Bankruptcies and Notes

14 Replies

How do Chapter 13 or Chapter 7 effect a note you have purchased or about to purchase? What are the opportunities and procedures necessary to take advantage?

Thanks in Advance

Hi Martin,

This is a great topic which deserves an entire blog post to properly address, but I can give you the highlights.  I am sure others will chime in if I miss anything important here. 

For both CH7 and CH13, secured lienholders cannot foreclose while the case is active unless a lift of stay is granted.

CH7

  • The debtor's assets are liquidated and unsecured debts are extinguished. 
  • The timeframe is usually a matter of a few months.
  • Lienholders cannot foreclose while the case is active without a lift-of-stay.  (Not worth the trouble for CH7 IMO.)
  • After CH7 completes, the borrower is no longer personally obligated to repay a mortgage loan, but the loan still encumbers the property.
  • CH7 can help us as secured lienholders because the borrower emerges in better financial condition and more able to make mortgage payments.

CH13

  • CH13 is a reorganization, so assets are not liquidated as in CH7.
  • The debtor files a plan for repayment, which must address payments for secured debt.
  • The timeframe for the plan is variable but can be up to 5 years.
  • Personal liability for the debt remains intact.
  • Once the plan is confirmed, the debtor makes plan payments to the trustee, who distributes them to creditors on a pro-rata basis.
  • Frequently plans call for mortgage loan arrearage payments to be paid through the trustee while the P&I payment is made directly to the creditor (or servicer).
  • Because the plans are longer term, lien holders must file for lift-of-stay if the debtor does not live up to the plan and they wish to pursue foreclosure.

Key Procedures

  • For new BK filings, secured lienholders must file a Proof of Claim (POC) with the trustee. This defines the amounts owed, including a break out of principal and arrearage. This filing must include copies of recorded DOT/Mortgage and Note.
  • If you are purchasing a note where the borrower is already in BK13, you will need to file a Transfer of Claim.  This informs the trustee of the change in ownership of the lien.  The POC can also direct payments from the trustee to your servicer.
  • Generally it is a good idea to find a good BK attorney who can help with these filings.  Bankruptcy is a federal code, so a single attorney can usually deal with all of your BK filings regardless of state.  The attorney can file an Appearance on the BK case to get a feed of any changes that happen on the case and make you aware of the important ones.
  • If you have liens with BKs you will want to register for an pager.gov account.  You can search and find BK cases and drill down and see all of the details.  The Case Summary provides some good basic information.  If you go to the History listing of a CH13 case, you can find the plan the borrower is committed to, which details how the mortgage loan should be treated in terms of payments from the debtor.

Sorry for the info dump.  Hope it helps.

I should have added that if you are buying notes one at a time, there are generally fewer bids on those that show BKs in the O&E.  That can be an advantage for someone who understand how to deal with them.  Personally I don't consider it a negative if I am looking at non-performing or semi-performing notes.  Anyone who has done a number of foreclosures has seen borrowers file for BK a day or two before the sale, so you will end up getting an education one way or another.  IMO, its best to dive in and get educated, get a pacer account and find an attorney who can help you with the filings.

Excellent reply Mark.  That is great information to many of us starting out in note trading.  Thank you.

Great post @Mike Hartzog  

Great topic as well. I can throw in a few things as well.  

I believe you can file a "Motion for Relief" from the stay and that legally allows you to continue the foreclosure process on the property. The other thing as well is you are not allowed to contact the borrower if they are in active BK, but I have heard of some creditors who "accidentally" contact the borrower and have them email them permission to contact them to do a workout package with the borrower or the BK attorney out of bankruptcy.

Since I'm not as experienced as other investors, I'm curious to know what other peoples' experience is like working with BK attorneys.  

@Arthur Mayer  

Thanks for throwing the point about no contact in.  That is correct, creditors should not contact the debtor for debt collection purposes when they are in active BK.  As a practical matter, I end up having conversations with these borrowers fairly regularly, but I don't initiate the contact.  As an example, I had a property going to FCL sale earlier this month and the borrower filed for BK7 to stop the foreclosure on the day of the sale.  The borrower then reached out to me for a loan modification.  That was my desired outcome anyway, so overall the BK filing was a benefit, but I wish the borrower had responded to my earlier mitigation attempts and saved me the FCL expenses.  If I want to initiate contact, I generally have my BK attorney reach out to the borrower's BK attorney to start the conversation.

Originally posted by @Mike Hartzog :

Hi Martin,

This is a great topic which deserves an entire blog post to properly address, but I can give you the highlights.  I am sure others will chime in if I miss anything important here. 

For both CH7 and CH13, secured lienholders cannot foreclose while the case is active unless a lift of stay is granted.

CH7

  • The debtor's assets are liquidated and unsecured debts are extinguished. 
  • The timeframe is usually a matter of a few months.
  • Lienholders cannot foreclose while the case is active without a lift-of-stay.  (Not worth the trouble for CH7 IMO.)
  • After CH7 completes, the borrower is no longer personally obligated to repay a mortgage loan, but the loan still encumbers the property.
  • CH7 can help us as secured lienholders because the borrower emerges in better financial condition and more able to make mortgage payments.

