The Bankruptcy Code
Who Is In Charge
The Bankruptcy Estate
Injunctions In Bankrupcty Cases
Sale Of Property Out Of A Bankruptcy Case
Contracts And Assignments Of Leases In Bankruptcy
Liens Executed By Bankruptcy Estate
Abandonment In Bankruptcy Case
Exempt Property In Bankruptcy Case
Avoiding Powers In Bankruptcy Cases
Dismissal Of Bankruptcy Case
Discharge Of Debtor In Bankruptcy
Effect Of Confirmation Of A Bankruptcy Case
Post Petition Property And Prefiling Judicial Liens In Bankruptcy Case
Letters Of Credit In Bankruptcy Case
The Bankruptcy Code
The Bankruptcy Reform Act of 1978, enacted by Congress on November 6, 1978, applies to all cases filed on or after October 1, 1979. Those cases filed prior to and pending at that time are conducted as if the Reform Act had not been enacted. Under the Bankruptcy Reform Act, the person or municipality by or against whom the case is commenced is always called a "debtor," and no longer is called the "bankrupt." The commencement of a voluntary case or the determination that an involuntary case shall proceed constitutes "an order for relief"; no longer is the party adjudged "bankrupt."
Types of Proceedings
There are five types of proceedings by debtors. Those chapters are Chapter 7 (liquidation), Chapter 9 (municipalities), Chapter 11 (reorganizations by individuals, corporations, or partnerships), Chapter 12 (adjustment of debts of a family farmer with regular annual income), and Chapter 13 (adjustment of debts of individuals with regular income). Both Chapter 7 and Chapter 11 proceedings may be voluntary or involuntary. Chapter 9, Chapter 12 and Chapter 13 proceedings may only be voluntary filings.
Chapter 7 - Liquidations
Any individual, partnership, or corporation is eligible to file a Chapter 7 petition. Railroads, insurance companies, and certain banking institutions are not eligible for Chapter 7 bankruptcies. If a trustee is not elected at the first meeting of creditors, then the interim trustee shall serve in the case.
The trustee under a Chapter 7 proceeding has the power to avoid a lien securing a fine, penalty, forfeiture, or punitive or exemplary damages (for example, tax penalties).
The court may authorize a trustee to operate a business of the debtor for a limited time.
Chapter 9 - Adjustment of Debts of a Municipality
Chapter 9 allows a "financially distressed municipality" (a political subdivision or a public agency or instrumentality of the state) to adjust its debts. An involuntary proceeding is not allowed under Chapter 9. Chapter 9 does not limit the power of a state to control the municipality in the exercise of its governmental powers. Section 363 does not apply in a Chapter 9 bankruptcy.
Chapter 11 - Reorganization
Individuals, partnerships, or corporations (including a railroad) which are eligible to file a Chapter 7 petition also are eligible to file a Chapter 11 petition. Stockholder and commodity brokers are not eligible to file a Chapter 11 petition. The court may appoint a trustee or may allow the debtor to "remain in possession."
On request of an interested party made not later than 30 days after appointment of a trustee, the United States trustee shall convene a meeting of creditors to elect a trustee.
The United States trustee (or court where applicable) shall appoint a committee of creditors holding unsecured claims. On request of an interested party, the United States trustee (or court) may order appointment of additional creditor's committees. The creditor's committee shall generally consist of creditors with the seven largest claims of the kind represented on the committee.
The court, after "notice and a hearing," may appoint a trustee for cause, including fraud or current mismanagement by the debtor. If the court does not appoint a trustee, then upon request of a party in interest, the court, after "notice and a hearing," may order the appointment of an examiner to investigate the debtor for such matters as fraud, incompetence, or mismanagement.
Subject to court limitations, the debtor-in-possession has all of the powers and duties of a trustee, to manage, collect and protect the estate.
The Bankruptcy Reform Act of 1994 creates an expedited procedure for reorganizing a small business. A small business is a person engaged in commercial or business activities (not primarily real estate) with noncontingent, liquidated debts of $2,000,000 or less.
The debtor may file a plan with the petition or at any time. Any party in interest may file a plan at any time if a trustee is appointed. Any party may file a plan subsequent to 120 days after the order for relief if the debtor does not file a plan within that time; or subsequent to 180 days after the order for relief if the debtor's plan has not been accepted. Time limitations may be changed by court order.
The court may confirm a plan only after notice, an opportunity for objection, and an actual hearing.
Upon request of a party in interest before 180 days after the entry of the order of confirmation, the court may revoke an order procured by fraud. Any order of revocation shall contain provisions necessary to protect an entity acquiring rights in good faith reliance on the confirmation order.
Company Policy: Do not rely upon the confirmation and plan alone to invalidate preexisting liens. Require a separate adversary proceeding to invalidate liens.
The confirmation generally will discharge all dischargeable debts unless the plan or order confirming plan provides otherwise.
A deed or mortgage executed pursuant to a Chapter 11 confirmed plan will not be subject to a stamp or similar tax, such as New York state and city deed taxes and state and city mortgage taxes.
Chapter 12 - Adjustment of Debts of a Family Farmer with Regular Annual Income
Only persons who receive 80% of their gross income from farming during the taxable year preceding the year of the filing of their case are eligible to file a Chapter 12 petition. The debtor must be an individual, or certain family-owned corporations or partnerships. The aggregate debts must not exceed $1,500,000. At least 80% of the liquidated debts (excluding debts for the principal residence) must arise out of the farming operation.
A trustee is appointed in each case. The debtor as a "debtor-in-possession" controls, manages, and sells property of the estate unless removed as debtor-in-possession. The trustee must join in a sale free and clear of the interest of a third party.
The debtor must file a plan within 90 days of the bankruptcy unless the court extends the time.
The plan may limit the amount secured by a lien to the value of the land (if the land is worth less than the debt).
Unless otherwise provided, the confirmation vests the property of the estate in the debtor.
The plan may not provide for payments (other than secured claims) of more than five years.
After completion of the plan, the court shall grant a discharge; the court also may grant a discharge to a debtor who did not complete the plan.
A creditor generally may not proceed with a civil action to collect a consumer debt from a co-debtor of the debtor.
Chapter 12 was repealed on July 1, 2000. This will prohibit subsequent filings but will not affect previous cases.
Chapter 13 - Adjustment of Debts of an Individual with Regular Income
A person may file a Chapter 13 petition only if that person is an individual with regular income, or that individual and the individual's spouse, who owe noncontingent, liquidated, unsecured debts totaling less than $269,250, and noncontingent, liquidated, secured debts totaling less than $807,750.
A creditor generally may not proceed with a civil action to collect a consumer debt from a co-debtor.
The United States trustee (or court) shall appoint one or more persons to serve as a standing trustee in Chapter 13 proceedings. If there is a qualified standing trustee, that trustee serves as trustee in the case. Otherwise, the United States trustee (or court) shall appoint a trustee in the case.
Unless otherwise provided, the confirmation of a plan vests the property of the estate in the debtor.
Company Policy: Do not rely upon the confirmation and plan to invalidate preexisting liens. Require a separate adversary proceeding to invalidate liens.
After the plan payments are completed, the debtor shall be granted a discharge as to all debts, including claims based upon fraud or defalcation, but excluding debts for support, alimony, maintenance of a child or spouse, restitution included in a criminal conviction, certain government guaranteed educational loans, death or injury caused while operating a vehicle when intoxicated, and debts for which future payments will remain due under the terms of the plan.
If the payments are not completed as provided in the plan, then the debtor may be granted a discharge from all dischargeable debts except long-term debts.
A foreign bankruptcy proceeding does not have jurisdiction of U.S. land. The owner also must join with any foreign estate representative or ratify and confirm the conveyance on behalf of the owner. In the alternative an ancillary proceeding may be brought in the U.S.
Only a person who resides or has a domicile, place of business, or property in the United States, or a municipality, may be a debtor. In a Chapter 12 proceeding, only a family farmer with regular annual income may be a debtor. The farmer may be an individual (and spouse) or a family-owned partnership or corporation with debts of $1,500,000 or less; 80% of the noncontingent liquidated debts (excluding those related to the principal residence) must arise out of farming. In a Chapter 13 proceeding, only an individual with regular income owing noncontingent, liquidated, unsecured debts of less than $269,250 and noncontingent, liquidated, secured debts of less than $807,750 may be a debtor. A person includes an individual, partnership, or corporation. A spendthrift trust is not a business trust and cannot be a debtor. According to one view, a land trust, as opposed to a business trust, cannot be a debtor. A trust created to act as a vehicle to facilitate secured financing is not a business enterprise and is not eligible to be a debtor. A trust created to transact business for investors can be a debtor. Application of the appropriate choice of insolvency law for multinational business should depend on the debtor's nerve center, assets, creditors, and debtor's business and reasonable expectations of the parties. A corporation whose charter has been forfeited may file a bankruptcy petition if it is recognized as an entity under state law.
Commencement of Proceeding
A voluntary proceeding is commenced by the filing of the petition. The commencement constitutes an order for relief.
A joint case is commenced by the filing of a single petition by both spouses.
An involuntary proceeding may be commenced only under Chapter 7 (liquidations) or under Chapter 11 (reorganization). It may not be filed against government units, a farmer, or an eleemosynary institution. It may be commenced on the petition of: (a) three or more entities with noncontingent, unsecured claims totaling at least $10,775; (b) one or more holders of claims whose claims total at least $10,775 if there are fewer than 12 holders; or (c) fewer than all general partners of the partnership in question, or any general partner or holder of a claim or the trustee if all general partners are debtors for whom an order for relief has been granted. A title company's claim as assignee of promissory notes does not become a contingent claim in connection with an involuntary bankruptcy petition filed against the borrower simply because the debtor asserts a counter claim under its owner's title policy.
The debtor in an involuntary case retains control and possession of his or her property unless the court orders otherwise, or until an order of relief (that the bankruptcy case proceed) is granted, or until the interim trustee is appointed.
Company Policy: If the debtor in an involuntary case sells property before the order of relief is granted, require a copy of the notification of the proposed sale, certification by the party mailing the notice that notice was sent to all interested parties, and a final order of the bankruptcy court authorizing sale.
The court shall grant an order for relief in a contested, involuntary case only if:
(a) the debtor is generally not paying debts as they become due (the "equity insolvency" test, not the "balance sheet" insolvency test); or
(b) a custodian is appointed or takes possession of the debtor's property within 120 days of the filing of the petition, unless the custodian does not take charge of substantially all of the debtor's assets to enforce a lien.
The bankruptcy court may authorize a sale by the debtor.
Conversion of a case to a proceeding under a different chapter constitutes an order for relief. Conversion terminates the services of a trustee or examiner appointed before the date of conversion. According to one view, court orders lifting stays, approving stipulations, rejecting executory contracts and other matters are not negated by an order of conversion. According to another view, conversion creates a new order for relief and stay, and compels the creditor to file a new motion for relief from the stay to proceed with its collateral. Upon conversion from Chapter 13 to Chapter 7, the exemptions will be reconsidered and the trustee and all interested parties may make objections.
Company Policy: If a sale, loan or foreclosure after lift of stay has not been consummated prior to the conversion of a case to a different chapter, require a new order. A new entity controls the estate and that entity must comply with the procedures for sale, loans and other matters.
A case may be reopened in the same court to administer previously unadministered assets or for other causes as necessary.
A person qualifies as trustee, after appointment, by filing a bond in favor of the United States, subject to United States trustee approval of the surety and amount on the bond.
Creditor's Initial Meeting
There shall be a meeting of creditors after appropriate notice, within a reasonable time after the order for relief. The bankruptcy judge may not attend the meeting. The debtor must appear and submit to questions by all interested parties.
Death or Insanity of Debtor
Once the estate is created, no interests in property of the estate remain in the debtor. Therefore, if the debtor dies or becomes insane after the commencement of the case, then only exempt property, abandoned property, or certain property acquired by the debtor after the case began will be subject to control and administration by the debtor's personal representative. The bankruptcy proceeding will continue in rem as to estate property. However, if the sole debtor in possession dies after confirmation of the plan, the court will order dismissal of the case, since no other successor may substitute for the deceased debtor. If the Chapter 13 debtor dies post-petition, the Chapter 13 case will be dismissed and not converted to a Chapter 7 case. In a Chapter 11, 12, or 13 case, if the debtor dies or becomes incompetent, the court, in it discretion, however, may determine that the case will proceed if further administration is possible and in the best interests of the parties.
An adversary proceeding must be conducted to determine lien priority. Service on an entity must be mailed to the attention of an officer, managing agent or general agent, or other agent authorized to accept service.
It appears that Section 106 which waives sovereign immunity of states, is unconstitutional, at least in part as to Section 106(a), because of the limitations of U.S. Constitution Amendment XI. Apparently, sovereign immunity will prevent "suits" against the states in the form of adversary or similar proceedings, such as actions under Sections 506(d), 544,547, 548, and 522(f). However, it appears that some actions may still be undertaken without violating sovereign immunity, such as a discharge order or decision affecting the lien interests of the states, or perhaps an action seeking an injunction against future violations of the discharge. Sovereign immunity should not prevent jurisdiction over the estate, such as a confirmation of plan and the effect of orders (such as orders of sale) on liens on property of the estate.State sovereign immunity will not apply to jurisdiction in an in rem proceeding if the res is not in the state's possession; this rule should also extend to jurisdiction over estate property. An order authorizing financing on a first lien priority basis does not constitute a suit and does not violate sovereign immunity. The sovereign immunity extends to the states and agencies of the state and does not extend other entities, such as counties, municipalities and many school districts. A Chapter 11 plan may not extinguish a sovereign's lien. It has been said that sovereign immunity extends to "suits," but that not all legal actions are suits. Suits would include an action against a state to impose liability, or an adversary proceeding naming the state as defendant and summoning it to appear. However, a motion to clarify or enforce a discharge order may not constitute a suit and therefore the Eleventh Amendment may not apply. In any event, the state may, according to one view, waive its sovereign immunity if the claim arises out of the transaction that is the basis for a governmental unit's filed proof of claim or if common law principles of waiver apply. A suit has been construed as an adversarial proceeding which compels the attendance of parties and demands the restoration of something from the defending party. A state may waive sovereign immunity by filing a claim, a counterclaim, or a third party complaint, but not by filing an answer.
Who Is In Charge
Authority of Judges
Under the Act, bankruptcy judges may hear and determine all cases of bankruptcy proceedings and all core proceedings arising under such bankruptcy proceedings.
Core proceedings include but are not limited to:
- matters concerning the administration of the estate,
- allowance or disallowance of claims or exemptions,
- counterclaims by the estate,
- obtaining of credit,
- turnover of property,
- motions to terminate or annul or modify the stay,
- fraudulent conveyances,
- dischargeability of debts,
- objections to discharge,
- validity or priority of liens,
- confirmation of plans,
- use or lease of property,
- sale of property other than property resulting from claims brought by the estate against persons who have not filed claims, and
- liquidation of assets.
Noncore proceedings are those proceedings entitled "related proceedings" under the prior Emergency Rules. Noncore proceedings include a determination of title to real estate or tort suits. A bankruptcy judge may hear a "related proceeding." The judge shall submit proposed findings of facts and conclusions of law to the district court. The district judge shall enter the final order or judgment after considering the proposed finding and after reviewing de novo those matters to which any party has timely objected.
Company Policy: Require that any order in a noncore matter (such as a determination of title to real estate or lien priority) be signed by a district judge pursuant to an adversary proceeding.
Upon consent of the parties, related matters may be determined (by order) by the bankruptcy judge. This determination is constitutional. Several cases have upheld the reference of "core" matters as constitutional; the district court retains sufficient administrative controls to prevent erosion of the Article III power.
By limiting the bankruptcy jurisdiction, the Congress is attempting to avoid the problem of the unconstitutionality of blanket jurisdiction which previously existed in the Code because bankruptcy judges were given broad powers but were not given the lifetime appointment of an Article III judge.
If a right to trial by jury applies to a proceeding to be heard by the bankruptcy judge, the bankruptcy judge may conduct a jury trial upon consent of the parties and if instructed to do so by the district judge.
Certain proceedings remain neither "core" nor "related proceedings." The bankruptcy court has no jurisdiction over these proceedings. An example is lien priority on abandoned property.
To appeal to the district court or three-judge bankruptcy appellate panel (on consent of all parties) from an order of the bankruptcy court, the appellant must file a notice of appeal within 14 days of the date of the entry of the judgment, order, or decree appealed from. Within that time, a party may file a motion for judgment notwithstanding the verdict, a finding of additional facts, an amendment of the judgment, or a new trial. Then the time for appeal runs from the time of the entry of the order. The court may extend the time for filing the notice of appeal for a period of not more than 20 days from expiration of the 14-day deadline. A paper is "filed" when received by the clerk, not when mailed. A request must be made within 14 days if the order authorizes the sale or lease of real estate, relief from the stay, the obtaining of credit, assumption or assignment of lease or executory contract, confirmation of a plan, or certain other stated matters. An order is "entered" when entered by the clerk on the civil docket (noting the date of entry). The date of signature of the order is not necessarily the date of entry. The entry on the docket must correctly state the substance of the order (e.g., "order/granting..." is not effective where it was "order (a) denying. a part of motion)" to be effective and start the 14-day deadline for notice of appeal. The notice of appeal is deemed filed when received by the bankruptcy court clerk. Appeals from the appellate panel or district court are made to the circuit court of appeals. Unless the order states that the stay of its order is shortened or will not apply, the following orders on or after December 1, 1999, are stayed from implementation until 10 days after the order is entered on the docket:
- an order granting a motion for relief from the stay;
- an order confirming a Chapter 9 or Chapter 11 plan;
- an order authorizing the use, sale or lease of property;
- an order authorizing the trustee or debtor in possession to assign a contract or lease.
Company Policy: Determine that the order in the bankruptcy court on which you are relying is not being contested and that the order is final. This can be verified by letter from counsel, review of the file and docket sheet, or a clerk's certificate as to finality (after 10 days following entry of an order of sale, mortgage, lease or confirmation; after 30 days on other orders). If the order is not final and nonappealable, call a senior underwriter for approval. Factors we consider in relying upon the order include: (1) whether anyone objected to the proposed order; (2) whether a notice of appeal or motion objecting to the order has been filed; (3) whether the transaction involves a sale or loan solely to an unrelated third party for new value (contrast a lift of stay and contrast a sale to participants in the debtor); (4) whether the court has determined that the lender or purchaser is acting in good faith; (5) whether all advances will be made at closing (if not, the appellate court may be more likely to fashion other relief); (6) size of the transaction (reinsurance is unlikely if an appeal is pending unless we except); and (7) sufficiency of representation on any appeal.
The judicial council of each circuit must establish a bankruptcy appellate panel service to hear and determine, with consent of all parties, appeals from bankruptcy courts, unless the council finds that there are insufficient judicial resources or that establishment of the service would result in undue delay or increased costs.
Generally, appeal from a district court to a court of appeals must be made by filing a notice of appeal within 30 days after date of entry of the judgment or order appealed from.
Even if an order is final, it may be later set aside (generally, subject to a one-year time limitation) if there is an extreme case of abuse of discretion, fraud, mistake, or gross inadequacy of the original sales price in comparison to a later substantially higher sales price. The most common infirmity warranting a vacation of an order of sale is defective notice of the sale to the interested parties. Rule 9024 does not allow revocation of the order of confirmation after 180 days after entry.
Trustee or Debtor?
In a Chapter 7 proceeding, a trustee is in charge of the estate.
In a Chapter 11 proceeding, a debtor-in-possession generally controls and manages the estate and sells the property. However, a trustee may be appointed.
Company Policy: In a Chapter 11 proceeding, review the docket sheet to verify whether the debtor controls the estate as a "debtor-in-possession" or whether a trustee has been appointed. If the debtor-in-possession is selling, verify that the debtor retains authority to sell property. The debtor may be deprived of authority to sell by the court.
In a Chapter 12 proceeding, the debtor is usually a debtor-in-possession, and has power to sell property in accordance with Section 363. One view holds that the trustee must sell real estate, but that the trustee's consent is the functional equivalent of sale by the trustee. The debtor's authority may be limited by the court or the debtor may be "removed" as a debtor-in-possession. In that event, the trustee manages the estate.
Company Policy: Review the docket sheet to verify that the Chapter 12 debtor's power has not been limited. If a sale is made free and clear of liens, require that the trustee join with the debtor and be authorized to sell. Verify that the liens attach to the proceeds.
A trustee is appointed for the estate of a debtor in a Chapter 13 proceeding. However, the debtor is empowered (subject to the requirements of "notice and hearing") to sell property of the estate not in the ordinary course of business or free and clear of a lien or interest of another party.
Limit of Filing
A debtor is not entitled to a discharge if the debtor was granted a discharge in a case commenced within six years before the date of filing of the current case. This time limit does not apply if the prior case was in a Chapter 12 or Chapter 13 proceeding, and (1) payments totaled 100% of unsecured claims or (2) payments totaled 70% of unsecured claims and the plan was proposed in good faith and was the debtor's best effort.
This limitation does not restrict the frequency of bankruptcy filings. However, no individual or family farmer may refile within 180 days if the case was dismissed for willful failure to abide by court orders, or for failure to appear before the court, or if the debtor requested and obtained a voluntary dismissal following the filing of a request for relief from the stay. The filing of a Chapter 13 case before the prior Chapter 7 case is closed (a Chapter 20) is not per se prohibited.
Pursuant to Section 349(a), a bankruptcy court, for cause, may dismiss a bankruptcy case with prejudice to a subsequent filing of any bankruptcy petition under any chapter. A filing in violation of the 180-day ban may be treated as a nullity and consequently no automatic stay comes into effect.
A bankruptcy court may grant a lift of stay binding upon subsequent grantees of the debtor for 180 days, in the form of a equitable servitude that runs with the land.
Lessened Court Scrutiny
The proceedings under the Bankruptcy Reform Act are subject to less court scrutiny in most cases. For example: many acts of a trustee or debtor-in-possession are authorized after the requirement of "notice and a hearing." Notice and opportunity for a hearing "as is appropriate in the circumstances" shall be given. If a hearing is not timely requested, no actual hearing or court order approving the action is necessary. In the absence of an objection or request for a hearing, courts will often refuse to sign "comfort orders." As noted by one judge, "a suitable procedure exists, whereby a clerk's certificate for recording purposes may be obtained, which certifies that no objections or requests for a hearing were filed."
If there is insufficient time for a hearing to be commenced before the proposed act must be done, then the authorization "after notice and a hearing" shall mean authorization of the act without an actual hearing, provided that notice is properly given and provided that the court authorizes the act.
A sale not in the ordinary course of business may be made by a trustee (or debtor-in- possession, or debtor in a Chapter 13 proceeding) after notice and a hearing. If notice and an opportunity for a hearing are given, and a hearing is not timely requested, then the trustee may sell without a court order. If there is no time for a hearing, then notice must be given and the court must approve the sale.
In each case, notice is required if the Bankruptcy Reform Act authorizes an act "after notice and a hearing." The court cannot dispense with notice to interested parties. For example, the debtor, trustee, and a creditor secured by a lien on the property in question cannot by joint agreement avoid the required notice to all creditors before property can be abandoned.
One-day notice before the grant of a lien superior to that of a previous creditor violates due process of law if the notice does not clearly show the effect on the previous creditor. Two and one-half hour notice to creditor of intent to set aside an agreed order lifting stay was insufficient notice.
The presumption of receipt of properly mailed notice may be overcome by testimony of non-receipt combined with standardized procedures of processing mail.
A motion in a contested matter (such as Section 522(f) motion) must be mailed to the attention of a named officer of a corporation; mail to "Attention: President" is not satisfactory.
Failure of the debtor to give notice of proposed sale free and clear of liens to a party claiming ownership rights in a mortgage will generally not cause the sale to be ineffective if: (1) the creditor had actual knowledge of the sale; (2) the creditor failed to file a proof of claim; (3) the creditor failed to record an assignment of mortgage; and (4) the creditor failed to request notices in the bankruptcy case.
Service of summons and complaint must be made by first class mail on the debtor and a copy must be mailed to the debtor's attorney if so represented.
The Bankruptcy Estate
Land of the Debtor
Upon the filing of a bankruptcy, an estate is created. The estate consists of the debtor's interests, both legal and equitable, in all property, both tangible and intangible. The estate includes all land owned by the debtor or in which the debtor has an interest. For example, the estate includes title to land where the debtor had deposited a deed in escrow and the deed had not been delivered by the escrow agent to the grantee at the time of filing of the petition. Property of the estate includes the debtor's interest as a residuary beneficiary in a probate court proceeding pending in a state court (and, consequently, the automatic stay applies to probate proceedings until relief from the stay is granted). While perhaps a loosely worded conclusion, it has been said that title to the debtor's property "vests in" or "vests with" the trustee. It has also been said that the bankruptcy estate is a separate legal entity.
he partnership and a partner are treated as separate entities and their interests are separate. If a partnership owns property, then the filing of a bankruptcy by an individual partner does not vest the partnership property in the estate.
Company Policy: If a partnership is the record owner, require joinder of or consent to the sale by the debtor-partner or debtor's trustee) pursuant to a final court order or after notice to interested parties of the estate.
The estate of a partner consists only of the partner's personal property interest in the partnership. Thus, the automatic stay does not prevent foreclosure of a lien against the partnership property merely because a partner files a bankruptcy.
Company Policy: Foreclosure on partnership assets is not stayed by a bankruptcy of a partner.
There are different views on whether a general partner's bankruptcy dissolves the partnership. It is also unclear whether a debtor-in-possession succeeds to management authority formerly held as a general partner. According to one view, the debtor-in-possession cannot assume executory partnership agreements as a general partner without consent of all of the partners. It has been held that a trustee cannot assume management powers, although the trustee may attempt to scrutinize the transaction. Many, however, hold that the agreement can be assumed or rejected.
It is also unclear as to whether a debtor in possession may assume the right under an operating agreement of a Limited Liability Company to manage the LLC (although it appears that such rights can in no event be assigned).
Leases and Contracts
The interest of the debtor in a lease or contract (as lessor or lessee or as purchaser or seller) vests in the estate upon the filing of the bankruptcy. The estate succeeds to the debtor's option to purchase property.
Company Policy: To insure a purchase money mortgage on the closing of the contract entered by the debtor before the case commenced if the property is not yet exempted or abandoned, you must require a court order authorizing the completion of the contract and execution of mortgage. Prior to revesting of property in the debtor (such as by the Chapter 11 plan) and grant of discharge (approval of Chapter 11, completion of Chapter 12 or 13), you also should except to the effect of the automatic stay on foreclosure of the purchase money mortgage, unless the order allows foreclosure without further review.
A letter opinion from the state court judge ruling that the contract by the purchaser-debtors was rescinded is not entered on the docket book and is not effective to terminate the debtor's interest prior to the filing of the bankruptcy.
Trustee and Trusts
If the debtor has title to property as a trustee (of a private trust), the estate will succeed to the property subject to the interest of the beneficiaries. Since the estate receives no benefit from the interest, cause will exist to lift the stay. The estate cannot exercise the fiduciary powers of the trustee (of a private trust). If the debtor has no equitable interest or beneficial interest in the property, then the debtor should return the property to the true owners where possible. The trustee, in a bankruptcy case, has no authority to sell land held by the debtor as trustee for a partnership.
