Using Bankruptcy Chapter 7 To Get Short Sales Approved

In another article, we discussed utilizing a bankruptcy chapter 13 as a unique vehicle to stop a foreclosure and allow time to get a short sale approved. That technique also helps to get other, possibly more open, minds to approve a short sale when someone either with the servicer or the secondary market investor has previously denied the short sale.

However, there is another way to stop a foreclosure, particularly in a non-judicial state, and give time for a short sale to be processed and seek approval — filing a bankruptcy chapter 7.

The ability to utilize the following method will depend upon the practices and tolerance of the bankruptcy court judges. If the courts are pro-debtor as some are, this may be an effective means of stopping and delaying foreclosure.

In a bankruptcy chapter 13 case, the debtor always has the ability to voluntarily dismiss his Chapter 13, and when that happens, it is the same as not having filed one. A Bankruptcy Chapter 7 on the other hand, can only be voluntarily dismissed with the consent of the Court.

Additionally, there is a normally means test to qualify debtors whether they are permitted to obtain a discharge under Chapter 7, or must alternatively pursue Chapter 13.

However, there is a technicality in the code that states that if the debtor files only the petition, then unless the schedules are filed within 14 days, the case will be dismissed.

The Bankruptcy Petition consists of the Petition Pages, a creditor matrix, and the Schedules. Called a skeleton filing, if the attorney files just the Petition and creditor matrix, the clerk’s office will mail to all creditors notice of the Bankruptcy and an Order that stops all creditor action to collect on the debt, including moving against property. Then, within 14 days, the debtor must file the schedules or the Bankruptcy is dismissed.

Once the Bankruptcy has been dismissed, the creditor may again pursue foreclosure, but the bankruptcy filing interrupts the time periods and procedures required under various state laws to foreclose and operates as a reset of the process.

If more time is needed, the skeletal Petition can be filed again.

During the process, a creditor is not allowed to communicate with the debtor.  However, many lenders will be willing to proceed with the short sale if the attorney proveds a “Consent Letter” permitting the process to continue.  Some lenders will not allow it until the Order of Dismissal has been received, leaving less time for processing, but it may be enough.

Need more resources?  View other articles or Click here for more short sale resources.

Best Wishes,

Ken Lawson JD

Bankruptcy Ch 13 — A Unique Solution For Short Sales

In my 20 years of practicing law, I experienced 3 categories of attorneys who practice bankruptcy law: Those attorneys who will only file chapter 7 discharges. These attorneys do not really focus on the needs of the client, but believe that chapter 7 is the only way to go.

The next category consists of attorneys who will file both chapters, but do not like to spend time deviating from standard customs.

The third category of bankruptcy lawyers are those attorneys who will go to great lengths to take care of the needs of the client. These are the attorneys who are committed to really solving problems for their clients.

It is this third category of attorneys who will gain from this blog article, because most will not have not thought about this solution. Most of the lawyers in this category have little arrogance; rather, they are appreciative of any new or unique solution they can find to help their clients.

Well, here is another one.

For those clients who have either had a short sale declined, or the sale date is too close to submit a short sale proposal, a Chapter 13 Plan can be uitlized to resolve the issue.

In the Plan, propose that the property be sold as a short sale, with no secured payments, or in the alternative, interest-only payments. Provide also for the sale to be in full satisfaction of the debt. The bankrutpcy department of the servicing lender will be managing the file for most lenders, and they will review and forward the short sale proposal much faster than loss mitigation personnel.

The filing of the Chapter 13 Plan will stop the foreclosure, and if the proposal is submitted immediately, there will be a quick review of the proposal to determine if the proposal will be accepted. The attorney can find out immediately who the secondary market investor is and what the mininmum threshold percentage is. If the purchase offer is above that minimum threshold, the proposal will be accepted (assuming the elements of “hardship” are established in the letter and financials).

The creditor’s attorney will likely object to the Plan, however, that objection can be overcome if the attorney can show that the proposal meets the conditions of the secondary market investor who actually owns the note. An objection may be filed solely to reserve their standing, with the servicing lender allowing the objection to be continued to future dates allowing time for the proposal to be accepted and the sale to close.

Once the sale closes, if the Plan is still needed, then it can be confirmed. If not, then the Plan could be dismissed, resulting in the debtor not having a bankruptcy.

Remember, (many attorneys do not understand this point) both a deed-in-lieu and a foreclosure have a more devastating effect on the debtor than a bankrutpcy. A DIL and foreclosure are always asked on mortgage loan applications, and could bar the homeowner from owning a home for a long time, perhaps forever. However, a debtor can recover from bankruptcy in just a few years.

One caveat to this, however. If you have a second mortgage, some federal circuits allow for lien-stripping, and some do not. In the circuits that allow lien-stripping, if there is not even $1 to secure the note, then the lien can be stripped and paid with unsecured creditors, with no interest or preferred payment.

Another caveat. Bankruptcy jurisdictions differ in their application of the law. Some judges will gladly help a sincere debtor with a short sale. Some will not. Some trustees will like your using a Chapter 13 Plan to help the debtor in this way, and some will not and will object to the Plan themselves.

The bottom line is that only 30% or so short sales get approved because of mistakes, misinformation, and inadequate proof of hardship. We’ve been seeing agents with a better than 70% success in obtaining approvals. With these agents, the ones that cannot be approved are proposals with purchase contracts that are below the SMI’s minimum threshold (you may not be able to know who the SMI is, so you cannot know the minimum threshold). The only way to eliminate these rejections, is to not take any case with a purchase price lower than the highest minimum threshold. This is not acceptable, because we all have an ethical duty to our clients.

Agents and investors, it is a good idea to get acquainted with the bankruptcy attorneys in your area and observe which category descibes each one. Then discuss with attorneys in that third category the concept of using the Chapter 13 Plan in combination with a short sale.

Another good idea is to learn the mistakes and errors commonly causing short sale rejections with our publications: