Bankruptcy Information for Real Estate Practitioners: Basics to Emerging Trends Elizabeth M. Repetti

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1 2012 Seminar Series Bankruptcy Information for Real Estate Practitioners: Basics to Emerging Trends Elizabeth M. Repetti

2 Bankruptcy Information for Real Estate Practitioners: Basics to Emerging Trends Elizabeth M. Repetti, Attorney at Law SCOPE NOTE The scope of possible topics under the heading Bankruptcy Information for Real Estate Practitioners, and the depth of treatment of those topics, is monumental. This presentation is limited to ---- sections dealing with Bankruptcy Basics, Automatic Stay and Bankruptcy and Construction Liens. BANKRUPTCY BASICS Chapter 7 Liquidation All of debtor s non-exempt assets are collected by a Chapter 7 Trustee, liquidated, and proceeds distributed to creditors. Real estate can be sold to realize equity for benefit of unsecured creditors. Chapter 13 Wage Earner Plan Individuals only Debtor retains assets but all disposable income for up to 5 years is paid to Chapter 13 Trustee who then distributes to creditors. Often used to retain residence 1322(b)(2) prohibits modification of home mortgage beyond the term of the Chapter 13 plan. Debtor can pay arrearage plus regular payment Cannot be used to extend term (20-30year am) or modify rate Notice of Chapter 13 is often (but not always) filed in office of Register of Deeds in Debtor s county of residence. Chapter 11 Reorganization Individuals and businesses Debtor retains control and assets No trustee appointed unless creditor requests a trustee for cause (fraud, mismanagement, etc.) Bankruptcy for Real Estate Practitioners Page 1

3 AUTOMATIC STAY 362 All collection efforts against debtor and debtor s assets cease. Automatic upon filing of petition. Even if creditor is unaware of filing, stay goes into effect. Notice to creditor is not a pre-requisite to stay. Acts in violation of automatic stay are void, not merely voidable. Need cite Real Estate Foreclosure Process How late is too late? End of upset bid period. NCGS Owner can still redeem collateral during upset bid period. So long as there is equity of redemption, can still file. Creditor must seek relief from stay to complete foreclosure Petition filed after upset bid period Cannot still try to redeem Creditor must seek relief from stay to record trustee deed or evict Petition filed after foreclosure hearing but before upset bid period ends. Once stay is lifted, creditor does not need to have another hearing but does need to restart sale process (notice, publication, posting, etc.) What to look for with title search involving foreclosure and bankruptcy Timing Petition vs. hearing and sale dates Is order granting relief from stay in foreclosure file? Was a new hearing necessary, or just a new sale? What if foreclosure deed was recorded after petition? Is QCD needed? Bankruptcy by Guarantor vs. Owner If non-owner guarantor (or officer or director of owner) files, foreclosure is not stayed. Land is not property of the estate. Corporation of LLC borrower owns land in foreclosure. Officer/shareholder or member/manger or guarantor files bankruptcy foreclosure is not stayed. Guarantor land owner in foreclosure, LLC borrower files, foreclosure stays. Sale of Real Property during Bankruptcy Trustee can sell or Debtor in possession can sell Must obtain court approval. Include copy of court order as an exhibit to Deed or as a separate document. Chapter 7 cases Trustee needs to receive equity from sale. If all liens not paid in full, including judgments, trustee should not sell. Bankruptcy for Real Estate Practitioners Page 2

