actual fraud; or by a false statement
2. Debts for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny;
3. domestic support obligations
4. Debts for, what is essentially, bank fraud
5. for any payment of an order of restitution issued under title 18, United States Code
6. Election law penalties
7. Certain condo fees

See complete list at 11 U.S.C. s. 523.

Bankruptcy & Litigation Series: #3 Collections - Plaintiff Bankruptcy

A bankruptcy case can impact other litigation in many ways.  Some cases will be halted automatically by the filing of a bankruptcy due to the automatic stay.  Others might not be stopped, but might not be controlled by the bankruptcy trustee.  And some cases may not be affected at all.  Navigating these interactions can be difficult even for attorneys who are experts in other areas of the law if they don't practice in the bankruptcy court.

What happens to a Collection suit when the Plaintiff files for bankruptcy? 

It is generally a good idea to file a suggestion of bankruptcy to alert the court to the bankruptcy filing.  Most courts will temporary delay the hearing of the case, however 11 U.S.C. s. 362 is not designed for this application.  Ultimately, the suit itself is an asset of the bankruptcy estate.  Like any other asset, it may be exempt depending on the value of the potential claim.  In the event that it is not exempt (and at all times before being abandoned by the trustee), the Trustee steps into the plaintiff's shoes during the administration of the bankruptcy estate.

The Chapter 7 trustee may then offer to settle, or compel the debtor to pursue the suit (although the Trustee will bear the cost of compensating counsel for any post-petition legal fees).  Any proceeds obtained during the suit (less any exempt portions) will be turned over to the trustee as property of the bankruptcy estate and distributed to creditors.