CH13

  • CH13 is a reorganization, so assets are not liquidated as in CH7.
  • The debtor files a plan for repayment, which must address payments for secured debt.
  • The timeframe for the plan is variable but can be up to 5 years.
  • Personal liability for the debt remains intact.
  • Once the plan is confirmed, the debtor makes plan payments to the trustee, who distributes them to creditors on a pro-rata basis.
  • Frequently plans call for mortgage loan arrearage payments to be paid through the trustee while the P&I payment is made directly to the creditor (or servicer).
  • Because the plans are longer term, lien holders must file for lift-of-stay if the debtor does not live up to the plan and they wish to pursue foreclosure.

Key Procedures

  • For new BK filings, secured lienholders must file a Proof of Claim (POC) with the trustee. This defines the amounts owed, including a break out of principal and arrearage. This filing must include copies of recorded DOT/Mortgage and Note.
  • If you are purchasing a note where the borrower is already in BK13, you will need to file a Transfer of Claim.  This informs the trustee of the change in ownership of the lien.  The POC can also direct payments from the trustee to your servicer.
  • Generally it is a good idea to find a good BK attorney who can help with these filings.  Bankruptcy is a federal code, so a single attorney can usually deal with all of your BK filings regardless of state.  The attorney can file an Appearance on the BK case to get a feed of any changes that happen on the case and make you aware of the important ones.
  • If you have liens with BKs you will want to register for an pager.gov account.  You can search and find BK cases and drill down and see all of the details.  The Case Summary provides some good basic information.  If you go to the History listing of a CH13 case, you can find the plan the borrower is committed to, which details how the mortgage loan should be treated in terms of payments from the debtor.

Sorry for the info dump.  Hope it helps.

 Good stuff.  Thanks for putting it all in one place.

For the OP:  It's a pacer dot gov account you want, not pager.  An account is essential to watch what's going on in a case. I use my account mostly to confirm if BKs are dismissed and/or if real property was abandoned by the trustee.

@Bob E.  - Thanks for the vote!

@K. Marie Poe

Thanks for catching my typo.  Unfortunately its not the only one.  For some reason I don't see them until after I hit the post button.  :-)

I've acted as a registered creditor's representative in BK, the property is usually appraised by the court if they believe there is equity above exempted amounts. I realize most investors can't "testify" or show up, but in doing so, if the equity is anywhere near limited and you want the note reinstated, you show that the market value, allowable expenses and repairs required at that value are limited to provide equity for other creditors. As Mike mentioned, actually, any reinstatement or modification or acknowledgement of the debt can be a plus as to your risk analysis as they can't file for BK again for another 7 years.

If there is significant equity, all the better, it will be sold and you'll be paid off. In this case, you may not want to show up, if you bought the note there is a good chance you'll be asked what you bought it for.....guess what???? It's called a "cram down" the court may indemnify you at your purchase price allowing more to go to other creditors. If discounted amounts are not needed, you may get the unpaid balance.

Good post Mike! :)

@Bill Gulley  

Wow, that's interesting.  So are you saying that in certain cases, the collateral may be liquidated by the court?  I suppose that could be the case in a CH7 where the collateral is not the primary residence of the debtor.  Is that right, or are there other scenarios here?

The petitioner in Chapter 7 has a homestead exemption, excessive equities beyond the exemption of a residence can be sold for creditors, they can have the equity to the exemption amount and find another residence! I believe the amount is $25K. Can't say I'm current in BK matters as things have changed, but I don't believe the exemptions have been eliminated. Second homes or other properties don't qualify under the homestead exemptions. The exemptions will vary by state law as well as federal bankruptcy as the courts may consider exempt assets. Inherited property, wedding rings, joint interests, tools of the trade and other assets may be exempt from liquidation.

FYI, there is also a look back period for the sale or disposal of any asset prior to filing, some think they might out smart the system ya know....LOL 

Now, my experience is in the 11th District and what may be done is not always that uniform, which is why attorneys are usually needed.

What the government allows they can take away too. :)

@Bill Gulley  Registered Creditor's Rep. Now I like that because I don't want to make a court appearance unless there's an upside for me (and I don't see one at BK court). 

I joined the Receivers Assiciation here in CA and attended their big meeting thus last Saturday. Now there's a group who only deal with clusterf***s. All the time; every time. I'm ok with messy files however there's got to be an upside. 

I really enjoy this thread. Anyone who buys notes and is ok with bk messes ought to do well as there are very few note investors who are attracted to the bk world. Frankly, I'm not either howevr I get my hare of messes with deceased and missing owners.

Going back to contacting the borrower, if they have a decent attorney, then it is even better because either you or your attorney can contact their attorney and get a head start on a work out.  Some attorneys don't care about setting up their client after BK, but some steer them in the right direction to take advantage of the clean slate and use the excess cash to start making payments.   I forget the exact number, but I believe like 80% of chapter 13 plans fail and then you can go right back at them once they are dropped out of the program.  This is because a lot of people file 13 just to buy time and they never really even plan to restructure.  It keeps the creditors at bay for a few months.  They file the 13 then don't even show up to court.

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