4 Chapter 11 cases Trustee or debtor in possession can complete a short sale. Order can transfer liens, including judgments, to proceeds. Buyer takes free of all liens even if those liens not paid in full. Motion and order must reference the lien. Transfer liens to proceeds judgments that prevented a sale pre-bankruptcy can be cleaned off of the title to allow sale to go through. Funds are then distributed according to order of priority, or paid into the estate. Chapter 7 and 11 Chapter 7 Trustee Authority to sell is evidenced by order Trustee needs to obtain authorization from court to attached order to deed Lien Stripping Home mortgage that is underwater Chapter 13 prohibits modification of mortgage secured by personal residence 1322(b)(2) But if no value for 2 nd lien over and above 1 st lien, 2 nd lien is not considered secured, so can be modified. Strip off the junior lien How is stripped off lien identified in the register of deeds? File a certified copy of the Bankruptcy Order in register of deeds Timing End of Chapter 13 case Dirt for Debt Fact Scenario Debtor developer of subdivision with multiple lots Lender has lien on all lots Lender is over secured: value of land is greater than payoff Debtor s Chapter 11 plan proposes to convey less than all lots to creditor in full satisfaction of creditor s claim. Dirt for Debt Debtor then retains the balance of the lots free and clear of lender s deed of trust Concept is authorized under 11 USC 1129(b)(2)(A)(iii) if the value of the lots equals the indubitable equivalent of the secured claim. Creditor is forced to become an involuntary investor in the project. What is an indubitable equivalent? Originated in Met Life Ins. Co. v. Murel Holding Corp., 75 F2d 941(2nd Cir. 1935). Decision by Judge Leonard Hand. Indubitable equivalent is clearly the entirety of the collateral securing the claim. Common sense tells us that property is the indubitable equivalent of itself In re Sandy Ridge Dev. Corp., 881 F.2d 1346, 1350 (5 th Cir. 1989). In re Bannerman Holdings, LLC, SWH (E.D.N.C. 2011), the indubitable equivalence standard requires that there be no doubt that the secured creditor receives consideration equal to its claim in value or amount. Bankruptcy for Real Estate Practitioners Page 3

5 Dubitable = if open to doubt or question Indubitable = too evident to be doubted Central issue in dirt-for- debt cases is valuation of collateral. Result is battle of appraisals. Current economic climate makes valuation issues extra ordinary difficult. Recent NC cases In re Bannerman Holdings, LLC, 2010 WL Bankruptcy plan was confirmed that transferred to lender eleven of fifteen condominiums that were collateral. Recent Case -- Stillwater Investment Group, LLC, Case Number SWH, Eastern District of North Carolina, New Bern Division. o Residential real estate development consisting of lots o Plan proposed to convey 32 of those lots to BB&T in full satisfaction of BB&T s claim in the amount of $4,802,403. o Matter was going to be a battle of the appraisers to see if the 32 lots were the indubitable equivalent of BB&T s claim. o Parties agreed to a different plan treatment the day of the hearing. Unintended Consequents of Sloppy Paperwork Days of easy credit resulted in pressure to close on loan transactions rapidly and reduced rates for closing services. When default rates were low, loan documentation was rarely enforced. Less than 1% of a lender s home loan portfolio was ever in default. Many, many errors in documentation went unnoticed. When errors found, just refinanced. Since 2008 and Great Recession and the mortgage melt down, errors are now glaringly apparent. Attitude change from Lender s always right to sympathy for debtors has exacerbated problems with enforcement. Get out your fine tooth comb and you will find lots of problems. State court enforcement level, intent of the parties can carry the day. Witness seemingly endless cases of document reformation actions brought by counsel retained by title insurance companies. Bankruptcy for Real Estate Practitioners Page 4

6 Bankruptcy forum is different. A trustee, and the debtor in possession in a Chapter 11 case, has avoidance powers as found in 11 USS (a)(3) Trustee has the rights of a hypothetical bona fide purchaser of real property. ******** put in language of this section. Examples: In re: John G. McCormick 669 F3d 177 (4 th Cir. 2012) Orange County is unique in NC because the official index of the Register of Deeds office is a parcel identifier number ( PIN ) index adopted in 1983 in lieu of traditional grantor/grantee index. McCormick owed two adjoining parcels of land in Orange County. Mc Cormick borrowed money from bank in Deed of Trust described tract 1 and tract 2 but the lien only included the PIN for tract 2, note tract 1. In 2004 McCormick borrowed money from Lender 2. That Deed of Trust was only on a part of the tract 1 and was property indexed. McCormick put into bankruptcy in Trustee sold all of Tract 1 and transferred liens to proceeds. Trustee then filed an adversary proceeding (lawsuit within a bankruptcy case) and sought to avoid the SunTrust lien on tract 1. (Index was corrected in 2008, but to no avail). Despite the fact that the SunTrust Deed of Trust would be located using the grantor/grantee method of title searching, the lien was voided and SunTrust received no funds from the sale of that collateral. Knowledge of lien is irrelevant if the lien is not noted in the official records. Practice Pointer: Be cautious in Orange County. In re Head Grading Co., Inc. (unpublished) (Bankr. E.D.N.C. 2006). In this case, the Chapter 7 trustee filed a complaint seeking to avoid a lien held by Ruby Lee Head. The dispute arose from a deed of trust granted by the Debtor to Ms. Head, dated July 28, 1998, in the amount of $180, The deed of trust stated that it secured a Promissory Note of even date herewith. The actual note held by Ms. Head was dated Bankruptcy for Real Estate Practitioners Page 5

