2.04 Bankruptcy

2.04.1

The Code

The Enactment

The Bankruptcy Reform Act of 1978 applies to all cases filed on or after October 1, 1979. 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

Individuals, partnerships, and corporations are 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 as trustee in the case. 

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 11 - Reorganization

Individuals, partnerships, or corporations (including a railroad) which are eligible to file a Chapter 7 proceeding also are eligible to file a Chapter 11 petition. Stockholder and Commodity brokers may not file a Chapter 11 bankruptcy. In this proceeding, the court may appoint a trustee or may allow the debtor to “remain in possession”. 

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 appoint additional creditor’s committees. The creditor’s committee generally consist of creditors with the seven largest claims of the kind represented on the committee. 

The court may appoint a trustee for cause, including fraud or current mismanagement by the debtor. 

Subject to court limitations, the debtor in possession has all of the powers and duties of a trustee to manage, collect, and protect of the estate. 

The debtor may file a plan with the petition or at any time. Any party in interest, including creditors or a trustee, may file a plan at any time if a trustee is appointed; or subsequent to one hundred twenty days after the order for relief if the debtor does not file a plan within that time. 

The court may confirm a plan only after notice and an opportunity for objection, and after 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 the order if the order was 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: The confirmation and plan alone will not invalidate A Preexisting lien unless the lienholder consents. A separate adversary proceeding must be brought to invalidate liens.

The confirmation generally discharges all dischargeable debts unless the plan or order confirming plan provides otherwise. 

Unless otherwise provided, the confirmation vests the property of the estate in the debtor.

 

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 the case are eligible to file a Chapter 12 petition. The party may be an individual or certain corporations or partnerships owned by a family. The aggregate debts must not exceed $1,500,000 and 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, but the debtor as a “debtor in possession” controls, manages, and sells property of the estate unless removed as debtor in possession. 

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. 

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 may also grant a discharge to a debtor who did not complete the plan.

 

Chapter 13 - Adjustment of Debts of an Individual with Regular Income

Only an individual with regular income, or that individual and his spouse, who owe noncontingent, liquidated, unsecured debts totaling less than $100,000, and noncontingent, liquidated, secured debts totaling less than $350,000 may file a Chapter 13 petition. 

The United States trustee (or court) shall appoint one or more persons to serve as a standing trustee in Chapter 13 proceedings if the number of cases warrant appointment. If there is a qualified standing trustee, that person shall serve 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: The confirmation and plan alone will not invalidate a preexisting lien unless the lienholder consents. A separate adversary proceeding must be brought to invalidate liens.

After the plan payments are completed, the debtor shall be granted a discharge of his debts, including claims based upon fraud or defalcation, but excluding debts for support, alimony, or maintenance of a child or spouse 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 by the court after “notice and a hearing”.

 

Commencement of Proceeding

Voluntary Proceeding
A voluntary proceeding is commenced by the filing of the petition. The commencement constitutes an order for relief.

 

Joint Case
A joint case is commenced by the filing of a single petition by both spouses.

 

Involuntary Proceeding
An involuntary proceeding may be commenced only under Chapter 7 (liquidations) or under Chapter 11 (reorganization). It may be commenced on the petition of: (a) three or more entities with noncontingent, unsecured claims totaling at least $5,000; (b) one or more holders of claims whose claims total at least $5,000 if there are fewer than twelve 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. 


The debtor in an involuntary case retains control and possession of 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 is offering to sell property before the order of relief is granted, the company requires a copy of the notification of the proposed sale, certification by the party mailing the notice that notice of the proposed sale was sent to all interested parties, and a final order of the bankruptcy court authorizing sale.

 

Conversion
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. Court orders lifting stays, approving stipulations, rejecting executory contracts and other matters are not negated by an order of conversion.

Company Policy: If a sale or loan has not been consummated prior to the conversion of a case to a different chapter, the procedure for the transaction must be reinitiated: A new entity controls the estate and that entity must comply with the procedures for sale, loans and other matters.

 

Reopening Cases
A case may be reopened in the same court to administer previously unadministered assets or for other causes as necessary.

 

Trustee qualification
A person qualifies as trustee, after appointment, by filing a bond in favor of the United States, subject to United States trustee (or court) approval of the surety and amount on the bond.

 

Creditors' initial meeting
There shall be a meeting of creditors after appropriate notice, within a reasonable time after the order for relief.

 

Death or inanity or 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 the bankruptcy estate property.

Company Policy: The confirmation and plan alone will not invalidate A Preexisting lien unless the lienholder consents. A separate adversary proceeding must be brought to invalidate liens.
Company Policy: The confirmation and plan alone will not invalidate A Preexisting lien unless the lienholder consents. A separate adversary proceeding must be brought to invalidate liens.
Company Policy: The confirmation and plan alone will not invalidate A Preexisting lien unless the lienholder consents. A separate adversary proceeding must be brought to invalidate liens.
Company Policy: The confirmation and plan alone will not invalidate A Preexisting lien unless the lienholder consents. A separate adversary proceeding must be brought to invalidate liens.
Company Policy: The confirmation and plan alone will not invalidate A Preexisting lien unless the lienholder consents. A separate adversary proceeding must be brought to invalidate liens.
Company Policy: The confirmation and plan alone will not invalidate A Preexisting lien unless the lienholder consents. A separate adversary proceeding must be brought to invalidate liens.
Company Policy: The confirmation and plan alone will not invalidate A Preexisting lien unless the lienholder consents. A separate adversary proceeding must be brought to invalidate liens.
Company Policy: The confirmation and plan alone will not invalidate A Preexisting lien unless the lienholder consents. A separate adversary proceeding must be brought to invalidate liens.
The confirmation generally discharges all dischargeable debts unless the plan or order confirming plan provides otherwise. 

