In the News
The following was originally published in Lynchburg Business Magazine, January 2014 issue, and was written by David Cox.
For small businesses, receiving a notice of a customer’s bankruptcy can be confusing. While the best advice is always to contact an attorney to determine the exact impact of the bankruptcy, the analysis can be broken down into a few basic steps following the receipt of a bankruptcy notice.
Stop Collections and Gather Information
With very few exceptions, upon the filing of a bankruptcy by an individual, the automatic stay of the bankruptcy code generally prohibits further collection activities or legal actions against that individual and his or her property. The focus of a business that receives a bankruptcy notice should first be on identifying the debtor in its customer records, determining what, if any, collection actions it has pending, and ceasing those collection actions as well as the generation of further billing statements to the customer.
Most creditors will learn of the bankruptcy filing by receiving a written notice in the mail. This notice is the first document generated by the court upon the filing of a bankruptcy petition by an individual and it includes key information that the creditor should review. For example, the notice will indicate the full name and social security number of the debtor to aid in the creditor’s identification of the individual in its customer rolls. The bankruptcy case number will also be disclosed and should be referenced by the creditor in any correspondence it sends to the bankruptcy court related to the debtor.
The notice also includes the chapter that the debtor has filed, typically 7 or 13 for consumer debtors, and the date, time and location of the Meeting of Creditors. The chapter is particularly important because it will provide an early indication of whether funds might be available for the creditor in the case. Typically Chapter 13 bankruptcies provide some level of distribution to the creditor, albeit often just a small percentage for many general unsecured creditors. Chapter 7 bankruptcies may also produce dividends for the creditors, but whether funds will be available is typically not something that the creditor will be able to determine at such an early stage in the case.
Determine the Impact of the Bankruptcy
Many small business creditors mistakenly ask whether their debts are “included” in the bankruptcy. Technically this is not correct since all debts must be included, that is, listed and noticed, in the bankruptcy petition. The real question is whether a particular debt will be discharged or wiped out by the bankruptcy. The answer to that question depends in large part on whether the debt owed to the creditor satisfies one or more of the exceptions to discharge found in the Bankruptcy Code.
The Bankruptcy Code lists a number of types of debts that are not discharged in a bankruptcy. Examples include certain types of taxes, child and spousal support obligations and student loans that would not typically impact a small business creditor. Small business creditors often need to look more to the manner in which the debt was incurred. For example, such businesses may be able to assert that a debt should not be discharged because it was incurred by fraud or by the misrepresentations of the debtor.
Also, the receipt of a bankruptcy notice does not necessarily mean that the creditor will not receive further payments toward the debt. In Chapter 13 cases, the debtor’s proposed plan will be mailed to all creditors and provides information on what payments a creditor might expect. In Chapter 7 cases, the debtor files a Statement of Intention that indicates whether he or she will continue to make payments to certain creditors that have liens on the debtor’s property.
Consider Whether Further Action is Necessary
When faced with a customer’s bankruptcy filing, the creditor’s range of options extend from taking no action to becoming actively involved in the case, reviewing all filings and attending court hearings. Although much of the initial information gathering can be done without the assistance of an attorney, determining the effect of the bankruptcy filing and evaluating whether further action is necessary typically will require the expertise and advice of an attorney.
The bankruptcy process actually includes a fair amount of safeguards for creditors even if they do not participate in the case. Other parties, such as case trustees, are assigned to all consumer cases and oversee parts of the process. Although these trustees are not responsible for protecting the rights of any particular creditor, they will often bring to the attention of the court issues related to the debtor’s eligibility to seek bankruptcy relief.
Even if a creditor does not intend to become actively involved in a case, it should consider filing a proof of claim with the court if distributions are likely. A blank proof of claim form normally will accompany the initial bankruptcy notice from the court in all Chapter 13 filings since some level of distribution to creditors is anticipated in such cases. For Chapter 7 cases, the court generally only issues a notice to creditors to file a proof of claim in a case where distributions are expected. Timing is important, however, and a creditor needs to ensure its proof of claim is filed before the deadline noted for such claims.