7 July 29, There was no note of even date with the deed of trust, and the deed of trust did not reference future advances. The court relied upon North Carolina case law requiring that deeds of trust specifically identify the debt. The court held that because the note dated July 29, 1998 did not properly identify the obligation, Ms. Head s lien was avoided and her claim was unsecured. In re Law Developers, LLC, 404 B.R. 136 (Bankr. E.D.N.C. 2008). In this case, the Debtor objected to the secured claim filed by The Bank of Currituck in the amount of $204,117.59, alleging that the legal description in the deed of trust was incorrect. The deed of trust identified Lot 43 of Cedarwood Village, but the property intended to be encumbered was Lot 17 of Cedarwood Village. The Bank of Currituck contended that the deed of trust should be reformed to correct the mistake and reflect the true intention of the parties. The court s analysis came in three parts. Initially, the Court found that the deed of trust was void under North Carolina law because it failed to provide an adequate description of the encumbered property. However, the court next considered The Bank of Currituck s equitable argument that it should be able to reform the deed of trust to conform to the parties intentions. Under North Carolina law, reformation rights cannot be granted if the rights of a bona fide purchaser would be prejudiced by such reformation. Additionally, Fourth Circuit precedent holds that a debtor-in-possession, a bona fide purchaser pursuant to Section 544(a)(3) of the Bankruptcy Code, cannot invalidate a deed of trust where he is an original party to the deed of trust and had actual notice of its existence. Thus, the court in Law Developers found that the Debtor could not invalidate the deed of trust because it was a party to the original transaction with actual notice of the transaction and the recording of the deed of trust. Unfortunately for The Bank of Currituck, the court did not stop its analysis there. In part three of its decision, the court analyzed Section 544(a)(1) of the Bankruptcy Code. This section gives a debtor-in-possession the status of a judicial lien creditor. Under North Carolina law, an intervening judgment lien will cut off reformation rights where the lien creditor lacks knowledge of the mistake and has provided new consideration or incurred new liability. The court found that The Bank of Currituck s reformation rights were cut off as of the petition date because Section 544(a)(1) assumes that a debtor-in-possession is a judicial lien creditor that has no knowledge of the mistake and has incurred new liability. Based on the Debtor s status as a judicial lien creditor, the court determined that the Bank of Currituck had an unsecured claim. Bankruptcy for Real Estate Practitioners Page 6

8 In re Easthaven Marina Group, LLC, (unpublished) (Bankr. E.D.N.C. 2009). In this case, the Debtor sought an order from the court finding that the $9,000, debt of B&M Holdings, LLC was unsecured despite the existence of a recorded deed of trust. The deed of trust was executed and delivered in favor of B&M from the grantor, SHM Marina Group, LLC, on March 1, The deed of trust referred to a note dated March 1, 2007 from Scotts Hill Marina Group, LLC, whereas the actual date of the note was March 2, Additionally, Scotts Hill Marina Group, LLC, the name used in the note, was not a legal entity but merely the trade name of SHM Marina Group, LLC. In late 2007, SHM conveyed the property in question to David White with the following language: [g]rantee acknowledges that this conveyance is subject to deed of trust to B&M Holdings, LLC in the amount of $9,000, Subsequently, Mr. White formed Easthaven Marina (the Debtor) and conveyed the subject property to it with the following language: [s]ubject to the Deed of trust in Book 3176, Page 109. The court found that the deed of trust was invalid due to the errors in the date and grantor s name. However, the court held that the obligation to B&M was enforceable under the theory of estoppel. The theory of estoppel is that a person cannot accept the benefits of a transaction while simultaneously rejecting the associated burdens. Because the Debtor was attempting to invalidate a conveyance two transfers back in the chain of title, the court found that the doctrine of estoppel was applicable and refused to avoid the deed of trust. In re James A. Rose, III, (unpublished) (Bankr. E.D.N.C. 2009). In this case, the court determined whether a deed of trust in favor of Homecomings Financial Network, Inc. was invalid due to an ambiguity in the block number. The deed of trust contained three identifying markers: the tax identification number, street address and block number. Two of the markers correctly identified the property as Lots 20 and 21 in Block 96, while the third marker identified the property as Lots 20 and 21 in Block 98. Lots 20 and 21 of Block 96 had twice been encumbered by the Debtor. The prior deeds of trust contained accurate information and were satisfied prior to the Debtor filing bankruptcy. The court focused its analysis on whether a bona fide purchaser could have defeated the claim of Homecomings. If the hypothetical purchaser was on notice of the error in the deed of trust, then the trustee/debtor-in-possession is prohibited from taking free and clear of the liens. The court held that the deed of trust was valid because a diligent purchaser of the land would have examined each recorded deed and other instrument in the chain of title, would have noted the discrepancy between Block 96 and Block 98, and would have determined that the reference to Block 98 Bankruptcy for Real Estate Practitioners Page 7