Unless otherwise provided, the confirmation vests the property of the estate in the debtor.
Company Policy: The confirmation and plan alone will not invalidate a preexisting lien unless the lienholder consents. A separate adversary proceeding must be brought to invalidate liens.
Company Policy: The confirmation and plan alone will not invalidate a preexisting lien unless the lienholder consents. A separate adversary proceeding must be brought to invalidate liens.
Company Policy: The confirmation and plan alone will not invalidate a preexisting lien unless the lienholder consents. A separate adversary proceeding must be brought to invalidate liens.
Company Policy: The confirmation and plan alone will not invalidate a preexisting lien unless the lienholder consents. A separate adversary proceeding must be brought to invalidate liens.
Company Policy: The confirmation and plan alone will not invalidate a preexisting lien unless the lienholder consents. A separate adversary proceeding must be brought to invalidate liens.
Company Policy: The confirmation and plan alone will not invalidate a preexisting lien unless the lienholder consents. A separate adversary proceeding must be brought to invalidate liens.
After the plan payments are completed, the debtor shall be granted a discharge of his debts, including claims based upon fraud or defalcation, but excluding debts for support, alimony, or maintenance of a child or spouse 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 by the court after “notice and a hearing”.
After the plan payments are completed, the debtor shall be granted a discharge of his debts, including claims based upon fraud or defalcation, but excluding debts for support, alimony, or maintenance of a child or spouse 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 by the court after “notice and a hearing”.
After the plan payments are completed, the debtor shall be granted a discharge of his debts, including claims based upon fraud or defalcation, but excluding debts for support, alimony, or maintenance of a child or spouse 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 by the court after “notice and a hearing”.

2.04.2

Who Is In Charge

Authority of Judges

Under the Act, bankruptcy judges may hear and determine all bankruptcy proceedings and all core proceedings arising under the bankruptcy proceedings.

Core proceedings include:

  • matters concerning the administration of the estate,
  • allowance or disallowance of claims or exemptions, 
  • counterclaims by the estate,
  • obtaining of credit,
  • turnover of property,
  • preferences,
  • 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”. “Noncore proceedings would include a determination of title to real estate. A bankruptcy Judge may hear a “related proceeding” and shall submit proposed findings of facts and conclusions of law to the district court. The district judge shall enter the final order after considering the proposed finding and after reviewing de novo those matters to which any party has timely objected.

Company Policy: Any order involving a noncore matter (such as a determination of title to real estate or lien priority) must be signed by a district judge pursuant to an adversary proceeding.

 

Upon consent of the parties, related matters may be heard and determined (by order) by the bankruptcy judge.

Certain proceedings are neither “core” nor “related proceedings”. The bankruptcy court has no jurisdiction of those proceedings. An example would be lien priority on abandoned property.

 

Appeal

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 ten days of the date of the entry of the judgment, order, or decree appealed from. Within that time, a party may otherwise file a motion to have a judgment notwithstanding the verdict, a finding of additional facts, an amendment of the judgment, or a new trial. If a motion is filed, the time for appeal would run from the time of the entry of the order on the motion. 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 ten-day deadline. A request to extend time must be made within the ten day period if the order authorizes the sale of real estate, obtaining of credit, confirmation of a plan, dismissal of a case, or certain other stated matters. An order is deemed 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.

Company Policy: You should be satisfied 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).

Appeals from the appellate panel or district court are made to the circuit court of appeals. 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 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.

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, it is possible that 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. It is possible that the debtor may be deprived of authority or have its power to sell limited by the court. SEC. 1107.

 

In a Chapter 12 proceeding, the debtor is usually a debtor in possession, with the power to sell property in accordance with the procedures of Section 363. 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 to verify that the Chapter 12 debtor has had no limits placed on the debtor’s power. If a sale is made free and clear of liens under section 1206 of the code, the trustee must join with the debtor on and be authorized to sell.

 

A trustee is appointed for the estate of a debtor in a Chapter 13 proceeding. However, the debtor is the party 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 on Filing

A debtor is generally 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 a Chapter 12 or Chapter 13 proceeding, and payments totaled 100% of unsecured claims, or payments totaled 70% of 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.

 

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”. Under this requirement, notice “as is appropriate in the circumstances” and opportunity for a hearing “as is appropriate in the circumstances” shall be given. However, if a hearing is not requested in a timely manner by a party in interest after notice and opportunity for a hearing are given, then no actual hearing or court order formally approving the proposed action is necessary. If there is provision for “notice and a hearing”, then, 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 of the act under the Bankruptcy Reform Act “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 by a party in interest, then the trustee may sell without a court order approving the sale. If there is no time for a hearing, then notice must be given and the court must approve the sale.

In each case, however, some form of notice is required if the Bankruptcy Reform Act authorizes an act “after notice and a hearing”.  

The presumption of receipt of properly mailed notice may be overcome by testimony of non-receipt combined with standardized procedures of processing mail.

motions to terminate or annul or modify the stay,
motions to terminate or annul or modify the stay,
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2.04.3

The Bankruptcy Estate

Land Of The Debtor
Upon the filing of a bankruptcy, an estate is created. The estate includes all land owned by the debtor or in which the debtor has an interest.

Partnership
The 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, you should secure joinder of or consent by the debtor-partner (or trustee) to the sale pursuant to a final court order or after notice to all 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.

