Feature
by G.M. Filisko
The new bankruptcy law that took effect on October 17, 2005, included many provisions that affect both residential and commercial real estate. But whether the real-estate market overall will benefit from the changes to bankruptcy law is debatable, in part because some kinks still need to be worked out, and also because fewer bankruptcies are being filed as consumers appear to be confused about whether they can still file for bankruptcy at all. There are provisions in the new bankruptcy law that affect average property owners and renters, and a few that apply to commercial properties.
One part of the new law could help landlords with tenants who are behind in rent payments. Before bankruptcy reform, courts across the country constantly faced the question of which law governed—state landlord-tenant law or federal bankruptcy law—when a tenant facing eviction filed for bankruptcy. The answer to that question determined whether the eviction went forward or whether the eviction was stayed until a bankruptcy court resolved the issue of the tenant’s bankruptcy.
The new law now says state law will govern. Kevin E. Mangum, a bankruptcy attorney in Casselberry, Florida, describes how the eviction process works. If a landlord has gone through the eviction process and obtained a judgment of possession and the tenant files for bankruptcy, under the old law, the eviction action was stayed. Now, however, the eviction isn’t stopped automatically, he says.
Tenants have a right to “cure” (legal lingo: fix a breach in a contract, in this case, by paying overdue rent) and keep the rental unit by paying back rent. According to Mangum, “If there’s an eviction in process, and the tenants file for bankruptcy, instead of waiting on the landlord to act, the tenants have the duty to be proactive and tell the court why they have a right to stay in the premises.”
Being proactive means tenants have to take several steps. First, they have to obtain a 30-day stay by listing their landlord on their bankruptcy petition. They must also file a certificate attesting to two things: one, their state’s law allows them to cure their default after their landlord has obtained a judgment for possession, and two, that they’ve deposited money with the clerk of the court to cover rent that will come due if the court grants a 30-day stay. In California, tenants have these rights.
The landlord can object to the tenants’ certification, and if that happens, the court must hold a hearing to determine whether the tenants’ certification is true. If the court finds that it’s not, the landlord wins, and there’s no stay. The eviction can go forward. If tenants are able to get a 30-day stay, in order to keep the rental property any longer than that, they have to file a second certificate stating that they’ve paid all overdue rent required under the lease. If they can do that, the stay remains in effect.
Don’t forget, however, that if tenants are endangering the property or using drugs on it, you can still proceed with the eviction. The tables are turned, however, and the burden is on you to file a certification—and serve it on the tenants—stating that you started the eviction before the bankruptcy petition was filed or that the tenants are endangering the property or allowing drugs to be used on it. Just as you can object to a tenants’ certification to stay in the property, tenants can object to your certification to get them out for misusing the property. If that happens, the court will hold a hearing to determine who’s telling the truth.
Commercial Property Owners
The code also has several provisions that affect commercial properties. First, it makes it easier for creditors to ask the court to lift the automatic stay in single-asset real-estate bankruptcies, regardless of value, if the debtor hasn’t filed a confirmable reorganization plan or begun making interest payments within 90 days of filing for bankruptcy. The old bankruptcy rules defined single-asset real-estate cases as those with projects of $4 million or less, says Robert Nelson, a bankruptcy attorney in Salt Lake City, who specializes in large bankruptcies that often involve commercial property. “The $4 million limit has been eliminated, and the new automatic stay provisions now apply to all real-estate projects small and large,” he reports. “Take the example of a developer who’s begun his project but run out of funds and is in jeopardy of foreclosure, so he files for Chapter 11 bankruptcy hoping to buy time to find a new investor. I’ve seen real-estate debtors hide behind the automatic stay, and courts have permitted it.” Under the new rules, within 90 days the developer must file a reasonably confirmable plan of reorganization or start making interest-only payments under the loan agreement. “This forces the developer very quickly to put up or shut up,” Nelson argues, “and it forces activity so that commercial agents will benefit through a sale or some other transfer.”
“I think the direction this amendment has taken has been foreshadowed in the past few years,” Nelson adds. “Developers file at the last minute just to see if they can buy more time, but single-asset cases aren’t favored, and they haven’t been favored for some time. Judges have seen enough of these cases that they no longer buy pie-in-the-sky projections from developers. The changes reflect what many judges I was dealing with were imposing anyway.”