However, simply because the debtor has title as "trustee" (of a private trust) does not clearly show that there is a trust. The burden rests upon a claimant to establish the trust relationship. If a debtor is a beneficiary under a spendthrift trust, that interest is not part of the estate. A person cannot create a spendthrift trust for himself or herself, and avoid control in the bankruptcy case as an asset of the estate. A spendthrift trust interest is subject to restrictions on transfer of the beneficial interest, which are enforceable under nonbankruptcy law. Profit-sharing and pension plans containing ERISA anti-alienation clauses are not exempt from the estate under Section 522(b)(2)(A). A debtor's beneficial interest in a spendthrift trust is neither property of the estate, nor subject to the automatic stay. A debtor's contingent interest in a (nonspendthrift) trust is property of the estate, though the principal could be invaded for the life beneficiary. A subcontract by a general contractor may provide that payments by the owner to the general contractor are trust funds; such funds are not property of the estate of the general contractor.
The trust assets are property of the estate where the trustee (debtor) retains the power to withdraw property or revoke the trust. If the debtor owns the equitable interest of the nominee trust res, the stay prevents foreclosure of the mortgage on the land.
Where an accommodator took title as part of a reverse exchange (to sell property where the grantor had already acquired the target land), the grantor continued to control and maintain the land (it rented). The grantors continued to retain equitable title. The trustee cannot use the strong arm provisions of Section 544 because the grantor's control and management was constructive notice of the claim. According to one view, the trustee in bankruptcy cannot use strong-arm powers to avoid a beneficial interest held in trust by the debtor; the avoidance powers extend only to actual voidable transfers by the debtor. According to a contrary view, the trustee may avoid unrecorded beneficial interests if the debtor acquires title as "trustee" without disclosure of the beneficiary or terms of the trust.
Loan Servicing Agreements
If a lender-servicing agent agrees to assign a mortgage to an investor, the investor's rights will be enforceable in a bankruptcy filed by the lender-servicing agent even though no assignment is filed of record and even though the lender-servicing agent retains the original note. "As the statute's legislative history indicates, section 541(d) was enacted to protect "bona fide secondary mortgage market transactions' ". Section 541(d) creates a presumption that in a legitimate secondary mortgage market transaction the retention of loan documents by the seller is retention of legal title only." However, if the servicing company guarantees payments of the interests "assigned" to the participants, the participants are merely creditors.
It remains unclear whether the trustee or debtor in the servicing agent's bankruptcy can assume the servicing agreement unless the investor consents. In addition, many servicing agreements do not allow the servicing agent to accept full prepayment.
Factors indicating a loan and not a participation are:
- guarantee of repayment by the lead lender to the participant;
- participation for a different term than the loan;
- different payment arrangements between borrower and lead lender, and lead lender and participant; and
- discrepancy between interest rate on note and on participation.
Company Policy: When faced with bankruptcy by the servicing agent, require:
- written payoff (agreed to) from both the investor and servicing agent;
- verification by review of the note (or copy front and back) as to the
party (or parties) who is (are) the holder;
- written agreement from the servicing agent and investor as to whom you
should pay; and
- written agreement by both the servicing agent and investor to furnish a release upon payment.
If only one spouse files a bankruptcy petition and the debtor-spouse owns community property, then the community property under the sole or joint management of the debtor and other community property liable for claims against the debtor (to the extent of liability) is part of the estate. According to one view, the estate includes community property of the debtor and debtor's former spouse if the division of the community property had not been made when the case was filed. In the event both spouses file separate bankruptcies, such community property is property of the estate of the first spouse to file. The nondebtor spouse has a right of first refusal to buy that property before consummation of the sale. The separate property of the nondebtor-spouse and the community property under the sole management of the nondebtor (where there are no claims against the debtor which could extend to the property) is not subject to the bankruptcy proceeding.
Company Policy: If a nondebtor spouse is conveying community property held only in that person's name, secure joinder by the estate. If the debtor (or trustee) is offering to sell nonexempt community property of the debtor, require joinder of the nondebtor spouse. If joinder by the nondebtor-spouse is not possible, you must be satisfied that the property was under the sole management (where state law so provides) of the debtor and that the nondebtor spouse is not exercising the right of first refusal (such as by calling or notifying the spouse of the scheduled closing or verifying that the debtor makes no tender in the bankruptcy).
Any property acquired by the debtor by gift, devise, or inheritance, or as a result of a property settlement agreement in a divorce within 180 days after the filing of the bankruptcy is property of the estate. Any property acquired during the bankruptcy as proceeds of property of the estate (e.g., distribution of corporate assets if stock is owned by estate) becomes property of the estate. A person becomes entitled to an inheritance or bequest from date of the testator's death, not date of probate of will. A codicil to a will which disinherits the debtor if the testator should die within 180 days of the debtor's bankruptcy is not void as a violation of federal public policy. One view holds that the debtor cannot avoid this provision by disclaiming or renouncing a bequest or devise. Contingent or vested remainder interests owned by the debtor at commencement of the case are property of the estate. A right of first refusal arising out of a proposed sale under the Agricultural Credit Act of 1987 after the debtor filed a Chapter 7 bankruptcy in connection with land foreclosed before the commencement of the bankruptcy is not property of the estate.
Property acquired by a deed delivered before the filing of a bankruptcy and recorded after the filing is property of the estate.
Property that a debtor in a Chapter 12 or Chapter 13 proceeding acquires after the commencement of the case and before the closing or conversion (including earnings) becomes property of the estate (at least until revested in the debtor in accordance with the confirmation and plan if the plan or order does not provide otherwise). However, according to one view, upon conversion of a Chapter 12 or Chapter 13 bankruptcy proceeding to a Chapter 7 proceeding, real estate or other property acquired by the debtor subsequent to the filing of the Chapter 12 or Chapter 13 case but prior to conversion is not property of the Chapter 7 estate. If a Chapter 13 case is converted, the property of the estate of the converted case consists of property of the estate as of the date of the filing of the Chapter 13 petition. If the debtor converts a case under Chapter 13 in bad faith to another chapter, the property in the converted case includes property of the estate as of the conversion.
There are differing views as to whether the bankruptcy estate in a Chapter 7 case after conversion from a confirmed Chapter 11 case will include property revested in the debtor pursuant to the plan. According to one view, if a Chapter 11 case is converted after confirmation and revesting of assets in the debtor, those assets do not become part of the estate; conversion will only affect assets still clearly in the bankruptcy court jurisdiction. According to the contrary view, the Chapter 7 estate will include such property that had revested in the debtor pursuant to the Chapter 11 plan.
These sections (1207, 1306) subject the earnings of the debtor to the Chapter 12 or Chapter 13 plan. Consequently, extensions of credit subsequent to confirmation may be subject to court review and approval.
Company Policy: We generally do not require court orders on purchase money mortgages executed on property acquired by the debtor by contract entered after the commencement of a Chapter 7 or Chapter 11 proceeding. We may accept a consent letter by the trustee in a Chapter 12 or 13 case where applicable after confirmation of the plan if neither the plan nor local rules prohibit borrowing.
If a debtor acquires property and executes a purchase money mortgage in a Chapter 12 or Chapter 13 proceeding before the plan is confirmed, then the court must approve the transaction (since this property is arguably property of the estate) and any mortgagee's policy must except to the automatic stay in the bankruptcy proceeding (which extends to all property of the estate). Likewise the court must approve a refinance before the plan is confirmed in a Chapter 11, 12, or 13 case.
If the debtor enters a contract after the commencement of a Chapter 12 or Chapter 13 proceeding and before the plan is confirmed and thereafter executes a purchase money mortgage after the plan is confirmed, you must review the plan to verify that the property is revested in the debtor in order to insure the purchase money mortgage. Verify that the local rules and plan do not prohibit borrowing and verify (by letter) that the trustee does not object to the mortgage. Follow these procedures on a refinance.
If it is clear that the mortgagor is the debtor, make a disclosure of a pending bankruptcy to the lender in any case where the debtor is acquiring property.
If the debtor enters a contract to purchase property before the bankruptcy commences, and the property is not yet abandoned or revested in the debtor (pursuant to a confirmed plan) then, to insure a purchase money mortgage on the closing of the contract, require a court order authorizing the completion of the contract and execution of the mortgage. Except to the effect of the automatic stay on foreclosure of the purchase money mortgage unless the order allows foreclosure without further review or the property is revested in the debtor.
The property of the debtor vests in the estate and is subject to the bankruptcy proceeding regardless of whether it is listed on the schedules and regardless of whether schedules are actually filed. If the property is not scheduled, the case is closed, and the property is not otherwise administered or abandoned, then it remains subject to the jurisdiction of the bankruptcy court. Property not scheduled in a Chapter 11 case does not revests in the debtor after confirmation of the plan. On the other hand, if the case is dismissed, all property of the estate, regardless of whether scheduled, revests in the debtor. It is possible to have the case reopened to administer or abandon the property. Section 727(e) allows a revocation of discharge within 1 year after discharge (for fraud) or 1 year after the later of discharge or closing of case (for fraudulent concealment of property). These time limits do not prevent the trustee from later reopening a case to administer assets that were fraudulently concealed. If a note and deed of trust to a debtor are not scheduled and the bankruptcy is closed, the note and deed of trust remain property of the estate; the bankruptcy case must be reopened to receive payment for the note. The automatic stay does not terminate upon closing if the property remains property of the estate.
Company Policy: Require a court order reopening the case and authorizing sale or abandonment of the property, after notice to interested parties if (1) the property was acquired by the debtor before the proceeding was filed or was otherwise property of the estate of the debtor, (2) the case has been closed, (3) the property was not formally abandoned or dealt with, and (4) the property was not scheduled.
If the debtor has placed funds in escrow prior to the filing of a bankruptcy in order to satisfy certain claims at a later date, the estate may claim the funds by turnover order.
Money placed in an escrow or for an undertaking or deposit into court is transferred on the date of deposit in order to calculate the time for a preference.
Funds were held with a title company agent to insure a lien without exception to prior mortgages. The court, while stating that perhaps bare legal title to the funds was held by the debtors (indemnitors), imposed a constructive trust on the funds. The court directed the debtors "to set aside and eventually pay over the sums necessary to fully satisfy" the mortgages. If the agreement had expressly provided that legal title to the funds was transferred to the agent (or underwriter) with any excess to be retained to the indemnitors, then the insurer might have been better protected. If the debtor has bare legal title to an escrow account, the account is not property of the estate.
A deposit to protect against defects in title may be construed as a security agreement creating a security interest in the deposited money, generally perfected by possession of the money, and may not be considered an escrow.
Escrowed funds are not property of the estate. The limited right of the debtor to review contractor's invoices or to co-sign checks does not invalidate an escrow. The right to withdraw funds and to revoke the agreement constitutes the type of control by debtors that will invalidate an escrow and result in the funds being property of the estate.
An escrow account is not property of the estate and the trustee is not entitled to a turnover order since the debtor has only a contingent interest in the account due to a pending appeal.
If the debtor has established an escrow before the commencement of the bankruptcy case, the debtor has only a contingent remainder interest and the estate has no higher rights, provided the language of the escrow stated that the debtor would not receive funds until stated amounts were paid, and the escrow did not allow the debtor to dissolve the agreement and recover the funds. A junior pledgee can perfect its security interest in an escrow fund by delivering notice of the pledge to the title agency.
A cash deposit with the state is property of the estate, since the debtor has a residual right to return, subject to a constructive trust or equitable interest in favor of creditors who may claim rights to the deposit under state law. Funds advanced to a settlement agent by a lender in trust for a closing and commingled in the settlement agent's operating account are not property of the estate.
The debtor has an equitable interest in a reserve account (and the account is property of the estate) since the balance would be remitted to it after paying bond issues and issuer of letter of credit (for reimbursement agreement). The issuer of the letter of credit had a perfected security interest in the account when the agreement granted it, trustee held the funds, and the agreement acknowledged that the agent took possession on behalf of the pledgee and perfected the security interest.
A surety may recover funds claimed by the debtor, pursuant to an indemnity agreement, if the funds are held in trust. Four elements of a trust are:
- an intent by the settlor to create a trust;
- a trust res;
- an identifiable beneficiary; and
- a trustee.
If a debtor's deed is delivered in escrow and the conditions for delivery by the escrow agent have not been met, then the estate retains title to the land.
Company Policy: Consult with our underwriting personnel before accepting indemnities and related escrows of funds to secure the indemnities. The agreement must grant us an adequate security interest. The agreement should clearly describe the depositor's remaining interest as only a contingent interest, which is subject to vesting only if certain terms of the escrow occur. The funds also should be deposited in a separate escrow account (in order to reduce any argument of a preference).
According to one view, property acquired after the filing of a bankruptcy petition and owned by the debtor or debtor's estate at time of conversion of a Chapter 12 or Chapter 13 bankruptcy case to a Chapter 7 bankruptcy case becomes property of the estate. There are differing views as to whether the bankruptcy estate in a Chapter 7 case after conversion from a confirmed Chapter 11 case will include property revested in the debtor pursuant to the plan. If a Chapter 13 case is converted, the property of the estate of the converted case consists of property of the estate as of the date of the filing of the Chapter 13 petition. If the debtor converts a case under Chapter 13 in bad faith to another chapter, the property in the converted case includes property of the estate as of the conversion.
Property seized by the U.S. under 21 U.S.C. sec. 853(f) (money laundering; criminal forfeiture) is not property of the bankruptcy estate if the bankruptcy petition was filed after the seizure and before criminal charges are filed. The debtors do not have equitable control over the land at the commencement of the bankruptcy. The debtor may use judicial process to contest the seizure warrant and to seek mitigation or remission if a conviction is secured.
If a debtor or trustee expends money to protect or dispose of collateral subject to the lien and the expenditure benefits the lienholder, the debtor or trustee may recover expenses from the lienholder.
Injunctions In Bankrupcty Cases
The court may enter a discretionary injunction whenever advisable.
The Automatic Stay
The automatic stay begins at the filing of the bankruptcy proceeding.
Termination of Agreements
The stay prohibits termination of leases or contracts.
Foreclosure and Filing of Documents
The stay prohibits foreclosure of liens against property of the estate or foreclosure of preexisting liens or claims against property of the debtor. The stay also may prohibit acts in connection with the foreclosure, such as recordation of the sheriff's deed after foreclosure. The majority view is that the stay prohibits acts such as filing a foreclosure deed after the bankruptcy commences. According to one view, the rights of a purchaser at foreclosure are avoidable under Section 544 if the foreclosure deed is filed after the bankruptcy. According to another view, the foreclosure sale is not voidable because of the post-petition recordation of a trustee's deed, since the public records reflected a default and reschedule of sale. These facts were sufficient notice of the prebankruptcy sale. According to one view, if a nonjudicial sale is final before the filing of a bankruptcy case, such as by the falling of the hammer at the auction, the debtor may have no further rights in the land, even though a foreclosure deed is not executed. The sale is not avoidable under Section 544 because a recorded notice of trustee's sale provides constructive notice of a later sale.
Another view concludes that under the applicable state law the trustee is charged with a duty of reasonable inquiry, by virtue of the recorded deed of trust, to determine the status of that deed of trust by inquiry of the mortgage company identified in the recorded deed of trust; if such inquiry would disclose that a foreclosure occurred before the filing of the bankruptcy case, then the foreclosure would not be avoidable under Section 544 because of failure to record the trustee's deed before the filing of the bankruptcy petition.
The stay may not prevent the post-petition filing of a prepetition trustee's deed, if state law provides that the recordation relates back to the time of sale. However, one view holds that Chapter 13 plan may reinstate a mortgage foreclosed before commencement of the case, if the trustee's deed was not recorded until after the petition was filed. According to another view, cause exists to lift the stay to allow the creditor to "close" the trust deed sale where foreclosure had occurred prepetition and the debtor had no remaining trust in the land.
Another view on foreclosures is that the debtor retains an interest in the land and a lift of stay will not be granted if the foreclosure sale occurred before the bankruptcy, but was not complete under state law because (1) the consideration bid at the foreclosure sale had not been paid and (2) the foreclosure deed had not been executed. However, if the consideration has been paid (by a lender's credit bid) and the substitute trustee's deed has been executed then the debtor has no interest in the land, the stay will be lifted, and the foreclosure sale will be confirmed.
Refiling of a mortgage executed by the debtor to correct the legal description violates the automatic stay.
Recordation of a mortgage assignment from the debtor violates the automatic stay, even though a state law does not require recordation of the assignment.
According to one view, the stay will not prevent a foreclosure proceeding against a landlord of the debtor-tenant if the foreclosure will not extinguish the lease and if the debtor is not joined in the foreclosure action. The stay involving a lessee's estate will not prevent foreclosure of a mortgage if the lender subordinates to the lease. The stay will not prevent foreclosure of a mortgage granted by the debtor to secure obligations of the debtor if the debtor conveyed the land prior to the bankruptcy case. The bankruptcy stay will not prevent a foreclosure of a mortgage if the debtor has only an option to purchase the land, which is not an interest in property under the specific state law. In some states a foreclosure trustee may, by statute, rescind or postpone a trustee's foreclosure sale that is invalidated by a pending bankruptcy.
Company Policy: Require lift of stay to authorize the filing during the bankruptcy of a sheriff's or trustee's deed executed before the bankruptcy.
Notice of Default or Postponement
Letters of default on leases sent by landlords to debtors after the filing of the bankruptcy are violations of the automatic stay. Arguably, the stay extends to foreclosure notices sent to the debtor in accordance with the law where the debtor no longer owns the land. At least one case holds (in language which is arguably dictum) that the automatic stay prevents any attempt to collect a debt which is the debt of a debtor even if the attempt to collect is by foreclosure of real property not owned by the debtor (who remains in possession of the property).However, the better view is that the automatic stay does not prevent foreclosure of a deed of trust or mortgage where the land is not owned by the debtor, but the debtor is liable on the debt. A foreclosure after dismissal of the bankruptcy case does not violate the stay if the sale occurs on the date scheduled prior to the bankruptcy. Posting of notices of postponement of a foreclosure sale, including date of the new sale, does not violate the stay if the original notice is posted prior to the bankruptcy, even though the notices of postponement are posted during the bankruptcy. Public announcement of postponement of a foreclosure sale at time of sale does not violate the automatic stay. A continuance of the sheriff's sale does not violate the automatic stay. A postponement of foreclosure after confirmation of a plan dealing with the mortgage does not violate the automatic stay; the confirmed plan does not remove the creditor's ability to rely on prepetition default for a possible post confirmation foreclosure. However, if the foreclosure sale has been orally continued, due process may require that the debtor be given actual notice prior to a trustee sale scheduled after stay relief or dismissal of the bankruptcy case.
Tolling of Redemption
The majority of cases state that the automatic stay (Section 362) does not toll the redemption period except as provided in Section 108(b). Section 108(b) tolls redemption for the longer of the redemption period or 60 days after the filing of the bankruptcy.
However, there are differing views on whether Section 108(b) applies to redemptions:
a. The Majority View: Section 108(b) applies:
b. The Minority View: Section 362 applies:
Company Policy: Assume that the preforeclosure and post-foreclosure redemption and reinstatement time limits are tolled by section 362 during the period of the stay. Do not waive requirements of continued notice or redemption rights at an earlier time until the latter of (a) 30 days after the stay is lifted or (b) the time limits of state law.
Mechanic's Liens and Relation Back
The automatic stay does not prevent a mechanic's lien claimant from filing a lien claim after the filing of the bankruptcy if the lien claim and priority relate back prior to the bankruptcy. If the lien claimant must file suit to perfect the lien, the claimant can file a notice in accordance with Section 546(b). According to one view, if a complaint must be filed with a circuit court and notice given to debtor in order to perfect the mechanic's lien, the filing and notice to debtor do not violate the automatic stay, although the creditor may not thereafter take any action in the state court to pursue the complaint. This conclusion has been criticized as ignoring Section 546(b), which provides for notice to be filed in the bankruptcy court, instead of filing of a complaint or suit for perfection. The filing of a bankruptcy by a general contractor stays enforcement of a mechanic's lien foreclosure, even though the contractor is not the owner. An environmental superlien filed after the commencement of a bankruptcy case relates back to a time prior to the filing; consequently, the filing did not violate the automatic stay. A filing of a trustee's deed may relate back to the date of sale and thus not violate the stay if state law expressly recognizes such relation back.
Company Policy: Do not rely on a filing of a bankruptcy to ignore possible unfiled mechanic's liens for recent construction.
Property of Estate
The stay continues as to property of the estate until the case is closed, or the stay is lifted, or the property is no longer in the estate (but stay then possibly continues as to property of debtor, if land exempted or abandoned). Property of the estate may include a claim that the conveyance was a fraudulent transfer.
Lack of Notice
The stay is effective regardless of whether notice of the bankruptcy is given to the creditors.
If the debtor transfers property by sale or if a foreclosure occurs and a good faith purchaser (not the creditor) buys at the foreclosure, then the trustee or debtor-in-possession may not avoid the sale or foreclosure if made to the bona fide purchaser without knowledge of the case for present fair equivalent value unless a copy or notice of the petition is filed in the office of the county where the land is located before the transfer is perfected by recording.
Company Policy: Do not rely upon this innocent purchaser protection if we are aware of a bankruptcy. Require a determination that the transfer was effective by adversary proceeding or by other satisfactory settlement.
A judicial or nonjudicial foreclosure by a senior lienholder without court permission is prohibited due to the stay if a junior lienholder has filed a bankruptcy. Many do not agree with this view; another view is that the automatic stay does not prohibit a senior lienholder from nonjudicially foreclosing if the junior lienholder has filed a bankruptcy. A judicial foreclosure that joined the junior lienholder would clearly be prohibited by the stay. One pre-Bankruptcy Code case said that a debtor's lien was property of the estate; arguably this principle would extend the stay to any foreclosure extinguishing the lien.
Company Policy: If a nonjudicial foreclosure would extinguish a junior lien of a debtor or redemption right of the debtor-junior lienholder, require a lifting of the stay in the junior lienholder's bankruptcy.
The bankruptcy of a general partner does not stay a foreclosure of property owned by the partnership. However, the partner could possibly secure a discretionary injunction under Section 105.
Property of Debtor
The stay does not prevent foreclosure of a preexisting lien against property of the debtor (which is not property of the estate as for example where exempted or abandoned) after a discharge is granted or denied. Section 524(a)(2) was amended by the Amendment Act in 1984 to delete the language "or from property of the debtor" which previously raised questions as to whether a lien could be foreclosed on any property of the debtor after the discharge. It is now clear that, even if personal liability is discharged, the lien remains effective unless otherwise cancelled in the bankruptcy. The automatic stay prevents a foreclosure of a preexisting lien or claim against property of the debtor (including exempt or abandoned property) until the case is closed or dismissed, or until the discharge is granted or denied. Therefore, the creditor should secure relief from the stay by court order authorizing foreclosure on property of the debtor prior to the discharge. For example, according to one view (not universally accepted) where the property was abandoned without a lifting of the stay, the second lienholder could attack the foreclosure by the first lienholder prior to discharge as being violative of the stay; the junior lienholder has standing to attack the foreclosure. The stay applies to property of the debtor in connection with prebankruptcy mortgage debt in a Chapter 12 or Chapter 13 proceeding after plan confirmation until the discharge is granted or denied. The automatic stay no longer applies to debt for support collected from property of the debtor once the debt is found to be nondischargeable. However, it has been held that the stay does not extend to a post-petition claim (e.g., condominium assessment and lien) against property revested in the Chapter 13 debtor by confirmation of a plan. According to one view, there is no automatic stay preventing foreclosure of a mortgage executed on property acquired by a Chapter 13 debtor after confirmation of the plan and with approval of the trustee, since the property was not estate property. Although some cases hold that the property remains subject to the stay after confirmation of the plan, "the competing policy focuses upon enabling the debtor to perform throughout the term of the plan without post-petition creditors depriving the debtor of the ability to perform by seizing property or wages. That competing policy, however, is implemented by the requirement that debtors obtain permission of the Chapter 13 trustee before any credit or loan is obtained... Additionally, if debtor wishes the ... protection of the automatic stay following confirmation, that protection may be obtained by ... so providing in the plan or confirmation order ..." However, competing lines of cases have emerged and reached conflicting views in Chapter 13 cases: the estate ceases after confirmation of the plan; the estate continues after confirmation of a plan and includes subsequently acquired property; all of the estate except property necessary to fund the Chapter 13 plan vests in the debtor upon confirmation; and only property of the estate at time of confirmation vests in the debtor and all subsequently acquired property is property of the estate. Consequently, according to one accepted view, property acquired by the debtor post-confirmation and prior to the closing, dismissal or conversion of the Chapter 13 case is property of the estate and subject to the automatic stay. One cannot safely assume the stay does not exist as to property in a Chapter 13 case (no matter when it was acquired), until the case is closed, dismissed or converted. Transfer of property to a spouse pursuant to a divorce decree violates the stay.
Motion to Lift or Annul Stay
It is possible for a creditor to file a motion in accordance with Section 362(d) to lift or annul the automatic stay. The creditor need not file an adversary proceeding. The Code and Bankruptcy Rules do not require notice to unsecured creditors of a motion to lift stay. Local rules often require that parties with inferior liens on the property be given notice but the Code and Bankruptcy Rules promulgated by the Supreme Court do not require notice to inferior lienholders.
If the court does not act within 30 days after the request for relief is filed, then the stay is terminated with respect to the movant unless the court extends the time for a hearing and orders the stay continued in the interim. The final hearing on a motion to lift stay must be concluded not later than 30 days after the conclusion of the preliminary hearing.
The Bankruptcy Reform Act of 1994 provides expedited lift of the stay in a single asset real estate case. Such case involves land having noncontingent liquidated secured debt of not more than $4,000,000. A creditor may secure relief from the stay unless the debtor files a plan with a reasonable possibility of confirmation within 90 days after the case commences or commences monthly payments to secured creditors.
Although local rules may require that an objection and request for hearing be filed within a much shorter deadline (e.g., 15 days after notice), you should verify that no objection or request for hearing is filed within 30 days. The stay continues for at least 30 days unless ordered otherwise, and the court may have authority under the local rules to extend the deadline for objections.
Company Policy: If more than 30 days have passed since the filing or delivery of notice of the motion for relief from the stay, you may rely upon a certified copy of the motion, a current docket sheet, a certificate of service and a clerk's certificate (or credible counsel's letter) that no objection or request for hearing was filed.
If the trustee or debtor-in-possession agrees to lift the stay, Rule 4001(d) provides that objections may be filed within 15 days of the mailing of notice unless the court fixed a different time. If no objection is filed, the court may enter an order approving or disapproving the agreement without conducting a hearing.
It is possible to annul a stay so that a prior foreclosure in violation of the stay can be ratified. The order annulling stay must be explicit; a lift of stay does not validate prior acts in violation of the stay.
Company Policy: Do not rely upon a motion annulling the stay unless you secure a court order.
One case (not universally accepted) has held that once relief from the stay has been granted, the mortgagee is entitled to foreclose. The stay is not reimposed by filing a new petition, the effect of the relief is res judicata even if granted by default.
It is the view of some that relief from the stay after confirmation of the Chapter 13 plan is inappropriate, and that the only relief available for substantial default to a creditor is dismissal of the case. We will rely upon a lifting of the stay if the appropriate procedure is followed and the order to lift stay is no longer appealable.
Lifting of the stay does not remove property from the estate. The property remains in the estate until removed by judicial process or abandonment.
A lift of the stay to foreclose does not lift the stay to confirm a foreclosure.
Types of Creditors (Governmental Charges and Taxes)
The stay provided by Section 362 applies to an "entity." The term "entity" includes a governmental unit. Sec. 101(15). The limited exemptions to the stay include commencement or continuation of criminal proceedings against a debtor and proceedings by a governmental unit to enforce its regulatory power. The stay will prohibit a levy upon property of the estate for state taxes if no leave of the bankruptcy court has been given.