A common misconception is that creditors must attend the Meeting of Creditors hearing or they will not be able to further participate in the bankruptcy. This is not true. The failure to attend the meeting of creditors by the creditor does not eliminate any of its rights with respect to the bankruptcy. It is an optional meeting that simply provides basic information about the case and the opportunity for questions to be asked of the debtor regarding his or her debts and property interests.
Depending on the circumstances of a particular case, some creditors may consider becoming more deeply involved in the proceedings. Creditors will want to consult with counsel before taking actions such as objecting to the debtor’s plan of reorganization, filing a special lawsuit to ask the court to determine that a debt is not discharged, seeking dismissal of the case or asking the court to lift the automatic stay in order for normal collections to proceed.
Although small business creditors are understandably concerned with incurring more expenses and legal fees when faced with a customer’s bankruptcy filing, hiring counsel is always advisable when dealing with significant accounts. As with any legal matter, a business is best positioned to limit the impact of a bankruptcy when that business understands the process and its options.
David Cox was inducted on March 15, 2013, as a Fellow in the American College of Bankruptcy at a ceremony at the Smithsonian Donald W. Reynolds Center for American Art and Portraiture in Washington, D.C. David was one of 39 attorneys, judges and insolvency professionals nationwide extended an invitation to join the College based on his achievements related to bankruptcy and insolvency law and practice. The College now has 821 Fellows, each selected by the Board of Regents from among recommendations of the Circuit Admissions Council in each federal judicial circuit.
An Article by David Cox Featured in the Lynchburg Business Magazine: “Looking for a Lifeboat When Your House is Underwater”
As homeowners across the country are painfully aware, the U.S. housing bubble burst beginning in 2006 as home prices plummeted for several years thereafter and even into 2013. Homeowners have watched helplessly as any equity they had built in their homes quickly diminished to the point that many homeowners now find their homes “underwater.” When a property is underwater, the debt or mortgage owed against the property exceeds the current market value of the property, leaving the homeowner feeling like more of a renter than owner. Some homeowners become effectively trapped in the property, unable to sell their home in a traditional fashion without bringing significant cash to the closing simply to pass a clear title to the buyer.
Some options exist, though, for homeowners in this situation. Understanding the choices they have is the first step a homeowner should take before determining how to best solve the problem.
Abandon Ship and Walk Away
Although tempting, simply ceasing payments on a home mortgage in Virginia and walking away from the property is not typically a good idea. Under such a scenario, the home would ultimately be sold by the lender at foreclosure, and the mortgage borrower would be left owing whatever deficiency remained on the mortgage loan after the proceeds from the sale were applied to the outstanding debt. While in some states such deficiency claims may not be asserted against and collected from the homeowner and borrower, Virginians are not so lucky. If you walk away from your home and mortgage, expect to be sued for the deficiency after foreclosure.
Weather the Storm and Stick it Out
Although this choice provides the least immediate relief to the homeowner, staying in the property and remaining current on the mortgage loans will minimize the negative impact on your credit. If the property suits a homeowner and his or her family’s needs, it is often best to stick it out and wait for property values to eventually recover, if such an option is financially feasible.
Chart a New Course with a Loan Modification
The buzz words in home lending and mortgage servicing for the last several years have been “loan modifications.” A loan modification is simply an agreement whereby the mortgage lender changes the terms of the loan typically to reduce the monthly payment amount, interest rate, principal balance or any combination of the above. Unfortunately, the reality is that few homeowners successfully negotiate and finalize loan modifications with their mortgage lenders. The promise of generous and widespread loan modifications simply has not become a reality. With that said, interested homeowners should certainly consider the option.