The bigger difference affecting commercial property applies to “debtors with megalocations that have to make decisions quickly about whether to assume or reject their leases,” says Nelson. For instance, the attorney was involved in the Sizzler International bankruptcy case in 1996, and the company took years to tell landlords the leases it would accept and reject for its steakhouses. “Some leases, it was clear they should reject, so they just didn’t make payments. Others, they reinstituted monthly rent payments, but they didn’t cure delinquencies. The court kept extending the deadline for accepting or rejecting the leases for almost two years,” he reports, which left landlords holding the bag on delinquent rent for all of that time.
Even better for landlords, damages from a breach under the new, assumed leases would become priority claims under the bankruptcy. That means, if the company defaulted on the rent under the assumed lease, the landlord’s claim would be at the top of the line for repayment, right up there with legal fees and other expenses that are given priority status in a bankruptcy.
Bankruptcies Down, Foreclosures Up
One big, yet unresolved issue for homeowners is whether the new law will result in more foreclosures. Under the new law, homeowners who are in arrears on their mortgage can’t wait until the last minute to file for bankruptcy—as many people do—to stop foreclosure. “Before, bankruptcy was a last-minute thing,” reports Thomas S. Linde, a Seattle attorney. “If you were in foreclosure, you could file right before the foreclosure sale,” and in some cases stop the sale. “Now, if you’re on the eve of foreclosure, it may be difficult to file if you wait until the last minute.”
That’s because a new provision requires that people filing for bankruptcy must undergo credit counseling before or within five days after filing their bankruptcy petition. To show you’ve complied with that requirement, you have to file a certificate with the bankruptcy petition stating that you’ve completed an approved credit-counseling course.
According to Linde, who specializes in real-estate law and represents creditors in bankruptcy, “The policy was to see if people could qualify for something short of bankruptcy, say, could they work a deal with creditors?” The counseling isn’t onerous, he says, and can often be completed in less than an hour online or by telephone. But it still must be arranged and completed, which can create delays for homeowners who need an immediate stay from a foreclosure action.
Linde says he’s recently seen fewer people filing for bankruptcy to stop foreclosure, but he’s not sure if it’s because the new law is more restrictive or because there’s uncertainty over some of the new provisions, and people and their attorneys are waiting for courts to clarify those muddy provisions. Over time, however, he predicts fewer foreclosures will be stopped because homeowners won’t be able to file for bankruptcy as quickly as they could before.
Duane H. Gillman, an attorney and longtime Chapter 7 bankruptcy trustee in Salt Lake City, agreed. Homeowners who wait until the last minute to try to save their homes “may be unable to conduct the credit review in time, and that may have some impact on the number of homes lost to foreclosure,” he argues.
Real-estate agents who specialize in foreclosed properties offer mixed reports on whether changes in the law have affected their inventory. “I got more foreclosed properties assigned to me in the first quarter of 2006 than were assigned to me in all of last year,” says Alex Macau, broker associate at Keller Williams Realty Premier Properties in Miami. “I can confidently say the new bankruptcy law has something to do with that.”
But Chris Mann, broker-associate at RE/MAX Horizons Group in Firestone, Colorado, who specializes in short sales and foreclosed properties, says the new law hasn’t affected his business in any noticeable way. “My business has gone gangbusters,” he comments, “but I haven’t seen the bankruptcy law play a large part in that. The problems I see are because of interest-only mortgages and because two-year ARMs are coming due, and our economy hasn’t seen the growth it did in the past. These homeowners can’t refinance because they can’t afford the refinance fee, and they can’t afford the higher payments, so they’re short-selling or they’re losing their house to foreclosure.”
Carl Bradley, founding broker of Eagle Realtors in Houston, who’s specialized in foreclosure sales for 29 years, questions whether filing for bankruptcy ever helped homeowners in the first place. “Filing for bankruptcy didn’t affect whether people could save their house,” he claims. “It was just a stall tactic. Even though homeowners can stop the foreclosure by filing for Chapter 7 bankruptcy, the mortgage company gets released from the stay and continues the foreclosure. Homeowners have to file for Chapter 13 bankruptcy to save their house, and if they do that, then their payment becomes higher than it was before. So I don’t think the new law is going to have a long-term affect on foreclosures for people who file for bankruptcy.”
Frequent Filers
Perhaps the most damaging provisions for homeowners behind in their mortgage payments under the new bankruptcy law are those that apply to homeowners who’ve filed for bankruptcy once or twice within the previous year, which is actually fairly common even for people filing in good faith. “One area we’re seeing emerging in the case law that really impacts the ability to save a home is in the area of repeat filers,” reports Gillman. “The advantage has substantially shifted to lenders wanting to foreclose. Repeat filers really get clobbered.”
