Mark P. wrote to me to say that he’s interested in investing in non-performing notes – but what happens when the borrower files bankruptcy? If you’re investing in non-performing notes this is something you need to keep in mind and it’s always a potentiality.
When Your Commercial Borrower Files Bankruptcy
Let me say first that the vast majority of my personal experience in this business is with commercial debt not with homeowners and the processes are different. However I’ve been in the business long enough that I’ll try to shed some light on both.
A bankruptcy filing creates a kind of a “time out”. So if you’re taking action on foreclosing on or collecting from a borrower then the bankruptcy filing will halt that activity.
In the case of commercial real estate this typically means the borrower has filed a chapter 11. The court will issue a “stay of execution” which is the order that causes you to halt. What the process usually looks like after that is that you’ll seek “relief from stay”. In order to be granted “relief from stay” you need to demonstrate to the court why the asset you’re foreclosing on shouldn’t be included in the bankruptcy but more importantly the borrower needs to show a workable reorganization plan.
I’m not an attorney and none of this is a qualified legal opinion or legal advice. It would be your attorney’s job to fight for your rights as the lender.
Depending on the bankruptcy district you’re in the length of this process will vary. I’ve seen relief granted in under 60 days and I’ve seen lenders denied relief and the borrower allowed a time period in which to execute their plan. A successful plan will typically result in your loan being repaid (from what I’ve seen).
Rarely have I seen these plans work, it is often a stall, but I have seen a few. The decision for the court will typically hinge on what kind of equity is or isn’t in the property for the owner.
When Your Homeowner Borrower Files Bankruptcy
First, understand what a homeowner’s rights are because as the owner of the note you’ll be on the other end of this.
When you’re talking about homeowners things work differently than they do with commercial loans. The homeowner may try to exclude their residence from the bankruptcy file a Chapter 13 and keep the home or they could use the filing as an opportunity for a clean slate – Chapter 7.
In the case of a clean slate you’re going to have to wait for the filing to make its way through the court. At the end you’ll have the right to proceed. The benefit to the homeowner in addition the extended time in the home while they figure out their next move is if they’re in a state that would have allowed you to collect on the deficiency that right goes away.
In the case of a Chapter 13 the borrower is going to reaffirm the debt and continue to make payments.
- When your borrower files bankruptcy there’s a “time out”.
- As the lender you will seek to end the time out with your attorney.
- In the end most of the time you will end up foreclosing on the property but you will not be able to pursue deficiencies.
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