When a borrower files bankruptcy, lenders frequently try to have the court lift or modify the bankruptcy stay under Section 362 of the bankruptcy code so the lender may foreclose on the real estate that secures its debt.
However, this might not always be the best strategy for a mortgage lender.
Often, a borrower files a bankruptcy proceeding to stop a foreclosure since the filing results in an automatic stay that prevents creditors from pursuing the borrower or his assets to collect debt.
Whether the borrower files a Chapter 7, a Chapter 13 or a Chapter 11 case depends on a variety of factors, including the borrower’s income and aggregate debt amount.
For now, we’ll focus on Chapter 7 bankruptcy filings, which are often thought of as “liquidation” bankruptcies.
In a Chapter 7 bankruptcy, a trustee is appointed with the obligation to determine whether the borrower has assets that may be liquidated to generate money to distribute to unsecured creditors.
The secured lender’s first instinct may be to file a motion asking the court to lift the automatic stay so the lender may resume the foreclosure process, but the lender may have a better option — particularly when there is no equity in the lender’s collateral.
After the real estate crisis, with the steep decline in property values and an oversupply of properties, many lenders have begun to entertain short sales — sales to which the lender consents even though its debt will not be paid in full.
Some lenders have discovered a short sale may also be accomplished within the context of a Chapter 7 bankruptcy.
A short sale can save the lender the time and expense of foreclosing, as well as the cost of maintaining and marketing the property once it is owned by the lender. In addition, a sale by the trustee may well bring a higher price than if the lender were to sell the property at or after a foreclosure sale.
After a Chapter 7 bankruptcy case is filed, the trustee becomes the owner of all property owned by the borrower. The trustee’s fee per bankruptcy case is small, but he also receives a commission based on the dollar value of the assets of the bankruptcy estate.
That means the trustee has a significant incentive to market and sell any property titled in the borrower’s name, but the trustee cannot sell encumbered property without the lender’s consent unless the lender is paid in full.
A short sale within the Chapter 7 bankruptcy case would require a lender to take less than the full debt owed by the borrower in order to leave a “carve out” from the sale proceeds for the purpose of making a distribution to the unsecured creditors and paying the trustee’s fees and expenses.
Under the right circumstances, the benefits to the lender can outweigh any risk, which is virtually non-existent. Dealing with the disinterested, professional trustee will be far easier than dealing with the emotionally invested and typically overwrought borrower.
The trustee, rather than the lender or the borrower, will market the property and he and his real estate professionals have incentives to invest time and expenses to sell the property as quickly as possible.
The bankruptcy court must approve the sale, and this usually takes 45–60 days after a sales contract is signed.
A short sale in a Chapter 7 bankruptcy is an option mortgage lenders often overlook although there is little, if any, risk to the lender.
If the lender doesn’t like an offer brought by the trustee, the lender may reject it. If the trustee doesn’t get a sales contract within a reasonable amount of time, the lender still has the option of foreclosure.
So, depending on the nature of the collateral and other considerations, lenders may want to explore the possibility of a short sale after a borrower files bankruptcy.
Margaret “Maggie” Puccini is a partner at Bouhan Falligant law firm with expertise in bankruptcy law and creditors’ rights. Kathleen Horne, also a partner with similar expertise, contributed to this article. Maggie can be reached at mpuccini@bouhan.com or 912-644-5746.