Here’s a typical scenario of a good-faith, two-time filer: Homeowners fall behind in their bills. They file a Chapter 13 bankruptcy, which allows them to develop a plan to pay back debts over time. While paying according to their plan, they get hit with a medical emergency or job layoff, which prevents them from making the payments as promised. When that happens, their bankruptcy case is dismissed, and they’re back to the drawing board with overwhelming debt. So they file a Chapter 7 bankruptcy, which allows for a neutral third-party to act as trustee and conduct an orderly liquidation of their assets.
Linde describes another common repeat-filing scenario he’s seen during the refinancing boom of the past few years. These homeowners file for Chapter 13 bankruptcy to reorganize their debt. While making payments according to their reorganization plan, they decide to refinance their home to take out equity to pay some of their overdue debts. “But the refinance lender doesn’t want anything to do with a bankruptcy,” Linde says. “So the homeowners voluntarily dismiss their case to get the refinancing approved, but the refinance goes south. The homeowners are out in the cold because they dismissed their bankruptcy case, so they file again, but after the new law has taken effect.”
Under the new law, second-time filers like the homeowners in these two scenarios get penalized. “If they’ve had one filing within the past year, the presumption arises that the second filing is an abusive filing,” Gillman reports. In that case, the automatic stay—which prevents creditors from doing such things as selling a home at a foreclosure sale—lasts for only 30 days. If homeowners want to try to extend that stay beyond the 30-day period, they have to arrange for a hearing within 30 days, where they must prove by clear and convincing evidence that their filing is in good faith and the stay should continue. “That’s not an easy standard to meet to prove this isn’t an abusive filing,” says Gillman. “There’s a greater likelihood there’ll be a foreclosure sale, and you’re going to have more homes lost. That’s unfortunate in my opinion. The new law significantly puts at risk somebody who’s had prior filings, and I think it’s unnecessary.”
Don’t even ask about three-time filers. According to Gillman, if a debtor has had two bankruptcy cases during the year before this petition, there’s an absolute bar to any automatic stay being available to contest foreclosure.
Before you turn up your nose at three-time filers, consider this scenario: Homeowners are in trouble with debt. They file for Chapter 13 bankruptcy to pay it back over time, but they try to save money by not hiring a lawyer to file their petition. As it turns out, it’s hard to fill out every form exactly as the court requires if you don’t do that for a living, and the court dismisses the first petition as incomplete or incorrect. So the homeowners hire a lawyer, who files a second petition. They then run into the same problems Gillman and Linde mentioned, such as a job loss or voluntary dismissal to facilitate refinancing that goes south, and end up dismissing their second Chapter 13 case and filing a third Chapter 7 liquidation. That’s three strikes, and the homeowners are out. “If this is the third case,” says Linde, “there’s no stay, and the foreclosure’s going to happen.”
All of this raises a cautionary note for investors in foreclosed properties. Linde thinks it’s possible that courts will, on occasion, undo foreclosure sales in cases involving good-faith repeat filers. Despite the draconian measures for repeat filers, there’s still a sliver of discretion on the judge’s part. “Courts can impose a stay if there’s good cause,” Linde comments. “Is the court going to have the power to go back to void a sale? I don’t know. But if a court sees that it would benefit everybody to void a sale, and everybody comes out whole, maybe it will.”
Linde thinks that’s possible in a case where homeowners have substantial equity, and the only party that benefited from the foreclosure sale having gone through is the third party investor who bought the property for a song. “When there’s equity that could benefit the homeowners and their creditors, maybe the judge should unwind the sale, let the homeowners get their money back and the creditors get paid, and give the third party his money back. Why should a third party get that windfall when that money could go to the homeowners and their creditors?” he asks.
Gillman, however, has faith in the trustees, like himself, who oversee bankruptcy cases. “It’s true that if somebody’s not paying attention, you could lose substantial equity. But that assumes the trustee isn’t paying attention to what’s going on in that particular case,” he argues. “I’m more of an optimist. I think if we’re monitoring what’s going on in our cases, there are remedies in terms of injunctions or imposing the stay. I don’t think we’re going to see foreclosure sales set aside.”
The opinions expressed in this article are those of the author and do not necessarily reflect the viewpoint of SFAA or the San Francisco Apartment Magazine. Copyright © 2006 by Inman News. All rights reserved.