The Effect of a Bankruptcy on a Foreclosure
THE EFFECT OF A BANKRUPTCY ON A FORECLOSURE
Imminent foreclosure is what prompts many people or entities to file for bankruptcy. In general, a Chapter 7 bankruptcy will not prevent a foreclosure, but a foreclosure may be prevented by the filing of a Chapter 11 or Chapter 13 bankruptcy petition. Both Chapter 11 and Chapter 13 petitions require that the debtor have a feasible repayment plan. However, to qualify for a Chapter 11 or Chapter 13 bankruptcy, a debtor must have enough income to pay all of its secured and priority debts, and at least 25% of its unsecured debt, or the value of its nonexempt assets, whichever is greater. Thus, a secured creditor may be in a better situation if its borrower attempts to reorganize if the value of its collateral is “upside down”, and its borrower has the ability to satisfy its entire outstanding secured debt inside a bankruptcy plan.
THE PROCESS OF FORECLOSURE
Foreclosure is a legal procedure that allows property pledged as collateral to secure a loan to be liquidated to repay the loan when the borrower is in default. All liens junior to the foreclosing lender are eliminated in the process.
If a borrower defaults on a loan for property serving as collateral for the loan, the lender will most likely accelerate the loan, which forces the borrower to pay off the entire loan immediately in order to prevent a foreclosure.
After a lender files a foreclosure complaint it must prove it is owed money from the borrower, and that the borrower’s promissory note is secured by a mortgage, i.e., real property to secure its debt. In order for a lender to accomplish its goal, it must first file a foreclosure complaint. It will then serve the complaint on its borrower, and all parties that have or could claim an interest in the property. After the lender is able to serve its foreclosure complaint it will then move the court for either a default judgment (against parties that failed to timely answer the complaint) or summary judgment (against those parties that timely answered the complaint). A lender can move for and obtain a summary judgment order when it can show a court that there are no genuine issues of fact, and that it is therefore entitled to judgment as a matter of law.
In other words, the purpose of conducting trials and having juries listen to evidence is to decide who is telling the truth when two parties have conflicting memories of certain events. In contrast, if the parties do not (or cannot) dispute the facts, then it is proper for either party to move for summary judgment. This is simply asking the Court to make a legal determination because the facts are not in dispute. This process is very typical in commercial or residential foreclosure litigation. If the Court agrees with a lender that the facts are not in dispute, it will grant the lender’s motion for summary judgment, and it will then set the matter for a Sheriff’s Sale. The lender will then publish notice of its sale and in 30-45 days a public sale will be conducted where the property will be sold to the highest bidder. If the sale of the property fails to satisfy the entire balance of the loan, a deficiency judgment will be entered against the borrower and in favor of the lender for the balance. This deficiency judgment is an unsecured judgment that will allow the lender to seize a borrower’s remaining assets to satisfy its loan.
THE EFFECT OF A CHAPTER 7 BANKRUPTCY ON A FORECLOSURE
A Chapter 7 bankruptcy petition does not prevent foreclosure. When a debtor files for bankruptcy protection, an automatic stay takes effect, which temporarily prevents a lender from proceeding with the foreclosure. However, a lender is able to lift the automatic stay, and, in most cases, it will be granted, allowing the foreclosure to proceed.
If a debtor has little or no equity in his/her/its property, losing it in a foreclosure will not have a financial impact. If a debtor has “nonexempt equity” in his/her/its property, then the bankruptcy trustee will most likely oppose the state court foreclosure, so that the trustee could sell the property in order to satisfy the debtor’s creditors. In that situation, the senior secured lender would be paid in full, followed by junior secured creditors, followed by other unsecured creditors - prorate. A trustee is entitled to a commission based on the amount of money it can distribute to unsecured creditors.
If a debtor does not have non-exempt equity in its property, then many debtors use a Chapter 7 bankruptcy petition to stall the sale of the property (presumable to sell the property or redeem it). A Chapter 7 bankruptcy typically lasts 4 to 6 months. Therefore, many debtors believe that if their debts are discharged they may have more disposal income that they may be able to apply towards a possible: (1) redemption of the property; (2) refinance of the loan; or (3) a sale. However, many of these strategies are only effective in a “hot” real estate market. As such, a lender should be very wary of providing its borrower with too much latitude, because in most cases, it simply increases a lender’s exposure under its loan.
THE EFFECT OF A CHAPTER 11 OR 13 BANKRUPTCY ON A FORECLOSURE
A debtor can attempt to stall a foreclosure by filing a Chapter 11 (business reorganization) or Chapter 13 (individual reorganization). However, if an individual’s unsecured and secured debts exceed a certain dollar amount then he or she is not able to file under Chapter 13, but must file a Chapter 11 petition.
A debtor that is seeking to “reorganize” its debt must satisfy “the means test”. In order to satisfy the means tests, a debtor must have enough disposable income to pay all its priority and secured debts, and to pay at least 25% of its unsecured debt or the value of its nonexempt property (whichever is greater) over a 3-5 year period. If it cannot accomplish this, a judge will most likely not approve a debtor’s proposed repayment plan, and a debtor will have no choice but to file a Chapter 7 bankruptcy or dismiss its case. A debtor must have its “plan” approved by the judge, and it must have the money at that time, or soon afterward, to fund its plan, or the bankruptcy will be dismissed or converted to a Chapter 7.
However, a lender must be aware that many debtors “park” themselves in a Chapter 11 or Chapter 13 bankruptcy with the sole intention of stalling the foreclosure process. A debtor may indicate to its lender that it intends to satisfy its entire debt in full, but in reality it may not have the means to follow through with its promise. In this situation, a lender could lose six months to two years while the debtor attempts to have its plan confirmed, only to be forced to foreclose against its collateral years later when the debtor breaches its bankruptcy plan. Therefore, a secured creditor needs to retain competent counsel to protect its interest even when its borrower promises to repay its loan in full in its reorganization plan.
If you would like more information relating to the effect of a bankruptcy on the foreclosure process or any other banking or finance need, please do not hesitate to contact me at arome@grglegal.com or by phone at 312-428-2740.
Very truly yours,
Adam B. Rome