It is unclear whether a debtor in possession succeeds to management authority formerly held as a general partner. It appears that a trustee cannot assume management powers, but we remain concerned about the trustee’s scrutiny of any transaction and, therefore, require trustee consent to sales.

Leases and Contracts
The interest of the debtor in a lease or contract (as lessor, lessee, purchaser, or seller) vests in the estate upon the filing of the bankruptcy.

Company Policy: In order to insure a purchase money mortgage on the closing of the contract if the debtor enters a contract to purchase property before the bankruptcy commences and if the property is not yet abandoned or revested in the debtor (pursuant to a confirmed plan), you must require a court order authorizing the completion of the contract and execution of the mortgage. You must except to the effect of the automatic stay on foreclosure of the purchase money mortgage.

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 interests of the beneficiaries. The estate cannot exercise the fiduciary powers of the trustee (of a private trust).

Company Policy: Require abandonment or joinder of the trustee or debtor in possession in the bankruptcy proceeding, and joinder of all other necessary parties in accordance with the trust documents.

Loan Servicing Agreements
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.

Company Policy: You should, when faced with bankruptcy by the servicing agent, require:

(1) written payoff (agreed to) from both the investor and servicing agent,

(2) verification by review of the note (or copy front and back) as to the party (or parties) who is (are) the holder,

(3) written agreement from the servicing agent and investor as to whom you should pay, and

(4) written agreement by both the servicing agent and investor to furnish a release upon payment.

 

Community Property
If only one of the spouses files a bankruptcy petition and that debtor-spouse owns community property, then the community property under the sole or joint management of the debtor and other community property which is liable for claims against the debtor (to the extent of liability) are part of the estate. The nondebtor spouse has a right of first refusal to buy that property. 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 extent to that property) shall not be 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 bankruptcy 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 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 and by verifying that spouse makes no tender in the bankruptcy).

After-acquired Interests
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 shall become 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) shall become property of the estate. 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. 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 (until revested in the debtor in accordance with the confirmation and plan if the plan or order does not provide otherwise).

Company Policy: We will not require court orders on purchase money mortgages executed on property acquired by the debtor by contract entered after the confirmation of a Chapter 12 or Chapter 13 plan, or after the commencement of a Chapter 7 or Chapter 11 proceeding. 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 should approve the transaction (since this property is arguably property of the estate), and any mortgagee’s policy should be issued subject to the effect of the automatic stay in the bankruptcy proceeding (which extends to all property of the estate). 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. If it is clear that the mortgagor is the debtor, a disclosure of a pending bankruptcy should be made to the lender in any case where the debtor is acquiring property.

Unscheduled Property
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. It is possible to have the case reopened to administer or abandon the property.

Company Policy: You should seek a court order reopening administration of the property 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 part of the estate of the debtor and (2) the case has been closed, and (3) the property was not formally abandoned or dealt with and (4) the property was not scheduled.

Escrowed Funds
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, there is a possibility that the estate will be able to claim the funds by turnover order.

Company Policy: Consult with our legal staff before accepting indemnities and related escrows of funds to secure the indemnities.

2.04.4

Injunctions

Discretionary Injunctions
The court has the authority to enter a discretionary injunction whenever it deems it advisable.

The Automatic Stay
The automatic stay begins upon 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 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 stay clearly prohibits acts such as filing a mortgage after the bankruptcy commences. The stay will not prevent foreclosure of a mortgage executed by the debtor to secure obligations of the debtor if the debtor conveyed the land prior to the bankruptcy case.

Notice of Default.
Arguably, the stay prevents foreclosure notices 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). 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. If the notice to the debtor who is no longer the owner of the property is sent in connection with a nonjudicial foreclosure and does not include any demand for payment from the debtor, it should not violate the stay, provided the debtor has no lien on the property and does not have any right in or possession of the property.

Tolling of Redemption.
The majority of cases state that the automatic stay 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.

Company Policy: You should assume that the preforeclosure and postforeclosure redemption and reinstatement time limits are tolled by section 362 during the period of the stay. You should not waive requirements of continued notice or redemption rights at an earlier time until the stay is lifted.

Mechanic’s Liens.
The automatic stay does not prevent a mechanic’s lien claimant from filing a lien claim after the filing of the bankruptcy where the lien claim and priority relate back to a time prior to the bankruptcy. If the lien claimant must file suit to perfect his lien, he can file a notice in accordance with Section 546(b).

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 (the stay then possibly continues as to property of debtor, if the land is exempted or abandoned).

Lack of Notice.
The stay is effective regardless of whether notice of the bankruptcy is given to the creditors.

Innocent Purchasers.
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: We do not rely upon this innocent purchaser protection if we are aware of a bankruptcy. We require a determination that the transfer was effective by adversary proceeding or by other satisfactory settlement in the bankruptcy proceeding.

Subordinate Liens.
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.

Company Policy: If a nonjudicial foreclosure would extinguish a junior lien of a debtor or redemption right of the debtor-junior lienholder, we require a lifting of the stay in the junior lienholder’s bankruptcy.

Partner.
The bankruptcy of a general partner does not stay a foreclosure of property owned by the partnership.

Property of Debtor.
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 the property. Otherwise, the foreclosure prior to a grant or denial of discharge is null and void. For example, 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 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. However, the stay does not extend to a postpetition claim against property revested in the Chapter 12 or Chapter 13 debtor by confirmation of a plan.

Motion to Lift or Annul Stay.
It is possible for a creditor to file a motion to lift or annul the automatic stay. The creditor need not file an adversary proceeding. 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.

