Chapter 7 and Foreclosure
Helpful hints for homeowner's who wish to surrender a property in their Chapter 7 Bankruptcy Case.
Surrendering a property in Chapter 7 bankruptcy can be an arduous and confusing process. Below are some helpful hints on what to expect when a homeowner elects to surrender a home or other real property in a Chapter 7 bankruptcy case:
1. How does Chapter 7 affect my mortgage? To understand the intersection of bankruptcy and foreclosure, it is important to begin by understanding what a mortgage actually is. A mortgage is, essentially, comprised of two documents a Promissory Note and a Deed of Trust. The Promissory Note is the document that evidences the terms of the borrowers repayment obligation to the lender. Terms in the promissory note include the borrowers name, the property address, the term of the loan, interest rate, and other legal provisions. On the other hand, the deed of trust provides the lender with the ability to foreclose (take the property) back in the event the borrower defaults under the terms of the promissory note. The deed of trust is recorded with the recorder's office of the county where the property resides. The deed of trust creates a (voluntary) Lien in the Property. In a Chapter 7 bankruptcy case, the obligation of the borrower to repay the loan obligation ends when the Debtor receives his/her discharge. However, the discharge does not mean that the borrower's name is removed from the title to the Property. Furthermore, the discharge of the loan obligation does not mean the borrower earns a "free" house either. The lien created by the deed of trust is unaffected by the Chapter 7 discharge. The lender may still institute foreclosure either before the bankruptcy is complete (See "What is Relief From Stay" below), or at some point after the bankruptcy case is closed.
2. When does title to a surrendered home transfer after Chapter 7? The transfer of title to a home surrendered in a Chapter 7 bankruptcy case occurs either after a Chapter 7 Trustee conducts a sale on the Property, or when the foreclosure process is finalized after the auction date. You may monitor the status of the title to your Property at the following web addresses:
(a) King County: http://www.kingcounty.gov/business/Recorders/RecordsSearch.aspx
(b) Snohomish County: http://www1.co.snohomish.wa.us/Departments/Auditor/Divisions/Recording/
(c) Pierce County: https://armsweb.co.pierce.wa.us/
3. What should I do with my Property after I file my Chapter 7 case? A common misunderstanding for those surrendering a Property in Chapter 7 is that the homeowner has no further obligations to deal with the Property after the bankruptcy filing. As noted above, the homeowner may remain as the title owner of the Property after the bankruptcy is filed. Although the homeowner does not maintain any further obligation to repay the mortgage loan (unless the homeowner is not surrendering the home), she/he should ensure that other matters affecting the Property are taken care of. First, we recommend you maintain comprehensive insurance on the Property. Very important, if any claim arises after the bankruptcy case but before title transfers in foreclosure, the homeowner may wind up being financially responsible for accidents that occur on the Property or other premises liability claims if there is no insurance on the Property even though the mortgage loan was discharged in Chapter 7. We do not recommend relying on the lender to secure and/or maintain insurance payments. Second, if the Client's Chapter 7 Trustee is attempting a short sale of the Property, the Client must cooperate with the Trustee in the Trustee's efforts. When an individual files Chapter 7, the individual maintains an obligation to cooperate with the Trustee appointed to the case. If the individual does not cooperate with the Trustee, it may be grounds for denying the Client's bankruptcy discharge. Third, if the individual filing Chapter 7 is leasing and collecting rent(s) on the Property to be surrendered in the Chapter 7, the lease payments may be subject to turnover to the Chapter 7 Trustee. This means that an individual filing Chapter 7 will no longer be able to retain monthly lease payments after the Chapter 7 bankruptcy filing if the Chapter 7 Trustee requests that such lease payments be turned over as part of the Chapter 7 bankruptcy case. Finally, if you are a condominium owner or have homeowner's association dues, you must continue to pay the monthly dues until title is transferred. If you have unpaid HOA dues that were incurred prior to the filing of your bankruptcy case and you intend to surrender the Property, the pre-filing HOA arrears may be dischargeable in a Chapter 7 case. For more information on the discharge ability of HOA dues, please see 11 U.S.C. 523(a)(16):