According to one view, under prior law, post-petition real estate taxes, as to which prior liens are automatically perfected, were secured by a priority lien on estate property, and the stay did not prevent the attachment of the lien. According to a second view, real estate tax liens which attached after the filing were ineffective. Even if the stay prevented attachment of the tax lien during a bankruptcy, the tax lien automatically attached upon termination of the stay.
Pursuant to the Bankruptcy Reform Act of 1994, the stay does not prevent the creation or perfection of an ad valorem property tax lien by the District of Columbia or a political subdivision of a state, if the tax comes due after the filing of the bankruptcy.
The stay does not apply to a tax assessment or to a tax lien by reason of the assessment if the tax is not discharged and the property is transferred out of the estate to, or otherwise revests in, the debtor.
The post-petition filing of a municipal tax lien notice violates the stay. The Internal Revenue Service must seek relief from the stay before it can sell estate property upon which it had previously levied.
According to one case, the automatic stay does not prevent recordation of a state environmental "superlien" claim under Mass. Gen. Laws. Ann. Ch. 21E, § 13 (in Massachusetts, because of the provisions of §546(b), state law is generally applicable to cleanup and does not single out bankruptcy debtors; state law permits perfection by recording the claim; perfection is effective under state law against entities acquiring rights in the land before date of perfection; and §546(b) does not require that the lien "relate back" to a date before the bankruptcy, only that the lien be effective against third parties with prior rights in the land.
Fraudulent transfer actions brought in another court by the FDIC under the Comprehensive Crime Control Act of 1990 violate the automatic stay.
Section 362(b)(4) excepts from the stay actions by a governmental unit to enforce its police or regulatory power. This exception is applicable to a receivership brought by the state to protect the welfare of a nursing home's residents from debtor's improvident financial practices and not merely to protect the state's pecuniary interest. An action by a state agency to require the debtor to perform cleanup of an environmentally hazardous coal mining site is properly brought to prevent future harm and is not stayed even though it requires expenditure of money. The state may seek and secure an injunction against environmental violations and an entry, but not enforcement, of a money judgment for damages from the violation.Likewise, the United States may seek a money judgment for recovery of costs expended in cleanup of a hazardous waste site, but may not enforce the judgment. Furthermore, the trustee may not abandon burdensome contaminated property without adequate protection of the public health and safety if there is a showing of "imminent and identifiable harm" to the public health or safety because of abandonment.According to one view, the stay does not apply to a civil forfeiture action; the forfeiture action is excepted from the stay as an enforcement of police power. According to a contrary view, the automatic stay prevents the commencement or continuation of a (civil in rem) forfeiture action.
Company Policy: Do not insure a forfeiture if an owner has filed a bankruptcy proceeding unless you secure approval from our underwriting personnel.
Tolling of Claims by Debtor
The Section 362 stay will not toll the statute of limitations on a mechanic's lien claim held by the debtor; rather, the debtor will have the longer of the applicable state limitation period, or (if the claim was not barred at time the bankruptcy was filed) two years after the voluntary bankruptcy was filed to sue. Actions, such as foreclosure of liens against a debtor, may be filed within the period allowed by state law, or within 30 days after notice of termination of the stay as to the debtor, whichever is later.
Tolling of Action Against Debtor
If the time limit for commencement of a civil action on a claim against a debtor (or codebtor under Section 1301 or Section 1201) had not expired prior to the commencement of a case, then the period will expire on the later of the end of such period as originally calculated, or 30 days after the notice of the end of the stay order with respect to the claim. If a mechanic's lien law requires that suit be commenced within a specified time in order to protect the lien (a statute of duration as opposed to a statute of limitation), then Section 108 provisions are inapplicable: the creditor must file a suit (after lifting of the stay) or file a notice pursuant to Section 546(b). According to one view, Section 108(c) does not distinguish between statutes of duration and statutes of limitation: time for enforcement of liens subject to either statute is extended by Section 108(c).
Company Policy: Do not waive statutory or contractual liens on the basis of limitations statutes or passage of time during a bankruptcy of the landowner if the liens are effective at the time of the filing of the bankruptcy.
This section tolls for 60 days the time to appeal a tax foreclosure judgment.
Neither Section 108 nor Section 362 tolls the term of a subordination agreement between creditors of the debtor.
The I.R.S. is granted an additional sixty (60) days after the discharge, together with the time remaining at the filing of the bankruptcy, to make its tax assessments.
Post-Bankruptcy Filings and Subordination
The stay prevents the filing of liens after the bankruptcy commences (with exceptions such as mechanic's liens which could be valid against prior bona fide purchasers).
There are conflicting views on whether the stay prevents the post-bankruptcy filing of a sheriff's or trustee's deed based on a foreclosure conducted before the bankruptcy. It has been held by the minority of cases that the stay does not prevent the post-bankruptcy filing of a sheriff's or trustee's deed concerning a foreclosure conducted before the bankruptcy. However, the majority and better view is that the stay does prevent the filing of a sheriff's or trustee's foreclosure deed. Consistent with this latter view, the execution of a foreclosure deed after the commencement of the bankruptcy case pursuant to a sale conducted before the bankruptcy violates the automatic stay. According to one view, the rights of a purchaser at foreclosure are avoidable under Section 544 if the foreclosure deed is filed after the bankruptcy.
The automatic stay prevents a federal tax lien filed against the debtor before the order for relief from attaching to property inherited by the debtor within 180 days after the order for relief (and which became property of the estate).
Company Policy: Require a lifting of stay to file during the bankruptcy a sheriff's or trustee's deed executed before the bankruptcy.
A subordination to a lease by a lienholder will not violate the general stay after the stay is specifically lifted to allow foreclosure of the lien on the lessor's title. A lender may unilaterally subordinate its lien to a debtor's lease and thereby avoid violation of the automatic stay when it forecloses.
Suits Against Third Parties
The stay against suing a debtor will not prevent a plaintiff from taking action against the surety of the debtor on a supersedeas bond. Similarly, the stay created by an original contractor's bankruptcy will not prevent a subcontractor from proceeding against an owner to foreclose its mechanic's lien. The stay against codebtors under Sections 1201 and 1301 is irrelevant if the debts were incurred in the ordinary course of business. (The stay will not then apply to a codebtor.) The stay against codebtors will enjoin a foreclosure against the spouse of the debtor who joined in a deed of trust; a motion under Section 362 as to the debtor will not operate to lift this separate stay.
Suits by Debtor
There are conflicting cases as to whether the stay extends to actions brought by the debtor. The stay will not prevent a defense in litigation by a defendant sued by the debtor, but will prevent the filing of a counterclaim. However, the stay will not prevent a counterclaim against the bankruptcy trustee in an adversary proceeding in the bankruptcy court
The automatic stay prevents partition suits against the debtor.
Effect of Dismissal
The majority view is that the automatic stay terminates immediately upon dismissal of the bankruptcy case.When the case is dismissed, the automatic stay terminates immediately upon the docketing of the dismissal order. The stay then terminates, even if the property was not scheduled. If the order of dismissal is vacated, then the automatic stay is reimposed to the extent it was in effect at time of dismissal.
Mootness of Appeal from Order Lifting Stay
Where the debtor fails to secure a stay pending appeal of a bankruptcy court order lifting stay, the appeal is moot if the creditor (or third party) acquires title by foreclosure unless (1) the purchaser at foreclosure is not a good faith purchaser because the purchaser engages in fraud, collusion, or gross attempt to obtain an unfair advantage, or (2) [according to the Ninth Circuit] the property is sold to a creditor who is a party to the appeal if the sale is subject to statutory rights of redemption. However, according to another view, the appeal may be moot in the absence of a stay even if the secured creditor purchases at the foreclosure. Mootness of an appeal may be equitable (unwillingness of court to allow appeal) or constitutional (inability to alter outcome on appeal because of third party, such as third party bidder at foreclosure sale after stay lifted), where a lift of stay has been granted and the order has not been stayed pending appeal.
Company Policy: Do not rely upon a lift of stay that is being appealed.
Agreements to Lift Stay and Other Bankruptcy Clauses
According to one view, a stipulation in a settlement, workout, or forbearance contract agreeing not to oppose relief from the stay is enforceable; enforcement of the settlement agreement encourages out-of-court restructurings.
According to a second view, prepetition agreements to waive the automatic stay are not "per se" binding on the debtor. If the debtor signs a prepetition waiver, the debtor has the burden to demonstrate that the waiver should not be enforced. "Prepetition agreements waiving defenses to relief from stay may be considered as a circumstance in deciding whether relief from stay for cause should be granted." In contrast, self-executing clause in prepetition agreements providing that no stay arises or vacating a stay or prohibiting a bankruptcy are unenforceable.
According to a third view, a prepetition waiver of automatic stay is unenforceable, per se.
A waiver of the stay is not self-executing under the Bankruptcy Code; relief from the stay must be authorized by the bankruptcy court.
Perhaps the appropriate conclusion is that prepetition waivers of the stay may be enforceable in the bankruptcy court if the court finds other grounds to modify the stay. The agreement of the debtor cannot bind non-party creditors or a later trustee. "Although the issue of the prepetition waiver of bankruptcy rights most often arises in the context of stay litigation, what may be gleaned from these cases are certain general principles. Prepetition waivers are not invalid per se ". A prepetition waiver of bankruptcy benefits may be binding unless the agreement was obtained by coercion, fraud or mutual mistake of material fact ?. Nonetheless, such waivers are not self-executing and are not binding on third parties ?. Thus, if a waiver adversely affects other creditors, it is unlikely that the waiver will be enforced."
A prepetition waiver of dischargeability of debt is unenforceable.
No court has ever recognized a waiver of bankruptcy eligibility. The code provides that a waiver of a right to convert a Chapter 7 case to a Chapter 11, 12, or 13 case is unenforceable. The legislative history stated that "the explicit reference in title 11 forbidding the waiver of certain rights is not intended to imply that other rights, such as the right to file a voluntary bankruptcy case under Section 301, may be waived." Consequently, courts have assumed that agreements to waive the right to file a bankruptcy are unenforceable. Alternatives adopted by creditors have included:
- waiver of stay or agreement not to oppose relief from stay (most likely enforceable as to debtor in a workout with involvement of many creditors);
- creation of entity ineligible for relief under the Bankruptcy Code (rarely used, since such entity might be construed as an eligible business trust anyway);
- requirement of unanimous or super majority vote of shareholders or directors (which does not prevent an involuntary filing);
- stipulation that a voluntary bankruptcy filing would be in bad faith and that such bad faith is cause for dismissal (probably enforceable only in a workout);
- waiver of right to seek extension of exclusivity period or period to assume or reject a lease;
- springing guarantees or standby letters of credit; and
- prepackaged bankruptcy plan (with pre-bankruptcy votes from creditors to the plan of reorganization).
A last opportunity order with a conditional drop-dead or lift of stay and with a prohibition on refiling for 180 days is not binding in a later bankruptcy filing. A court may enter a drop-dead order in the same bankruptcy proceeding.
According to some cases, the Bankruptcy Code prohibition against enforcement of "default upon filing" clauses applies only during the bankruptcy proceeding and no longer applies once the proceeding is concluded.
Voidness v. Voidability of Stay Violation
There is no universally recognized rule as to whether a violation of the stay is a void or voidable action. One view, apparently the majority view, is that an action by a creditor in violation of the stay is void and is not validated upon dismissal of the bankruptcy. Another view is that actions in violation of the stay are voidable during the bankruptcy proceeding. If a state court order is void because it violates the stay, a subsequent nunc pro tunc will not validate the order. If the violation of the stay is viewed as voidable, such as by perfection of a judgment lien after the voluntary bankruptcy petition is filed, the debtor may object to the proof of claim as a secured claim and secure an order allowing the claim only as an unsecured claim.
According to one view, a lienholder does not have standing to challenge acts, such as a trustee's sale conducted in violation of the automatic stay. A third party (other than the debtor or trustee) may have standing to seek damages under 362(h) for violation of a stay (the court does not resolve this issue), but has no statutory standing to sue to invalidate a violation of the stay.
Company Policy: If any filing (such as a statutory lien perfection) violates the stay, require a release of the claim or an order invalidating the filing.
According to one view, conversion of a bankruptcy creates a new order for relief and stay, and compels the creditor to file a new motion for relief from the stay to proceed with its collateral. According to another view, court orders are not negated by the order of conversion. This latter approach, ruling that conversion does not operate as a new automatic stay, appears to be the more common approach.
The stay does not prevent the filing of an extension of a statutory lien, according to one view.
The Bankruptcy Reform Act of 1994 permits a filing during the bankruptcy to maintain or continue perfection of an interest (such as an extension or continuation by refiling of a lien) if the rights of a trustee are subject to such perfection.
A stipulation granting relief from stay was assignable (under California law) in the absence of prohibition on assignment. If a mortgagee is granted relief from the stay, the subsequent assignee of the mortgage may foreclose without securing a separate order. The most reasonable interpretation of an order lifting stay to allow foreclosure of a mortgage is that the lift of stay applies to the property and the mortgage, so that an assignee of the mortgage may foreclose.
Automatic Stay During Appeal Period
Effective December 1, 1999, an order granting a motion for relief from an automatic stay is stayed until the expiration of 10 days after the entry of the order, unless the court orders otherwise. An order confirming a Chapter 9 or 11 plan is stayed until the expiration of 10 days after the entry of the order, unless the court orders otherwise. An order authorizing the use, sale or lease of property is stayed until the expiration of 10 days after entry of the order, unless the court orders otherwise. An order authorizing the trustee to assign an executory contract or unexpired lease is stayed until the expiration of 10 days after the entry of the order, unless the court orders otherwise. These provisions are added to provide sufficient time for a party to request a stay pending appeal of an order. The stay does not affect the time for filing a notice of appeal. The court may, in its discretion, order that this stay is not applicable so that the order may be implemented, or may order that the stay is for a fixed period less than 10 days.
Damages for Violation of Stay
An individual injured by a willful violation of a stay may recover actual damages, including costs and attorneys' fees, and, in appropriate circumstances, may recover punitive damages. "Appropriate circumstances" warranting punitive damages have been construed as "bad faith," "reckless or callous disregard for the law or rights of others," or "egregious intentional misconduct on the violator's part."
Willful Violation of Stay
If a debtor appears at a foreclosure sale and informs the foreclosing lender that the debtor has filed a bankruptcy, the lender must, at a minimum, determine whether a bankruptcy has been filed, and if so, stop the sale.
Sale Of Property Out Of A Bankruptcy Case
If property has been properly abandoned by the estate, then a purchaser may rely upon a deed from the debtor (with any necessary corporate resolutions) without motion, notice, or order of sale.
Company Policy: If the debtor sells abandoned property while the bankruptcy is pending and receives cash proceeds (in excess of lien payoffs and closing costs), require joinder or consent by the trustee (after notice), or notice to the estate creditors (if the debtor is a debtor-in-possession), unless you secure approval from our underwriting personnel. The abandonment may otherwise be attacked.
Rule 4003 (b) specifies a 30-day limit after conclusion of the creditor's meetings to file objections to the scheduling of property as exempt. If no objections are made and the time to object is not extended, the property (or equity) which is scheduled as exempt is no longer part of the estate. A debtor generally does not need a court order to sell property once it is exempted in a Chapter 13 case. However, local rules may require court approval of the sale or refinance of a principal residence, even after confirmation.
Company Policy: If property has been fully exempted (not simply an equity interest) and set aside to the debtor, you may rely upon the evidence (scheduled as exemption without objection for 30 days after meeting of creditors is adjourned) that it is exempted and you may insure a deed from the debtor without further court order in a Chapter 7 or Chapter 11 case. In a Chapter 12 or Chapter 13 case also secure court approval unless you determine that the local rules do not require such approval. Also obtain approval of the trustee in a Chapter 12 or 13 case. If only an equity interest is exempted (e.g., portion of gross value), require that the remaining interest be abandoned. If only an equity is exempted and the remaining interest is abandoned, you may not insure the sale if the net proceeds to the debtor exceed the equity exemption unless you secure approval from our underwriting personnel.
Exempted property may not be sold by the trustee. However, the court may order sale of property if only a portion is exempt and the property cannot be divided.
Company Policy: If the trustee is offering to sell property in the estate of an individual debtor, verify that the property is not scheduled as exempt. If a debtor in a Chapter 12 proceeding schedules farmland as exempt, you should require court approval of the sale with notice to interested parties. The farmland is generally essential to the plan.
Procedure on Sale of Property in the Estate
The trustee will sell property of the estate in a Chapter 7 proceeding or, if qualified and appointed, in a Chapter 11 proceeding. A debtor-in-possession in a Chapter 11 proceeding will sell property of the estate, subject to limitations by court order. The debtor-in-possession will sell property of the estate in a Chapter 12 proceeding, subject to any limitations by court order, and subject to joinder by the trustee on sales free and clear of liens under Section 1206. The debtor will sell property other than in the ordinary course of business in a Chapter 13 proceeding.
Ordinary Course of Business
The debtor in a Chapter 13 proceeding (Section 1304), the debtor-in-possession (Section 1203) subject to any court limitations in a Chapter 12 proceeding, the trustee in a Chapter 7 proceeding (Section 721) if authorized, and the debtor-in-possession (Section 1107) (or trustee if appointed) subject to any court limitations in a Chapter 11 proceeding can sell real property in the ordinary course of business without notice or court order. An ordinary course of business sale of real estate is not plausible in a Chapter 12 or Chapter 13 proceeding.
Company Policy: Do not rely upon the provision authorizing sales in the ordinary course of business in a Chapter 12 or Chapter 13 proceeding without underwriter approval. It is possible in a Chapter 11 or a Chapter 7 proceeding to have a sale in the ordinary course of business. On a case-by-case basis, we will rely on a deed from the debtor-in-possession or trustee in a Chapter 11 or Chapter 7 proceeding if the schedules reflect a large inventory of real estate, if the transaction involves only a transfer of isolated lots or tracts of relatively small value, and if we secure an opinion of counsel for the debtor or a credible affidavit by the trustee or debtor that the particular transaction is in the ordinary course of business. In a Chapter 7 proceeding, the court must authorize a trustee to continue the business of the debtor in order for this provision to apply.
Not Ordinary Course of Business
Most sales of real estate will not be in the ordinary course of business. There may be sales where property is free and clear of liens. Sometimes, there are other co-tenants. There may be an adverse claim or claim to an equitable interest in the property, reflected by a suit and lis pendens. The trustee in a Chapter 7 proceeding, debtor-in-possession (or trustee if appointed) in a Chapter 11 proceeding subject to any court limitation, debtor-in-possession in a Chapter 12 proceeding subject to any court limitations, and the debtor in a Chapter 13 proceeding may sell real estate other than in the ordinary course of business. If the sale is to be made free and clear of liens and payment will not fully satisfy the liens, then the trustee (not simply the debtor) in a Chapter 12 proceeding should sell the property with the liens to attach to the proceeds. The sale must be "after notice and a hearing." The phrase "after notice and hearing" means that the trustee or debtor is to give notice in accordance with the Bankruptcy Rules and that no actual hearing or order is needed unless there is an objection and request for hearing. However, if the sale is made free and clear of liens, the rules appear to require that a hearing shall be held. According to one view, a trustee need not file a motion to sell free and clear of liens (or secure an order of sale) if the trustee provided proper notice of a proposed sale under Section 363(f) and no objections have been filed, notwithstanding rule 6004(c).
Where "notice and a hearing" are required, then the court may refuse to sign a "comfort order"; instead "a suitable procedure exists whereby a clerk's certificate for recording purposes may be obtained, which certifies that no objections or requests for hearing were filed."
A title company may have a duty to insure on a sale free and clear of tax liens if the sale complied with the Kansas Title Standards.
The trustee or debtor is not required to file a time-consuming adversary proceeding, except where the interest of a co-owner (such as a tenant by the entireties, if the land is not exempt) is also sold. In that case, an adversary proceeding must be filed against the co-owner. If the cotenant actually consents to the sale, an adversary proceeding is not required.
Section 363(h), which authorizes a sale free of the rights of a co-owner, does not apply retroactively to rights that had vested prior to the Code enactment (on November 6, 1978).
Company Policy: If the sale is free and clear of rights of a co-owner, require (1) proof of notice to the co-owner (in accordance with Rule 7004), (2) a specific final order requiring and determining necessity of partition by sale, (3) a notice to other interested parties of proposed sale. The complaint and notice of sale to all interested parties may be combined in the adversary proceeding. The law does not expressly allow a sale free and clear of liens against a cotenant.
The right to sell free and clear of other interests does not allow the estate of a partner to sell partnership assets. "Code Section 363(h) only authorizes the sale of interests in property held by tenants in common, joint tenants and tenants by the entirety. While the statute is silent as to tenants in partnership, it has generally been held that since a tenant in partnership is a well recognized form of tenancy, Congress would have included it among the tenancies expressly covered by the statute if that had been its intention. Thus the weight of authority is that a sale of an interest held by tenants in partnership is not authorized by Code Section 363(h)."
A perfected security interest in a debtor's option to purchase real estate does not attach to the title upon exercise of that option by the debtor and simultaneous resale by the debtor.
A settlement of claims can be resolved by sale of the estate claims pursuant to section 363, avoiding any required findings and conclusions of law.
The court may decline to authorize a sale free and clear of rights of a cotenant because economic, emotional, or psychological detriment to the cotenant outweighs benefit to the estate.
The trustee or debtor must, in a sale not in the ordinary course of business, give notice of the proposed sale. The notice must reflect the terms and conditions of the sale and the time fixed for filing objections. In lieu of the notice, the trustee or debtor may send a copy of the actual motion in accordance with local rules. The trustee or debtor must give notice of the proposed sale (in accordance with the local rules) not less than 20 days (and any additional time required by local rules) by mail to interested parties unless the court shortens the time for notice. The court also may order that the notices be mailed only to committees and to interested parties filing a request for notices. The court may not dispense with notice in connection with a sale not in the ordinary course of business.
The debtor may sell all or substantially all of assets of the estate under Section 363(b) if there are articulated business reasons. The notice to parties in interest should disclose that the sale will terminate the business, the terms of sale, name of Buyer, why the price is reasonable, and why a sale before confirmation is in the best interest of the estate. The court should also consider the good faith of the buyer.
According to one view, to sell free and clear of liens the sale must have reasonable promise of realizing excess value over the existing liens. At best this "rule" is ambiguous; it can be argued that the "value" of the liens cannot exceed the value of the property. The contrary view is that the sale must exceed the amount secured by the liens.
Notice of a sale free and clear of liens must be given in accordance with Rule 9014. For example, to sell free of an IRS lien, notice must be given to the United States Attorney for the district where the action is brought, the Attorney General, and the IRS, pursuant to Rule 7004(b)(5).
A sale free and clear of liens, claims and encumbrances does not sell free of non-monetary restrictions since the sale contract was subject to restrictions of record. A court may not authorize a sale free and clear of restrictive covenants. However if unrecorded restrictions are potentially avoidable under Section 544(a)(3) (because ineffective against a bona fide purchaser), then the debtor may sell free and clear of those restrictions because they are in "bona fide dispute."
Service on an insured depository institution in a contested matter (such as a sale free and clear of liens) or adversary proceeding must be made by certified mail addressed to an officer of the institution unless (1) the institution appeared by its attorney, in which case the attorney shall be served by first class mail; or (2) the court orders otherwise after service by certified mail of notice of an application to permit service on the institution by first class mail on an officer; or (3) the institution waives in writing its entitlement to service by certified mail by designating an officer to receive service.
Those liens as to which a sale can lawfully be made free and clear include federal tax liens.
If the bankruptcy court orders a sale free and clear of ad valorem taxes, the title company may secure reimbursement from the taxing authority for taxes paid to avoid forfeiture of the land.
A trustee may sell land free and clear of a HUD lien; however, Section 363 does not authorize a sale free and clear of the HUD regulatory agreement or HUD's related statutory interests relating to low income housing (restrictions on low-income use, limitation on prepayment unless a notice of intent and plan of action is filed allowing HUD to approve the buyer or approve removal of the land from the low-income housing project, as enacted in 1987).
The debtor may not sell free and clear of the interest of a lessee that remains in possession of the land after rejection by the debtor of the lease. The debtor may sell free and clear of a lease if it is in bona fide dispute (Section 363(f)(4)), according to one case. A debtor may not sell free and clear of an easement.
A sale free and clear of liens and other interests does not affect recorded restrictions that run with the land or easements that run with the land.
A debtor may not sell exempted property free and clear of liens or interests.
The sale free and clear of a tax lien may provide that payment of the tax lien will be made after payment of administrative expenses.
The ad valorem tax lien may be subordinate to payment of administrative expenses and deeds of trust in distribution of proceeds after a sale free and clear of liens.
If a lien creditor fails to object to the sale after notice, it may be deemed to "consent" to a sale free and clear of liens under Section 363(f).
Although Rule 6004 requires a hearing on a sale free and clear of liens, one view is that no hearing is required in the absence of objection to the sale.
Notice of a proposed sale is presumed received if mailed to the correct address. However, the presumption of receipt of properly mailed notice may be overcome by testimony of nonreceipt combined with standardized procedures of processing mail. Another view is that a certificate of or proof of custom of mailing raises a presumption that notice was properly mailed and received; that presumption can be overcome only by clear and convincing evidence that the mailing was not accomplished. Denial of receipt of mail does not rebut the presumption of proper notice; however, evidence that other creditors did not receive notice or that notice was not mailed will rebut the presumption.
A bankruptcy court may order a sale free and clear of a stated right to recapture depreciation on sale of a nursing facility.
Notice of a bankruptcy case is not sufficient notice of the determination of dischargeability to satisfy due process of law.
According to one view, if the lienholder is not notified of a sale free and clear of its lien, it may proceed with its foreclosure. According to another view, if a lienholder does not receive notice of a sale free and clear of its lien, a bona fide purchaser of a judicially approved sale takes title free and clear of all liens, at least where more than one (1) year has passed since the order. If a secured creditor (taxing authority) is not notified of a sale free and clear of liens where proceeds were paid to the mortgagee, the court may remedy the defective sale by invoking §105(a) to require the mortgagee to disgorge sufficient proceeds to pay the taxes. If adequate notice of sale is not given, the most common remedy is to set aside the sale or treat it as voidable, at the option of the person who failed to receive notice.
Failure of the debtor to give notice of proposed sale free and clear of liens to a party claiming ownership rights in a mortgage will not cause the sale to be ineffective if: (1) the creditor had actual knowledge of the sale; (2) the creditor failed to file a proof of claim; (3) the creditor failed to record an assignment of mortgage; and (4) the creditor failed to request notices in the bankruptcy case. A sale free and clear of a lien to a bona fide purchaser will not be set aside where the lienholder did not receive notice of the sale since the creditor knew of the case for two years and did not seek to set aside the sale until 3-1/2 months after it knew of the sale.
The notice of proposed sale must include the time and place of public sale, or the terms and conditions of a private sale, the time fixed for filing objections, and a general description of the property to be sold. A notice of sale does not comply with due process requirements or with Rule 2002(c)(1) (requiring notice of the terms and conditions of the sale) if it does not disclose that the creditor's lien will be divested. A notice stating that the "terms and conditions announced at time and place of sale shall supersede any inconsistent provisions of this notice or the motion filed" is not notice that a lien will be divested. A motion attaching a list of lienholders whose interests were to be divested that did not include the creditor is not sufficient notice. A notice of sale which failed to disclose that the bankruptcy court would determine priority of liens does not satisfy due process.
A notice sent to an attorney who represented the lienholder in another proceeding, but not in the bankruptcy proceeding sale, was not sufficient notice; the order of sale is void because of such notice.