Although local rules may require that an objection and request for hearing be filed within a much shorter deadline (e.g., ten days), 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 together with a certificate of service and together with the clerk’s certificate (or credible attorney’s letter) evidencing that no objection or request for hearing was filed and that the stay has been lifted so that a foreclosure can proceed.

If the trustee or debtor in possession agree to lift the stay, objections may be filed within 15 days of the mailing of notice. 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.

Company Policy: You should never rely upon a motion annulling the stay unless you secure an order of the court to that effect.

One case has held that once relief from the stay has been granted, the mortgagee is entitled to foreclose, and the stay is not reimposed by filing a new petition, the effect of the relief being 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 if the order to lift stay is no longer appealable.

Types of Creditors.
The stay provided by Section 362 applies to an “entity”. The term “entity” includes a governmental unit. 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, postpetition real estate taxes, as to which prior liens are automatically perfected, will retain a priority lien on estate property, and the stay will not prevent the attachment of lien. According to a second view, real estate tax liens with an inception date after the filing are ineffective. The postpetition 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. Forfeiture proceedings are not excepted from the stay as criminal prosecutions or proceedings to enforce regulatory powers.

Police Powers.
Section 362(b)(4) excepts from the stay actions by a governmental unit to enforce its police or regulatory power. 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. The trustee may not abandon burdensome contaminated property without adequate protection of the public health and safety.

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; the debtor will have the longer of the applicable state limitation period, or (if the claim was not barred at the time the bankruptcy was filed) two years after the voluntary bankruptcy was filed to sue.

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 the period as originally calculated, or 30 days after the notice of the end of the stay order with respect to the claim. Therefore, actions, such as foreclosure of liens, against a debtor are allowed to be filed within the period allowed by state law, or until 30 days after notice of termination of the stay as to the debtor, whichever is later. 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.

Post Bankruptcy Filings.
The stay prevents the filing of liens after the bankruptcy commences (with exceptions such as mechanics’ liens which could be valid against prior bona fide purchasers).

There are conflicting views on whether the stay prevents the postbankruptcy filing of a sheriff’s or trustee’s deed concerning a foreclosure conducted before the bankruptcy.

Company Policy: Our policy is that the filing during the bankruptcy of a sheriff’s or trustee’s deed executed before the bankruptcy violates the automatic stay unless a lifting of the stay (by motion) has been secured. We require a lifting of stay in order to file the deed.

Effect of Dismissal.
The majority view is that the automatic stay terminates immediately upon dismissal of the bankruptcy case.

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.

Company Policy: We will not issue a policy without exception until the appeal is finally exhausted.

2.04.5

Sale Of Property

Abandoned Property
If property has been properly abandoned by the estate, then you can secure a deed from the debtor (with any necessary corporate resolutions) without any need for a motion, notice, or order of sale.

Company Policy: If the debtor is selling the abandoned property while the bankruptcy is pending and is to receive cash proceeds (in excess of lien payoffs and closing costs), you should require joinder by the trustee (after notice), or notice to the estate creditors (if the debtor is a debtor in possession). The abandonment may otherwise be attacked.

Exempt Property
Rule 4003 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 if the time to object is not extended, the property (or equity) which is scheduled as exempt is not property of the estate.

Company Policy: If property has been fully exempted (not simply an equity interest) and set aside to the debtor, you can rely upon the evidence (schedule 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. If only an equity interest is exempted (e.g., portion of gross value), then you should 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.

Exempted property may not be sold by the trustee.

Company Policy: If the trustee is offering to sell property in connection with the estate of an individual debtor, you should verify that the property is not scheduled as exempt. If a debtor in a Chapter 12 proceeding schedules farmland as exempt, you should require that a sale (as outlined in paragraph c) with notice to interested parties be made. The farmland is essential to the plan in most cases.

Procedure On Sale Of Property In The Estate
The trustee will sell property of the estate in a Chapter 7 proceeding or, if he is qualified and has been appointed, in a Chapter 11 proceeding. A debtor in possession in a Chapter 11 proceeding will sell property of the estate, subject to any 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 pursuant to 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, the debtor in possession subject to any court limitations in a Chapter 12 proceeding, the trustee in a Chapter 7 proceeding if authorized, and the debtor in possession (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. It is generally not plausible to have an ordinary course of business sale of real estate in a Chapter 12 or Chapter 13 proceeding.

Company Policy: The provision authorizing sales in the ordinary course of business should never be relied upon in a Chapter 12 or Chapter 13 proceeding without national office 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, and 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 also authorize a trustee to continue the business of the debtor in order for this provision to be applicable.

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 sold 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, perhaps 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. 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, a hearing shall be held.

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”.

The trustee or debtor is not required to file an adversary proceeding--which is time-consuming and requires or allows answer by a third party after service--except where the interest of a co-owner (such as a tenant by the entireties, if the land is not exempt) is also being sold. In that case, an adversary proceeding must be filed against the co-owner.

Company Policy: If the sale is free and clear of rights of a co-owner, we require, (1) proof of personal service to the co-owner, (2) a specific final order requiring and determining necessity of partition by sale, (3) a separate notice to interested parties of proposed sale, (4) a separate motion to sell and a separate order of sale should also be secured or in the alternative, the complaint and notice of sale to all interested parties should be combined in the adversary proceeding.

The right to sell free and clear of other interests does not allow the estate of a partner to sell partnership assets.

The trustee or debtor must, in a sale not in the ordinary course of business, give notice of the proposed sale which reflects 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) of not less than 20 days 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 on a sale not in the ordinary course of business.

The debtor can sell all or substantially all of the 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.