The process is started by contacting the mortgage lender and requesting a loan modification application. Be prepared to spend a great deal of time preparing and submitting such an application as careful documentation of every aspect of the transaction is key. Also be prepared to deal with the frustrations of the loan modification review process. No doubt, you will have to submit and resubmit your application and supporting documents several times as the mortgage companies have become notorious for losing entire client files during the process. Nonetheless, homeowners should treat the process like a full-time job, stay organized and patient, and they will have the best chance at successfully negotiating a loan modification.
Navigate to Safe Harbors with Short Sales and Deeds in Lieu of Foreclosure
Two other popular options are a short sale or a deed in lieu of foreclosure. From the homeowner’s perspective, these are similar options in that the end result of each is the loss of the home. In a short sale, the home is sold to a third party for less than the balance due under the mortgage loans. In order to pass a clear title to the new buyer, though, the mortgage lender must agree to release its lien for less than the full payoff of the loan. Therefore, the mortgage lender is an important party to the transaction. A deed in lieu is the transfer of the home directly to the mortgage lender who will thereafter resell the property to a third party without ever completing the foreclosure process. In both of these transactions, the key for the homeowner is to negotiate with the lender as to whether the remaining balance of the mortgage loan will be forgiven and to document the same by some written agreement.
Decommission the Ship with the Planned Surrender of the Home in a Bankruptcy
Surrendering a home through a bankruptcy provides protection to the homeowner from the potential deficiency claim that might otherwise be collected from him or her after the foreclosure of the property is completed. Depending on the homeowner’s income and assets, such a bankruptcy might take the form of either a Chapter 7 liquidation or Chapter 13 reorganization, but either form of bankruptcy will provide the ultimate relief for the client. Another benefit of surrendering a home in a bankruptcy is that the homeowner may continue to reside in the property without making any mortgage payments until the ultimate foreclosure sale, often months or even years before the final sale is completed.
Lighten the Load and Eliminate Second Mortgages and Equity Lines
For those homeowners with multiple mortgages who want to remain in their homes but cannot afford their mortgage payments, a Chapter 13 bankruptcy permits a homeowner to void and remove second mortgages and equity lines to the extent that they are completely unsecured. In other words, if the balance of the first mortgage exceeds the value of the home, then the homeowner may use the Chapter 13 process to strip off and void the remaining inferior mortgage liens against the property.
Second mortgages and equity lines were heavily marketed by some lenders in the early 2000′s as property values soared but these loans have choked the finances of many homeowners during the recession of the last several years. The ability to completely eliminate such a mortgage payment from a homeowner’s budget is a unique and powerful tool in bankruptcy that will often make the difference in whether the home may be saved.
Right the Ship and Get Back on Course through a Chapter 13 Bankruptcy
Another important use of a Chapter 13 bankruptcy is to help a homeowner stop the foreclosure process and catch up any missed mortgage payments through a court approved repayment plan. Although such a scenario would not permit the homeowner to reduce his or her mortgage payment or otherwise modify its terms, a Chapter 13 bankruptcy may offer the struggling borrower the second chance necessary to save the home and recover from some temporary personal financial setback, like a job loss, demotion or unforeseen medical complication.
A family’s largest single investment is typically their home. Trying to keep a home that is significantly underwater can, in some cases, prolong a bad investment and lead to financial pressures in the family. Options are available to such homeowners but they should always seek out professional legal advice to guide them through the process in order to navigate the smoothest course out of the financial storm.
David Cox was selected to speak on Recent Developments in the area of Bankruptcy Law at the 19th Annual Tidewater Bankruptcy Bar Association 2010 Seminar in Norfolk, VA, in January 2010.
David Cox was selected to moderate a panel of the three sitting US Bankruptcy Judges from the Western District of Virginia at a 2010 seminar in Roanoke, VA, produced by Virginia CLE in April 2010. The panel discussed “Best Practices” …
David Cox was selected to speak at a panel on Bankruptcy Options for the Small Business Debtor at the Virginia State Bar conference in June, 2010.