If notice is not given to creditors, the order may be set aside within a reasonable time. The time to set aside is then not limited to one year.
Company Policy: If the sale is not made free and clear of liens, require a copy of the notice of sale, a certificate evidencing notice to all interested parties, and a copy of the docket sheet or a bankruptcy court clerk's certificate or a letter of attorney of the debtor showing that no objection or request for hearing has been filed on or before the date of the certificate (which should be dated at least 21 days after notice of the proposed sale, subject to any reasonable order shortening notice). If the sale involves all or substantially all of the assets of the estate in a Chapter 7, 11 or 12 proceeding, require notice of sale, a certificate of service, and a final court order approving the transfer.
If the sale is to be made free and clear of liens, require:
(i) the notice by the trustee or debtor-in-possession and order specifically describing the liens as to which the sale is free and clear;
(ii) recitation in the order that the lien(s) (which must be specifically described) attach(es) to the proceeds;
(iii) evidence that the lienholder was given notice (for example, by appearance of the creditor at the hearing, or satisfactory certificate of service);
(iv) a recited justification under section 363(f) in the court order to allow the sale free and clear, except in a Chapter 12 proceeding where the trustee joins. For example, search for recitation that the lien is in dispute (if so, the dispute must be specified) or that the lienholder consents, or that the sales price exceeds (the value of) all liens or that the sale involves only a portion of land covered by the lien;
(v) a court order authorizing the sale that is final as evidenced by a an attorney's letter or review of docket sheet;
(vi) verify the liens as to which the sale is free and clear are not ad valorem tax liens, or hazardous waste clean-up liens or other governmental assessments or charges (you should secure underwriter approval in such case);
(vii) determine that the sale is not to a party related to the debtor; and
(viii) verify that the property was not scheduled as exempt.
If you cannot secure these requirements, call our underwriting personnel.
A lien is in "dispute" if it is claimed that the lien is a preferential transfer.
A title company may be liable to the bankruptcy trustee for refusal to issue a title insurance policy free of exception to a tax lien, because of the Kansas Bar Association's Title Standards which supported reliance upon an order to sell free and clear of liens.
Bankruptcy Rule 7062 explicitly provided until December, 1999 that Federal Rule 62(a) (imposing a 10-day stay on execution sales) did not apply to court-authorized sales. A trustee or debtor was not required to wait ten days before completion of a sale, if no stay was secured. However, if a sale was consummated immediately on the heels of the order, this court left open the possibility that a subsequent stay could be sufficient to prevent the sale. Rule 62, F. R. Civ. P, which imposes a 10 day automatic stay against the effect of an order, applies to adversary proceedings as provided in Rule 7062. By Rule 9014, the automatic stay may be expressly imposed on other court orders. Rule 6004(g), effective December 1, 1999, provides that a court order authorizing the use, sale, or lease of property is stayed until the expiration of 10 days after entry of the order, unless the court orders otherwise.
It is generally stated that the sale becomes final and cannot be reversed on appeal if an order confirming the sale has been entered and the stay of the sale is not obtained. Two exceptions to the mootness rule are: (1) where real property is sold subject to a statutory right of redemption, and (2) where state law permits the transaction to be set aside. A court may reconsider a sale on appeal if (1) the buyer is not a good faith purchaser; (2) the contract makes finality a contingency; or (3) the buyer is also a creditor. The court must determine whether a buyer gave "value" to determine if the buyer acted in good faith. An appeal is not moot due to the lack of a stay if the trial court had not found that the purchaser acted in "good faith" or paid "value." "The requirement that a purchaser act in good faith speaks to the integrity of his conduct in the course of the sale. As noted in Abbotts, typical misconduct which would destroy a purchaser's good faith status would involve fraud, collusion between the purchaser and other bidders, or an attempt to take grossly unfair advantage of other bidders ?. [T]raditionally, courts have held that fair and equitable consideration is given in a bankruptcy sale when the purchaser pays 75% of the appraised value of the assets." A bidder that does not secure a stay of the sale may appeal on the issue of whether the successful bidder was a good-faith purchaser. Good faith speaks to the integrity of the buyer's conduct in the sale proceedings. Misconduct that would destroy good faith status involves fraud or collusion between the buyer and other bidders or the trustee, or an attempt to take grossly unfair advantage of other bidders. A minority of courts recognize as an exception to the mootness doctrine an appeal of an order of sale if the court is able to afford the appellant a "measure of effective relief" (to sales proceeds) that will not affect the "validity" of the sale to a good faith purchaser.
Mootness under Section 363(m) applies not only to a lease but also to an assignment of an existing lease.
A finding in the order approving sale that the sale "is being made in good faith" is not a finding that the buyer's behavior during the sale was in good faith; there was no inquiry as to whether the sale involved fraud or an attempt to take advantage of the other bidder.
A sale may be set aside within one year if the sales price was arrived at through bid rigging (or other fraud, error, or similar defects in equity affecting the validity of private transactions).
Another type of mootness is equitable mootness, now recognized by some courts. Equitable mootness holds that an appeal should be dismissed as moot if effective relief could be rendered, but implementation would be inequitable.
Determining whether an appeal of a confirmation order is moot requires a "fact-specific inquiry into the nature of the relief sought, and the effects that relief could have on the overall reorganization plan." Although the fact that a court can undo prior actions taken will not necessarily avoid mootness, it is relevant.
An appeal from a confirmation order is moot if significant steps have been taken since entry of the order to implement the plan (such as transfer of funds). Substantial consummation of a plan does not moot an appeal if (a) the court can order some effective relief; (b) relief will not affect reemergence of the debtor as a revitalized corporate entity; (c) relief will not unravel intricate transactions and create an unmanageable situation; (d) the parties adversely affected by a modification have notice of the appeal and an opportunity to participate in the proceedings; (e) the appellant pursued all available remedies to obtain a stay of the order. An appeal from an order confirming plan is not moot due to lack of a stay if the debtor has transferred land to a creditor pursuant to the plan. Only that transaction had been carried out; it was possible to fashion effective judicial relief and the parties to the transfer were also parties to the appeal so that the court could order the creditor to return the land. Substantial consummation of a plan will not necessarily moot an appeal if (1) the court can still order effective relief; (2) the relief will not affect the reemergence of a revitalized debtor; (3) the relief will not unravel complicated transactions; (4) the parties who would be adversely affected by a modification have notice of the appeal and an opportunity to participate; and (5) the appellant diligently pursued available remedies to secure a stay of the judgment. Since the asset sales already occurred and the proceeds had been distributed, effective relief could not be granted.
Company Policy: Unless you secure underwriting approval, do not rely upon section 363(m) which provides that the reversal or modification on appeal on a sale does not affect the validity of the sale to a purchaser in good faith even if the entity knew of the pending appeal unless the sale was stayed pending appeal. Without underwriter approval do not issue where there is a contest and pending appeal of the sale since the issue of "good faith" could be litigated. You can verify the order is final or is not being contested by reviewing the file, and by securing an attorney's letter as to the finality of the order.
After an order authorizing sale is final, it will not be set aside because of a substantially higher price unless the original price is so grossly inadequate so as to shock the conscience of the court. A final order may be set aside because of an extreme abuse of discretion, fraud, mistake, or like infirmity. Usually, the failure timely to appeal an order of sale prevents an attack in a collateral proceeding, but in light of cases allowing vacations of judgment, this rule is not unqualified.
Section 363(n) allows the trustee to avoid a sale if the price was contracted by agreement among potential bidders. This provision applies to bidders at public auction or private sale. An agreement between two parties that one will not bid and the other will bid a specified amount may constitute collusive bidding, for which the trustee can avoid the sale or seek damages. A sale to an insider is not, per se, a sale in bad faith.
Company Policy: Do not insure a bankruptcy sale if you know the land will be transferred immediately at a higher price unless the debtor-in-possession or trustee consents to the transfer.
If a sale is made free and clear of a lien or liens, the lien creditor may bid at the sale (and offset its debt) unless the court orders otherwise.
If a sale of community property or of a co-owner's interest or free of dower or courtesy rights occurs, the debtor's nondebtor spouse (provided there is no joint filing) and any co-owner have a right of first refusal before consummation of the sale.
Company Policy: Review the docket sheet to verify that the right of first refusal of the non-debtor spouse or other co-owner was not asserted.
If the sale is made free of a co-owner's interest, the order may specify the time and manner of exercise of the right.
It remains unclear whether the court can order a sale free and clear of liens of a co-tenant.
Company Policy: Require releases of all liens if the court orders a sale free and clear of liens against co-tenants.
Exempted property may not be sold free of interests pursuant to Section 363(f) since it is not property of the estate.
In an involuntary case, the debtor may continue to operate the business and use, acquire, or dispose of property as if the involuntary case had not been filed, unless the court orders otherwise and until an order for relief is granted.
Company Policy: Because of concern over possible fraudulent conveyances, we will require a final order of the bankruptcy court authorizing a sale after an involuntary proceeding is commenced and before the order for relief is granted.
Contracts And Assignments Of Leases In Bankruptcy
Assumption or Rejection
In a Chapter 7 proceeding, if the trustee does not assume or reject an executory contract or lease within 60 days as extended by the court, the contract or lease is deemed rejected. The lease automatically terminates at the end of the 60 days, unless the time for assumption or rejection is extended; that period may not be extended on motion filed after it expired for excusable neglect. The time for assumption is not extended by conversion of a case from a Chapter 7 case to a Chapter 13 case. An approval of a "sale" of the lease within the required time will comply with the requirement of assumption of the lease. In a Chapter 11, 12, or 13 proceeding, the trustee or debtor may assume or reject the contract or lease as to residential realty before confirmation of the plan unless the court shortens or lengthens the time. In a Chapter 11, 12, or 13 proceeding, the trustee or debtor must assume or reject an unexpired lease of other property within 60 days as extended by the court or the lease is deemed rejected. A lessor can waive the time limit and protection of Section 365 on assumption times. The trustee or debtor may assign an executory contract or unexpired lease of the estate if the trustee or debtor assumes the contract or lease and provides adequate assurances of the performance of the contract or lease. The proposed assignment is offered by motion practice.
Company Policy: Always require a specific court order authorizing the assignment, proof of notice to the lessor, letter from counsel and/or review of docket sheet evidencing that the order is final (30 days since entry), and a letter by the lessor consenting to the transaction and certifying that there is no default.
Bankruptcy termination lease clauses (types of "ipso facto" clauses) are not enforceable in a bankruptcy. Leases may be assigned in a bankruptcy though the lease and applicable state or local law prohibit same, since the prohibitions or assignment under Section 365 prohibit assignment only of nondelegable personal services contracts. The debtor may assign a lease notwithstanding provisions "that are so restrictive that they constitute de facto anti-assignment provisions." Mootness absent a stay pending appeal will apply not only to a lease, but also to an assignment of an existing lease.
If a contract to sell land is rejected by the seller (as debtor) in the bankruptcy proceeding, then a purchaser in possession may remain in possession and continue to pay under the contract. If a purchaser is not in possession under an executory contract, then the purchaser shall have a lien on the property for the amount of the price paid. This lien is subordinate to other secured claims, whenever created. According to some cases, an installment land contract is not an executory contract if the vendor retains legal title as security for the amounts owed and if the vendor has placed the deed in escrow prior to the bankruptcy. An installment sale contract is not an executory contract if the only remaining obligation of the vendor is to deliver legal title upon completion of payments. Once a lessee has exercised a purchase option, the lessee is a purchaser in possession who may remain in possession and pay the purchase price. Of course, if the contract is not of record, then it can be avoided entirely as a secured claim, since the trustee is treated as a bona fide purchaser. According to one view, an option to purchase real estate can be an executory contract subject to rejection. According to another perspective, a right of first refusal or option is not an executory contract subject to rejection unless exercised, but closing has not taken place when the bankruptcy was filed. Even if treated as an executory contract, some cases hold that the rights of an optionee (or person with a right of first refusal) are not terminated or canceled by rejection; rejection simply avoids treatment of damages as administrative expense. Prior to exercise of the option to purchase, the option is not an executory contract subject to rejection; rather it is an executed unilateral contract, and can be assigned by the debtor without having been assumed by the debtor. Rejection of a lease does not constitute rejection of an option to purchase in the lease, at least where the option has been previously exercised.
An issue under prior law involving rejection by a debtor landlord was whether the tenant in possession continued to retain a leasehold estate (that could be assigned, sublet, or mortgaged) or whether the tenant's right of possession after rejection was a personal right that could not be assigned. One case held that the tenant's right was then a nonassignable personal right of possession.
According to one view under prior law, a lessee remained in constructive possession through a sub-lessee so that the lessee retained its rights after rejection by the debtor-lessor.
Under current law, if a trustee or debtor in possession as lessor rejects a lease and the term of the lease has commenced, the lessee may retain its rights under the lease (including rights of subletting, assignment, or mortgaging). The rejection of the lease in a shopping center does not affect the enforceability of provisions relating to radius, location, use, exclusivity, tenant mix or balance. The "lessee" rights extend to a successor, assign, or mortgagee permitted under the lease.
If the lessee remains in possession after rejection by the debtor of the executory lease, the debtor may not sell free and clear of the lease under Section 363.
According to one view, if a lessee (as debtor) rejects the contract or if the lease is deemed rejected by failure to assume the lease, then the lease is terminated as of the date of the Bankruptcy filing as to all parties, including Leasehold mortgagees. The fact that the lease requires notice of breach or allows the debtor or leasehold mortgagee to cure defaults is irrelevant; no default has occurred by the Bankruptcy rejection of lease. However, the more persuasive view is that rejection does not cause the lease to terminate. While it means that the estate will not perform the obligations, the lease does not then automatically cancel or dissolve. This view is consistent with the interpretation that rejection of an executory contract does not invalidate, repeal, or avoid an executory contract. According to this more widely accepted view, rejection of a lease or contract does not terminate the agreement; it results in a deemed breach. It does not result in an implied forfeiture of the rights of a third party to the lease. Because rejection does not terminate the lease, the lease then revests in the debtor. However, under the contrary view, the rejection terminates the lease with respect to the debtor, and with respect to a non-debtor (such as a sub-lessee); the lease exists only if explicitly mentioned therein or under non-bankruptcy law.
Because of the historic uncertainty of the effect of rejection by a debtor-lessor or debtor-lessee, a mortgagee of a leasehold estate may pursue several approaches: (1) to address a possible rejection by a debtor-lessor, (seemingly addressed by the law in 1994) the leasehold mortgagee may require a mortgage of the lessor's fee interest to secure performance of the lessor's obligations under the lease; (2) to anticipate a possible rejection by a debtor-lessee (mortgagor), the mortgagee may require an option from the lessor to enter a new lease (subject to issues relating to title companies if the option is insured, such as rejection by the lessor, separate option consideration, the prior lease, defense or litigation costs, and rule against perpetuities).
A lease may not be subject to rejection if it is in substance closer to a sale.
The condominium declaration and covenants, such as assessment obligations, may not be rejected as executory contracts by a condominium unit owner. Rejection would effect a severance of ownership interests prohibited by state law. A severance would be impossible as long as the owner retained the unit, since by such ownership the owner would receive the benefits of maintenance provided by the Association. Restrictive land covenants are not subject to rejection as an executory contract. The assessment fee for a membership association relating to the debtor's unit that is due and payable after the order for relief is not dischargeable if the debtor physically occupies the unit or rents to a tenant.
A right of first refusal in a Declaration of Restrictions was held to be an executory contract. It was deemed rejected 60 days after the conversion to a Chapter 7 proceeding, since time to assume or reject was not extended. The sale was free of the right of first refusal since it was rejected; there was no lien for damages due to the rejection since no consideration was paid for the right.
It has been previously held that time share rights which did not specify a certain period for occupancy were not leases entitled to protection. The owners of these rights interests were not treated as lessees in possession. As a result, they were unsecured creditors if the declarant filed a bankruptcy. These rights also did not amount to a sale contract allowing the purchaser protection. The Bankruptcy Code was amended in 1984 to allow parties who are purchasing a time share interest (minimum of three years) for a specific period of time less than a full year but not necessarily for consecutive years to remain in possession of their interest. A contract to sell may be an executory contract subject to rejection even though there are material obligations outstanding on the part of only one of the parties (the seller) to the contract. In determining whether a contract is executory, the court may consider the benefits of assumption and rejection for the estate (this is the "functional approach", as opposed to the "Countryman approach", which requires unperformed material obligations on both sides). Although Section 365 does not contain a statutory mootness provision, the mootness doctrine will be applied to an assignment, absent a stay or unless the reversal or modification on appeal will affect the validity of the transfer.
Among the dangers of a recharacterization of a sale-leaseback as mortgage financing are: lengthened time for recovery of the land, lack of waiver of right of redemption, usury claims, and lack of other covenants regarding default. The dangers of recharacterization as a joint venture would include: subordination to other creditors, liability for the lessee's business debts, and reduction of claim to unsecured status.
If a sale-leaseback has sufficient unusual features, it may be treated as a joint venture or subordinated financing in a bankruptcy and the "Lessor" may not be entitled to receive rent during such proceeding. Unusual features to be considered include prior negotiations for a partnership interest as opposed to a sale, purchase price not related to the value of the land (but related to other costs such as renovation costs and working capital needs), unusually long lease terms or renewal term (e.g., 165 years), no fixed rent during the term of the agreement (except for percentage rentals based on gross revenue increases), a right to prepay the Landlord's "investment" (at which time the Lessor would share solely in profits), agreement to subordinate to all future mortgages, condemnation awards in some ratio other than the relative value of the land and building or other than the unexpired portion of lease term, an option to become an equity partner, a right of Lessor to share in proceeds of Lessee financing, and rights of first refusal to purchase. On later appeal, In re PCH Associates, 949 F.2d 585 (2nd Cir. 1991) held that the transaction shall be recharacterized as a loan and equitable mortgage: it provided a fixed rate of return on funds advanced; the amount advanced was subject to reduction or payoff; and there was a right to acquire the land upon default. The court held that the following controls were consistent with a loan: access to books and required accounting procedures; cooperation in disposition of insurance proceeds; veto power over architect, engineer and contractor if costs exceeded $500,000; consent required to sale and right of first refusal; right to step in and perform acts the borrower failed to do. The "lender" could not make policy decisions or control operational management.
Of key importance in analyzing whether a lease with an option to purchase may be recharacterized as a loan are whether the option price is the fair market value (or, in the alternative, nominal) and whether the Lessor may take control of the property at the end of the lease (or, in the alternative, whether the Lessee may control or force a sale). If the tenant is not obligated to become owner of the land a the end of the lease, and if the option purchase price is the fair market value at the time of exercise of the option, this suggests that the transaction is not a loan.
A synthetic (structured) lease is a financing vehicle that provides off-balance sheet financing for a sponsor. Credit support for the debt is issued by a special purpose entity or multiproperty substantive lessor. The financing is structured to treat the payment obligations of the sponsor as operating lease rental (instead of debt), while giving the lessee the tax benefits of owning the project and the potential appreciation. The synthetic lease provides off-balance sheet treatment for the sponsor to (1) show less debt on the balance sheet (although the footnotes will disclose lease obligations), (2) avoid covenants in credit agreements (limiting amount of debt, etc.), and (3) show less total assets on the balance sheet, thus increasing return on assets and equity. The lease will often indicate that it is intended to provide a financing mechanism. If new construction occurs, the "lessee" is typically named as a construction agent for the "lessor." The rent will equal debt service and a return on the equity investment. It may be tied to LIBOR (a commercial paper index). The transaction must comply with the Statement of Financial Accounting Standards (SFAS) No. 13 by the Financial Accounting Standards Board (FASB) to be treated as off-balance sheet accounting: (1) no automatic transfer to lessee at end of lease, (2) option to buy cannot be bargain price, (3) term of lease cannot be 75 years or more of economic useful life of land, (4) present value of minimum rents must be less than 90% of fair market value of land at beginning of lease. If lessee previously owned the land, the lessee cannot have continued involvement (under SFAS 98); to avoid this, the lessee may structure a synthetic lease for the improvements and continue to show the land in its balance sheets.
"Typically a bank establishes an SPE (special purpose entity) with the stated purpose of acquiring property to be leased by the corporation. The SPE, which uses what is essentially a mortgage loan from the bank to buy the property, has no economic independence or control over the real estate it "owns.' Under certain circumstances, it may even be a passive trust. The SPE signs an operating lease with the corporation that will be using the property and the lease payments go to pay off the loan to the bank which books the transaction as a corporate loan to the lessee, not as a mortgage to the SPE. Result: one real estate loan fewer on the bank's books.... These transactions employ a broad variety of financing, bearing such colorful names as "synthetic leases,' ?full benefit leases,' and TROLs (tax retention operating leases). Regardless of the name, the objective is to park assets off the bank's and lessee's books while letting income flow back to the lender.... Upon completion of the lease, the tenant must purchase the real estate at a set price or find another buyer. If the buyer won't pay as much as stipulated, the tenant makes deficiency payments to raise the amount to the agreed upon level. The loan and the lease are both relatively short-term--three to five years....But the bank's and the tenant's burden of responsibility for the real estate is as great off the balance sheet as it would be on the balance sheet."
A synthetic lease will be treated as a financing vehicle, so that the special purpose entity, which took "title," will not be treated as a buyer or owner in determining whether each transfer violated limits on authority to transfer ownership.
A significant factor in determining whether the sale-leasehold is in reality a loan is whether the rent reflects fair rental value or simply amortizes the investment and provides a rate of return on the investment.
In the case of Fox v. Peck Iron and Metal Co. Inc., 25 B.R. 674, 9 B.C.D. 1154 (Bankr. S.D. Cal. 1982), certain key factors led to recharacterization: (1) the assets transferred were worth at least twice as much as the purchase price; and (2) the repurchase terms allowed resale to the lessee for the original price (not later value); and (3) the term of the Lease was unrealistically short in duration (three years); and (4) the original purchase price was substantially less than fair market value; and (5) the lessor-purchaser had the right to force the seller to repurchase. The court did recognize the Deed to be sufficient as a mortgage.
In the case of Matters of Kassuba, 562 F.2d 511 (7th Cir. 1977), the transaction was held to be a bona fide sale and leaseback with option to repurchase. Key factors in the court analysis were: the lessee's acknowledgment that it was sophisticated in real estate, the parties' intentional structure of the transaction to avoid foreclosure, and the expressed intent to have a sale.
The case of In re 207 Montgomery Street, Inc., 160 B.R. 181 (Bankr. M.D. Ala. 1993) analyzed the debtor-lessee's claim that its lease was a disguised security arrangement that should be construed as a sale and mortgage (in order to propose a plan inconsistent with the lease). The historical preservation authority had purchased the land, leased to the debtor whose rent equaled monthly payments, given the debtor an option to purchase for $1,000 and rent due, and required the debtor to pay maintenance and other costs. The court held the transaction was a lease, recognizing the adverse impact on similar transactions if it ruled differently.
Factors in determining whether a conveyance created an equitable mortgage include (1) intentions of the parties; (2) adequacy of consideration; (3) retention of possession by the grantor; and (4) satisfaction or survival of the debt.
A lease which provides for "installment" payments and reflects amortization of the purchase price over 18 years at 8% interest, and states that installments will be applied to the purchase until a deed is executed, will be treated as a mortgage.
The court in the case of In re Omne Partners II, 67 B.R. 793 (Bankr. D.N.H. 1986), upheld the lease. It stressed the refusal of the purchaser to make a loan and the sophistication of the parties who understood the transaction. Since the intent was not disputed, the economic substance of the transaction was irrelevant. The intent, for example, was evidenced by an opinion of counsel for the seller that the buyer would receive good title from the seller.
A sale-leaseback is a financing scheme if the lease payments are calculated to retire bond debt, the lessee must pay rental even if the property is destroyed, and the lessee has the option to repurchase at the end of the lease for a nominal sum. A sale-leaseback from a financially beleaguered homeowner with an option to re-purchase is likely to be viewed as a finance transaction.
A transaction would not be subordinated to other creditors where the lender acquired the land from the borrower and leased it back, received a conversion option to convert to an equity ownership in the project, received a shared appreciation mortgage, received 50% of cash flow, gave an option to the borrower to repurchase the land at fair market value, and received the option to convert the loan to a 60% interest in the borrower. The lender actually did not overreach: it consented to all leases, it did not select management, it did not exercise its conversion option, and it did not otherwise virtually control the borrower. The fact that the loan provided "Kickers" to the lender does not itself amount to inequitable conduct that amount to fraud or overreaching. Its access to records, annual financial statements, approval of rental leases and additional financing are simply prudent acts.
A loan may be recharacterized as a capital contribution under the doctrine of equitable subordination, if the "borrower" is undercapitalized and if the lender exercises control (directly or through tiers of ownership) of the borrower. A "lender" may exercise control de facto (actual exercise of managerial discretion) or de jure (structural analysis of the borrower).
Where the debtor owned land and then sold, took back a lease and a repurchase option (redemptive agreement), "not only was the recording of the collateral leasehold mortgage prior in time to the recording of the federal tax liens (against the debtor), but given the purely financing or pignorative nature of the arrangement and the absence of surrender by the Debtor of possession and ownership, the collateral mortgage became effective against all foundry property not upon exercise of the repurchase agreement but from the very beginning (ab initio) ?. [B]ecause the repurchase option had been collaterally assigned to the Ross Group as mortgagee and remained thus assigned as of the time of its exercise - the redemption by Debtor would have to be deemed to be for the benefit of the assignee of that option, i.e., the Ross Group, as mortgagee."
Company Policy: If you are asked to insure on a sale-leaseback, call our underwriting personnel. Key factors in whether the transaction could possibly be recharacterized as a loan or joint venture include:
(1) the lease should recite that the relationship is not a loan or joint venture.
(2) review of documents reflecting no excessive control of the lessee by the purchaser (e.g,. Control of annual budgets and leases; at worst any controls should be passive review);
(3) the term of the lease should not be excessive (e.g., 165 years) or oppressively short (e.g., 3 years);
(4) the original purchase price for the land and the rental payments should approximate fair market value (not be the original sales price) (evidence by estoppel letter and appraisals if possible);
(5) any repurchase price should approximate fair market value upon exercise (not be nominal or approximate required rental payments);
(6) the purchaser lessor cannot have the power to force or "put" a repurchase;
(7) the lease must not contain "loan terms" or words, such as "amortize," "interest," "loan," "debt," or "debt service." Rental should not be based solely on profitability;
(8) the seller may not have originally applied to the purchaser - lessor for a loan;
(9) if the lessee has no personal liability for rent and if rent is based on a portion of net profits, this may evidence a partnership;
(10) agreement to subordinate to all mortgages may evidence a partnership;
(11) nominal or below fair market value rent indicates financing;
(12) expressions of intent that the transaction is not a finance transaction indicate a true lease. Some cases emphasize intent. "[S]o long as the lessor retains significant and genuine attributes of the traditional lessor status, the form of the transaction adopted by the parties governs for tax purposes.";
(13) prior negotiations of the parties for a loan (for example, a loan default may have precipitated the transaction);
(14) right of tenant to sell fee indicates financing; and
(15) short-term lease generally indicate financing.
Consequences of recharacterizations as financing include no deduction of depreciation by lessor, no business deduction by lessor, seller cannot deduct rent-just "interest," seller cannot recognize loss on sale, less stringent cure obligations in bankruptcy, payments to lessor may be usurious, and lessor must foreclose judicially.