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. 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, to the Attorney General, and to the IRS.

Those liens as to which a sale can lawfully be made free and clear include federal tax 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.

Company Policy: If the sale is not made free and clear of liens, then we will require a certified copy of the notice of sale, a recordable certificate evidencing notice to all interested parties, and a bankruptcy court clerk’s certificate or certificate of attorney of the debtor 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). However, if the sale involves all or substantially all of the assets of the estate in a Chapter 7, 11 or 12 proceeding, require the notice of sale and a certificate of service and a final court order approving the transfer.

If the sale is to be made free and clear of liens, we will require:

(1) the notice by the trustee or debtor in possession and order specifically describing the liens as to which the sale is free and clear;

(2) recitation in the order that the lien(s) (which must be specifically described) attach(es) to the proceeds;

(3) evidence that the lienholder received notice (for example by return receipt, or by appearance of the creditor at the hearing, or by conference with the creditor);

(4) there must be 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 pursuant to court order. For example, search for a recitation that the lien is in dispute (of so, the dispute must be specified) or that the lienholder consents, or that the sales price exceeds (the value of) all liens or verify that the sales is only a portion of land covered by the lien;

(5) there must be a court order authorizing the sale and it must be final as evidenced by a clerk’s or attorney’s certificate;

(6) the liens as to which the sale is free and clear cannot be ad valorem tax liens, or hazardous waste clean-up liens, or other governmental assessments or charges (unless you secure home office approval);

(7) the sale must not be made to a party related to the debtor; and

(8) the property may not have been scheduled as exempt.

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 if a stay of the sale is not obtained. However, an appeal is not moot due to the lack of a stay unless the trial court had found that the purchaser acted in “good faith” or paid “value”. The good faith rule also will not protect a third party if there was denial of procedural due process due to failure to give notice to unsecured creditors.

Company Policy: We 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. You should never close on a transaction 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 discussing this issue with the attorneys in the transaction, and by reviewing the file, and by securing a clerk’s or attorney’s certificate as to the finality of the order.

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 a sale free of a co-owner’s interest or free of dower or curtesy rights occurs, the debtor’s nondebtor spouse (provided there is no joint filing) and any co-owner have a right of first refusal.

Company Policy: You should verify that the right of first refusal of the nondebtor-spouse was not exercised: review the bankruptcy for notice of any exercise of first refusal, get a clerk’s certificate, get a letter from the attorney, contact the co-owner or spouse if possible and/or get an affidavit from the debtor or trustee.

Involuntary Case.
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.

2.04.6

Contracts And Assignments Of Leases

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. 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 otherwise assume or reject an unexpired lease within 60 days, as extended by the court, or the contract or lease is deemed rejected. 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.

Company Policy: Always require a specific court order authorizing the assignment of lease, proof of receipt of notice by the lessor, a clerk’s certificate evidencing that the order is final (30 days since entry), and a letter by the landlord consenting to the transaction and certifying that there is no default.

If a contract to sell land is rejected by the seller (as debtor) or if the lessor (as debtor) rejects a lease in the bankruptcy proceeding, then a lessee or purchaser in possession may remain in possession and continue to pay under the lease or 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. 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. An option to purchase real estate can be an executory contract subject to rejection. 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.

Recharacterization
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 or 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 the 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 the 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), an 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. 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).

A significant factor in determining whether the sale-leaseback 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.

Certain key factors have led to recharacterization as a loan: (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. Key factors in the court analysis of leases with options to repurchase have included: 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.

Company Policy: If you are asked to insure on a sale- leaseback, call our legal department. We will analyze whether the transaction could possibly be recharacterized. Key factors are:

Estoppel letter from the seller certifying that the transaction is not a loan or joint venture, and that the seller has been advised by counsel and freely entered the transaction;

Letter from seller’s counsel that the transaction is effective as a sale and was entered by the seller after review with counsel;

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);

The term of the lease should not be excessive (e.g., 165 years) or oppressively short (e.g., 3 years);

The original purchase price for the land and the rental payments should approximate fair market value (evidence by estoppel letter and appraisals);

Any repurchase price should approximate fair market value upon exercise (not be the original sales price);

The purchaser cannot have the power to force a repurchase; and

The lease should recite that the relationship is not a loan or joint venture and should not recite terms such as amortization or interest rate.

2.04.7

Liens Executed By 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.

Company Policy: You should be furnished with a certified copy of the notice and motion, certificate of service and evidence of receipt of notice (by contacting the parties or by return receipt) by the creditors secured by current liens on the property if the new lien is to have priority over them. The order from the bankruptcy court must be final. It must authorize the execution of the mortgage, and contain specific provision for adequate protection of the current lienholders (due to other collateral, or pay-down of loan) the new lien is to have priority over them. 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.

2.04.8

Abandonment

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, then we should be furnished a certified copy of the notice of intent to abandon, a certificate that all interested parties were notified, and a clerk’s certificate, review of file, 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 certified copy of the motion, certificate of service, order of abandonment, and clerk’s certificate or other evidence that no notice of appeal or motion extending time for appeal was filed within 30 days after entry of the order.

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.

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. Absent unusual and compelling circumstances, or a particularly egregious fact situation, the court should not vacate an abandonment.

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 subject to the estate.

The abandonment of property does not lift the stay prohibiting an action against the property of the debtor.

