Short sales are part of the new way of doing business for mortgage lenders. This is why we feel mortgage lenders should be happy to learn their borrower filed Chapter 7 bankruptcy.
Bankruptcy Short Sales
When a homeowner files Chapter 7 bankruptcy the standard play called by the lender is to (a) hire a lawyer to file the motion to lift the automatic stay; and once the stay is lifted, (b) initiate or continue the foreclosure process. This is an outdated, knee-jerk strategy aimed at limiting the foreclosure delay caused by Chapter 7 bankruptcy. In the past three years, outside of the bankruptcy arena, mortgage lenders have learned the benefit of the “short sale.”
A “short sale” occurs when the debtor-homeowner tries to sell his or her home but is unableto generate enough sales proceeds to pay off all liens and closing costs associated with the property. Therefore, the lender must consent to the sale of a home despite not receiving 100% of what’s owed on the mortgage note. Many times the deficiency debt is negotiated down to a fraction of the total owed, if not outright cancelled by the lender. The logic is simple: cash out now while the market is trending down or bottoming out without having to endure the cost and time of foreclosing, maintaining and remarketing the property.
Short sales are now a major part of the way of doing business for most mortgage lenders. This begs the question, is the “lift the stay & foreclose the property” strategy the best strategy? Arguably, it is not. Mortgage lenders need to reconsider their outdated bankruptcy strategy and instead consider a new, more efficient and solution-minded strategy that a few regional banks have recently discovered, the “Bankruptcy Short Sale.” As discussed in further detail below, closing a short sale within the bankruptcy arena has a few extra steps but has a great deal of benefit to the lender – benefits that most attorneys, let alone lenders know nothing about.
Back to Business
Whether debtors are surrendering their home or an investment property, once a property is surrendered in a Chapter 7 bankruptcy, by operation of law, the Trustee of the bankruptcy estate becomes the new owner of the property. This is good for the mortgage lender because the typically unsophisticated, distraught homeowner has been replaced with a sophisticated, emotionless fiduciary who can proactively manage the efforts to sell the property. Unfortunately, many times debtors who are faced with surrendering their home are losing their primary residence and are frustrated with their financial situation. A popular strategy employed by these frustrated debtor homeowners is to not only fail to cooperate with the mortgage lender, but in many instances, proactively stall the foreclosure of the home so as to live “rent free” for as long as possible. While the debtor homeowner may be "maintaining" the property, the cost and consequence to the lender of carrying this "toxic asset" can be material...and something it would like to avoid.
Once the debtor's home becomes property of the bankruptcy estate the debtor's ability to stall is over and the lender can focus on liquidating their collateral, just in a new, more expeditious manner. With the Trustee stepping into the shoes of the debtor homeowner, the Trustee and the lender can focus on working together to list the property for sale, procure a buyer and close a sale...all without further debtor-created delay.
Save Time and the Cost of Foreclosure
A common issue when closing on a short sale outside of the bankruptcy court is that all lien holders must consent to the sale – and gaining their consent can be time-consuming, challenging and expensive. Junior lienholders, like second mortgages and equity lines of credit, will typically ask for $ 4,000 to $ 6,000 to gain their consent to a short sale. Some lien holders, like judgment creditors, can be very difficult to work with and sometimes ask that a lien be paid in full before gaining their consent. In short, if the debtor homeowner cannot "run the gamut" and obtain full lien-holder consent, time and money will have been wasted and the lender no better off.
Under 11 U.S.C. § 363(f), a Chapter 7 Trustee can bypass the need for junior lienholder consent to sell the property by filing a motion to sell the property free and clear of liens. Such a motion is served on all lienholders and has the effect of a foreclosure complaint. Assuming no sustainable objection to the sale is made, the Bankruptcy Court can enter an order that authorizes the Trustee to proceed with the sale of the property and that transfers the liens to the sale proceeds in the same order of priority and effect as they existed on the property that was sold. In most short sales the sale proceeds are not enough to satisfy the senior lienholder, so in effect the junior lienholders are wiped out - just like in a state court foreclosure pursuant to Florida Statutes, Chapter 702.
By virtue of working with the Chapter 7 Trustee, mortgage lenders can derive all the benefits of a short sale, on a faster timetable when the same short sale might not have otherwise been feasible outside of the bankruptcy court.
