For secured lenders, a consumer debtor’s chapter 13 bankruptcy filing can be a mixed bag.
A chapter 13 bankruptcy petition often is utilized by a consumer debtor to avoid a foreclosure by allowing a debtor time (usually three or five years) to catch up on mortgage payment arrears. In the ideal situation, where real property is not underwater, chapter 13 allows a secured lender to recoup a debtor’s delinquent payments over time and avoid costly foreclosure procedures. On the other hand, if the secured real estate is underwater (or the debtor otherwise does not wish to retain the property), the Bankruptcy Code allows a debtor to “surrender” the property to the secured lender. Until relatively recently, “surrender” meant merely allowing the secured lender to exercise its rights with respect to the property in accordance with its ordinary and customary practice under state law (usually by foreclosure, deed in lieu of foreclosure or short sale).
Recently, however, there has been a trend in some jurisdictions whereby secured lenders might end up being forced to accept title to underwater real estate without any say in the matter (i.e., over its own objection).
The Bankruptcy Court for the District of Massachusetts is now split as to whether a chapter 13 debtor can force a secured lender to accept underwater real estate over the lender’s objection. Indeed, two bankruptcy judges in the District of Massachusetts recently issued opinions on the exact same day (March 4, 2016) reaching the exact opposite conclusions as to this issue, a possible signal that these judges want this practice to be reviewed by a higher court. See In re Brown (finding that a chapter 13 plan may provide that title to real estate vests in the secured lender despite lender’s objection); In re Tossi (finding that a plan that vests title in a lender over the lender’s objection is not permissible).
Here is a typical scenario: A debtor may have decided that it does not want the property anymore (possibly because the property is underwater, the debtor moved away and/or the lender instituted foreclosure proceedings—which under this scenario have stalled or been cancelled); therefore, the debtor crafts a chapter 13 plan that provides that the debtor will attempt to sell the property within ninety days—regardless of whether a buyer has been lined up—and that, if a sale is consummated, the proceeds will pay the secured lender’s mortgage claim. The plan also provides for an alternative if the debtor is unable to find a buyer for the property or the sale is not consummated: after the ninety-day marketing and sale period, the plan provides that the debtor will “surrender” the property pursuant to 11 U.S.C. § 1325(a)(5)(c) and that title to the property will immediately and automatically “vest” in the secured lender without any action by the lender or further order of court. In other words, the lender will automatically own the property without any real say in the matter.
You (secured lender) may be shocked to learn that a court can force you to essentially accept a deed in lieu of foreclosure without your consent (and potentially without the opportunity to elect to accept title in an REO holding company or similar affiliate/subsidiary). But just wait until you find out that you already own the property without having taken any affirmative steps, and then the tax bills and code violations (remember we likely are talking about abandoned property here) start showing up at your door.
Some may be wondering why a bank wouldn’t want to accept title to the property when the borrower is not paying the mortgage loan and is in bankruptcy. There may be any number of possibilities, including the tax bills and code violations mentioned above, potential liability (slip and falls and the like), title problems, environmental concerns, costs of maintenance and upkeep, etc.
That these two bankruptcy decisions were issued on the same day may be a signal that the Bankruptcy Court of Massachusetts is looking for some guidance, in the form appellate review, regarding this curious practice. As soon as an appeal is presented, the higher courts will be able to weigh in.
Until that time, secured lenders beware of, and be ready for, a chapter 13 plan that provides for automatic vesting of real estate in the lender. Always read those chapter 13 plans carefully and make sure your attorney gets a copy and briefs you on the situation.