2.04.9

Exempt Property

Federal And State Exemptions
Debtors are given the choice of using state exemptions or, if the state does not prohibit federal exemptions, federal exemptions of $7500 (plus wildcard of $400) of equity. 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 to select the federal exemptions. States prohibiting use of federal exemptions include Alabama, Alaska, Arizona, Arkansas, California, Colorado, Delaware, Florida, Georgia, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine, Maryland, Missouri, Montana, Nebraska, Nevada, New Hampshire, New York, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, South Carolina, South Dakota, Tennessee, Utah, Virginia, West Virginia, and Wyoming.

Proceeds Selection
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.

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 clerk’s certificate, attorney’s letter, or file review. Also require the trustee to abandon the encumbered portion of the property by notice, secure a certificate of notice to all interested parties, and require a certificate 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.

Procedure
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 causes prejudice. The exemptions are deemed allowed without court order. Creditors may object within 30 days of the amendment. The trustee or creditor may file objection 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. 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 creditor may not be bound by the 30-day limit if the schedule is not made in good faith or if the exemption has no legal basis.

Company Policy: Secure a certified copy of the listed exemptions together with verification of passage of 30 days beyond the meeting for creditors as adjourned with no objection having been filed. Verification can be reflected by a clerk’s certificate, attorneys letter, or file review. Unless a party in interest objects, the property or equity interest claimed is exempted. If an equity interest is exempted the remaining interest of the estate should be abandoned or sold by the trustee or debtor in possession. You should be satisfied that the claimed exemption does not exceed the maximum allowable by the applicable federal exemption or by applicable state law before relying upon a sale of the land by the debtor.

Chapters 12 And Chapter 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 inconsistent with the applicable rules and code provisions. It has been noted that the debtor can waive his exemptions and use the exempt property in paying the debts under the plan. This right is irrelevant if the debtor has sold his exempt property prior to filing the plan.

Company Policy: If the property is scheduled as exempt and time for objections has passed, you should verify that the proposed (or confirmed) plan, if any, filed does not treat the property inconsistently by providing that it is to be conveyed to a creditor, to remain part of the estate, or to be sold to pay debts after notice.

Judicial Liens
A debtor may avoid a judicial lien on his exempt property to the extent the lien impairs his exemption.

Company Policy: In all cases involving lien avoidance, we will require a final court order. The court cannot dispense with notice. The order is not final until 30 days after entry. Finality should be evidenced by a certificate of the clerk or counsel.

This section cannot be used as to a judicial lien attaching before the enactment date of the Bankruptcy Code of 1978 (November 6, 1978).

A proceeding under Section 522(f) may be brought at the court’s discretion after the discharge is granted and after the case is closed by reopening the case.

The majority view 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.

The scheduling of property as exempt without timely objection is only determinative of the issue of whether the property remains in the estate: it does not constitute 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 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 merely on the scheduling of property as exempt (without objection) as determinative of whether a judgment lien attaches to the land.

Company Policy: A dismissal under section 349 reinstates any judicial lien avoided under section 522(f). Therefore, a lien avoidance order generally should not be relied upon unless the discharge has been granted in Chapter 7, 12, or 13, or unless the plan is completed in a Chapter 11 or unless the order recites that, in accordance with state law, the lien never attached to the property.

2.04.10

Avoiding Powers

Party Bringing Actions
Avoidance actions normally are brought by the trustee or by a debtor in possession under Chapter 11 or Chapter 12. Any avoidance action is an adversary proceeding under Rule 7001 et seq.. The trustee cannot avoid the lien simply by noting his “intent” to avoid it by reference in the proposed plan and disclosure.

Company Policy: You should 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 until 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, you should require a sale free and clear of the previously avoided interest. Any sale free and clear of the lien must be made pursuant to the procedural requirements for sale. The sale order must provide that it is made free of the lien (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.

Statutory Liens
Certain statutory liens may be avoided under Section 545 of the Bankruptcy Code. However, mechanic’s 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 avoidable 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).

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 appointment of the trustee or before the case is closed or dismissed, whichever is earlier. According to one view, the two-year period runs from appointment of the first permanent trustee, regardless of whether a successor is thereafter appointed. 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 for avoidance exists under state law, longer state time limits (for example, fraudulent conveyances) will control. Indeed there may be no time limit if an applicable creditor is a governmental unit. Time limits of this Section do not apply to debtors in possession. Even if the time limit has passed to set aside a voidable lien or other transfer, the court may reject the claim and merely void the lien or other transfer. An action under Section 549 to recover a postpetition 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 is converted to a different chapter. 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.

Preferences
A preference occurs where a transfer was made when the debtor was insolvent and where 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 transfer must occur within one year of the bankruptcy. Where the debtor pays or satisfies debt which is guaranteed by an insider third party (e.g., stockholder), the payment of debt may be a transfer benefiting an insider of the debtor. In that event, the transfer to satisfy the debt may be voidable as a preference if a bankruptcy is filed within a year (e.g., after a deed in lieu of foreclosure). 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.

A judgment lien could be a voidable preference. A foreclosure sale may be an avoidable preference if occurring within 90 days of the debtor’s bankruptcy (or within one year if the lender is an insider or if a guarantor of the debtor is an insider of debtor) if the bidder receives property valued in excess of the amount bid. A bid in excess of 70% of fair market value may still be a voidable preference. A Deed in cancellation of existing indebtedness may constitute a voidable preference. A substitution of collateral is not a voidable preference, at least where the value of the collateral is approximately the same.

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 (possibly within 10 days) with the loan, then the encumbrance may be a preference. 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 ten days to be contemporaneous; another line holds that the ten-day limit of 547(c)(3) is not controlling and that other factors can be considered.

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.

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.