Time Really is Money
Empty homes result in declining of values. This is a major concern for mortgage lenders. Here in Florida, foreclosures can take as long as three years, sometimes longer if there are problems with the chain of custody with the note and/or the foreclosure lawsuit is being actively defended. With soaring temperatures, high humidity, mold potential, gigantic palmetto bugs and all the other great things that come with living in Florida, vacant homes don’t stand a chance. Plain and simple, no matter where the home is located, homes need to be occupied and attended to if you are going to preserve their value. Limiting vacancies as well as fairly and lawfully dealing with defaulting squatters is vital to mortgage lenders attempting to mitigate their losses.
Before Chapter 7 Trustees and mortgage lenders began engaging in Bankruptcy Short Sales the outlook was pretty grim on vacant homes. The mortgage lender would either need to engage in the lengthy process of state court foreclosure and remarket the property before being able to get cash out of the home and take the asset off the books, or hope that the debtor homeowner (despite little incentives) cooperates with the process of short sale post-bankruptcy. As mentioned earlier, people who have to go through the stress of bankruptcy are usually too emotionally and mentally exhausted to go through the document intensive process of gaining short sale approval. Furthermore, the debt and the pressure that goes along with it have been discharged. Some debtor homeowners even blame the mortgage companies for their financial ruin and would rather steal all the counter tops, copper wiring, ceiling fans and light switches than cooperate with the lender to make sure they maximize the value of the home.
In short, the Chapter 7 Trustee functions as a savvy, emotionless seller who can work with the lender to ensure that the home is secured and sold as quickly as possible, thereby preserving as much value as possible for the mortgage lender.
No Complicated Document Requirements
There are two basic components to the average, non-bankruptcy short sale negotiation: (a) does the sale price truly reflect the value of the home; and (b) what is going to happen to the deficiency debt owed to the mortgage lender. When the homeowner files bankruptcy the debt is discharged and--there is no deficiency debt to discuss. Therefore, in a bankruptcy estate short sale, the only issue left to consider is the value of the property – and that’s what appraisers, real estate brokers, investors and the free market are for. Chapter 7 Trustees have the ability to list and market surrendered homes and are under a fiduciary duty to get the best, yet most efficient sale price possible. This creates a win-win-win-win scenario. The debtor wins: no final judgment of foreclosure on their record and no ordinance violations or home owner’s association (HOA) problems to worry about. The lender wins: it is able to quickly and more efficiently sell distressed property. The local community wins: selling surrendered or abandoned properties to caring, solvent owners, helping to stem the tide of declining property values. And finally, the creditors win: through a "carve-out" approved by both the secured lender and the bankruptcy court, the creditors participate in a meaningful distribution from the estate.
Many Chapter 7 Trustees already have the relationships in place -- real estate brokers, title companies and special counsel - familiar with the Bankruptcy Code's and Court's requirements, so that properties surrendered in Chapter 7 bankruptcies can quickly and efficiently be liquidated for fair market value, allowing lenders to quickly sell distressed, toxic properties free and clear of liens, ultimately saving them time, money and solving some of their largest problems: dealing with distressed real estate. Contact Us if you have questions about Bankruptcy or Foreclosures.
About the Authors:
Richard M. Dauval is a partner with Leavengood, Dauval & Boyle, P.A. who manages its consumer bankruptcy practice. Richard is also a Chapter 7 bankruptcy panel trustee in the Middle District of Florida, Tampa Division. Richard is board certified in consumer bankruptcy law by the American Bankruptcy Institute and has personally been involved in thousands of consumer bankruptcy filings. His experience in consumer bankruptcies and Chapter 7 trustee short sales has positioned himself to be hired as special counsel to other Chapter 7 bankruptcy trustees, helping them to facilitate and successfully negotiate these 11 U.S.C. § 363 bankruptcy short sales.
Ian R. Leavengood is a partner with Leavengood, Dauval & Boyle, P.A. who manages its real estate & title practice. Ian too has been involved with thousands of consumer bankruptcies over his career and is very familiar with the consumer bankruptcy process and contested matters in the bankruptcy court. Ian is a licensed member of the Florida Attorneys Title Insurance Fund and has worked with its general counsel to gain approval for the content and form of the 11 U.S.C § 363 short sale.