Equity kicker loans also may be recharacterized as joint ventures or partnerships. Factors considered include the following:
(1) control. The right to direct daily operations, to approve all tenants, to join in execution or negotiations, to exercise operating control if key individuals leave the borrower, power to approve operating budget, veto over a sale or refinance, and approval of change in operations may evidence a partner's control. Review of annual operating statements, (veto) right to disapprove tenants, approval of standard form lease, and approval of management company do not evidence excessive control. Where possible, approval should be passive (veto). Examples of matters that should not be excessive controls are periodic access to the borrower's records, cooperation in disposition of insurance proceeds, reasonable veto powers over selection of contractors, right to approve lease standards, required consent before the borrower can sell its interest, right of the lender to cure covenant violations by the borrower. The lender should not exercise control of daily operations and management. Such control may be evidenced by a requirement of approval by the lender [other that passive (e.g., veto)], review of operating budgets or change in operations, by approval of all leases, by lender member on board or in management, or by right of the lender to set salaries or prices or costs, absent a default by the borrower. Lender selection of design plans and contractors may be viewed as indicative of a joint venture, but review and waiver should be acceptable. Veto, consultation or disapproval powers should be viewed more favorably than affirmative approval requirements.
(2) liability. While lack of personal liability may evidence lack of a loan, this is a common loan attribute. However, the loan must be repayable regardless of profitability.
(3) share of profits. An excessive share of profits (e.g. over 50%) may indicate an ownership position. A share of gross proceeds, rather than net profits, is more indicative of a loan. Sharing in net profits as interest on a loan without control will not constitute a partnership under state partnership law.
(4) disclaimer. The loan agreement should disclaim a joint venture.
(5) state law. State laws (e.g., Cal. Civil code § 1917 et. seq.) Must be reviewed.
(6) term of loan. If excessive or if only due on sale, it may indicate a joint venture.
(7) profits after repayment. A right to profits after payment of the loan may evidence a partnership interest.
(8) open ended subordination clause. This may evidence a joint venture.
(9) option to purchase. The option itself may be considered a clogging of the equity of redemption, particularly if exercisable on default.
(10) share in losses by lessor. This indicates a joint venture. If payments to a lessor are contingent on profit, this indicates sharing in losses.
(11) maturity date. The transaction should have a fixed and ascertainable maturity date (acceleration provisions should be okay). If not, the transaction may be viewed as a joint venture.
(12) unwind. A right by the borrower (an unwind mechanism) to defeat or repurchase an option indicates a financing transaction.
(13) extended payment. Substantial and extended periods provided in the documents for nonpayment and deferral may indicate a joint venture.
(14) undercapitalization. Undercapitalization may indicate a joint venture, such as where the lender finances all costs, but the lender then has a conversion option to convert the loan to equity in the borrower.
Possible issues in options (or first refusals) for the benefit of the lender ["Once a mortgage, always a mortgage"]:
- Is separate and independent consideration paid for the option? If so, it
is less likely to be viewed as a clog, particularly if the option is not tied
to fair market value.
- Is the option price based upon fair market value? If so, it is less likely
to be viewed as a clog.
- Is the option exercisable upon default? If so, it is likely a clog.
- Can the borrower defeat the option (by buyout)? If so, it is unlikely to be a clog. A waiver of redemption at the time of the mortgage is a clog.
Examples of statutes:
- Va. Code Ann. Section 55-57.2. Notwithstanding any rule of "fettering"
or "clogging the equity of redemption" or "claiming a collateral advantage,"
a mortgagee may acquire a direct or indirect present or future ownership interest
in collateral (except one-to-four family loans to individuals), including
income, proceeds, or increase in value. An option granted to a mortgagee is
effective and takes priority from recording of the option or memorandum if
the right to exercise is not dependent upon occurrence of a default.
- Cal. Civ. Code Section 2906. An option granted to a secured party to acquire
an interest in collateral takes priority from recording and is effective if
the right to exercise the option is not contingent upon the occurrence of
a default under the security agreement and if the land is not one-to-four
family residential land.
- 42 Okla. St. Section 11. All contracts in restraint of the right of redemption
from a lien are void.
- Cal. Civ. Code Section 1917 et. seq. (relating to shared appreciation loans,
not one-to-four family). At section 1917.001, the relationship is not as partners
or joint venturers.
- Tenn. Code Section 47-24-101 to 102 (relating to equity participation over
$500,000). At Section 47-24-102 the lender is not deemed a partner or joint
- N.Y. Gen. Obligations Law Section 5-334. Option by mortgagee to acquire
an interest in the borrower or land is not invalid if the exercise is not
dependent on default under the loan and the loan is $2.5 million or more.
- Revised Limited Partnership Act. Except as otherwise provided by the partnership
agreement, a partner may lend money to and transact other business with the
limited partnership and, subject to other applicable law, has the same rights
and obligations with respect to those matters as a person who is not a partner
- Section 40 UPA. Distribution first to creditors and other than partners.
According to one view, an escrow of a deed in lieu of foreclosure made after default in the loans and pursuant to an agreement to deliver the deed to the lender after subsequent default is not viewed as a clog, since it is secured subsequent to the creation of the mortgage. According to another view, an escrow of a deed in lieu of foreclosure made after default in loans and pursuant to an agreement to deliver the deed to a lender upon subsequent default is a mortgage and must be foreclosed. A deed in lieu of foreclosure may be an equitable mortgage if the parties intend for it to secure a continuing debt. An option granted to a mortgagee at the time the loan was made allowing exercise upon default under the loan is an unenforceable forfeiture, clog or fetter of the equity of redemption.
Section 306.101, Texas Finance Code (certain options are not additional interest for usury calculations on qualified commercial loans).
Deeds in escrow as provided in a confirmed plan have been upheld in subsequent bankruptcies.
A mortgage with an "equity sweetener" (e.g., transfer of some stock in borrower) will not be a basis for treating the transaction as an equity participation rather than a secured loan (and then subordinated to other creditors) if most loan participants had no prior contact with the borrower and were not insiders and if the equity given is not overreaching (in case at hand corporation had negative net worth).
An equity participation option agreement (to acquire a 1/3 interest in the building instead of principal payment) granted as part of a loan cannot separately be rejected as an executory contract while the remaining benefits of the loan are retained. In any case, the option granted as part of a loan apparently is not an executory contract that can be rejected.
A deed absolute coupled with a repurchase option will be recharacterized as a mortgage when so intended by the parties. Intent that the transaction be a mortgage is lacking if the "purchaser" never discussed the prospect of making a loan and if the purchaser paid fair market value.
Absent an affirmative endorsement to the title insurance policy, a claim of recharacterization should not be covered by the policy. "When requested to indemnify or defend against a recharacterization of a sale leaseback transaction, a title insurer's first defense is that Exclusion 3(a) of the ALTA policy excludes coverage for matters "created, suffered, assumed or agreed to by the insured claimant." If the insured's intent was that the sale leaseback transaction did not create a sale and a lease, the insurer should be excused from its policy obligations under Exclusion 3(a)."
Liens Executed By Bankruptcy Estate
The debtor or trustee can obtain credit and execute a mortgage or lien on property which is either an inferior mortgage or a new mortgage prior to any outstanding liens after notice and a hearing. In order to secure first lien financing on encumbered land, the debtor must establish that:
- the prior lender whose lien is subordinated to the new financing is adequately protected and
- the debtor has made every effort to seek financial assistance by other means.
Adequate protection may be shown by an equity cushion, a third party guaranty, or substitute collateral. Not every available lending institution need be contacted but several attempts apparently must be made to establish unavailability of other financing.
The court cannot dispense with notice; some notice and opportunity for hearing must be furnished.
Cross-collaterization (securing of prepetition and post-petition debts) is viewed with disfavor, since it is not expressly permitted under Section 364. According to one view, cross-collaterization of prepetition debt on additional collateral may be reviewed on appeal, even in the absence of a stay since not authorized by the Code.
An appeal from an order to create a superpriority lien is not moot due to lack of stay pending appeal, if the new loan has not been fully disbursed.
If the court order so provides, a super priority lien (or other lien) granted by the bankruptcy court does not have to be perfected under state law.
Company Policy: Review the docket sheet, where possible, if the debtor is selling or mortgaging land, to verify no other order created a lien on the land.
Unless otherwise provided, the grant of a mortgage in a bankruptcy proceeding remains subject to the automatic stay until later lifted.
Company Policy: Require a copy of the notice and motion, order and certificate of service by the creditors secured by current liens on the property if the new lien is to have priority. The order from the bankruptcy court must be final. It must authorize the execution of the mortgage, and must contain specific provision for adequate protection of the current lienholders (due to other collateral, or pay-down of loan) if the new lien is to have priority over current liens. The lien must secure only new advances and will not be insurable to the extent it is to have priority over tax liens or government assessments. Except to the effect of the automatic stay on enforcement or foreclosure of the mortgage unless the order allows foreclosure without conditions.
Local Rules also may require a debtor in a Chapter 13 case to obtain court order or trustee approval of consumer debt, including a refinance of real property debt. Local Rules may require a modification of plan to incur debt in a Chapter 13 case. Local Rules may require court approval of a sale or refinancing of the debtor's principal residence, even after confirmation.
According to one case, a pre-petition mortgage securing advances made after the filing of the bankruptcy petition to the debtor's corporation is not avoidable under Sections 549, 364, or 365, even absent court approval. Post-petition drawing upon a future advances clause in a note and deed of trust is an unauthorized post-petition transfer. A pre-petition lien cannot attach to a post-petition property unless a court orders a "rollover lien."
Abandonment In Bankruptcy Case
The trustee, or the debtor-in-possession (under Chapter 11 or Chapter 12) may abandon property after giving notice to all interested parties of the proposed abandonment. All interested parties, not simply the secured party, must be notified of the proposed abandonment. An objection must be filed within 15 days of the mailing of the notice or within the time fixed by the court. If objection is made by a party in interest to the proposed abandonment of the property, the court shall set a hearing and an order shall be entered; otherwise, no order is necessary. Any other interested party may move that property be abandoned, but must secure an order compelling the trustee or debtor to abandon.
Company Policy: If a motion or notice is filed by the debtor-in-possession or trustee, require: (1) a copy of the notice of intent to abandon, (2) a certificate that interested parties were notified, and (3) review of docket or attorney's letter evidencing that no objections or requests for hearing were filed within 15 days after notice. However, if any other party files a motion to abandon property, an order is required under rule 6007 and section 554. In that case, also secure a copy of the motion, certificate of service, order of abandonment, and evidence that no notice of appeal or motion extending time for appeal was filed within 30 days after entry of the order.
Contaminated property may not be abandoned if there is a showing of "imminent or identifiable harm" to the public health or safety by reason of the abandonment.
An abandonment of estate property does not automatically vest the property in a creditor; it simply revests the property in the debtor. The Court, in a Chapter 7 proceeding, though, may order property conveyed to a party in interest such as a creditor, or the Environmental Protection Agency pursuant to Section 725.
If property is scheduled but is not administered before the case is closed, then it is deemed abandoned upon the closing of the case.
However, the case is not closed simply by the filing of a no asset report of the Trustee; the case is closed when the court enters an order closing the estate. A Chapter 7 trustee's no asset report does not result in abandonment of real estate. "The filing of a no-asset report does not abandon property of the estate until the case is closed." According to one view, notice by the trustee that the trustee may announce intent to abandon property at the creditors' meeting is not sufficient notice of abandonment. According to a contrary view, Section 341 notice of the meeting of creditors disclosing intent to abandon burdensome or inconsequential property by notice at the meeting of creditors is sufficient notice; the rules do not require specific identification of the property. Although property scheduled in the Schedule of Assets and Liabilities is abandoned by the closing of the case, a cause of action solely listed in the Statement of Financial Affairs (a fraudulent transfer claim) is not abandoned since not properly scheduled.
An abandonment by the Trustee may be undone if information concerning the property value was not properly disclosed so that the Trustee could make an informed decision. However, absent unusual and compelling circumstances, or a particularly egregious fact situation, the court should not vacate an abandonment (pursuant to Section 105).
If property is not scheduled or specifically abandoned and is not administered in the case, then it is not abandoned by the closing of the case. Instead, it remains property of the estate. Actual knowledge of an asset by the bankruptcy trustee will not substitute for scheduling of the asset; such asset that is not scheduled is not deemed abandoned by closing the case. The longer the time between the closing of the estate and reopening to administer assets the more cause must be shown. "Although no time limit is specified during which a motion to reopen must be filed, such a motion must be filed within a reasonable time and laches may justify the denial of the motion."
The abandonment of property does not lift the stay prohibiting an action against the property of the debtor.
Exempt Property In Bankruptcy Case
Federal and State Exemptions
Debtors are given the choice of using state exemptions or, if the state does not prohibit the federal exemptions, federal exemptions of $16,150 (or for case commencing prior to April 1, 1998, $15,000) (plus wildcard of $850 or for cases commencing prior to April 1, 1998, $800) of equity. The amount of the federal exemption shall be adjusted every three years. Joint debtors must choose only state or federal exemptions. If they cannot agree, they will be deemed to have chosen the federal exemptions if the state has not opted out. There is conflict as to whether spouses in a joint filing can separately claim the exemptions of state law or are entitled only to one set of exemptions.
State law can explicitly prohibit election by the debtor to select the federal exemptions. States prohibiting use of federal exemptions include Alabama, Alaska, Arizona, California, Colorado, Delaware, Florida, Georgia, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine, Maryland, Mississippi, Missouri, Montana, Nebraska, Nevada, New York, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, South Carolina, South Dakota, Tennessee, Utah, Virginia, West Virginia, and Wyoming. New Hampshire repealed its opt-out law effective January 1, 1997. Texas provides that, to the extent state exemptions conflict with federal law that imposes an upper limit on the amount, including the monetary amount or acreage amount, of homestead property a person may exempt from seizure, state law prevails to the extent allowed by federal law.
If a state (such as Tennessee) does not explicitly permit exemptions for tenancies by the entirety in its statutes, but regards such interests as immune from process as a matter of law, the debtor may claim the tenancy as an exemption under state law. If creditors can execute on the right of survivorship of such tenant, then the right of survivorship may not be exempted under state law and may be sold by the trustee. If property is held by debtors as tenants by entireties and can be reached by judgment against both of them, it cannot be claimed as exempt to the extent there are joint creditors. The case of In re Lambert, 34 B.R. 41, 9 C.B.C.2d 805 (Bankr. D. Colo. 1983), held that a bankruptcy effected a severance of a joint tenancy property in Colorado and distinguished entireties property as not being severed by the bankruptcy.
A debtor's interest in a trust, which in turn owns the residence in which the debtor lives, may not be allowed as an exemption.
If the acreage exceeds a state acreage homestead exemption and the allowed exemption cannot be severed because such size would violate zoning limitations, the trustee can have the entirety of the parcel sold and allocated the proceeds equitably. However, in other subdivisions the preference for the exemption will trump subdivision prohibitions. Any business homestead exemption will be narrowly construed to apply only to the business (convenience store) operated by the debtor, and not to any adjoining rented shopping center space.
If exemptions under state law are selected, the debtor may schedule as exempt land located only in that state.
A claim of state exemption must apply the state law in effect on the date the bankruptcy petition was filed.
A general claim of a state exemption can be no greater than that actually allowed by state law.
Proceeds and change in character of exempted property after the filing of the bankruptcy will not be property of the estate; once property is exempt, it remains exempt.
If the comparable state exemptions apply only to an equity interest or value or if the federal exemption is used, then the encumbered portion of the property (being that portion equal to the secured debt) remains subject to the bankruptcy until abandoned or until the case is closed. That interest will not be exempted merely by approval of the exemptions or by court order setting aside the exemptions. According to one view, post-petition appreciation of land with exempt and non-exempt equity will inure to the estate. Thus, further court approval or notice and opportunity for hearing must be secured to abandon the encumbered portion of the property or to allow sale of the property.
Company Policy: If an equity interest is scheduled as exempt, verify the exemptions are applicable due to lack of objections more than 30 days after conclusion of creditor's meeting by attorney's letter or docket sheet review. Also (1) require the trustee to abandon the encumbered portion of the property by notice, (2) secure a certificate of notice to all interested parties, and (3) require a docket sheet or letter to verify that no objection was made within 15 days. If only an equity is exempted and the remaining interest is abandoned, you may not insure the sale if the net proceeds to debtor exceed the equity exemption. If the debtor is selling exempted land in a Chapter 12 or 13 proceeding, secure a letter from the trustee evidencing lack of objection to the sale and, if Local Rules require court approval, secure a court order.
The debtor shall list the property claimed as exempt on the schedules. An amendment of the schedules to revise the claimed exemptions may be filed at any time before the case is closed, unless delay in doing so evidences bad faith or causes prejudice (creditors may object within 30 days of such amendment). A debtor may amend the plan or schedules to change from federal to state exemptions if creditors are not prejudiced. The trustee or creditor may object to the property claimed exempt within 30 days after the meeting of creditors concludes (which meeting may be adjourned and extended) or within 30 days of the filing of any amendment to the scheduled exemptions, unless the court within the 30 day period grants further time. The 30-day provision does not begin to run until the full detail of the exemption is disclosed by (any) amendment. The meeting of creditors must actually be held, and the 30-day period for objection does not run from the scheduled, as opposed to actual, meeting date. Otherwise, the exemptions are deemed allowed without court order. An objection can be evidenced by assertions in a complaint in an adversary proceeding or by a motion to lift stay filed within the time for objections. A response to a debtor's motion to avoid the claimant's judicial lien that states the debtor is not entitled to an exemption in the residence sufficiently manifests an objection to the exemption within the 30-day period. In the absence of objection within 30 days after the creditors' meeting or after the amendment to exemptions, the property claimed as exempt is exempted even though the claim is invalid. According to one view, conversion of a bankruptcy from a Chapter 11 case does not enlarge the 30-day time limit for objection. If a case is reconverted to a Chapter 7 case from a Chapter 13 case, the trustee has an additional 30 days after the meeting of creditors to object to debtor's exceptions. According to one view conversion of a bankruptcy from a Chapter 13 case triggers a new 30-day time limit for objections following the subsequent Sec. 341 meeting. This view has been rejected by some courts as contrary to the effect of the Bankruptcy Amendment Act of 1994, as applied to 11 U.S.C. 348(f), which states that the trustee may not object to exemptions allowed in the converted Chapter 13 proceeding. A right to a homestead exemption is determined at the time of commencement of the original case, rather than the date of conversion to a case under Chapter 7.
Company Policy: Secure a certified copy of the listed exemptions together with verification of passage of 30 days beyond the meeting of creditors as adjourned with no objection having been filed. Verification can be reflected by a clerk's certificate, attorneys letter, or file and docket sheet review. Unless a party in interest objects, the claimed property or equity interest is exempted. If an equity interest is exempted, require the remaining interest of the estate to be abandoned or sold by the trustee or debtor-in-possession.
Chapters 12 and 13 Exemptions
It has been stated that, until confirmation of the proposed plan, property claimed as exempt may not be divested from the estate. This language appears to be overly broad dictum, and inconsistent with the applicable rules and code provisions. It has been noted that the debtor can waive exemptions and use the exempt property in paying the debts under the plan. This right is irrelevant if the debtor has sold the exempt property prior to filing the plan. Unless the plan and confirmation provide otherwise, the debtor's property is revested in the debtor by the confirmation. If property is exempted in a Chapter 13 case, the debtor does not need a court order to sell and may not sell free and clear of liens or interests. However, Local Rules may require court approval of a sale or refinancing of the debtor's residence in a Chapter 13 case (even after confirmation).
Company Policy: If the property is scheduled as exempt and time for objections to be filed has passed, verify that the proposed (or confirmed) plan, if any, does not treat the property inconsistently by providing that it will be conveyed to a creditor, remain part of the estate, or be sold to pay debts. Request a letter from the trustee evidencing no objection to a sale or refinance after plan confirmation and before the case is closed. Require court order if local rules so require.
A debtor may avoid a judicial lien on exempt property to the extent the lien impairs the exemption. A lien impairs an exemption to the extent the lien and all other liens on the property and the amount of the exemption available if there were no liens exceeds the value that the debtor's interest would have in the absence of any liens. This provision does not apply to a judgment arising out of a foreclosure. An avoided lien shall not be considered in the calculation of the amount of liens on the property. This new provision allows avoidance if (1) the debtor has no equity in the property above a lien superior to the judgment lien; (2) the judgment lien is partially secured; and (3) the judgment lien is superior to an unavoidable mortgage which is greater than the value of the land. The proceeding is by motion and notice (not adversary proceeding). No order is necessary if no objection is made.
Company Policy: In all cases involving lien avoidance, we will require a final court order. Do not insure if the court dispenses with notice. Wait until the order is final (30 days after entry) which finality should be evidenced by a certificate of the clerk or counsel and docket sheet review. Since the order will be rendered void if the case is dismissed, do not rely upon the order until the discharge or completion of the plan (if a Chapter 11 proceeding).
This section cannot be used as to a judicial lien attaching before the enactment date of the Bankruptcy Code of 1978 (November 6, 1978). The lien does not attach, however, until the land is acquired.
This section can be used as to judicial liens even if the state exemptions are used and even if state statutes or other law creating the exemptions specifically provide that the exempt property is subject to the judicial liens. Therefore, even if state law allows a judgment lien to attach to property owned by the debtor if it attaches before the property acquires exempt status, the lien may be avoided. However, if the lien attached before the debtor acquired the land or simultaneously with the acquisition of title by the debtor, the lien may not be avoided if it would attach under state law. A lien that affixes before or at the time the debtor acquires the interest, such as a judicial lien fixed at the time the debtor receives the property in a divorce, is not avoidable under Section 522(f); the debtor must have owned the property before the lien attached in order to avoid the lien.
According to one view, Section 522(f) could not be used to avoid a judicial lien to the extent of future appreciation in excess of a state exemption of a fixed dollar amount (e.g., $45,000). This view was abrogated by amendment of Section 522 in 1994.
At the court's discretion, a proceeding under Section 522(f) may be brought by reopening the case after the discharge is granted and the case is closed. The local rule time limitations may be ignored. Local districts may impose a time limit to file a motion for lien avoidance motions. The court in its discretion may refuse to reopen the case. One case has held that a lien may not be avoided under Section 522(f) after the case is closed due to the limitations of Section 550(f)(2) (concerning avoidance of transfers under 544, 545, 547, 548, 549, 553, and 724); however, this case does not appear to be correct. A debtor may not resort to Section 522(f) to avoid judicial liens on homestead sold before the commencement of the bankruptcy or sold after the case is commenced but before the motion to avoid the lien is filed.
The order avoiding a judicial lien pursuant to Section 522(f)(l)(A) prior to completion of plan and receipt of discharge should be conditioned upon completion of the plan and grant of discharge in order to protect the creditor's interest, because a case dismissal reinstates the avoided lien; however, the order voiding the lien may provide that a sale by the debtor may be made free of such lien with the lien to attach to the proceeds.
The majority view (consistent with Section 522 as amended) is that the procedure can be used even if the exemption of the debtor under state law extends to equity (e.g., $10,000 maximum in Colorado) in the property where there is no equity in the case at hand.
If the debtor is a tenant by the entireties, one-half of the equity in the property will be allocated to her or him to determine whether the judgment lien can attach to excess equity or whether, in the alternative, the lien can be avoided.
The scheduling of property as exempt without timely objection is only determinative of the issue of whether the property remains in the estate: it is not a binding determination of the homestead claim in connection with a motion to avoid a judicial lien as interfering with the homestead rights either under Section 522(f) or as ineffective under any state law exemption from attachment of judicial liens. It also is not determinative as to whether a mortgage (which would be invalid against exempt property) is invalid because of claimed homestead rights.
Company Policy: Do not rely on the scheduling of property as exempt (without objection) as determinative of whether a judgment lien attaches to the land.
Company Policy: Because a dismissal under section 349 reinstates any judicial lien avoided under section 522(f), do not rely upon a lien avoidance order unless the discharge has been granted in Chapter 7, 12, or 13, or unless the plan has been completed in a Chapter 11 or unless the order recites that, in accordance with state law, the lien never attached to the property.
For purposes of Section 522(f) avoidance, judicial liens obtained pursuant to agreement of the parties are not avoidable judicial liens: The Courts distinguish consensual ("security interest") liens which are non-avoidable, and involuntary judgment liens which are avoidable under Section 522(f).
A mechanic's lien created by state law is a statutory lien, not a judicial lien, and is not avoidable under Section 522(f).
According to one view, a divorce decree creating an equitable lien for the purchase price to be paid to one spouse or other court order creating an equitable lien (such as one creating a constructive trust) and later reflected by a judgment lien for such amount is not a judicial lien avoidable under Section 522(f).
A statutory federal tax lien is not a judicial lien avoidable under Section 522(f).
According to one view, a judgment lien cannot be avoided under Section 522(f) if the debt is not dischargeable. A debtor may not avoid under Section 522(f) a judicial lien that secures a debt to a spouse, former spouse or child for alimony, maintenance, or support unless the debt is assigned to another entity. Property exempted under state law pursuant to Section 522 is not subject to a judicial lien for nondischargeable debts for alimony, maintenance, or child support, nondischargeable debts for fraud and willful injury to federal depository institutions, a regulatory agency acting as conservator, receiver, or liquidating agent, if state law exempts the land from such judicial lien.
Avoiding Powers In Bankruptcy Cases
Party Bringing Actions
Avoidance actions are brought by the trustee or by a debtor-in-possession under Chapter 11 or Chapter 12. A debtor may generally bring avoidance actions in connection with exempt property. The debtor may avoid the transfer if (1) it is avoidable by the trustee under Sections 544 or 548, (2) the trustee does not seek to avoid the transfer, (3) the debtor could exempt the property, (4) the transfer was involuntary, and (5) the debtor did not conceal the property. Any avoidance action is an adversary proceeding under Rule 7001 et seq. Some cases recognize the authority of a Chapter 13 debtor to exercise avoidance powers. The trustee cannot avoid the lien simply by noting "intent" to avoid the lien by reference in the proposed plan and disclosure. As a rule, only the trustee or debtor-in-possession may bring the action; however, a creditor committee or creditor may initiate a proceeding if it requests the debtor-in-possession or trustee to prosecute the action, the debtor or trustee refuses, and the committee or creditor demonstrates a colorable claim of benefit to the estate and an unjustifiable refusal by the trustee or debtor to act. A creditor may institute an action on behalf of the debtor in possession or trustee, if authorized by the bankruptcy court. A subsequent owner does not have adequate standing to invoke the avoidance powers of Section 549. The creditor may, with court permission, bring a derivative action in the name of the debtor. A party other than the debtor or the trustee may prosecute avoidance claims in a Chapter 11 case if it is appointed to do so and if it is acting as a representative of the estate.
Company Policy: Do not rely on an avoidance proceeding (sections 544, 545, 547, 548, 549) as to exempt property being sold unless the discharge has been granted or denied in Chapter 7, 12, or 13, or the Chapter 11 plan is completed. If nonexempt property is being sold where a lien was avoided and the discharge is not yet granted (in Chapter 7, 12 or 13) or plan (Chapter 11) is not completed, require a sale free and clear of the previously avoided interest. Require that any sale free and clear of a lien be made pursuant to the procedural requirements for the sale. Require that the sale order provide that it is made free of the lien in question (with adequate verification that the lender received notice of the proposed sale).