9 was a minor typographical error. Because the hypothetical purchaser would have had constructive notice of a valid lien on the property, the Debtor could not take the property free and clear of Homecomings lien. Hinson v. Chase Home Finance, LLC (In re Huffman), AP No JRL, May 16, Deed of Trust description referred to Lot 17 and Lot 7. The correct lot number was 7, there was no lot 17 on the plat. The Chapter 7 Trustee challenged the validity of the Deed of Trust. The Court held that a reasonable and diligent title searcher would have found the lien and be put on notice of the lien. Therefore, the Chapter 7 trustee would not be a bona file purchaser under section 544 and could not avoid the lien. Meade v. Bank of America (In re Meade), AP No JRL, July 29, Two Deeds of Trust contained the correct street address of property but the wrong lot number. The correct lot number was 978 but the deeds of trust said 979. The court avoided the deeds of trust because the lot number was not accurate. The plaintiff in this case was the chapter 11 debtor in possession, not a trustee. Burns vs. CitiMortgage, Inc. (In re: Goelst), AP No , Case No Chapter 7 Trustee sought to avoid $645, lien where the Deed of Trust was dated January 29, 2004, and said that is secured a note dated January 29, The Note was pre-printed with the date January 29, 2004, but the closing did not occur until January 31, The Borrower struck out 29 and wrote in 31, therefore making the note be dated January 31, The court held that there was no note that was secured by the deed of trust. The matter was resolved by CitiMortgage paying the Trustee $212,500.00, and retaining its lien. Case was complicated by the existence of a junior deed of trust. IV. BANKRUPTCY AND CONSTRUCTION LIENS Addressing the impact of bankruptcy on construction issues is beyond the scope of this manuscript. Seminars of the Construction Law Section and the Bankruptcy Law Section periodically address the collision of bankruptcy and construction projects, from the viewpoints of various parties. The North Carolina Construction Law Deskbook has a chapter on titled Effects of Bankruptcy. This section of the manuscript is limited to perfection and enforcement of lien rights when an owner has filed bankruptcy. The filing of a bankruptcy case imposes a stay against collection activities against a debtor. 11 U.S.C The stay generally applies to lien perfection and enforcement actions against property of the bankruptcy estate taken after the filing of the bankruptcy petition. Bankruptcy for Real Estate Practitioners Page 8

10 However, by virtue of an exception to the bankruptcy stay and a 2005 amendment to N.C. Gen. Stat. 44A-13(a), the steps to follow the perfect and enforce a lien on real property are fairly clear. The applicable statutory provisions are quoted below, and the resulting practice steps follow. 11 U.S.C. 362(b)(3) provides: (b) The filing of a petition under section 301, 302, or 303 of this title, or of an application under section 5(a)(3) of the Securities Investor Protection Act of 1970, does not operate as a stay -... (3) under subsection (a) of this section, of any act to perfect, or to maintain or continue the perfection of, an interest in property to the extent that the trustee's rights and powers are subject to such perfection under section 546(b) of this title or to the extent that such act is accomplished within the period provided under section 547(e)(2)(A) of this title; 11 U/S/C/ 546(b)(1) provides: (b)(1) The rights and powers of a trustee under sections 544, 545, and 549 of this title are subject to any generally applicable law that - (A) permits perfection of an interest in property to be effective against an entity that acquires rights in such property before the date of perfection; or (B) provides for the maintenance or continuation of perfection of an interest in property to be effective against an entity that acquires rights in such property before the date on which action is taken to effect such maintenance or continuation. (2) If - (A) a law described in paragraph (1) requires seizure of such property or commencement of an action to accomplish such perfection, or maintenance or continuation of perfection of an interest in property; and (B) such property has not been seized or such an action has not been commenced before the date of the filing of the petition; such interest in such property shall be perfected, or perfection of such interest shall be maintained or continued, by giving notice within the time fixed by such law for such seizure or such commencement. Bankruptcy for Real Estate Practitioners Page 9

