A CREDITOR'S CHAPTER 13 BANKRUPTCY CHECKLIST
COASTLINE CAPITAL FUND MANAGEMENT
A Creditor's Chapter 13 Bankruptcy Checklist
by Andy Mirza
Over the last few years, I’ve seen more and more Chapter 13 Bankruptcy filings by borrowers on the eve of foreclosure sales. As a lender, it’s frustrating to have your sale postponed and the foreclosure process thwarted by someone who hasn’t made a payment in months or years.
I have no problem with legitimate filings in which the Debtor has a well thought out plan and a reasonable chance of success. We’ve had a couple of situations where the Debtor made a comeback, they’re doing the best to meet their obligations, and where we’re rooting for them to succeed.
In our experience, however, 90% of filings have been clearly bad faith filings with the intent to stall a foreclosure or ones in which the Debtor had no real means of completing the plan; it’s a desperate moonshot to “save” their house without regard to the consequences of going bankrupt.
For the newer note investor, what do you do when a borrower files Chapter 13 bankruptcy? (DISCLAIMER: I am not an attorney. This is not intended as legal advice. This is for informational purposes only and relates to what I have done or what my practices are.)
Here’s my take on what you should do in mostly sequential order:
Chapter 13 Bankruptcy Checklist
1. Monitor the Bankruptcy in PACER
2. Postpone or Cancel the Trustee or Sheriff’s Sale
3. Find an Attorney to Represent You
4. Determine Your Strategy
5. Wait to See What the Debtor Files
6. File a Proof of Claim
7. Take Action if Your Strategy Dictates:
a. Motion for Relief
b. Object to the Plan
8. Continue to Monitor at Least Once a Month.
1. Monitor the Bankruptcy in PACER
PACER stands for “Public Access To Court Electronic Records.” It’s a site maintained by the Administrative Office of the U.S. Courts and it provides the user access to the court docket, documents, and all publicly available filings. Before a property goes to foreclosure sale, those involved in the sale check PACER to see if the borrower has filed BK so that they can stop or postpone the sale so that they don’t violate the automatic stay.
PACER is the place that every involved party goes to see what’s happening with the BK.
As an investor, you absolutely should do this yourself. Don’t rely on your attorney to do this for you. As the most motivated person on the creditor side, you need to know what’s going on and you can pick up on things that an attorney might miss because you probably know the asset a lot better than he or she would.
Download the petition, plan, and schedules. Check the details. Check for accuracy.
2. Postpone or Cancel the Trustee or Sheriff’s Sale
Once you’ve been given notice of the Debtor’s BK filing, you need to be very careful about not violating the automatic stay that is created by the filing that protects the Debtor from any collection efforts by Creditors. (When a borrower files bankruptcy, he or she becomes a “Debtor” in the BK case and you, as the lender, become the “Creditor.”) I haven’t personally had to deal with the consequences of violating an automatic stay because I’ve heeded the warnings of every attorney, note servicer, and trustee that’s advised me. I’ve been warned that violating the automatic stay can result in sanctions and penalties in the tens of thousands of dollars not to mention the lost time in having to deal with these consequences.
To avoid violating the automatic stay, postpone or cancel the foreclosure sale, whichever is appropriate for the state in which the foreclosure is taking place. If you can postpone the sale, do so for one month. You most likely won’t be able to do anything in a shorter time period but it’s not too long in case you can get relief right away.
Rare exception: In cases where the borrower and/or accomplices make multiple BK filings to obstruct, delay, or hinder subsequent sale dates and you do not receive proper notice, you may proceed with a foreclosure sale and validate it afterwards.
Warning: This is a tactic that should be used in only the most blatant and egregious cases and only when recommended and approved by a competent, experienced attorney. If you’re not sure, postpone or cancel the sale.
3. Find an Attorney to Represent You
If you don’t already have an attorney to represent you, find one right away. As note investors, we may have notes with collateralized property in far away states. Geographically, you’ll need an attorney to be able to attend the hearings in the BK Courts where the Debtor files his BK. Generally, with an owner occupant, that’s going to be in the district where the property is located.
Attorneys that specialize in bankruptcies should know a lot more than you do. You’ll need to rely on their expertise to guide you through the process and determine your strategy. If this is your first time, try getting referrals from your network or servicer. Foreclosing attorneys oftentimes handle bankruptcies as well since these are a natural extension of the business they are already in.
Since you’re checking PACER for status, you can evaluate the performance of your attorney. Are they on top of the Debtor’s filings? Do they make you aware of the important deadlines and hearings? If your attorney isn’t doing a good job, find another one.
The Debtor is protected from creditors because of the automatic stay. Having an attorney represent you also relieves you of the possibility of violating that stay by handling all communications for you. Although you can contact the Debtor directly as long as you’re not trying to collect on the debt, you run the risk of the Debtor taking any communication the wrong way and alleging that you violated the Stay. Safer to let your attorney handle the communications.