Powers as Purchaser or Creditor
The trustee or debtor-in-possession is treated as a bona fide purchaser and lien creditor in order to set aside various transfers; thus, the trustee can set aside unrecorded liens, deeds, contracts, and suits for which no lis pendens has been filed. These suits or transactions are not void but are simply voidable in an adversary proceeding. Therefore, it is extremely important to file all documents quickly. An unrecorded deed from the debtor that was sold by the grantee to its ultimate buyer was avoidable under Section 544. However, an unrecorded deed will not be avoidable if the purchaser is in possession of the land, and possession operates as notice under state law. If a mortgage is improperly attested or acknowledged and not eligible for recordation, the recordation is ineffective to give notice and the bankruptcy trustee can avoid the lien. A mortgage erroneously released and subsequently reflected by the mortgagees affidavit may be avoidable as a voidable preference or as an unperfected interest voidable by the trustee as a bona fide purchaser. If a mortgagee erroneously releases its mortgage, the mortgage will be avoidable by the trustee as a bona fide purchaser under Section 544(a)(3) (and preserved for the benefit of the estate). A mortgagor-debtor or trustee of the debtor (who was the mortgagor) cannot avoid an unrecorded assignment of mortgage; only the assignor can attack such transfer. A mechanics lien is not avoidable where the claimant failed to file a notice of lis pendens of the foreclosure, but the lien was properly and timely recorded. If a debtor collaterally assigns its note secured by a mortgage but does not deliver possession of the note, the collateral assignees rights are avoidable. Actual knowledge of the debtor-in-possession is not imputed to the debtor as a bona fide purchaser for avoidance under Section 544. The debtor may rely on this section as to exempt property. According to one view, the provisions of Section 544 will authorize the avoidance of unrecorded beneficial interests in the land, notwithstanding Section 541(d) recognizing beneficial interests in third parties, since the sections must be construed together. Under this view, the trustee may avoid unrecorded beneficial interests if the debtor acquires title as "trustee" without disclosure of the beneficiaries or terms of the trust. The trustee as a hypothetical bona fide purchaser may take free and clear of the unrecorded beneficial, equitable, or nominee interest in favor of a third party for whom the debtor record owner holds title. A trustee does not have the right as a hypothetical bona fide purchaser of personal, as opposed to real, property. Perfection of a deed of trust after filing of the petition and within 10 days after execution is avoidable under Section 544; the provisions of Section 547(e)(2)A are irrelevant. The avoidance power under Section 544 applies only to prepetition transfers, and not to post-petition transfers. According to one view, a recorded certificate of delinquency is constructive notice of a related tax foreclosure. The recordation of a Lis Pendens prevents avoidance of a constructive trust imposed in a state court action. Where under state law a bona fide purchaser cannot extinguish a prescriptive easement, the trustee cannot avoid such easement. While a security interest in an unexercised option to purchase real estate may be perfected as a UCC filing in general intangibles in the Secretary of States Office, the security interest ceases once the option is exercised; a lien on the optionees interest would have to be perfected in the county recorders office to then be effective.
Certain statutory liens may be avoided under Section 545 of the Bankruptcy Code. However, mechanics liens cannot be set aside if they relate back to a time prior to the filing of the bankruptcy even though they are recorded after the bankruptcy.
Judgment liens are not subject to avoidance under Section 545 (but may be voidable preferences).
Statutory governmental liens which are not perfected by filing a notice in the property records may be avoided under Section 545(2).
Tax liens may be avoided (if not perfected at filing of the case) by a trustee, but not by a Chapter 13 debtor.
According to one view, under prior law, if state law provides that the right to collect real estate taxes was automatically perfected as a lien, the trustee could not avoid the lien for prepetition and post-petition taxes on the property. In a Chapter 13 Bankruptcy, the city is entitled to interest on both prepetition and post-petition taxes.
Pursuant to the Bankruptcy Reform Act of 1994, the stay does not prevent the creation or perfection of an ad valorem tax lien by the District of Columbia or a political subdivision of a state, if the tax comes due after the filing of the bankruptcy.
Limitations on Avoidance
Under Section 546, actions to set aside transfers or liens under Section 544, 545, 547, 548, or 553 must be commenced within two years after the earlier of the entry of the order for relief or 1 year after the appointment or election of the first trustee if the appointment or election occurs before 2 years after the entry of the order for relief. The running begins from the date of signing of the Order confirming the appointment of the trustee; not from the date of docketing of the Order. According to one view, the date of the questioned event is omitted in calculating the limitations. The limitation period may be irrelevant if the lien is avoided pursuant to Section 506 because it is a preference, fraudulent transfer or other voidable transfer. However, if a cause of action exists under state law, longer state time limits (for example, fraudulent conveyances) may control. (Indeed there may be no time limit if an applicable creditor is a governmental unit). Even the longer state limitations (such as Texas four year limitation relating to fraudulent transfers) may be tolled because of fraudulent concealment by the debtor. Fraudulent concealment may occur even if the transfer is recorded in the public records, because such recordation is not notice to creditors for purposes of fraudulent transfers. According to one view, an action under Section 549 to recover a post-petition transfer by a debtor is governed by a two year limit after the transfer, regardless of whether there is a trustee and regardless of whether the Bankruptcy in converted to a different chapter. According to one view, if state limits have not run, the two-year limitation of Section 546 will control, if shorter (perhaps subject to equitable tolling). Even if the time limit has passed to set aside a voidable lien or other transfer, the court may reject the claim and void the lien or other transfer. Confirmation of a plan does not bar a subsequent avoidance action, particularly where the possibility of action was disclosed in the Disclosure Statement and Plan. There is no express time limit for assertion of equitable subordination.
A preference occurs if a transfer was made when the debtor was insolvent and if the transfer is made for or on the account of an antecedent debt (such as a deed in lieu of foreclosure). The transfer must be made within 90 days of the bankruptcy. If the recipient of the deed or transfer is an insider (such as a partner), the time limit is one year. A creditor who has a stranglehold over the debtor is an insider with control. Actual management is control: it includes control of personnel or contract decisions, protection schedules, and accounts payable.
Where the debtor pays or satisfies debt which is guaranteed by an insider third party (e.g., stockholder), the payment of debt was considered before 1994 to be a transfer benefiting an insider of the debtor as a creditor of the debtor. In that event, the transfer could be voidable under prior bankruptcy law as a preference if a bankruptcy was filed within a year (e.g., after a deed in lieu of foreclosure). A transfer to an unrelated third party does not "benefit" an insider partner simply by reduction of its liability for the debt as a matter of law as a partner (and thus the one-year time was inapplicable). As to cases commenced on or after October 22, 1994, it appears the trustee or debtor in possession may not recover a voidable preference from a creditor that is not an insider if the transfer was made between 90 days and one year before the bankruptcy filing. This amendment made in 1994 is intended to overrule the Deprizio line of cases. The construction has been applied to prevent recovery of preferential payments made to a non-insider creditors more than 90 days before the filing of the bankruptcy case, where the payments benefitted "insiders" of the debtor. However, in a conflicting interpretation it has been concluded that Deprizio was not overruled, so that a mortgage to a non-insider lender could be avoided as a preference if the bankruptcy is filed more than 90 days but less than one year after the transfer, and if the transfer benefited an insider of the debtor.
Factors used in evaluating insider status include: (1) whether the loan is documented; (2) whether the loan is unsecured and did not entail an analysis of the debtors creditworthiness; (3) whether the transferee knew the debtor was insolvent when the loan was made; (4) whether the creditor made numerous loans to the debtor; (5) whether there were limits on use of loan proceeds; (6) whether the loan was commercially motivated; (7) whether the transferee had the ability to control or influence the debtor; (8) whether there was a personal, professional or business relationship allowing the transferee to gain advantage; (9) whether the transferee had authority to make business decisions for the debtor; (10) whether there was a desire to treat the transferee different from other general unsecured creditors; and (11) whether there was an agreement to share profits and losses from business transactions. The preference must enable the recipient to receive more than it could in a Chapter 7 liquidation proceeding. Insolvency is presumed within 90 days of the bankruptcy. The debtor who is not a debtor-in-possession may avoid a voidable preference if it involves an exemption.
A judgment lien may be a voidable preference. A mechanics lien claim is not a voidable preference.
The recording of a lis pendens may be an avoidable preference.
A transfer of a mortgage to a title company that had advanced funds based on the assignors dishonored check may be a voidable preference.
Prior to the case of BFP v Resolution Trust Corp., 511 U.S. 531, 128 L. Ed.2d 556, 114 S. Ct. 1757 (1994), it appeared that a foreclosure sale could be an avoidable preference if occurring within 90 days of the debtors bankruptcy (or one year if the lender is an insider or if a guarantor of the debtor is an insider of debtor) if the bidder received property valued in excess of the amount bid. Under that reasoning a bid in excess of 70% of fair market value could be a voidable preference. Under this reasoning a foreclosure sale bid in by the creditor could be a voidable preference; a foreclosure sale bid in by a third person could not be a voidable preference. Since the BFP case held that a regularly conducted noncollusive mortgage foreclosure is not a fraudulent transfer (because the bid is "reasonably" equivalent value), it is reasonable to assume and it has held that a (regularly conducted non-collusive) mortgage foreclosure will not be avoidable as a voidable preference. According to one case, a federal tax lien sale is not a voidable preference. This policy may not be adopted for foreclosures of other liens or for deeds in lieu of foreclosure.
The cancellation of a note and replacement with a new note within 90 check days prior to the bankruptcy is not a preference. The payment in exchange for a release of a perfected lien is not a preference; it represents a contemporaneous exchange for new value. A substitution of collateral is not a voidable preference, at least where the value of the collateral is approximately the same. The payment prior to a bankruptcy of a lien that would be voidable in the bankruptcy is a preference. A Deed in cancellation of existing indebtedness may constitute a voidable preference. A deed in lieu of foreclosure may be a voidable preference or fraudulent transfer. Transfers to post-confirmation creditors of post-confirmation property of a Chapter 11 debtor may be voidable preferences if the debtors bankruptcy is then converted to a Chapter 7 proceeding.
Forbearance by a creditor from exercise of its rights does not constitute new value. The substitution of a new obligation for an existing obligation is not new value under Section 547(a)(2). Substitution of a new lease for a prior lease is not new value. Substitution of a new lien for a prior unenforceable lien on land subject to a prior mortgage securing an amount greater than the land value may be a preference.
Generally, the transfer by a third party to the credit of the debtor is not a voidable preference, but if a creditor initiates the transfer for eventual repayment to itself, the transfer is a voidable preference. As a result, if the creditor loans money to a debtor and takes a lien on the debtors property knowing that the loan will be used to pay off an unsecured creditor (such as the creditor who is owed by an affiliate of debtor), then the lien is a voidable preference. According to a different view, payment by a creditor to a debtors other creditors qualifies as new value for the benefit of the debtor and is not a voidable preference.
Company Policy: If you are asked to insure a loan modification made by the same lender where the lender receives more advantageous interest rate or other benefits (such as contingent interest), add the following creditors rights exception:
Any claim by reason of the operation of federal bankruptcy, state insolvency, or similar creditors rights laws.
Upon request you may limit the exception to any claim arising out of the modification or substitute the 1992 policy creditors rights exclusion. You do not need to add this exception if the policy issued to the lender is the ALTA 4-6-90 policy or ALTA 10-17-92 policy (with the creditors rights exclusion retained) or if the loan is made by an institutional lender on a single-family residence.
If the loan is refinanced by a different lender, you do not need to add the exception in the absence of other creditors rights issues.
The consolidation of three unsecured loans into one new loan secured by a mortgage was a partial preference: the only new value was a lower interest rate and favorable payment terms.
A purchase money mortgage is not avoidable as a preference where the deed and mortgage were effective and recorded on the same day. The mortgage had been executed more than 10 days before the deed, pursuant to a prior contract. The mortgage was not effective until the deed was delivered.
A transfer by a predecessor of the debtor is not avoidable in the bankruptcy proceeding of the debtor as a preference. A transfer by a partnership is not avoidable in a partners bankruptcy. A transfer by a predecessor by merger of the debtor corporation was a transfer of the debtors property avoidable as an avoidable preference.
A transfer of a security interest in property is not an avoidable preference made to secure debt of a third party. If the debtor was determined pre-petition to be a constructive trustee for third parties and ordered to transfer title to these parties, the transfer was not a preference, since it was not a transfer of the debtors property.
In calculating the 90-day period for a preference (since the preference normally must occur on or within 90 days of bankruptcy), the first day of the time period (date of transfer) is included and the last day (date of filing of bankruptcy) is excluded. The period is calculated by counting backward from the date of the petition to the date of the transfer (relevant if the last day is a weekend or holiday).
A voidable preference has not occurred if the creditor receives no more than it would in a Chapter 7 liquidation. For example, if the secured debt exceeds the value of the property at the time of the foreclosure or deed in lieu of foreclosure, there is no preference.
A transfer is not a voidable preference if it is made for substantially contemporaneous consideration. However, a delay of two months in recording the security document will prevent it from being substantially contemporaneous. Where the security documents are not recorded contemporaneously with the loan, then the encumbrance may be a preference. Untimely perfection may be protected following inquiry into the reason for the delay, intent of parties, and contemporaneous nature of the exchange. If the loan is made to enable the purchase of the collateral described in the security document, one line of cases holds that the documents must be perfected within 10 days to be contemporaneous; another line holds that the former 10-day limit of 547(c)(3) is not controlling and that other factors can be considered. "There is a split of authority among federal courts regarding whether a non-purchase money security interest that is perfected more than 10 days after the date of transfer can be considered substantially contemporaneous in fact." One line of cases requires perfection within 10 days to avoid a claim of preference. The second line applies a more flexible standard and allows a delay in perfection beyond 10 days where there are circumstances beyond the control of the lender. Pursuant to the Bankruptcy Reform Act of 1994, a security interest is substantially contemporaneous if the security interest secures new value to enable the debtor to acquire the property and if the security interest is perfected on or before 20 days after the debtor receives possession of the property. Based on this amendment, it has been held that a purchase money mortgage may be a preference if not recorded within 20 days after the debtor takes possession. In other circumstances the transfer is made at the time the transfer takes effect, if the transfer is perfected within 10 days. A mortgage is a voidable preference if it is executed and delivered more than 10 days before the filing of the bankruptcy, even though the mortgage is recorded within 10 days after disbursement of loan proceeds.
To determine a partnerships solvency, the court must consider nonpartnership assets of general partners.
In determining insolvency of the debtor at the time of a transfer, the bankruptcy court is not required to consider book value, the purchase price of assets less accumulated depreciation, but may consider the worth of assets in a realistic marketplace, valuing the assets based on the sales price the trustee actually obtained or accounts receivable actually collected.
A mortgage granted on the eve of Bankruptcy to secure previously unsecured debt may, in addition to characterization as a preference, be considered a fraudulent transfer since it hinders, delays, or defrauds creditors.
Deeds not recorded in timely fashion may constitute voidable preferences.
A transfer by a tax deferred exchange company (accommodator) that is not made simultaneously with the receipt by the company of the funds may be a voidable preference.
Impression of a constructive trust upon a debtors property is not avoidable as a preference.
Company Policy: If you are insuring a mortgage securing previously outstanding unsecured debt, or if you are insuring a deed in lieu of foreclosure, place the following exception in the policy:
Any claim by reason of the operation of federal bankruptcy, state insolvency, or similar creditors rights laws.
Upon request you may substitute the 1992 creditors rights exclusion.
This exception will not be necessary if the insured transaction (such as a current loan to finance prior unsecured debt) creates the "creditors rights" issue and if the 4-6-90 or 10-17-92 ALTA policy is issued. The 4-6-90 ALTA policy and 10-17-92 ALTA policy contain a similar "creditors rights" exclusion.
Under Section 548, a transfer made within one year before bankruptcy may be set aside as a fraudulent conveyance if (i) the debtor made the transfer or incurred the obligation with actual intent to hinder, delay or defraud existing or subsequent creditors, or (ii) the debtor was insolvent or had insufficient capital at the time to engage in business and if the debtor received less than reasonably equivalent value. The one-year period commences from the recordation of the deed which evidences the fraudulent conveyance.
American fraudulent transfer laws derive from Englands Statutes of 13 Elizabeth, which was adopted in 1570. This law required proof of actual intent to hinder, delay or defraud creditors. Soon, badges of fraud were gleaned as evidence of fraud, such as a general or clandestine transfer. The American schedule of badges of fraud expanded, such as insolvency at the time of a gift. The Uniform Fraudulent Conveyance Act was approved by the ABA as a Uniform Act in 1918 (and remains in law in 4 states - Maryland, New York, Tennessee and Wyoming). The Uniform Fraudulent Transfer Act has largely replaced that act in state legislation (and has been adopted in 39 states and D. C.) The UFTA establishes a limitation of four years, subject to a one year limit on preferable transfers to insiders and a one year additional limit from date of frauds discovery outside the general four year limitation period.
In 7 states, modern versions of the Elizabethan statutes or other fraudulent transfer laws (such as rescission for lesion if sale for less than half of value in Louisiana under Civil Code Section 2589) remain in effect.
"UFTA distinguishes between present and future creditors, and specifies the kinds of transfers that are fraudulent to each of the two categories of creditors. Both present and future creditors may recover property when there is a transfer with intent to defraud. Both may recover when a transfer is made without receiving reasonably equivalent value when the result is to make the debtors assets unreasonably small in relation to the business or transaction in which the debtor is engaged or about to be engaged. Also, present and future creditors can both recover when a debtor transfers property without receiving reasonably equivalent value when intending to incur debts beyond the ability to pay.
"Present creditors, however, can recover property when it is transferred by a debtor to another person without receiving reasonably equivalent value if the debtor is insolvent or becomes insolvent as a result of the transfer. A transfer to an "insider" without receiving reasonably equivalent when the debtor is insolvent, is also fraudulent to present creditors. The term "insider" is defined, and is someone with a special relationship to the debtor. Examples are relatives or business partners (when the debtor is a partner). To be liable, an "insider" must have reasonable cause to believe that the debtor is insolvent.
"The fundamental relief for a creditor when there is a fraudulent transfer is recovery of the property from the person to whom it has been transferred. UFTA allows "avoidance of the transfer or obligation to the extent necessary to satisfy the creditors claim ...." Whatever is necessary to obtain the property is provided for, including attachment, injunctive relief, appointment of a receiver, or "any other relief the circumstances may require." If the creditor has reduced the claim to a judgment, the court may levy execution against the recovered assets. This means that the property can be sold to satisfy the amount of the judgment.
"Much of the UFTA resembles UFCA, its predecessor. What, then, are some of the differences? (A more detailed comparison is available from the ULC.) To begin with, the term "transfer" taken from the Federal Bankruptcy Act replaces the term "conveyance." UFCA uses the term "fair consideration" instead of "reasonably equivalent value." "Reasonably equivalent value" does not include the element of good faith as "fair consideration" does, and is more sharply defined than "fair consideration" is in the UFCA. UFTA overcomes the problem raised in the case of Durrett v. Washington National Insurance Co., 621 F.2d 201 (5th Cir. 1980), a case that jeopardized mortgage foreclosure sales. Under UFTA, a properly conducted foreclosure sales is not a fraudulent transfer, notwithstanding the fact that it does not recover an amount somewhat near the actual market value of the property. The concept of the "insider" is new in the UFTA. UFTA provides for defenses of transferees and for a statute of limitations. Both issues are not addressed in the UFCA."
The preponderance of evidence (instead of clear and convincing evidence) standard applies in bankruptcy proceedings grounded in allegations of fraud.
To determine solvency, contingent liability is valued at its present, or expected, value (not the total liability). Fair valuation, or the balance sheet test of assets, is based on market value, not book value. A trustee "may be able to prove insolvency at earlier periods through the process of retrojection, i.e. showing that the debtor was insolvent a reasonable time after the transfer and that the debtors financial condition did not materially change during the intervening period. "
Prior case law has indicated that a timely disclaimer of an interest in inheritance was likely not a fraudulent conveyance. According to this previous prevalent view, the disclaimer acts as a rejection of a testamentary gift and is not a fraudulent transfer. However, based upon the Drye v. U. S. case relating to the ineffectiveness of a disclaimer upon a prior federal tax lien, a disclaimer may be a fraudulent transfer.
The estate may, instead of recovering property fraudulently transferred, recover the value of the property.
A deed in lieu of foreclosure may be a voidable preference or fraudulent transfer. A deed to a "lender" is for reasonably equivalent value if the total of prior liens, secured lenders mortgage and closing costs (such as brokers commission) on resale total 87% of fair market value.
A voluntary transfer by a debtor within one year of bankruptcy while insolvent and for less than reasonably equivalent value is a fraudulent transfer.
A friendly foreclosure allowing sale to another entity controlled by debtors principals may be a fraudulent transfer.
A termination of a lease or other contract may be a fraudulent transfer. According to one view a prepetition, ordinary course of commercial business, non-collusive termination of an executory contract in accordance with the contract because of material default is not a fraudulent transfer.
According to one view, a termination of a real estate contract can be a fraudulent transfer that is perfected at time of recordation of the buyers deed to the seller.
A cancellation of debt owed by the general partner in consideration of a transfer of the partnerships note is not reasonably equivalent value.
A grant of an encumbrance and new guaranty in substitution for a prior guaranty may not be made for reasonably equivalent value if the prior debt was adequately secured by adequate collateral of the primary obligor.
An award of property in a divorce decree may be a fraudulent transfer if the debtor does not receive reasonably equivalent value.
A partition between spouses of community property may be a fraudulent transfer.
A modification of mortgage is a transfer to the extent of increased secured debt; consequently, the modification may be a fraudulent transfer.
Hotel casino bets may constitute reasonably equivalent value; under the particular facts the bets are not fraudulent transfers. It has been stated that a tithe to a church may be recovered as a fraudulent transfer because any value from the church was not "in exchange for" contributions. Value means property, not spiritual commitment. Pursuant to the Religious Liberty and Charitable Donation Protection Act of 1998, Section 548(a)(2) prohibits avoidance of charitable contributions by natural persons to a qualified religious or charitable entity or organization if the contribution does not exceed 15% of the debtors gross annual income for the year of the contribution, or the contribution exceeds the 15% limit but is consistent with the debtors charitable contribution practices.
A civil in rem forfeiture under 21 U.S.C. sec. 881 is not avoidable under Section 548; the title vested in the U.S. no later than the date the government seizes the property and thus occurred more than one year before the bankruptcy filing (and more accurately, at the time of the illegal action). It has also been held that when the forfeiture order is entered, the title of the United States relates back to the time of the criminal activity unless the debtor establishes that he or she is an innocent owner. Such forfeiture is also not avoidable by an unsecured creditor under state fraudulent transfer law. Congress did not intend to allow debtors to include in the estate property that had been seized under a criminal forfeiture statute before the filing of the case.
If a portion of the advances are retained by the mortgagor and the remainder are upstreamed, a good faith creditor may retain a lien for the amount retained by the borrower; the lien will be subordinated for the funds upstreamed.
Use of loan proceeds to pay off antecedent debts to the debtors principal shareholder were fraudulent conveyances under state law. The scheme for use of the proceeds would be collapsed if the lender knew of the circumstances that would lead it to inquire further into the transaction.
A guarantee secured by a deed of trust will not be a fraudulent transfer if the party receives benefits (direct or indirect) from the loan and the benefits are reasonably equivalent to the obligation. The basic issue involving guarantees usually is whether the consideration flows downstream (e.g., a stockholder mortgages its property to secure a loan to its wholly owned corporation) or upstream (a corporation mortgages its assets to secure a loan made to its parent stockholders).
If the proceeds flow downstream, the mortgagor generally has received the benefits of the loan by advances to its owned entity and no fraudulent transfer has occurred. This position is not conclusive; it may be only a rebuttable presumption. If the subsidiary is insolvent at the time of the parents guaranty, the net effect may not benefit the parents creditors.
However, if the proceeds flow upstream, a possible fraudulent transfer has occurred. Similarly, a guarantee by an affiliate may, in appropriate circumstances, constitute a fraudulent transfer.
Intercorporate guarantees "fall into three types: upstream, downstream and cross-stream. ... [A] cross-stream guarantee is when a corporation guarantees the debt of an affiliate.... Some courts applying traditional fraudulent transfer rules to intercorporate guarantees found that the guarantor had not received reasonably equivalent value for the guarantee, because from the standpoint of the unsecured creditor, the guarantor had received no consideration for the guarantee.... However, requiring a direct flow of capital to a cross-guarantor to avoid a finding of a fraudulent transfer is inhibitory of contemporary financing practices, which recognize that cross-guarantees are often needed because of the unequal abilities of interrelated corporate entities to collateralize loans . Thus, even when there has been no direct economic benefit to a guarantor, courts performing a fraudulent transfer analysis have been increasingly willing to look at whether a guarantor received indirect benefits from the guarantee if there had been an indirect benefit.... Generally, a court will not recognize an indirect benefit unless it is fairly concrete. The most straightforward indirect benefit is when the guarantor receives from the debtor some of the consideration paid to it.... But courts have found other economic benefits to qualify as indirect benefits .... when the loan strengthened the corporate group as a whole, so that the guarantor corporation would benefit from the synergy within the corporate group. The Mellon court stated that indirect benefits included intangibles such as good will and an increased ability to borrow working capital.... Telefest indicated that indirect benefits to a guarantor exist when the transaction of which the guaranty is a part may safeguard an important source of supply, or an important customer for the guarantor... . Two of the three cases explicitly acknowledge that indirect benefits can constitute reasonably equivalent value.... Indirect benefits may be considered as part of the inquiry into reasonably equivalent value in a transaction.... On the other hand, indirect benefits from a guarantee can be found to constitute reasonably equivalent value.... if there are not two functioning corporations that benefited mutually from the loan.... Even though it was not officially dissolved the company [which had incurred the debt] had been liquidated and was inactive.
"[C]ourts have been willing to consider indirect benefits received by a debtor if those benefits are fairly concrete.... [S]uch situation might occur when the debtor and the third party for whom the debt is paid are so related and share such an identity of interests that the benefits of one will benefit the other to some degree."
A guarantor, whose liability may be contingent or direct, will have the following equitable rights by operation of law, absent waiver:
(1) Exoneration: right to compel the primary obligor to pay the debt or to compel co-guarantors to pay their shares of debt.
(2) Reimbursement: right to indemnity for sum paid.
(3) Subrogation: right to enforce the remedies and rights of the obligee upon payment of the entire debt.
(4) Contribution: right to recover from co-guarantors their share of the obligation, upon payment of an amount in excess of the guarantors share.
Where the sole stockholder of the debtor corporation had the corporation guarantee his personal loans and pledge corporate property as security for a $135,000 loan of which the corporation received a benefit of only $8,000 for payment of its taxes, the guarantee and pledge could be avoided under Section 548. Similarly, a fraudulent conveyance may occur if a subsidiary transfers assets to a creditor of its parent and receives no benefit from the creditor.
A transfer to an affiliate may be suspect as a fraudulent transfer. Badges of fraud include (1) actual or threatened litigation against the debtor, (2) transfer of all or substantially all of debtors assets, (3) insolvency of debtor, (4) special relationship between debtor and the transferee, and (5) retention by the debtor of the asset involved in the putative transfer.
A transfer of all assets and only some unsecured liabilities (even if may exceed asset value) may be a fraudulent transfer. Given the possible limited value of liabilities, a purchaser may wish to avoid assumption of unsecured liabilities as a portion of consideration. Debt may be worth less than face value. "Debtor issues its note for $10 million. It has assets of $5 million, secured debt of $2 million, and no other debt. From the creditors perspective this note is worth somewhat less than $3 million."
If the identity of interests of affiliated corporations is sufficiently close, payment of affiliate debts will not be a fraudulent conveyance. A cross-collateralization transaction by several affiliates will not be avoidable as a fraudulent transfer if the affiliates are a single business enterprise: one corporate office pays the bills for affiliates; each affiliate pays its share of office expenses; the same principals have overlapping ownership among the entities; operation occurs from the same office; there is use of same telephone number and post office box; there is centralized accounting; and the companies are referred to by a single name.
