Bankruptcy as Means to Keep the House

house

Homeowners  resort to finally seeing a bankruptcy lawyer as the road to keeping a house that’s in foreclosure.

They are often not sure just how bankruptcy will accomplish this, but they are resolute that keeping the house is the centerpiece of their bankruptcy.

A capable lawyer can tell the client how that might be done through bankruptcy;  a standout bankruptcy lawyer challenges the premise altogether.

Often these days, the fixation on keeping the house is irrational and uneconomic.

Own vs. rent

I start by walking the client through the analysis of the mortgage payment and property taxes compared to the cost of renting.

The difference between the two is the investment aspect of home ownership:  you are paying more than just the price of housing in the expectation of owning something with value.

Not to be overlooked is ownership as a hedge against inflation in the cost of housing.

Is there equity?

Then, we look at the difference between the current value of the house and the total mortgage debt.

Don’t forget that the mortgage debt includes the arrearages.  Too often, asked what he owes on the house, the client will tell you what the principal balance on the loan is, not what the payoff totals.

The further underwater the house is, presumably the longer the client will have to pay that “investment premium” before his investment is worth even what is owed.

Funding old age

Finally, I ask the client about what he has saved for retirement.  The smaller the savings and the older the client, the stronger the case that the “investment premium” in the current mortgage payment is better spent in diversified investment in something other than real estate.

The challenge of being a consumer bankruptcy lawyer is that this analysis may be strikingly different for each client and doesn’t always lead to the same conclusion.

But it is a conversation you need to have with the client.

How Lien Stripping Differs From Lien Avoidance

The draft of a lien avoidance motion my paralegal presented me was garbled.  Lien stripping concepts sat next to a cite to §522.

I doubt my staff is alone in missing the critical differences between lien stripping under (or despite) §1322 and lien avoidance pursuant to §522(f).

So let’s try some compare and contrast on liens we want to excise.

Avoid liens that impair exemptions

Section 522(f) enables the debtor to eliminate, in whole or in part, liens that impair an exemption to which the debtor is entitled.

With an small exception, it is only judicial liens that may be avoided.  Tax liens are statutory, so they aren’t avoidable under § 522.

The exception to the rule confining avoidance to judicial liens is that for a nonpossessory, nonpurchase money lien on household goods, tools of the trade, or professionally prescribed health aids.  This exception is drafted to extract the debtor from the tentacles of finance company loans where the lender took a security interest in everything the debtor owned,  not because the collateral had value but because it was essential to the debtor.

Avoidance under §522 works in Chapter 7 and in Chapter 13.

Because the aim of the exercise is to see that the debtor gets the benefit of the available exemptions, a creditor with a judgment lien might find itself secured in part and avoided in part.  Once the debtor gets the full exemption, if there is equity remaining to which the lien attaches, it survives.

Lien stripping in Chapter 13

What we call lien stripping is exploiting the §1322 workaround.  Section 1322 prohibits the modification of a mortgage lien on the debtor’s principal residence.  But if there is no equity whatsoever for the mortgage lien to attach to, most circuits permit the lien to be voided in Chapter 13.

So, here we’re eliminating a voluntary lien.  It’s all or nothing:  either there’s some value to support the lien or there isn’t.  But see my post on settling disputes about value.

Up until recently, all circuits held that you could only strip voluntary liens in Chapter 13.  Then came Mcneal  in the 11th Circuit.

Then there’s 506

Section 506 is the utility player in Chapter 13.  This section defines an secured claim.  A claim is secured if there is value in the estate’s interest in an asset to which the lien can attach.

If there is no value for the lien to attach to, then it is not a secured claim and at the end of the Chapter 13, the lien is void.

For the purposes of §506, it doesn’t matter whether the lien is voluntary, statutory or judicial (so long as it isn’t a mortgage lien on a principal residence or a long term debt).  It’s gone at plan completion.

Clearer?

Image courtesy of automania.

Hammered By Rule 3002.1

To my mind, Rule 3002.1 is the most powerful, most under-utilized tool in our tool box.

And its power is coming to the fore as Chapter 13’s filed in 2011 and 2012 wind to a close.

Don’t let your home-owning client leave Chapter 13 without a determination that they are current

Or, if they are not current, without a plan for addressing the default.

Rule spotlights mortgage balance

During the case, the rule requires timely notice to Chapter 13 debtors and their counsel of payment changes and the addition of fees to a loan balance.

The debtor has an opportunity to challenge the change or the fee before the court.  So, disputes can be ironed out before the bankruptcy court, before there’s a post petition crisis.

But the real punch is at the end of the case when the trustee “shall” file and serve a notice of final cure payment and inform the creditor of its obligation to respond to the notice.  If the trustee fails to serve the notice, the debtor may do so.

And here’s where it gets interesting.  The creditor’s failure to respond properly to the notice is grounds for deeming the mortgage current.

And, the creditor’s failure to have given timely notice of “fees, expenses, and charges” added to the loan balance can bar introduction of evidence by the creditor.

Pretty powerful stuff.

In one of my cases last year, the creditor ate $62,000 in post petition advances on the loan because it botched the response to the trustee’s notice. And the lender paid the debtor’s attorneys fees to boot.