(a) A discharge under section 727, 1141, 1228 (a), 1228 (b), or 1328 (b) of this title does not discharge an individual debtor from any debt—(16) for a fee or assessment that becomes due and payable after the order for relief to a membership association with respect to the debtor’s interest in a unit that has condominium ownership, in a share of a cooperative corporation, or a lot in a homeowners association, for as long as the debtor or the trustee has a legal, equitable, or possessory ownership interest in such unit, such corporation, or such lot, but nothing in this paragraph shall except from discharge the debt of a debtor for a membership association fee or assessment for a period arising before entry of the order for relief in a pending or subsequent bankruptcy case;
4. What is "Relief from Stay"? When a Chapter 7 bankruptcy case is filed, an automatic stay goes into effect. The Automatic Stay (For more information, Google 11 U.S.C. 362) prohibits creditors from undertaking any efforts to collect on certain debts after the filing of a Chapter 7 bankruptcy case. Among the numerous types of debts stayed upon a Chapter 7 bankruptcy filing is a mortgage. Therefore, a mortgage lender is prohibited from commencing or continuing any foreclosure action after the filing of a Chapter 7 bankruptcy case. However, if the lender desires to continue the foreclosure before the Chapter 7 bankruptcy case is closed, the lender may petition to the Court to lift the automatic stay. To do this, a lender files a document with the bankruptcy court called a motion for relief from stay. The Court may grant the lender's motion if the Debtor does not have equity in the Property and the Property is not necessary for an effective reorganization. The standard for the Court granting relief from stay motions is quite low and these motions are routinely granted. If the lender is granted relief from stay, the foreclosure process may commence or continue even though the Chapter 7 bankruptcy case is not closed.
5. What is a bankruptcy short sale? A bankruptcy short sale occurs when the Bankruptcy Court-appointed Chapter 7 Trustee sells a surrendered Property as part of an individual's Chapter 7 bankruptcy case. A Chapter 7 Trustee can generate proceeds to pay unsecured creditors from the proceeds of a "short sale" of a Property surrendered in Chapter 7. While the Chapter 7 case will remain open longer in the case of a bankruptcy short sale, there may be positive consequences in the credit reporting of the mortgage on an individual's credit report. As noted above, it is important to cooperate with the Chapter 7 Trustee if the trustee desires to sell a Property in the bankruptcy case.
6. When will Foreclosure occur? In the event the Chapter 7 Trustee does not wish to conduct a bankruptcy short sale on your surrendered Property, the foreclosure process can take months to complete after the Chapter 7 bankruptcy case is over. The foreclosure process begins when a homeowner receives a document called a notice of default (Google RCW 61.24.031 for more information). The notice of default is delivered via certified mail and must include the following verbiage:
"You must respond within thirty days of the date of this letter. IF YOU DO NOT RESPOND within thirty days, a notice of default may be issued and you may lose your home in foreclosure.IF YOU DO RESPOND within thirty days of the date of this letter, you will have an additional sixty days to meet with your lender before a notice of default may be issued. You should contact a housing counselor or attorney as soon as possible. Failure to contact a housing counselor or attorney may result in your losing certain opportunities, such as meeting with your lender or participating in mediation in front of a neutral third party. A housing counselor or attorney can help you work with your lender to avoid foreclosure. You should contact a housing counselor or attorney as soon as possible. Failure to contact a housing counselor or attorney may result in your losing certain opportunities, such as meeting with your lender or participating in mediation in front of a neutral third party. A housing counselor or attorney can help you work with your lender to avoid foreclosure. If you filed bankruptcy or have been discharged in bankruptcy, this communication is not intended as an attempt to collect a debt from you personally, but is notice of enforcement of the deed of trust lien against the property. If you wish to avoid foreclosure and keep your property, this notice sets forth your rights and options.";
Not less than 30 days after delivering the Notice of Default, the lender can record a document entitled Notice of Sale (Google RCW 61.24.040). The Notice of Sale sets forth the date, time and location where the home will be auctioned. The Notice of Sale is recorded in the county recorder's office and states as follows:
NOTICE OF TRUSTEE'S SALENOTICE IS HEREBY GIVEN that the undersigned Trustee will on the . . . . day of . . . . . ., . . ., at the hour of . . . . o'clock . . . . M. at . . . . . . . . . . . . . . . . . . . . . . . . . . . . [street address and location if inside a building] in the City of . . . . . ., State of Washington, sell at public auction to the highest and best bidder, payable at the time of sale, the following described real property, situated in the County(ies) of . . . . . ., State of Washington, to-wit: I.[If any personal property is to be included in the trustee's sale, include a description that reasonably identifies such personal property]which is subject to that certain Deed of Trust dated . . . . . ., . . ., recorded . . . . . ., . . ., under Auditor's File No. . . . ., records of . . . . . . County, Washington, from . . . . . . . . ., as Grantor, to . . . . . . . . ., as Trustee, to secure an obligation in favor of . . . . . . . . ., as Beneficiary, the beneficial interest in which was assigned by . . . . . . . . ., under an Assignment recorded under Auditor's File No. . . . . [Include recording information for all counties if the Deed of Trust is recorded in more than one county.] II.No action commenced by the Beneficiary of the Deed of Trust is now pending to seek satisfaction of the obligation in any Court by reason of the Borrower's or Grantor's default on the obligation secured by the Deed of Trust.[If there is another action pending to foreclose other security for all or part of the same debt, qualify the statement and identify the action.] III.The default(s) for which this foreclosure is made is/are as follows:[If default is for other than payment of money, set forth the particulars]Failure to pay when due the following amounts which are now in arrears: IV.The sum owing on the obligation secured by the Deed of Trust is: Principal $ . . . . . ., together with interest as provided in the note or other instrument secured from the . . . . day of . . . . . ., . . ., and such other costs and fees as are due under the note or other instrument secured, and as are provided by statute. V.The above-described real property will be sold to satisfy the expense of sale and the obligation secured by the Deed of Trust as provided by statute. The sale will be made without warranty, express or implied, regarding title, possession, or encumbrances on the . . . . day of . . . . . ., . . . The default(s) referred to in paragraph III must be cured by the . . . . day of . . . . . ., . . . (11 days before the sale date), to cause a discontinuance of the sale. The sale will be discontinued and terminated if at any time on or before the . . . . day of . . . . . ., . . ., (11 days before the sale date), the default(s) as set forth in paragraph III is/are cured and the Trustee's fees and costs are paid. The sale may be terminated any time after the . . . . day of . . . . . ., . . . (11 days before the sale date), and before the sale by the Borrower, Grantor, any Guarantor, or the holder of any recorded junior lien or encumbrance paying the entire principal and interest secured by the Deed of Trust, plus costs, fees, and advances, if any, made pursuant to the terms of the obligation and/or Deed of Trust, and curing all other defaults. VI.A written notice of default was transmitted by the Beneficiary or Trustee to the Borrower and Grantor at the following addresses:by both first-class and certified mail on the . . . . day of . . . . . ., . . ., proof of which is in the possession of the Trustee; and the Borrower and Grantor were personally served on the . . . . day of . . . . . ., . . ., with said written notice of default or the written notice of default was posted in a conspicuous place on the real property described in paragraph I above, and the Trustee has possession of proof of such service or posting. VII.The Trustee whose name and address are set forth below will provide in writing to anyone requesting it, a statement of all costs and fees due at any time prior to the sale. VIII.The effect of the sale will be to deprive the Grantor and all those who hold by, through or under the Grantor of all their interest in the above-described property.Anyone having any objection to the sale on any grounds whatsoever will be afforded an opportunity to be heard as to those objections if they bring a lawsuit to restrain the sale pursuant to RCW 61.24.130. Failure to bring such a lawsuit may result in a waiver of any proper grounds for invalidating the Trustee's sale.
7. Is mortgage debt discharged in bankruptcy assessed by the IRS as taxable income? No. Pursuant to 26 U.S.C. 108 debt discharged in bankruptcy is not taxable income:
(a) Exclusion from gross income(1) In generalGross income does not include any amount which (but for this subsection) would be includible in gross income by reason of the discharge (in whole or in part) of indebtedness of the taxpayer if—(A) the discharge occurs in a title 11 case, (B) the discharge occurs when the taxpayer is insolvent,(C) the indebtedness discharged is qualified farm indebtedness,(D) in the case of a taxpayer other than a C corporation, the indebtedness discharged is qualified real property business indebtedness, or(E) the indebtedness discharged is qualified principal residence indebtedness which is discharged before January 1, 2013.Conversely, if a debt settlement is negotiated and consummated outside of bankruptcy, the amount forgiven may be taxable income to the borrower. For questions about the tax consequences of any debt, please consult a CPA or tax lawyer.
We hope this information proves helpful in navigating the various issues arising in Chapter 7 when you wish to surrender a home or other real property. If you have questions, please schedule a consultation with a Foster Law Offices attorney.