11 N.C. Gen. Stat. 44A-13(a): (a)... If the title to the real property against which the claim of lien on real property is asserted is by law vested in a receiver or is subject to the control of the bankruptcy court, the claim of lien on real property shall be enforced in accordance with the orders of the court having jurisdiction over said real property. The filing of a proof of claim with a receiver or in bankruptcy and the filing of a notice of lis pendens in each county where the real property subject to the claim of lien on real property is located within the time required by this section satisfies the requirement for the commencement of a civil action. Practice Steps for perfecting and enforcing claim of lien upon real property when the land owner files bankruptcy: Bankruptcy commenced after claim of lien filed and enforcement lawsuit is pending: The enforcement lawsuit is stayed (just like all other actions against the debtor). File a proof of claim. The adjudication of the lien claim will take place as part of the asset and claims administration process in the bankruptcy case. Bankruptcy commenced before claim of lien has been filed: 1. File the claim of lien upon real property with the Clerk of Superior Court within the 120 day period. The 120 day period is not tolled by the bankruptcy. 2. File a proof of claim in the bankruptcy case. It should be filed as a secured claim, with the security being the improved real property. File the proof of claim within the 180 day period of N.C. Gen. Stat. 44A-13. The bankruptcy deadline for filing the proof of claim might be beyond the 180 period; however, in order for the lien to be timely, the proof of claim must be filed within the 180 day period. In re Orndorff Construction, Inc., 2008 WL (Bankr. M.D.N.C. 2008). 3. File a lis pendens in the county of the real property. File it within the 180 day period. 4. File a notice of perfection of statutory lien in the bankruptcy case. A form is included in the Appendix. Bankruptcy for Real Estate Practitioners Page 10

12 Appendix Statutory Lien Form, N.C. Gen. Stat. 44A-12(c) V-23 Statutory Lien Form, N.C. Gen. Stat. 44A-12(c) V-24 Complaint (against owner, by party that contracted with owner) V-25 Bankruptcy for Real Estate Practitioners Page 11

13 UNITED STATES BANKRUPTCY COURT FOR THE OF NORTH CAROLINA DIVISION IN RE: ) ) ) CASE NO. ) CHAPTER Debtor. ) NOTICE OF PERFECTION OF STATUTORY LIEN PURSUANT TO SECTION 546(b) OF THE BANKRUPTCY CODE ( Lien Claimant ), pursuant to Section 546(b) of the United States Bankruptcy Code, gives notice as follows: 1. Lien Claimant claims a statutory lien and has perfected such statutory lien against certain property and improvements owned by the Debtor, located in, North Carolina (the Property ), more particularly described in the Claim of Lien on Real Property filed on with the County Clerk of Court, a copy of which is attached hereto as Exhibit A. 2. The Debtor contracted with Lien Claimant for used in the construction of improvements to the real property. 3. Lien Claimant hereby gives notice, pursuant to Sections 362(b)(3) and 546(b) of the Bankruptcy Code, that it has perfected its statutory lien against the Property under Part 1 of Article 2 of Chapter 44A of the North Carolina General Statutes in accordance with N.C. Gen. Stat. 44A- 13(a). Lien Claimant reserves the right to enforce its interest in such Property and improvements. Dated this day of. Bankruptcy for Real Estate Practitioners Page 12

14 Bankruptcy commenced after claim of lien has been filed but before lawsuit has been filed: 1. File a proof of claim in the bankruptcy case. It should be filed as a secured claim, with the security being the improved real property. File the proof of claim within the 180 day period of N.C. Gen. Stat. 44A File a lis pendens in the county of the real property. File it within the 180 day period. 3. File a notice of perfection of statutory lien in the bankruptcy case. Bankruptcy for Real Estate Practitioners Page 13