4. Determine Your Strategy
The first three things in this checklist should be done as soon as possible once the Debtor files his or her BK petition. They are things that require your immediate attention. At this point, you’ll have to wait for the process to play itself out. The Debtor may not have filed all of the documents that he or she is required to do. There are events that happen at specific times: Meeting of Creditors, Confirmation of Plan, Deadline to File Claims, etc.
Now is the time to determine your strategy. First, ask the question: is this a bad faith, good faith, or a moon shot, “I don’t know if I can really do this” filing?
The next question to ask is how does the BK fit into your business strategy? For us, our business model is to liquidate our NPNs as soon as possible. If we get a re-performing note, that’s great because the borrower is succeeding and doing well and we can sell the note after 6-12 months seasoning for more than we bought it. So, the good faith BK filings are good for us. The bad faith and shaky ones, not so much. Typically, we’ll move aggressively on bad faith BK filings, be flexible about a response on the middle of the road ones, and be passive on the good faith filings.
If you’re perfectly happy getting a re-performing note and/or want to avoid having a NPN, then your strategy will be different. You’ll have a passive strategy.
5. Wait to See What the Debtor Files
This is especially important for the bad faith and low chance of success BK filings. When you evaluate the Debtor’s filed documents, keep an eye out for inconsistencies, inaccuracies, and outright falsehoods. This information will be useful to your attorney when Objecting to the Plan or filing a Motion for Relief.
Some Debtors will file a barebones petition. The court will require that the Debtor file their additional documents within a certain period of time. If the Debtor fails to file their additional documents, the trustee will file a Motion to Dismiss the bankruptcy. In a case like this, you might not even have to go onto the next step. Unfortunately, these kinds of filings are common and it’s hard for me to understand why a borrower would do the additional damage to their credit of adding a bankruptcy in exchange for a two month postponement on their foreclosure sale.
6. File a Proof of Claim
Creditors usually have two months or so to file their Proof of Claim (“POC”). Unless the BK is dismissed or you get an Order for Relief from the Automatic Stay far in advance, you don’t want to miss this deadline.
The POC provides notice to the world that you claim that the Debtor owes you a specific amount of money. This gets verified by the trustee and the court and your claim becomes part of the BK plan. Your debt will take its place in line to get paid according to the confirmed Plan.
If you don’t file your claim by the deadline, the court may give you extra time. The debtor might also file something on your behalf. Someone who is legitimately filing BK will do this since they are trying to pay down their debts.
If you don’t file a POC, your debt won’t disappear. It becomes uncollectible until the BK Plan is dismissed or discharged.
7. Take Action if Your Strategy Dictates
The Motion for Relief is the most common tool to fight a bad faith BK filing. For any number of reasons, your attorney files the Motion and argues in front of the judge and the Debtor’s attorney. If the judge agrees with the Motion, he or she will issue an Order of Relief from the Automatic Stay. When this happens, the creditor is free to resume collections activity, which includes foreclosure.
Another common tactic is to Object to the Plan. The judge and trustee have to believe that the BK Plan is viable in order to confirm it. If the Plan is not viable, the judge will require the Debtor to come up with another Plan. If you as the creditor object to the plan for legitimate reasons, you can have an effect on how the judge view’s the debtor’s plan. Judges and trustees are inundated with information and typically, if something is not presented in court or if their attention isn’t focused on relevant facts, a non-viable Plan can slip through. Conversely, if you bring their attention to part of the Plan that makes it non-viable and it’s not correctable, it can sink the Plan and the BK can be dismissed.
8. Continue to Monitor the BK at least once a month
When a borderline Debtor gets his Plan confirmed, it can be discouraging as a creditor. Bankruptcy judges have a lot of power and I’ve seen them give Debtors enormous leeway and lots of second, third, and fourth chances. Borderline Debtors, if they don’t correct their financial behaviors that got them into financial distress, have a greater chance of failing their plans.
If you’ve put up a fight and lost your Motions for Relief, if you’ve had a judge who consistently rules in favor of the debtor, then sometimes it’s best to just sit back and wait. Monitor the progress of the BK and, hopefully, collect some payments. If the Debtor fails enough times, the trustee may file a Motion to Dismiss and do the work for you.
Plus, you never know when a Debtor’s situation has changed for the worse. They may have been barely hanging on when things change to the point where they can’t keep up.
Conclusion
Chapter 13 Bankruptcies are complicated operations of law that involve multiple participants. Although there are a lot of similarities, each one will be different and require a different response. If you’re new to being a creditor affected by a bankruptcy or don’t deal with it often, you can use this checklist as a guide and a stepping off point to taking the action necessary to protecting your asset.
Andy Mirza is the Chief Operating Officer for Coastline Capital Fund Management, LLC, a company that creates and manages funds that buy, sell, and liquidate residential non-performing notes (defaulted mortgages).