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 ALTA policies are issued. The 4-6-90 ALTA policies contain a similar “creditors’ rights” exclusion. However, if the “creditors’ rights” issue arises out of a prior transaction within one year (such as prior mortgage financing unsecured debt and now being refinanced), add this creditors’ rights exception to the 4-6-90 policy. The creditors’ rights exclusion in the 4-6-90 ALTA policies will then be irrelevant since it extends only to a claim arising out of the insured transaction.

Fraudulent Conveyances
Under Section 548, a transfer made within one year before the bankruptcy may be set aside as a fraudulent conveyance if the debtor was insolvent or had insufficient capital at the time and if where the debtor received less than reasonably equivalent value. The one-year period commences from the recordation of the deed or mortgage which evidences the fraudulent conveyance.

The estate may, instead of recovering property fraudulently transferred, recover the value of the property.

A voluntary transfer by a debtor within one year of bankruptcy while insolvent for less than reasonably equivalent value is a fraudulent transfer.

A termination of a lease or other contract may be a fraudulent transfer.

An award of property in a divorce decree may be a fraudulent transfer if the debtor does not receive reasonably equivalent value.

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 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. 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.

Financing of a leveraged buyout of a corporation or partnership (by mortgaging of the target corporation’s assets to fund a loan to buy out its owners or by sale of the target corporation’s assets or stock) may be a fraudulent transfer. 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.

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.

Company Policy: In any case of upstream guarantees, leveraged buyouts or gift deeds in your transaction, even though no bankruptcy is pending, the following “creditor’s rights” exception should appear:

Any claim by reason of the operation of federal bankruptcy, state insolvency, or similar creditors’ rights laws.

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 ALTA policies are issued. The 4-6-90 ALTA policies contain a similar “creditors’ rights” exclusion. However, if the “creditors’ rights” issue arises out of a prior transaction (such as a leveraged buyout loan now being refinanced), add this creditors’ rights exception to the 4-6-90 policy. The creditors’ rights exclusion in the 4-6-90 ALTA policies will then be irrelevant since it extends only to a claim arising out of the insured transaction.

The case of Durrett v. Washington National Insurance Co., 621 F.2d 201, 6 B.C.D. 954 (5th Cir. 1980) held that a foreclosure 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. 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 is a transfer under Section 548. The Durrett guideline of 70% is now binding in the Eleventh Circuit.

In a second approach, the case of In re Winshall Settlor’s 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. Similarly, In re Madrid, 21 B.R. 424 (Bankr. 9th Cir. 1982), aff’d on other grounds, 725 F.2d 1197 (9th Cir. 1984), cert. denied, 469 U.S. 833, 105 S. Ct. 125 (1984) held that, in accordance with state foreclosure law, a price obtained at a non-collusive foreclosure sale properly conducted under state law is irrebuttably presumed to be reasonably equivalent value.

A third approach states that the value equivalent is too uncertain, and instead requires that a commercially reasonable sale occur in order for reasonably equivalent value to have been bid. Factors involved in the analysis include advertising in real estate sections of newspapers and mailings to various brokers as well as the amount bid at sale. In re Ruebeck, 55 B.R. 163 (Bankr. D. Mass. 1985).

Some cases, in a fourth approach analogous to the third approach, provide no absolute guideline as to what reasonably equivalent value is, and state that reasonably equivalent value must be determined pursuant to an evidentiary hearing. In re Hulm, 738 F.2d 323, 11 C.B.C.2d 152 (8th Cir. 1984), cert. denied, 469 U.S. 990, 105 S. Ct. 398 (1984); Matter of Bundles, 856 F.2d 815 (7th Cir. 1988).  

If the lien foreclosed is a subordinate lien, there are 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 postsale liens; and bid compared to fair market value less presale liens.

There is conflicting thought on whether the debt canceled must be added to the amount bid at sale to determine whether reasonably equivalent value was bid.

State fraudulent conveyance statutes with language similar to Section 548 may apply by Section 544 and may provide a longer limitation statute. Some recent state fraudulent transfer acts (such as in Texas) provide that the amount bid at a regularly conducted noncollusive foreclosure is reasonably equivalent value. If several states have contact with the transaction, the state 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.

Although different results concerning foreclosures as fraudulent conveyances have been reached in different federal circuits, our company policy is as follows:

If there has been recordation of a deed in lieu of foreclosure, trustee’s deed, sheriff’s deed or other deed in connection with a foreclosure within the year prior to your examination or if the right of redemption under state law ended within the year prior to your examination, you should place the following exception in your commitment and/or policy:

“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 year after ____________ (here place date on which redemption rights end or deed is recorded).”

You do not need to use this exception in connection with a recent foreclosure on a resale after the foreclosure or deed in lieu of foreclosure provided that:

The party whose interest was foreclosed is not in possession of the property; and

That party has not filed a bankruptcy according to your records; and

The property constitutes a single family residence (not a sale of multiple residences); or

The party who acquired by foreclosure is conveying by sale to an unrelated third party and the amount of indebtedness either bid in or canceled pursuant to the foreclosure (in some states such as Florida and California, the full amount owing at time of foreclosure is deemed to be canceled or not subject to collection after foreclosure) is at least 70% of the amount of the resale price; or

You otherwise secure express home office 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).

If more than one year has passed since the recordation of the deed pursuant to the foreclosure or deed in lieu of foreclosure and if more than one year has also passed since all redemption rights have ended, then you will not need to make an exception under any circumstances where insuring a resale provided that the party whose interest was foreclosed or conveyed by deed in lieu of foreclosure is no longer in possession of the property and provided that party did not file a bankruptcy after the recordation of the deed or end of redemption rights.