A bankruptcy court has authority to substantively consolidate separate bankruptcy estates into one estate. Some courts have held that the estate of a non-debtor can be consolidated into the estate of a debtor under appropriate circumstances. "There are winners and losers in the process. The creditors of the poorer estate may benefit from the pooling of assets of a more solvent estate, and those from the more financially solvent estates will be diluted." It will not be used as a device of convenience if it unfairly impairs vested rights of some creditors, but may be invoked where there is substantial identity between the parties to be consolidated. For example, substantive consolidation may not be granted if it relegates some trade creditors with unsecured claims against partnerships owning properties generating positive cash flows to a general class of unsecured creditors with claims against partnerships owning properties generating both positive and negative cash flows. Factors in favor of substantive consolidation are (1) presence of consolidated financial statements; (2) unity of interest and ownership between entities; (3) existence of parent and intercorporate loan guarantees; (4) difficulty in segregating individual assets and liabilities; (5) existence of asset transfers without formal observance of corporate formalities; (6) commingling assets; and (7) profitability of consolidation at a single location. Courts may consider both indirect benefits and identity of interests in determining that a guarantee is made for reasonably equivalent value. The parties may establish bankruptcy remote entities in order to diminish the likelihood of a bankruptcy: independent directors, any decision to file a bankruptcy requires the vote of the independent directors, limit on debt, agreement not to institute an involuntary bankruptcy by creditors. However, these structures may be circumvented by filing an involuntary bankruptcy. A creditor loaning money to a debtor and taking a security interest with knowledge that the loan will be used to pay off an unsecured creditor has made a fraudulent transfer since it hinders collection of other debts. Benefits to affiliates may be sufficient value if they are so closely connected to be an "economic unit" or to have "identity of interest."
If a corporation pays a line of credit, on which its stockholder was the maker, a fraudulent transfer has not occurred if it received all advances on the line.
Financing of a leveraged buyout of a corporation or partnership (by mortgaging of the target corporations assets to fund a loan to buy out its owners or by sale of the target corporations assets or stock) may be a fraudulent transfer. In the context of a stock purchase LBO, the assets of the corporation should be valued on a going concern basis, unless the bankruptcy is "clearly imminent." A guarantee by the target may be viewed as a disguised direct obligation. The affidavit by a certified public accountant asserting that the target corporation will remain solvent raises a genuine issue of material fact respecting solvency. This, however, simply avoids summary judgment. "The presumption that fair saleable value of the stock was equal to the negotiated stock sales price was a "bursting bubble that "completely vanishe[d] upon the introduction of evidence sufficient to support a finding of the nonexistence of the presumed fact." Although purchase price may be highly probative of a companys value immediately after a leveraged buyout, it is not the only evidence."
The court may collapse various LBO transactions and treat them as one transaction. "Regardless of the number of steps taken to complete a transfer of debtors property, such as in a leveraged buyout transaction, if they reasonably collapse into a single integrated plan and either defraud creditors or leave the debtor with less than equivalent value post-exchange, the transaction will not be exempt from the Codes avoidance sections."
The claim that an LBO is a violation of a state fraudulent conveyance act may be asserted based on open account creditors whose debts at the time of the LBO were not based on the same invoices as the creditors debts at the time of the bankruptcy filing. In an open-account context, the existing creditor is defined by the continued use and availability of a credit facility.
Neither the opportunity to receive other new debt by credit lines nor the benefit of new management in an LBO is consideration under a state fraudulent conveyance act.
However, LBO transactions should not be a fraudulent transfer as to the seller of the corporation if the seller is not aware that the corporations assets will be mortgaged to fund the purchase. There are differing cases as to whether an "above-board" LBO can be a " fraudulent transfer or whether only the creditor at the time of the transaction can attack the transaction; some hold that LBOs which were very public events may not be avoided. Although it is the historic view of the Ninth Circuit that such LBOs may not be avoided, such view has been widely rejected elsewhere and other courts hold that even publicized LBOs are avoidable and that post-LBO creditors have standing to attach the LBO. If a transferee from a purchaser in a leveraged buyout is a bona fide purchaser for value without notice, then the transfer is not subject to avoidance. The transaction will not be avoidable if the target continues to have sufficient capital and is not rendered insolvent by the leveraged buyout. If the target is able to pay its bills as they mature for several months after the leveraged buyout, this will evidence solvency, particularly where the evidence of balance sheet insolvency is inconclusive.
Courts may have a variety of perspectives on the nature of complicated leveraged buyouts: one case analyzed a spin-off to a newly formed subsidiary of assets followed by a sale of stock of the new subsidiary and encumbrance of its assets. It concluded this was not truly a finance of stock sale of an existing corporation, but, rather, was a sale and finance of an asset purchase by a newly formed corporation. Consequently, the court concluded that fair value was given for the purchase (and finance).
A leveraged buyout may constitute settlement payment exempted by Section 546(e) from avoidance where paid in the securities or commodities market. While there are conflicting cases, it has been held that "a payment for shares during an LBO is obviously a common securities transaction, and we therefore hold that it is also a settlement payment for the purpose of Section 546(e)." Consequently a payment made through a financial institution in an LBO was not avoidable.
Actual intent to defraud creditors may be evidenced by a mortgage to an insider (including a "close friend") to secure pre-existing debt when the mortgagor was insolvent. Actual intent to defraud creditors was found where substantially all of the assets of the debtor were transferred to a successor corporation but one of the significant debts of the debtor was not assumed by the successor. Indicia of fraudulent intent also include corporate transfers to directors and transfers for inadequate consideration between closely related entities.
A transfer may be a fraudulent transfer if the debtor did not receive reasonably equivalent value and if the debtor retained unreasonably small capital to continue its business. Unreasonably small capital has been variously interpreted as (1) insolvency, (2) the encumbrance of all assets (as unreasonably small capital per se), or (3) insufficient cash flow.
A leveraged buyout may not be avoidable unless a creditor is unpaid and is prejudiced. A trade creditor may be prejudiced if the relationship arose before the leveraged buyout and the debt is owed for a period after the leveraged buyout.
A lien granted to a new lender refinancing a prior loan may be avoidable as a fraudulent transfer.
Redemption of corporate stock when a corporation is insolvent may constitute a violation by state corporation law and therefore may be voidable.
A claim of the United States government shall be paid first if the person indebted to the U.S. is insolvent and the debtor makes a voluntary assignment of property, property is attached, or an act of bankruptcy is committed.
Company Policy: In any case of upstream or downstream guarantees, leveraged buyouts or gift deeds in your transaction, even though no bankruptcy is pending, the following "creditors rights" exceptions should appear:
Any claim by reason of the operation of federal bankruptcy, state insolvency, or similar creditors rights laws.
Upon request you may substitute the 1992 creditors rights exclusion.
This exception will not be necessary if the insured transaction (such as a current loan to finance a leveraged buyout) creates the "creditors rights" issue and if the 4-6-90 or 10-17-92 ALTA policies are issued. The 4-6-90 and 10-17-92 ALTA policies contain a similar "creditors rights" exclusion. However, if the "creditors rights" issue possibly arises out of a prior transaction (such as a leveraged buyout now being refinanced), add this creditors rights exception to the 4-6-90 or 10-17-92 policy. The creditors rights exclusion in the 4-6-90 or 10-17-92 ALTA policies may then be irrelevant since it extends to a claim arising out of the insured transaction.
If we are asked to delete the creditors rights exclusion (from the 1990 or 1992 policy) or to issue the 1970 policy without a creditors rights exception, you may do so (where lawful):
1. On a loan policy if the property is a 1-4 family residence, and on purchase money loan by an institutional lender.
2. If our underwriting personnel approve such issuance in other cases. See our checklist of questions. We will consider, on a case-by-case basis, such issuance where cross guarantees by affiliates will occur. Factors include:
(1) debt to equity ratios;
(2) adequacy of case flow to service debt;
(3) what is the term of loan payment?
(4) relationship of affiliates (e.g., are they related partnerships with common partners; or sister corporations; do they engage in same type of business);
(5) type of business of mortgagors (e.g., are they single asset real estate related entities, or do they engage in industrial mining or other business)
(6) unsecured creditors of the mortgagors (do they have many; how much; current? Do they owe income taxes)
(7) any pending suits against the mortgagors (these may reflect debts and potential claimants)
(8) do the mortgage documents have a savings clause (e.g., not secure more than 95% of new worth; no more than maximum amount that would not cause insolvency, etc.")
(9) will each mortgagor receive some loan benefits, or will some mortgagors simply guaranty debt of affiliates?;
(10) will we have a "deductible" (e.g., lender may assume initial loss or initial defense cost, for example, up to $1,000,000?)
(11) are all improvements complete?
(12) is the land fully leased?
(13) is there a contribution agreement by affiliates?
If a prior loan transaction is subject to a creditors rights issue (e.g., leveraged buyout financing), the refinance also may be tainted and should be subject to the broad creditors rights exception.
A cross default clause alone does not appear to affect the validity of the mortgage.
A creditor loaning money to a debtor and taking a security interest with knowledge that the loan will be used to pay off an unsecured creditor has made a fraudulent transfer since it hinders collection of other debts.
Benefits to affiliates may be sufficient value if they are so closely connected to be an "economic unit" or to have "identity of interest."
Value can be present or antecedent debt. There are different views on whether an exchange involving security from a antecedent debt is receipt of less than reasonably equivalent value.
The parties may engage in "structured financing," in order to "separate the credit quality of the assets upon which the financing is based from the credit and bankruptcy risks of any entity involved in the financing." This may be accomplished by creating a Special Purpose Vehicle (SPV) as a bankruptcy remote entity. "A bankruptcy remote SPV is an entity that is unlikely to become insolvent as a result of its own activities and that is adequately insulated from the consequences of another partys bankruptcy." The transfer to the SPV must be a "true sale," (based in part upon purchase price paid being reasonably equivalent of fair market value) and not collateral for a loan, and the SPV must be separate from the transferor. Reduction of bankruptcy risk may include: (1) an independent director whose consent is necessary to any voluntary bankruptcy; (2) restrictions on activities unrelated to the particular asset without unanimous board or partner consent, (3) restrictions on change in organizational documents without unanimous consent, and (4) separateness covenants to maintain separate business in order to avoid substantive consolidation.
The case of BFP v. Resolution Trust Corp., 511 U.S. 531, 1 28 L. Ed.2d 556, 114 S. Ct. 1757 (1994) held that reasonably equivalent value at a nonjudicial or judicial mortgage sale is the price bid at the noncollusive sale conducted in accordance with state foreclosure law. The sweep of this case does not extend to statutory lien foreclosure or deeds in lieu of foreclosure. In order to invalidate a mortgage foreclosure sale, pursuant to BFP, the plaintiff must show (1) that the foreclosing party failed to comply with the requirements of state law, such that the irregularity would permit judicial invalidation under applicable state law; and, (2) the price actually received at the sale was not the reasonably equivalent value of the land. The benchmark of the sales price is not the lands fair market value, but the price that would have been received at a properly conducted sale. Not every irregularity will necessarily invalidate a sale under state law.
Under the 1984 amendments to this Section, a fraudulent transfer expressly included a transfer which is either voluntary or involuntary. The term "transfer" includes foreclosure of debtors equity of redemption. In the concurring opinion of Madrid v. Lawyers Title Insurance Corp., 725 F.2d 1197, 11 B.C.D. 945, 10 C.B.C. 2d 347 (9th Cir. 1984) cert. denied, 469 U.S. 833, 105 S. Ct. 125, 83 L.Ed. 2066, the judge stressed that the Act did not expressly apply to transactions that were involuntary conveyances. The majority opinion in the Madrid case said that the transfer of relevance where there has been a foreclosure is the initial deed of trust and not the trustee deed. That case may also have been rejected by the 1984 amendments. The case of In re Alsop, 14 B.R. 982, 8 B.C.D. 335, 5 C.B.C.2d 797 (Bankr. D. Alaska 1981), affd, 22 B.R. 1017, 6 C.B.C.2d 669 (D. Alaska 1982), agreed with the reasoning of Madrid in holding that the time of perfection under Section 548 in connection with the foreclosure is the recordation date of the deed of trust, as did the case of In re Ehring, 91 B.R. 897 (.B.A.P. 9th Cir. 1988) affirmed, 900 F.2d 184 (9th Cir. 1990) (acknowledging that the Code definition of "transfer" had been amended).
The case of Durrett v. Washington National Insurance Co., 621 F.2d 201, 6 B.C.D. 954 (5th Cir. 1980) held that actual foreclosure itself was a fraudulent conveyance if fair (reasonably equivalent) consideration was not given. It held that the 57.7% of fair market value was not fair consideration and that 70% probably would be so. In cases after Durrett, a transfer arguably for 68.5% of fair market value was not for reasonably equivalent value. A transfer for 62% of fair market value was not reasonably equivalent value. The case of In re Hulm, 738 F.2d 323, 11 C.B.C.2d 154 (8th Cir. 1984), cert. denied, 469 U.S. 919, 105 S. Ct. 398 (1984) agreed with Durrett that a foreclosure following the statutory redemption period was a transfer under Section 548.
However, in a second approach the case of In re Winshall Settlors Trust, 758 F.2d 1136 13 B.C.D. 839, 12 C.B.C.2d 605 (6th Cir. 1985) held that (in accordance with state law), there must be a showing of some element of fraud, unfairness, or oppression accounting for the inadequacy of price. The case of In re Strauser, 40 B.R. 868, 12 B.C.D. 171, 10 C.B.C.2d 1323 (Bankr. N.D. Ohio 1984), held that consideration received at a noncollusive and regularly conducted judicial foreclosure in Ohio is reasonably equivalent value, although less than 70% of fair market value. Similarly, In re Madrid, 21 B.R. 424 (B.A.P. 9th Cir. 1982), affd on other grounds, 725 F.2d 1197 (9th Cir. 1984), cert. denied, 469 U.S. 833, 105 S. Ct. 125 (1984), and In re BFP, 974 F.2d 1144 (9th Cir. 1992), affd, BFP v RTC, 511 U.S. 531, 128 L. Ed.2d 556, 114 S. Ct. 1757 (1994), held that, in accordance with state foreclosure law, a price obtained at a non-collusive foreclosure sale properly conducted under state law was irrebuttably presumed to be reasonably equivalent value.
A third approach stated that the value equivalent is too uncertain, and instead requires that a commercially reasonable sale occur in order for reasonably equivalent value to be considered to have been bid. Factors involved in such analysis include advertising in real estate sections of newspapers and mailings to various brokers as well as the amount bid at sale.
Some cases, in a fourth approach analogous to the third approach, provided no absolute guideline as to what reasonably equivalent value was, and stated that reasonably equivalent value must be determined in an evidentiary hearing.
In analyzing whether the foreclosure on a senior lien was made for reasonably equivalent value, the balance owing on junior liens was irrelevant.
If the lien foreclosed was a subordinate lien, one analysis compared the value of the equity in the property to the amount bid. Another method compares the amount of prior liens and bid to the fair market value. As noted in the case of In re Richardson, 23 B.R. 434, 9 B.C.D. 895 (Bankr. D. Utah 1982), there were several ways to analyze whether a fraudulent transfer has occurred: bid on second lien plus amount of first lien owed compared to fair market value; bid compared to fair market value; bid compared to fair market value less post-sale liens; and bid compared to fair market value less presale liens.
There was conflicting thought on whether the debt cancelled must be added to the amount bid at sale to determine whether reasonably equivalent value was bid. The amount of debt cancelled also must be considered.
The rulings in these cases no longer apply to mortgage foreclosure sales, although the reasoning is still relevant in the context of a tax foreclosure or other involuntary sale. Deeds in lieu of foreclosures may still be vulnerable as fraudulent transfers or voidable preferences. Some cases have extended the reasoning of BFP v RTC to tax foreclosure sales (holding that the bid price is reasonably equivalent value). Several cases have held that BFP v. RTC will apply to tax foreclosure sales if the protections afforded a debtor by a states tax sale foreclosure procedures are at least as adequate as the protection afforded pursuant to state mortgage foreclosure procedures; those basic procedural protections are notice, reasonable opportunity to cure and strict adherence to statutory requirements. The case of BFP v. RTC did not protect the taxing authority acquiring title through a nonjudicial tax forfeiture proceeding. The BFP case has also been held not applicable to a strict foreclosure (of mortgage) judgment. The BFP case will not apply to a tax sale pursuant to state law mandating that the land be sold to a person selected at random lottery for the amount of taxes; such sale did not afford the protections of a foreclosure sale requiring a public auction and competitive bidding. The BFP case has been construed as applying to a federal tax lien foreclosure sale.
The transfer of property sold at a tax sale occurs upon expiration of the redemption period (for calculation of the time to attack a transfer under Section 548).
According to one case, BFP will apply to executory contract forfeitures so that the courts should consider the effect that the distressed contract has on the lands worth on date of transfer; therefore, the propertys value is likely less than the fair market value.
According to another case, BFP applies to contract forfeitures. This view applied under state law because the forfeiture of contract did not shock the courts conscience so as to make the contract forfeiture unenforceable under state law; the transfer is for reasonably equivalent value and is not a fraudulent transfer. According to another view, a contract forfeiture may be a fraudulent transfer.
State fraudulent conveyance statutes with language similar to Section 548 may apply under Section 544. Those laws may provide longer limitation statutes. Some state fraudulent transfer acts (such as in Texas) provide that the amount bid at a regularly conducted noncollusive foreclosure is reasonably equivalent value. This risk, however, is minimal, in light of the BFP case even in other states that do not exempt foreclosures sales.
If several states have contact with the transaction, the sale of the conveyed property will often, but not always, be the state with the most significant relationship to a fraudulent conveyance action in order to determine applicable state law. If the trustee seeks to set aside a transfer as actual or constructive fraud under a state foreclosure act, the trustee must establish the existence of an actual unsecured creditor with an allowed, unsecured claim, who would set aside the transfer under state law. If the state fraudulent transfer law tolls the limitations period until discovery of the fraud or such facts that would have led to discovery with reasonable diligence, the recording of a deed is not constructive notice to the creditors of the fraud.
(1) You do not need to use a Durrett or creditors rights exception in connection with a judicial or nonjudicial foreclosure of a mortgage or resale after that foreclosure.
(2) If there has been recordation of a deed in lieu of foreclosure of a mortgage, a deed pursuant to foreclosure of taxes or involuntary liens, sheriffs deed or other deed in connection with a tax sale or involuntary lien foreclosure within the year prior to your examination or if the right of redemption from a tax sale or other involuntary lien foreclosure under state law ended within the year prior to your examination, you should place the following exception in your commitment and/or policy to be issued to the grantee of the deed in lieu or (foreclosure) deed:
"any claim by reason of the operation of federal bankruptcy, state insolvency, or similar creditors rights laws."
If this exception is to be placed in a policy covering single-family residential property, you may add the following language to the exception:
"as adjudicated or claimed in any present or future bankruptcy proceeding by or against ___________ (here place names of parties whose interests were foreclosed) provided that the bankruptcy petition is filed within one (1) year after __________________ (here place date on which redemption rights end or deed is recorded)."
(3) You do not need to use this exception in connection with a resale after the foreclosure of a tax lien or other involuntary lien or deed in lieu of foreclosure (if that transaction is otherwise satisfactory) provided that:
(1) the party whose interest was foreclosed is not in possession of the property;
(2) that party has not filed a bankruptcy according to your records; and
(3) (a) the property constitutes a single-family residence and (not a sale of multiple residences); or
(b) the party who acquired by foreclosure is conveying by sale to an unrelated third party and the amount of indebtedness either bid in or cancelled pursuant to the foreclosure (in some states, the full amount owing at time of foreclosure is deemed to be cancelled or not subject to collection after foreclosure) is at least 70% of the amount of the resale price; or
(c) you are issuing on an arms length sale only to unrelated persons (not to the party that acquired by foreclosure) and the sales price does not exceed $5,000,000; or
(d) you otherwise secure express underwriter approval for issuance without exception (for example, in some cases we will rely upon indemnities or, if there is no current sale, we will rely upon appraisals to determine current value).
(4) If more than one (1) year has passed since the recordation of the deed pursuant to the involuntary lien foreclosure or deed in lieu of foreclosure and if more than one (1) year also has passed since all redemption rights have ended, then you will not need to make an exception under any circumstances where insuring a resale. The party whose interest was foreclosed or conveyed by deed in lieu of foreclosure must no longer be in possession of the property and that party must not have filed a bankruptcy after the recordation of the deed or end of redemption rights.
(5) If the party whose interest was foreclosed in a tax or involuntary lien foreclosure or conveyed by deed in lieu of foreclosure subsequently filed a bankruptcy after foreclosure (of an involuntary lien or end of redemption rights), then you will need to place the above exception in the policy. You should secure express underwriter approval before deleting the exception.
(6) If the foreclosure occurred during the bankruptcy proceeding of the owner pursuant to proper lifting of the stay, you will not need to make any exception.
(7) If the rights of a purchaser under a contract for deed were forfeited within the year prior to your examination, then you will not need to make an exception, provided that the purchaser has not filed a bankruptcy proceeding according to your records, the purchaser is not in possession of the property, and the amount owed on the contract was at least 70% of the amount of the resale price. If more than one (1) year has passed since the forfeiture, and if the purchaser did not file a bankruptcy thereafter, no exception is necessary. If the purchaser did file a bankruptcy after the forfeiture, you should place the exception in the policy.
Company Policy: If you reasonably suspect that a seller in a voluntary transfer may file a bankruptcy shortly, do not insure unless you are satisfied that the sale approximates fair market value.
Company Policy: Do not rely on this section (protecting innocent purchasers) if you are aware of the bankruptcy: e.g., the purchaser may have knowledge or may not have bought in good faith.
A foreclosure (after the stay is lifted) during the pendency of a bankruptcy proceeding is not avoidable in that bankruptcy proceeding as a fraudulent transfer. If a debtor is dissatisfied with the lift of stay, the debtor may appeal (and secure a stay pending appeal) or secure a dismissal and wait 180 days to refile. A foreclosure during a Chapter 11 proceeding pursuant to a lift of stay is not subject to attack as a fraudulent conveyance when the proceeding is converted to Chapter 7, since the foreclosure still occurred after the date of filing of petition.
A post-filing foreclosure or sale to a good faith purchaser without knowledge for present fair equivalent consideration will not be set aside if no copy or notice of the petition has been filed in the real property records prior to the filing of the good faith purchasers deed.
Company Policy: Do not rely on this section (protecting innocent purchasers) if you are aware of the bankruptcy: e.g., the purchaser may have knowledge or may not have bought in good faith.
A mortgagee buying in at its foreclosure is not protected under Section 549(c) since by bidding in its preexisting debt it has not paid present consideration. Some cases recognize that Section 549(c) will protect a third party purchaser at foreclosure who records before a notice of bankruptcy is recorded.
The purchaser at a foreclosure sale must perfect the foreclosure by recordation of the foreclosure deed before a notice of bankruptcy is recorded. In the event the purchaser fails to do so, the post-bankruptcy foreclosure is avoidable under Section 549, even if the sale is effective against any bona fide purchaser.
A post-petition third-party purchaser at a foreclosure sale must record its deed to rely upon Section 549. A post-petition transfer by the debtor (or perfection of transfer by recordation), as opposed to an involuntary foreclosure in violation of the automatic stay, is not void, but is merely voidable during the bankruptcy proceeding.
An action to set aside the transfer must be filed within two years of the transfer, and is not tolled by conversion of the bankruptcy. The time to set aside the transfer may be tolled until the trustee knows or should know of the transfer. It will be tolled by inequitable conduct of the debtor (e.g., deceit and nondisclosure).
A third party, such as a creditor, lacks standing to attack a post-petition transaction as a violation of Section 549 (in the absence of court authorization to act on behalf of the trustee or debtor-in-possession) and may only seek damages for violation of Section 362.
Company Policy: Do not rely upon a violation of section 362 or section 549 to waive a lien perfected after the filing of a bankruptcy.
The assignment of a note secured by a mortgage during a bankruptcy proceeding is not protected by Section 549(c); this provision extends only to a purchaser of real estate and not to an assignee of a note secured by a lien.
A post-petition deed of trust by the debtor is avoidable as a violation of Section 364 if it is not approved by the court (and cannot be protected under Section 549(a)). However, since the loan was a purchase money lien, the lender, as a matter of equity, may recover the principal but will not be protected under section 549(c) because a deed of trust is not a protected "transfer."
A third-party purchaser at a post-petition foreclosure sale could not qualify as a good faith purchaser where the foreclosure trustee knew of the bankruptcy and the trustee also acted as attorney for a third-party agent of the purchaser. The trustees knowledge was imputed to the agent and, through the agent, the knowledge was imputed to the purchaser. If the third-party buyer at the post-petition foreclosure sale has no other relationship with the trustee, the knowledge of a trustee under a Deed of Trust of the bankruptcy of the mortgagor will not be imputed to the buyer at the foreclosure sale. Good faith depends on (1) whether the transaction was an arms length bargain and (2) whether the transferee possess sufficient facts to cause a reasonable person to investigate whether the debtor was in bankruptcy or whether bankruptcy was imminent.
A third-party purchase at a post-petition foreclosure sale is conclusively deemed to be made for present fair equivalent value if the sale is conducted in compliance with state law. Present "fair equivalent" value may require payment of a higher percentage of fair market value than "reasonably equivalent" value. According to another case, "present fair equivalent value" implies a more exacting standard than "reasonably equivalent value": it contemplates fair market value or "something very close to it." However, this view is not universally accepted.
According to the minority view, the protection afforded a post-petition purchaser will not apply to an involuntary transfer that violates the automatic stay (such as a tax or foreclosure sale). It will be limited to voluntary transfers by the debtor not in the ordinary course of business. Those foreclosure sales, according to this view, are simply void as violations of the stay. This view is not accepted by a majority of courts, which recognize Section 549(c) as an exception to the effect of a violation of the stay under Section 362. Section 549 does not protect a post-petition filing of a deed delivered before the filing of the bankruptcy case; such transfer is not a post-petition transfer.
Innocent transferees from parties to a fraudulent conveyance or a voidable preference or other voidable transfer will not have their transfer set aside if they pay value without knowledge of the voidability of the transfer. It has been said that "knowledge" means actual knowledge of the voidability of the transfer and not constructive notice by matters of record. Otherwise, good faith transferees may be given a lien to secure the amounts they paid and the amount spent in good faith for improvements. A party may not take in good faith if aware of a foreclosure which is the transfer in issue, since this may be sufficient evidence of a debtors financial difficulties. "Value" has been construed by one case as denoting fair market value. According to one case, if a secured party acquired title to the property in a voidable transaction, it is entitled to have its lien reinstated if the transfer of title is voided, even if it did not acquire title in good faith.
Company Policy: Do not rely on the innocent transferee provisions to issue without exception to fraudulent transfer or voidable preference issues except as provided in our guidelines of fraudulent transfers.
A "mere conduit" of a fraudulent transfer, such as an attorney or title company disbursing funds through a trust account, is not liable as an immediate transferee of a fraudulent transfer.
Any transfer avoided under these sections shall be preserved for the benefit of the estate. Any avoidance of a transfer or lien will not allow any parties, such as an inferior lienholder, to step up in priority.
A lien or claim can be equitably subordinated to other claims against a corporation (i.e., recharacterized as capital) formerly controlled by the creditor if the creditor dominated the corporation at the time and had knowledge that might render the loan unrepayable, the payment depended on a business turn around, and the transaction was made due to inside information giving an unfair advantage. Three categories of conduct sufficient to warrant equitable subordination are (1) fraud, illegality, or breach of fiduciary duty; (2) undercapitalization; and (3) use of the debtor as a mere instrumentality or alter ego.
