Editor’s note: The new bankruptcy law that took effect on Oct. 17, 2005, included many provisions that affect both residential and commercial real estate. But attorneys are still debating whether the real estate market overall will benefit from the changes. In this three-part series, we consulted with bankruptcy and real estate law attorneys on the specifics of how the new law impacts homeowners, renters, landlords and homeowner and condo associations. (See Part 1 and Part 3.)
Two lawyers who specialize in bankruptcy law say the most damaging provisions for homeowners behind in their mortgage payments under the new bankruptcy law are those that apply to homeowners who’ve filed for bankruptcy once or twice within the previous year. And they say repeat filing is fairly common even for people filing in good faith.
“One area we’re seeing emerging in the case law that really impacts the ability to save a home is in the area of repeat filers,” said Duane H. Gillman, an attorney with Durham Jones & Pinegar in Salt Lake City who’s served as a Chapter 7 bankruptcy trustee since 1982. “The advantage has substantially shifted to lenders wanting to foreclose. Repeat filers really get clobbered.”
“Not everybody dismisses their bankruptcy petition and refiles for bad reasons,” said Thomas S. Linde, an attorney with the Law Offices of Karen L. Gibbon, P.S. in Seattle, who specializes in real estate law and representing creditors in bankruptcy.
Here’s a typical scenario of a good-faith, two-time filer: Homeowners fall behind in their bills. They file a Chapter 13 bankruptcy, which allows them to develop a plan to pay back debts over time. While paying according to their plan they get hit with a medical emergency or job layoff, which prevents them from making the payments as promised. When that happens, their bankruptcy case is dismissed, and they’re back to the drawing board with overwhelming debt. So they file a Chapter 7 bankruptcy, which allows for a neutral third-party like Gillman to act as trustee and conduct an orderly liquidation of their assets.
Linde describes another common repeat-filing scenario he’s seen during the refinancing boom of the past few years: These homeowners filed for Chapter 13 bankruptcy to reorganize their debt. While making payments according to their reorganization plan, they decide to refinance their home to take out equity to pay some of their overdue debts. “But the refinance lender doesn’t want anything to do with a bankruptcy,” Linde said. “So the homeowners voluntarily dismiss their case to get the refinancing approved, but the refinance goes south. The homeowners are out in the cold because they dismissed their bankruptcy case, so they file again, but after the new law has taken effect.”
Under the new law, second-time filers like the homeowners in those two scenarios get penalized. “If they’ve had one filing within the past year, the presumption arises that the second filing is an abusive filing,” Gillman said. In that case, the automatic stay — which prevents creditors from doing such things as selling a home at a foreclosure sale — lasts for only 30 days. If homeowners want to try to extend that stay beyond the 30-day period, they have to arrange for a hearing within 30 days at which they prove by clear and convincing evidence that their filing is in good faith and the stay should continue. “That’s not an easy standard to meet to prove this isn’t an abusive filing,” Gillman said. “There’s a greater likelihood there’ll be a foreclosure sale, and you’re going to have more homes lost.”
“That’s unfortunate in my opinion,” Gillman added. “The new law significantly puts at risk somebody who’s had prior filings, and I think it’s unnecessary.”
Don’t even ask about three-time filers. “If a debtor has had two bankruptcy cases during the year before this petition, there’s an absolute bar to any automatic stay being available to contest foreclosure,” Gillman said.
Before you turn up your nose at three-time filers, consider this scenario: Homeowners are in trouble with debt. They file for Chapter 13 bankruptcy to pay it back over time, but they try to save money by not hiring a lawyer to file their petition. As it turns out, it’s hard to fill out every form exactly as the court requires if you don’t do that for a living, and the court dismisses the first petition as incomplete or incorrect. So the homeowners hire a lawyer, who files a second petition. They then run into the same problems Gillman and Linde mentioned, such as a job loss or voluntary dismissal to facilitate refinancing that goes south, and end up dismissing their second Chapter 13 case and filing a third Chapter 7 liquidation. That’s three strikes, and the homeowners are out.
“If this is the third case,” says Linde, “there’s no stay, and the foreclosure’s going to happen.”
All of this raises a cautionary note for investors in foreclosed properties. Linde thinks it’s possible that courts will, on occasion, undo foreclosure sales in cases involving good-faith repeat filers. Despite the draconian measures for repeat filers, there’s still a sliver of discretion on the judge’s part. “Courts can impose a stay if there’s good cause,” Linde said. “Is the court going to have the power to go back to void a sale? I don’t know. But if a court sees that it would benefit everybody to void a sale, and everybody comes out whole, maybe it will.”
Linde thinks that’s possible in a case where homeowners have substantial equity, and the only party that benefited from the foreclosure sale having gone through is the third party investor who bought the property for a song. “When there’s equity that could benefit the homeowners and their creditors, maybe the judge should unwind the sale, let the homeowners get their money back and the creditors get paid, and give the third party his money back. Why should a third party get that windfall when that money could go to the homeowners and their creditors?”
Gillman, however, has faith in the trustees like him who oversee bankruptcy cases. “It’s true that if somebody’s not paying attention, you could lose substantial equity. But that assumes the trustee isn’t paying attention to what’s going on in that particular case,” he said. “I’m more of an optimist. I think if we’re monitoring what’s going on in our cases, there are remedies in terms of injunctions or imposing the stay. I don’t think we’re going to see foreclosure sales set aside.”
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