I live and work in one of the Chapter 13 Bankruptcy capitals of the United States, Memphis, TN. Only the Atlanta and Chicago areas had more Chapter 13 filings than Memphis in 2014. Memphis has held this distinction for many years. No one really knows or has been able to fully explain why Memphis has this dubious distinction; it just seems to be a fact of life here.
Memphis is also a city of renters. Large portions of the population live in rental housing. Yes, that makes Memphis a strong rental market and attractive to investors from all over the world. But it also means that many of those people filing for bankruptcy here will be tenants.
Download Your FREE Tenant Screening Guide!
Hey there! Screening tenants can be a tricky business, and this critical step can be the difference between profits and disaster. To help you with your real estate investing journey, feel free to download BiggerPockets’ complimentary Tenant Screening Guide and get the information you need to find great tenants.
How Does a Tenant Bankruptcy Filing Affect the Landlord?
To figure that out, let’s start when a tenant gets behind on the rent.
It can be very easy for some tenants to get behind very quickly. Many people are only one paycheck away from financial hardship. An illness, car breakdown or just a series of bad decisions can create the tough choice between paying the rent or putting food on the table.
When tenants get behind on the rent, some landlords are very quick to pull the eviction trigger. They or their attorney will rush down to the courthouse to file for the FED warrant. While it is true that you do have to demonstrate to your tenants that you will not mess around, being too quick to pull the eviction trigger may just backfire on you, as we will see.
What Happens During An Eviction
When you file to evict your tenant, that filing becomes public record. Anyone can go down to the courthouse (or just go online) and look up the recent filings. Many real estate investors are already aware of this as they look up filings for foreclosures or tax sales for their particular marketing programs. Bankruptcy attorneys do the same thing with eviction filings.
Bankruptcy attorneys will soon be flooding the mailbox of your tenant with all kinds of solicitations. Those postcards and letters will say things like, “We can stop your eviction,” or “Stay in your home” and “Stop those harassing landlord calls.” It can all be very enticing to a tenant who has gotten behind. Some will see no other way out and will be convinced that filing for bankruptcy makes sense for them. If they do, your job as a landlord just became much more difficult.
Chapter 7 and Chapter 13 Bankruptcies
Personal (as opposed to business) bankruptcies generally come in two forms, Chapter 7 and Chapter 13.
A chapter 7 bankruptcy is a filing that is asking for many debts to be simply wiped away and forgiven. The standards for filing and getting a Chapter 7 approved are more complex and daunting, so most will file a Chapter 13. Chapter 13 is also called a wage earner plan, and it seeks to restructure debts into something “manageable” that the person filing it can pay. Most creditors will likely get something out of a Chapter 13 filing, while a Chapter 7 filing could wipe any monies owed away.
So let’s recap.
Your tenant got behind on the rent for whatever reason. You file for eviction. A bankruptcy attorney sends a letter, and your tenant decides to file a chapter 13 bankruptcy.
What does that mean to you? First and foremost, your eviction proceeding is halted. Yep, you are dead in the water. Why? An eviction is filed in a state court. A bankruptcy is filed in a federal court. Federal courts trump state courts. Thus, an automatic “stay” is put in place against your eviction proceeding. A local judge will not even hear the eviction case until an okay is granted from the bankruptcy court.
Secondly, your tenant gets to stay in the property. Furthermore, they do not have to pay you rent until they get the okay from the bankruptcy court.
Thirdly, you cannot attempt to collect any monies owned to you. You cannot call them. You cannot go knock on their door. You cannot text or e-mail them. You are now considered a creditor by the bankruptcy court, just like Visa or MasterCard, and you must stop trying to collect the debt or face contempt of federal court.
Related: Considering Accepting Money after the Eviction? Beware!
In effect, your tenant has bought some time. They get time to keep living in your property without paying you rent. Yes, you can often get the stay against your case lifted, but you will definitely need the services of an attorney familiar with bankruptcy court procedures. So after 3, 4, or 6 months — and hundreds if not thousands of dollars in extra legal fees and lost rents — you may finally get your property back.
What Are the Right Steps to Take?
What should you have done?
You should have tried your best to work out some kind of deal before you file for eviction and the tenant files for bankruptcy. Remember, filing for eviction triggers all of those letters and postcards offering the tenant a way out. If they choose to take that step and file bankruptcy, you are going to be out of a lot more and in a much worse position than you are today.
All of this is just another reason why I feel filing for eviction is an absolute last resort. Yes, I understand that sometimes it just has to be done. No, the tenant will not always file for bankruptcy, but the option will definitely be presented to them. So do your best to work out a deal on the front end. In my mind, it is better to lose a little up front and get possession of the property back rather than lose a lot more money and time down the road just to end up in the same place.
Do you have any tenant bankruptcy stories you would like to share?
Please do so with your comments below!