If more than one year has passed since the recordation of the deed pursuant to the foreclosure or deed in lieu of foreclosure or end of redemption rights but the party whose interest was foreclosed or conveyed by deed in lieu of foreclosure subsequently filed a bankruptcy after such foreclosure or end of redemption rights, then you will need to place the above exception in the policy. You should secure express home office approval before deleting the exception.

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, provided that the amount owed before foreclosure was equal to or greater than the resale price.

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 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 suspect that a seller in a voluntary transfer may file a bankruptcy shortly, you do not insure unless you are satisfied that the sale is for fair market value.

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, he can 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 has still occurred after the date of filing of petition.

Postfiling Transfer
A postfiling 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 purchaser’s deed.

Company Policy: You should 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.

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 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.

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.

Present “fair equivalent” value may require payment of a higher percentage of fair market value than “reasonably equivalent” value.

Innocent Transferees
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. 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 debtor’s financial difficulties.

Company Policy: We will not rely on the innocent transferee provisions to issue without exception to fraudulent transfer or voidable preference issues.

Preservation
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.

Equitable Subordination
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.

Equitable subordination has been granted where the secured creditor exercised total control over payments to a debtor’s creditors by permitting advances of funds to pay minimum operating costs in order to permit continued inventory sales and as a result assumed effective control of management. Subordination has been allowed where a lender also was in substance the owner of the corporate mortgages 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 also has been denied where the creditor had a pledge of stock of the debtor but did not exercise control over the business. An insider loan is subjected to rigorous scrutiny, however, and the burden is on the director or stockholder to prove not only 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 corporation’s 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 by insiders to the mortgagor as unsecured capital contributions.

Company Policy: If the lender is one of the joint venturers or general partners in the mortgagor, the following exception should appear (although an excluded “act of the insured”) in the loan policy:

“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.”

Company Policy: If you are asked to issue an endorsement concerning shared appreciation or contingent interest, call our legal department. 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.

Liquidated Damages
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. Recent bankruptcy code revisions generally affirm the enforceability of interest rate swaps.

Company Policy: If you are asked to issue an endorsement concerning an interest rate swap or hedge agreement, call our legal department. Although we are willing to provide an endorsement in some cases, we will not insure the enforceability of any specified amounts as set forth in the agreement.

2.04.11

Dismissal

A dismissal occurs only upon court order, not 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 this property was vested immediately before the case.

Company Policy: Because of the possibility of a dismissal (prior to discharge) in Chapter 7, 12, or 13, and of dismissal 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 the interest was “avoided” or otherwise).

 

2.04.12

Discharge

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. The majority view is that an adversary proceeding may 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. The scheduling of the debt as unsecured is not res judicata and will not void the lien.

After a discharge, a creditor retains his perfected lien unless the lien has been avoided by an adversary proceeding, judgment, or other court order.

Company Policy: We will not rely on a discharge or plan confirmation to waive liens. The discharge and plan confirmation do not extinguish a preexisting lien.

As regards abstract of judgment liens in Texas, Sec. 52.021 Property Code provides that discharge in bankruptcy cancels judgment lien.

2.04.13

Effect Of Confirmation

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.

Company Policy: No order of the court is necessary 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. 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 Chapter 11 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 that time, the automatic stay ceases as to property of the debtor. On the other hand, a discharge is not granted in a Chapter 12 or Chapter 13 until completion of the plan. The stay remains in effect until that time.

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 legal department. We will verify by review of the plan and confirmation that the court has not retained jurisdiction over claims or the property.

Chapter 12 Proceeding
Unless otherwise provided, the confirmation vests all property of the estate in the debtor. Thereafter, it is not necessary to secure an order of the court to sell property if it is vested in the debtor.

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 should secure court approval. That sale may be considered a liquidation or modification of the plan.

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 in any other entity upon confirmation or at a later time. Property of the estate vests in the debtor upon the confirmation unless the plan or the order confirming plan states otherwise.

Company Policy: If the debtor offers to sell, no order of sale is necessary nor is any court proceeding necessary if the property has vested in the debtor and is not subject to the plan in a Chapter 13 proceeding and if the court has not provided that the property shall remain subject to the court jurisdiction until the discharge.

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.

Discharge of an Abstract of Judgment after 9-1-93 – Section 52.041 Property Code provides that discharge in Bankruptcy operates to cancel a judgement debt and lien.

Abstract of Judgments files before 9-1-93 must be disclosed by court order.

2.04.14

Post Petition Property And Prefiling Judicial Lien

A prebankruptcy judicial lien does not attach to property acquired by the debtor after the filing of the bankruptcy if the debt is discharged. The debt generally is not dischargeable if for income taxes, false pretenses (if so determined at hearing), a creditor who is not listed in time and who receives no notice, child support and spouse maintenance, malicious tort (if so determined as a hearing), government fines, educational loans, or damages as result of D.W.I..

Company Policy: In order to ignore a prebankruptcy judicial lien in connection with property acquired after the filing of a bankruptcy, you should verify that (1) the debt is not nondischargeable and (2) the debt is listed in the schedules with an address of the creditor evidencing notice, and (3) the discharge is granted.

2.04.15

Letter Of Credit

The prevalent view is that cashing during a bankruptcy of a letter of credit secured by a debtor as a customer prior to the bankruptcy does not violate any automatic stay. 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.

Company Policy: If you are asked to provide title insurance on a mortgage securing a reimbursement agreement on a letter of credit, call our legal department. We will, in appropriate cases, issue an affirmative endorsement where allowed by law.