In deciding that equitable subordination would not lie, one court cited several factors: the lender did not own controlling stock in the borrower; the lender did not make management decisions for the borrower (e.g., which creditors to pay); the lender did not place its employees as directors or officers of the borrower; the lender did not influence the removal of borrower personnel; the lender did not request particular action at any shareholders meeting; the lender did not direct the borrower not to pay vendors; the lender did not coerce the borrower to execute security agreements after the borrower became insolvent; the control over finances and reduction in loan advances was based on the prior loan agreement. Subordination has been allowed where a lender also was in substance the owner of the corporation by holding (as collateral security) over 90% of the stock and controlling the income. Subordination has been denied where the creditor was a shareholder-principal, the capitalization of the debtor was sufficient, and the loan preserved valuable debtor property rights. Subordination has also been denied where the creditor had a pledge of stock of the debtor without exercise of control over the business. Subordination has been allowed where the lender acquired a mortgage pursuant to a guaranty on which the guarantor was obligated to the third-party lender. An insider loan is subjected to rigorous scrutiny, however, and the burden is on the director or stockholder not only to prove the good faith of the transaction but also its inherent fairness. Factors of relevance include: whether the corporation is grossly undercapitalized; where corporate formalities are observed; whether dividends are later paid; whether the insider siphons funds; whether other officers or directors function; whether corporate records exist; whether the corporation is a mere facade or has independent existence; and whether the consideration for the corporations mortgage is "debt" owed by it to its insider.
Situations that must be carefully scrutinized include mortgages by subsidiaries to their parents and mortgages by a joint venture to a lender which is a parent of one of the venturers. The doctrine of equitable subordination may be employed for recharacterization of secured loans as unsecured capital contributions by insiders bound by their fiduciary duty to the mortgagor.
Company Policy: If the lender is one of the joint venturers or general partners in the mortgagor, we generally add the following exception in the loan policy (although the exclusions already exclude liability):
"any loss, claim, or damage because the insured mortgage is attacked, set aside, or subordinated by reason of the fact that the insured is a partner or venturer in the mortgagor."
A transaction would not be subordinated to other creditors where the lender acquired the land from the borrower and leased it back, received a conversion option to convert to an equity ownership in the project, received a shared appreciation mortgage, received 50% of cash flow, gave an option to the borrower to repurchase the land at fair market value, and received the option to convert the loan to a 60% interest in the borrower. The lender actually did not overreach: it consented to all leases, it did not select management, it did not exercise its conversion option, and it did not otherwise virtually control the borrower. The fact that the loan provided "kickers" to the lender does not itself amount to inequitable conduct that amount to fraud or overreaching. Its access to records, annual financial statements, approval of rental leases and additional financing are simply prudent acts of a lender.
Company Policy: If you are asked to issue an endorsement concerning shared appreciation or contingent interest, call our underwriting personnel. We will analyze the extent of control by the lender, amount of appreciation shared, continuation of contingent interest feature after payment, and applicable law in deciding whether to offer the endorsement.
Section 510 may not be employed to avoid a transfer.
"When an insider makes a loan to an undercapitalized corporation, a court may recast the loans as contributions to capital."
A loan in connection with a leveraged buyout may be treated as a redemption of the debtors stock interests and claims on equity interests. Such claims may be subordinated to claims of unsecured creditors. Such equitable subordination may be imposed without regard to lender fault in an LBO.
There is no limitation period for equitable subordination.
According to some cases, recharacterization of loans as contributions to capital is a subset of the courts equitable subordination powers; however, others view the doctrine (of recharacterization and subordination) as serving different purposes. Factors considered in reviewing recharacterization include: "(1) The adequacy of capital contributions; (2) The ratio of shareholder loans to capital; (3) The amount or degree of shareholder control; (4) The availability of similar loans from outside lenders; and (5) certain relevant questions, such as (a) whether the ultimate financial failure was under-capitalization; (b) whether the note included payment provisions and a fixed maturity date; (c) whether a note or other debt document was executed; (d) whether advances were used to acquire capital assets; and (e) how the debt was treated in the business records."
Equitable subordination of an insiders claim is not justified solely because the corporation is under capitalized; there must be inequitable conduct by the insider.
A noninsider lender adhering to terms of a loan agreement is not vulnerable to equitable subordination.
A liquidated damage provision in a mortgage (such as prepayment penalty) will be enforced if (1) the provision is not a penalty but is reasonable, and (2) the damages are difficult to ascertain, and (3) there is an attempt to calculate the amount of damages at the time of contracting, with a discount for present value. Even if a clause, such as a prepayment penalty, is enforceable under state law, it may not represent an allowed claim under Section 506(b) if it does not provide an appropriate discount based upon conditions when applicable; if it fails to provide only for actual costs, charges, and fees; or if it provides post-petition interest beyond time of principal repayment.
In a Chapter 7 proceeding, the lien cannot be "stripped down" to the judicially-determined value of the claim under Section 506(d) since the claim was fully allowed under Section 502. A Chapter 13 debtor cannot bifurcate a mortgage lien claim only on the debtors principal residence into secured and unsecured claims.
Interest Rate Swaps
Public Law 101-311 enacted Section 560. This section authorizes exercise of any contractual rights created in swap agreements. Sections 546(g) and 548(d)(2)(D) insulate swaps from avoidance actions, absent actual fraud.
Company Policy: If you are asked to issue an endorsement concerning an interest rate swap or hedge agreement, call our underwriting personnel. Although we are willing to provide an endorsement in some cases, we do not insure the enforceability of any specified amounts as set forth in the agreement.
Dismissal Of Bankruptcy Case
A dismissal occurs only upon court order, not simply by notice of the trustee or debtor and lack of objection. A dismissal serves to reinstate all transfers avoided under most sections of the Bankruptcy Code, including fraudulent conveyances and voidable preferences. The dismissal vests the property of the estate in the entity in which the property was vested immediately before the case. A dismissal will reinstate a judicial lien avoiding as interfering with homestead rights. However, the court for cause can order otherwise. The legislative history indicates that "[t]his does not necessarily encompass undoing sales of property from the estate to a good faith purchaser." It should be possible under Section 349 to secure an order protecting any purchaser. It has been held, for example, that a judgment avoiding a preference can be preserved after dismissal of the voluntary bankruptcy and in connection with a new filing of an involuntary bankruptcy. The court noted that there is no provision in the code limiting the time within which the discretion to preserve the bankruptcy order may be exercised, other than a reasonable time. There may also be estoppel by deed if the debtor-in-possession actually executes the deed. The court may order dismissal of a bankruptcy without immediate revesting of the assets in the debtor to prevent abusive filing by the debtor. Upon dismissal of the case, the automatic stay terminates as to property of the estate, even if the property was not scheduled.
Company Policy: Because of the possibility of a dismissal prior to discharge in Chapter 7, 12, or 13, and prior to completion of the plan in Chapter 11, we require a deed or release by the claimant of the adverse avoided interest prior to discharge in a Chapter 7, 12, or 13 proceeding, or prior to completion of any Chapter 11 plan, if the property has been exempted. Otherwise, in all cases of nonexempt property, we require an order to sell the property free of the adverse interest (whether such interest was "avoided "or otherwise) while the case is pending.
Discharge Of Debtor In Bankruptcy
A mortgagee's lien survives a discharge even though no claim is filed in a Chapter 7 proceeding. The mortgagee may proceed to foreclose as to properties of the debtor (not remaining in the estate) without violating the automatic stay after the discharge. The lien is enforceable even though no claim was filed. Section 506(d) provides that a lien is not void due to a discharge merely because of a failure to file a proof of claim. The scheduling of the debt as unsecured is not res judicata and will not of itself void the lien. The schedule of a secured claim as "disputed" where the claim was not filed, allowed, or treated or classified inconsistent under the plan has no effect on the creditor's lien.
If no adversary proceeding was brought to avoid a lien or equitable claim to reinstate the lien, the claim of lien as an in rem right will not be affected by the discharge.
An adversary proceeding may not be brought in a Chapter 7 proceeding pursuant to Section 506(d) to avoid a lien to the extent it exceeds the value of the property.
Some cases have stressed the former language of Section 524(a)(2) which prohibited acts to collect from property of the debtor after a discharge if the creditor did not affirmatively seek to enforce or protect his rights in the bankruptcy proceedings. However, this language was deleted from Section 524 by the 1984 amendments. Apparently, this language was intended to apply only to later acquired property of the debtor.
After a discharge, a creditor retains its perfected lien unless the lien has been avoided by an adversary proceeding, judgment, or other court order.
After discharge the IRS may file a renewal to continue its preexisting lien and may notify the taxpayer of a levy to enforce its lien against property acquired by the taxpayer before the filing of the bankruptcy. After a discharge, the creditor still has one mode of enforcing its claim: an action against the debtor in rem.
A creditor may enforce a prepetition judgment lien after the discharge, if the automatic stay is no longer effective and the lien has not been paid, modified or avoided.
Under Texas law, as to judgments perfected before September 1, 1993, the debtor may, after one year elapses following the bankruptcy discharge, proceed to secure an order that extinguishes a prior judgment lien in the same state court that rendered the judgment. The judgment must have been a debt discharged in the bankruptcy. The property involved generally must be the homestead of the debtor. As to judgment liens perfected on or after September 1, 1993, no additional state court order is necessary. It should be determined that the debt was scheduled in the bankruptcy, that the debtor was not exempted from discharge in the bankruptcy (by a court order in an adversary proceedings, or possibly because it secured taxes, spousal alimony or maintenance or child support, fines, educational loans, or judgment involving DWI's) and that the property was scheduled as homestead in the Bankruptcy.
In a Chapter 11 proceeding (See 1141(c)), a Chapter 12 proceeding (See 1227(c)), and a Chapter 13 proceeding (See 1327(c)), if the property is dealt with in the plan or vested in the debtor thereby, a lien is arguably divested except as therein provided; in a Chapter 12 or 13 proceeding, the debt also must be provided for. However, we do not rely on the confirmation to waive preexisting liens. It has been held that the plan and confirmation cannot divest a lien without creditor approval or an additional adversary proceeding. If a lien is cancelled by a Chapter 13 plan, the lien remains in place until the debtors complete payments under the plan; if the case is dismissed the lien will be reinstated.
Company Policy: Do not rely on a discharge or plan confirmation to waive liens.
If the debtor can establish that an omitted creditor had notice or knowledge of the bankruptcy proceeding in sufficient time to file a proof of claim, the debt may be discharged. According to one view, if the case has been closed, the court can reopen the case to allow an action to determine dischargeability of the debt. Another view is that the case may be reopened to schedule and discharge omitted creditors, subject to the discretion of the court.
The creditor who challenges dischargeability under Section 523(a) may satisfy its burden by a preponderance of the evidence. A new note and mortgage for valuable consideration (e.g. refinance given after discharge to forego foreclosure) is a new contract; it is separate from the initial discharged note and is not subject to reaffirmation.
A claim by a title company arising out of concealment of a lien by the debtor in a closing is nondischargeable in a Chapter 7 proceeding. Similarly, a debtor's false affidavit of no liens may cause the title insurer's claim to be non-dischargeable in a Chapter 7 case.
Chapter 13 grants the most all-encompassing discharge. The discharge may include debts for fraud and willful malicious torts. This discharge is incentive to the debtor to complete performance of the plan. Unlike the Chapter 11 where the debtor receives a discharge upon confirmation, the Chapter 13 debtor does not receive a discharge, other than a possible hardship discharge, until the debtor makes all plan payments.
A lender may not secure a mortgage on new property that includes discharged debt that was previously secured by a lien on other property of the debtor unless the bankruptcy court approves a reaffirmation agreement. A creditor may enforce a pre-petition judgment lien after the discharge, if the automatic stay is no longer effective and the lien has not been paid, modified or avoided.
Effect Of Confirmation Of A Bankruptcy Case
Chapter 11 Proceeding
A Chapter 11 proceeding may provide for a sale of all, or substantially all of the assets of the estate. However, except as otherwise provided in the plan or in the order confirming plan, confirmation vests all the property of the estate in the debtor.
Several courts have concluded that, since the specific plans revested title in the debtor and since no express provisions prohibited sales, sales of (all or substantially all of) assets did not constitute modifications of the plans.
However, a transfer by the debtor that is inconsistent with the Plan may be avoidable in a later converted case, even though the asset was revested in the debtor by the Plan.
Company Policy: You do not need to require an order of the court to sell property if the property is vested in the debtor and if the plan and order do not preclude a sale. The plan and confirmation should be carefully reviewed to verify this fact. However, in any sale of all or substantially all of the assets of the debtor after confirmation of the plan but during the case, we should secure court approval. The sale may be considered a liquidation or modification of plan.
Upon the confirmation of the plan, the automatic stay of Section 362 generally ceases as to preexisting liens on debtor's property: the confirmation usually revests title in the debtor and grants a discharge; at this time, the automatic stay ceases as to property of the debtor. However, if the plan provides that business will be under court supervision by the trustee and that a discharge is not yet granted, it has been held the stay is not lifted. On the other hand, a discharge is not granted in a Chapter 12 or Chapter 13 until completion of the plan.
Unless an express plan provision postpones revesting upon confirmation (e.g. "the property of the estate will vest in the reorganized debtor on or when..."), the court will not imply it.
There are differing views on whether a subsequent post-confirmation conversion to Chapter 7 will revest such title in the Chapter 7 estate.
A plan cannot revest title in a debtor if the lien was foreclosed before the case was filed.
Even though the stay ceases as to property of a debtor in a Chapter 11 proceeding upon confirmation, provisions in the plan or confirmation decree stating that the bankruptcy court retains exclusive jurisdiction of the proceedings to determine controversies and disputes, and to effectuate payments may be construed as requiring authorization of the court before foreclosure.
Company Policy: If a mortgagee seeks to foreclose on a Chapter 11 debtor after confirmation of the plan without a lifting of the stay, please call our underwriting personnel. We must verify by review of the plan and confirmation that the court has not retained jurisdiction over claims or the property.
Real estate transfer taxes (but not recording fees) are prohibited on transfers under a Chapter 11 plan of reorganization. This prohibition extends to state and city deed and mortgage taxes. A liquidating trust created by a Chapter 11 plan receives the same exemption from taxation of stamp taxes, recording taxes, or similar taxes. Consequently, transfers from a liquidating trust established by a Chapter 11 plan to third party purchasers are exempt from stamp tax or similar tax, such as transfer and recordation taxes. The plan required the trust to liquidate and sell the assets and such sales are transfers under the plan. However, the recordation of a purchaser's mortgage will not be exempt from applicable recording taxes. Transfers (sales) made prior to confirmation of the plan are not made pursuant to the plan, and do not result in exemption from recording taxes and/or a right to refund of previously paid taxes. State and city mortgage taxes may be subject to the exemption from payment if the mortgage is made pursuant to the plan.
A Chapter 11 plan may provide for the cure of default under a mortgage and de-acceleration of same, even after a foreclosure judgment. The plan can also modify due-on-sale clauses in deeds of trust.
The plan may not modify the rights of a holder of a secured claim secured only in real property that is the debtor's principal residence.
According to one view, the Chapter 11 plan extinguishes liens (such as an attachment lien) not preserved in the plan if the lien is "dealt with" by stating that all property of the estate vests in the debtor subject only to other stated liens. According to one view, a lien is extinguished unless preserved in the plan if the lienholder participated in the reorganization and the plan calls for payment to the creditor. If the creditor does not participate in the reorganization (for voting and distribution) the plan may not extinguish its lien; since the creditor could only vote and receive distribution as an unsecured creditor, its lien was never brought into the bankruptcy case and could not be extinguished by the plan. A Chapter 13 confirmation does not extinguish an ad valorem tax lien if the plan provides that holders of allowed secured claims retain the liens securing claims. According to an advisory opinion that was remanded, a lien is not "dealt with by the plan" in a Chapter 11 case where the proof of claim and confirmed plan addressed only arrearages and not the entire secured debt. Thus, the creditors participated in the bankruptcy but did not attempt to collect the entire debt through the bankruptcy. Furthermore, if the lien has not been disallowed or avoided, it survives the bankruptcy. The plan becomes a binding contract between the debtor and the creditors upon confirmation. One case states that the general rule is that "upon confirmation, the property dealt with in the plan is free and clear of all claims and interests of creditors, including liens." Although the creditor did not file a claim and the plan was silent as to its lien, the (tax) creditor's lien was extinguished by the plan because the plan was an exception to the general provisions of Section 1141(b) ("except as otherwise provided in the plan or in the order confirming the plan..."), since this plan provides that "the property of the estate" was to be free of liens and thereby included all property, not simply property (or liens) dealt with by the plan. If a lien is cancelled by a Chapter 13 plan, the lien remains in place until the debtors complete payments under the plan; if the case is dismissed the lien will be reinstated.
The plan cannot delete portions of a HUD Regulatory Agreement.
A lien extinguished by the Chapter 13 plan is reinstated by a dismissal prior to discharge.
The validity of a lien may be affected by a Chapter 11 plan if the creditor actively participates in the plan confirmation process and actually consents to receiving unsecured treatment; otherwise, an adversary proceeding is normally required to affect the validity of a lien.
A plan cannot restructure a first lien (if the bankruptcy estate has only a lien under state law) on the land at the filing of the Chapter 11 case, although the Chapter 11 trustee was to receive the title post-confirmation.
In order to determine the value of collateral and of the security interest at a confirmation hearing, the court must provide specific notice that it will value collateral at the hearing.
According to one view, the debtor must specifically and expressly retain any preference claims under the plan.
The creditors of a Chapter 11 debtor may seek dismissal of the case for post-confirmation default under the plan. If the debtor does not comply with the terms of the plan, the creditors may seek remedy in a state court, as any other breech of contract, or may seek an order directing the debtor to perform under the plan (such as requiring a sale as provided in the plan).
A dismissal of the Chapter 11 bankruptcy case does not affect the finality of the plan or discharge; any order revoking the plan must be made pursuant to a Section 1144 order made within 180 days after the order of confirmation.
A dismissal of a Chapter 11 Bankruptcy will reinstate a lien avoided pre-confirmation, unless the court orders otherwise.
A plan may not be modified after it is "substantially consummated."
Chapter 12 Proceeding
Unless otherwise provided, the confirmation vests all of the estate in the debtor. Thereafter, it would not be necessary to secure an order of the court to sell some assets vested in the debtor. However, a significant transfer such as a sale of a negative (conservation) easement is accomplished by a modification of the Chapter 12 plan. According to one view, a confirmed Chapter 12 plan avoids liens of participating secured creditors provided for by the plan, unless the plan provides otherwise.
Company Policy: In any sale of all or substantially all of the assets of the debtor after confirmation of the plan but during the case, we require court approval. The sale may be considered a liquidation or modification of the plan. In other sales during the bankruptcy and after revesting under the plan, we prefer to secure a letter from the trustee reflecting no objection to the sale.
Chapter 13 Proceeding
Section 1303 provides that the debtor has the right to sell property of the estate other than in the ordinary course of business. The plan may provide for the vesting of property of the estate in the debtor or any other entity upon confirmation or at a later time. The plan may provide that assets do not vest in the Chapter 13 debtor until a discharge is granted, thereby deferring the vesting of such assets in the trustee until that time. Property of the estate vests in the debtor upon the confirmation unless the plan or the order confirming plan states otherwise. Four lines of cases have emerged: the first line holds that property of the estate ceases to exist after confirmation of the Chapter 13 plan and the property of the estate revests in the debtor; the second line holds that the Chapter 13 estate continues after confirmation of the plan; the third line holds that all but the property of the estate which the debtor needs to fund the Chapter 13 plan vests in the debtor post-confirmation and the estate is then replenished by property acquired post-confirmation; and the fourth line concludes that property which vests in the debtor is that which is property of the estate at time of confirmation and the estate is then replenished by property acquired post-confirmation.
Local Rules may require the debtor to secure trustee approval or a court order to authorize consumer debt. Local Rules may require a modification of plan to incur debt. Local Rules may require court approval of a sale or refinancing of the debtor's principal residence (even after confirmation).
Company Policy: If the debtor offers to sell, we do not require an order of sale or court proceeding if the property has vested in the debtor and is not subject to the plan in a Chapter 13 proceeding or approval pursuant to local rules. Verify that the court has not provided that the property shall remain subject to the court jurisdiction until the discharge and that the local rules do not require approval. We also require a letter from the trustee reflecting no objection to the sale.
A balloon payment, due prior to the Chapter 13 proceeding is not curable in a Chapter 13 plan and payment cannot be extended.
The court can, as part of the plan in a Chapter 13 proceeding, reinstate a loan on the residence of the debtor which had been accelerated.
If the debtor defaults in payments on a residential mortgage to be paid outside the plan, the appropriate relief of the lender is a lifting of the stay even though no default has occurred under the plan.
It has been held that the Chapter 13 plan can modify the interest rate and payment on a loan if it is a loan secured by the debtor's residence and farm.
The debtor may not modify the rights of a creditor secured only by a lien, such as a mortgage or maintenance assessment lien, on her residence.
Post-confirmation loan proceeds do not have to be submitted to the trustee, since they are not future earnings or income.
Confirmation of Chapter 13 plan which dealt with creditors negates a lift of stay granted to the creditor before the confirmation.
If a lien is cancelled by a Chapter 13 plan, the lien remains in place until the debtors complete payments under the plan; if the case is dismissed the lien will be reinstated.
A plan cannot revest property in a debtor if the title was vested in a lender by foreclosure before the bankruptcy case was filed.
Effect of Plan on Liens
There are conflicting cases on whether a plan can avoid a lien on land.
Although a confirmed Chapter 11 bankruptcy plan may extinguish a lien, the notice to the creditor must specify the treatment of that claim and allow the creditor to make an informed judgment; otherwise, a notice is not sufficient if the plan and disclosure statement sent did not disclose treatment (and a separate agreement did affect the lien).
If a Chapter 13 plan treats a purchaser after the foreclosure of the debtor's property as a lienholder rather that the owner, the plan will not be sufficient to revest title in the debtor. The debtor had no existing right to regain title (such as a right of redemption) and the notice of plan did not clearly warn the owner of the effect of a failure to object to the plan.
If a plan does not provide for a secured claim, the property may not vest free and clear and the creditor's lien will survive the bankruptcy. The lender is not provided for by the plan if it receives no payment on the value of its lien. "As a general matter, a plan "provides for' a claim or interest when it acknowledges the claim or interest and makes explicit provision for its treatment. If a Chapter 13 plan does not address a creditor's lien (for instance, by expressly providing for payment of an allowed secured claim and cancellation of the lien), that lien passes through the bankruptcy process intact, absent the initiation of an adversary proceeding. Several courts have held that a plan "provides for' the lien held by the secured creditor only when it provides for payment to the creditor in an amount equal to its security." "[W]here a debtor's plan does not expressly preserve a secured creditor's lien, the confirmation of the plan acts to extinguish the lien provided that (1) the lien holder participated in the debtor's bankruptcy case by filing a proof of claim and (2) the property is either "dealt from or "provided for' by the plan."
A Chapter 13 plan has not "provided for" a creditor so that the property revests free of the lien: in order to provide for a claim, the plan must make explicit provision for its treatment and will not eliminate the lien simply by failing or refusing to acknowledge it or by calling the creditor an unsecured creditor. The failure to provide specific notice of intent to accord the lien less than full protection denies the secured creditor due process. A lien may be avoided without an affirmative avoidance action if the lien is challenged through objection to secured claim or through valuation process if treated as unsecured by the confirmed plan. However, it has also been said that "lien avoidance cannot be accomplished through motion practice. An adversary proceeding is required, other than a proceeding under Section 522(f)." Although there are conflicting cases, one view is that a lien is extinguished by confirmation of a plan if (1) the creditor participates in the bankruptcy by filing a proof of claim; (2) the creditor's claim is dealt with or provided for in the confirmed plan, such as by providing for distribution to unsecured creditors; and, (3) the plan does not expressly preserve the lien, such as where it is silent as to the lien.
If a Chapter 12 plan provided that a lien was void due to valuation of the land and the lienholder was an active participant in the proceedings, the lienholder was barred by res judicata from relitigating its unsecured status. Post-confirmation modification of the plan may not be made after all payments have been made on the plan. A motion to reconsider allowance of a claim should be brought within one year pursuant to Rule 60 of the Federal Rules of Civil Procedure. A revocation of a confirmed plan must be sought within 180 days after confirmation, because of fraud.
"One line of cases holds that a creditor's lien can be extinguished pursuant to the debtor's (Chapter 13) plan upon payment of the creditor's secured claim.... Another line of cases holds that a debtor may not obtain a release of a secured creditor's lien until he successfully completes the confirmed (Chapter 13) plan and receives a discharge." If the debtor defaults under a confirmed Chapter 11 plan, the creditors may seek dismissal of the case.
A creditor can lose its lien if the claim is treated as an unsecured claim in a confirmed Chapter 13 plan and if the creditor participates in the confirmation by (1) filing a claim in the case; and (2) identification of the creditor and treatment of the claim in the plan. Treatment of a creditor as unsecured in the liability schedule filed with the petition is not sufficient if the plan did not identify the creditor or provide for that claim.
If a creditor does not file a claim, then if that creditor has notice of a plan treating it as unsecured it will lose its lien unless its rights are specifically preserved in the plan or the order of confirmation, unless it timely files a proof of claim. A different result could occur if it filed an unobjected proof of claim as secured claim and the plan then proposes to treat it as unsecured. Property conveyed by the debtors prior to the filing of a bankruptcy petition is not dealt with by the plan, and the plan treatment of a claim will not result in stripping of the lien from such property.
Post Petition Property And Prefiling Judicial Liens In Bankruptcy Case
The majority view is that a prebankruptcy judicial lien or tax lien does not attach to property acquired by the debtor after the filing of the bankruptcy if a discharge is granted, unless the debt is not dischargeable (e.g., income taxes assessed within three (3) years, credit card bill to pay taxes, false pretenses if so determined at hearing, a creditor not listed in time and no notice, child support and spouse maintenance, malicious tort if so determined as a hearing, government fines, educational loans, fraud or defalcation or with respect to failed depositor institutions, damages as result of D.W.I).
Company Policy: In order to waive a prebankruptcy judicial lien in connection with property acquired after the filing of a bankruptcy, verify that (1) the discharge was granted, (2) the debt is not nondischargeable and (3) the debt is listed in the schedules with an address of the creditor evidencing notice.
Letters Of Credit In Bankruptcy Case
The prevalent view is that cashing of a letter of credit during a bankruptcy secured by a debtor as a customer prior to the bankruptcy does not violate the automatic stay. It also is not a matter which should be subject to an injunction under Section 105.
A mortgage securing reimbursement under a letter of credit is deemed to be a transfer made when delivered and recorded, not when the credit is cashed.
It is perhaps possible that the security granted to the issuer of the letter of credit may be a voidable preference if the beneficiary is a prior unsecured creditor.
Company Policy: If you are asked to provide title insurance in connection with a mortgage securing a reimbursement agreement on a letter of credit, call our underwriting personnel. We will, in appropriate cases, issue an affirmative endorsement where allowed by law.
Third parties are prohibited from discriminating against an individual who is or has been a debtor because it filed a bankruptcy, was insolvent, or has not paid a dischargeable debt. The prohibition on discrimination applies to governmental units and the debtor's employer, not a third-party lender. Conditioning approval of a plat upon payment of taxes (inconsistent with installment payment allowed by the plan) is prohibited.