Had the creditor gotten the response to final cure payment right, they probably would have lost anyway, because the lender hadn’t given notice of the taxes it was advancing throughout the case.

Mine your files

A case now on my desk is simpler:  over the five years of the plan, the lender filed only one notice of fees, expenses, and charges for about $50.  But its response to the trustee’s notice has two defects:

  • The $7000 in fees, expenses and charges isn’t supported by timely notices.
  • The response fails to detail the nature and the timing of the claimed expenses.

Unless the creditor can show that $6950 in fees was incurred in the last six months, such that a notices under subsection (c) is still timely, I’d suggest that claim is dead in the water.

I’d bet that more often than not, servicers have not complied with the rule and, further, can’t tell a cogent story about what the debtor owes at case end.

And if the lender concurs that the loan is current, you want a record of it.  Nothing like a little claim preclusion, eh?

More to follow

I expect to explore Rule 3002.1 further in weeks ahead here.  So often, our clients filed Chapter 13 to save their home.  Yet sloppy mortgage servicing and client inattention can sabotage that effort.

Join me in vowing:  not on my watch.

Bankruptcy Sales Free And Clear

Bankruptcy sales

Now that the real estate market in my area is improving, we are dusting off another of our little used skills to effect sales of property during a Chapter 13:  the sale free and clear of liens.

The ability to sell property subject to disputes and continue the fight over a bank account, rather than a piece of property, is one of the real treasures in the Bankruptcy Code.

A sale free and clear transfers the disputed lien or interest from the property to the proceeds of the sale.  The order typically provides that the lien on the proceeds has the same validity and extent as the lien had when it attached to the real estate.

The seller can deliver clear title to a buyer, and the parties can work out or litigate the rights to the proceeds thereafter.

Let’s look at how it works, and flag some of the potholes you can fall in along the way.

Meet §363(f)

The governing subsection is found in Chapter 3 of the Code, thus it applies to sales in bankruptcy cases under any chapter.  So, while it speaks of the power of the “trustee” to sell property, a Chapter 13 debtor may invoke it as well.

Five alternative bases for a sale free and clear appear:

  1. Applicable non bankruptcy law permits sale free and clear
  2. The entity affected consents
  3. The interest is a lien and the value of the property is greater than the total of all liens
  4. The interest is disputed
  5. The holder of the interest could be compelled to accept a money judgment in satisfaction.

We’ll assume for ease of discussion that the interest we are selling free and clear of is a disputed lien, which is the most common scenario in my experience.  And, like anything associated with bankruptcy procedure, I’ll tell you how it works where I practice. Your mileage may vary.

Sale versus Sale Free and Clear

Be clear that getting an order to sell property free and clear of a particular lien doesn’t excuse you from complying with the usual procedures to sell property of the estate.

The creditors are entitled to notice of the sale, with the particulars of the price and the proposed disposition of the proceeds.  General creditors get 21 days notice of the proposed sale.  The real estate professionals may need to have their engagement approved by the court.

Motion to Sell Free and Clear

The motion directed at the disputed lien is a contested matter, directed at a particular entity.  Check out the bankruptcy rules for contested matters for the notice required to be given and the manner of service. FRBP 9014.

Note that moving papers in contested matters must be served in the same manner as adversary proceedings.  FRBP 9014(b). Serve the right folks just as though the motion was a complaint (FRBP 7004) , or you’ll find yourself redfaced or worse at the hearing.

Absent an order shortening time, our local rules provide 28 days notice to the target creditor of your intent to convey the property without full payment of the lien.

The motion papers have to establish that the lien or interest in question is one to which the statute applies. Be clear about which of the statutory bases for the sale apply.

Typically, the order granting the motion will specify

  • how much money will be held back, subject to the disputed lien; 100% or some larger increment
  • who will hold the money
  • whether a separate interest bearing account is required
  • any time limits within which an adversary proceeding for a determination on the merits must be filed

Be mindful of FRBP 6004 which provides that any order authorizing the sale of property is automatically stayed for 14 days.

Close the deal

Most real estate transactions come with timelines.  Trouble results when the client and/or the real estate agents craft the deal without involving bankruptcy counsel.

Your role, in a perfect world, will be to identify up front the need for a motion to sell free and clear, and to educate all concerned about the requirements of a bankruptcy sale.  Particularly, make sure that closing is scheduled for after the sale order becomes final, not just after that order is issued.

The player in a sale transaction too often forgotten, to the parties’ later chagrin, is the title insurer.  The joke in our office and in our bankruptcy courtrooms is that the world is really run by title companies.  No matter how right and tight your legal procedures are, if the title company won’t issue title insurance, your transaction is not going to close.

Get the title company involved early with the issues and the timelines.  Draft the proposed order authorizing sale free and clear early and solicit comments and approval, in advance, from the title insurer, to the form of the order.

Then, while everyone else is patting themselves on the back for having closed the sale, you can retreat to your office to file the adversary to determine who, in the end, gets the money now impressed with the disputed lien.

Image courtesy of Flickr and Dan Moyle.