Think Again Before Walking Away from Second Trust Deeds in Bankruptcy |

Lawyer Commentary

JD Supra United States

Think Again Before Walking Away from Second Trust Deeds in Bankruptcy

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Cited Authorities (8)

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Lender Alert

June2012

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BuchalterNemerisafull‐servicebusinesslawfirmrepresentingnationalandglobalclientsineightprimaryareasofpractice:BankandFinance,Corporate,HealthCare,Insolvency&FinancialSolutions,Litigation,Labor

andEmployment,IntellectualProperty,RealEstateandTaxandEstatePlanning.ThefirmhasofficesinLosAngeles,OrangeCounty,SanFranciscoandScottsdale.Formoreinformation,visitwww.buchalter.com

Thisarticleispublishedasaservicetoourclientsandfriends.Thematerialcontainedhereisprovidedforinformationalpurposesonlyandisnotintendedtoconstituteadvertising,solicitationorlegaladvice.

ThinkAgainBeforeWalkingAwayfromSecondTrustDeedsinBankruptcy

JosephM.Welch,Esq.



Banksandcreditunionsroutinelywalkawayfromsecondtrust

deedswherethereisn'tenoughequitytocovertheoutstanding

loanbalanceplusinterest,arrears,costsofsaleandattorneys'

fees.Thisisespeciallytruewheretheborrowerfilesachapter

13bankruptcycase,whichallowscertainsecuredlienstobe

completelyavoided.1



Butthereisnoreasonforbanksorcreditunionstounknowingly

andprematurelywalkawayfromsecondtrustdeedsthatare

givenspecialprotectionsinbankruptcy.



Theproblemforborrowerswhofileachapter13bankruptcy

caseisthe"anti‐modificationprovision"ofBankruptcyCode

section1322(b)(2),whichprotectssecondtrustdeedholders

fromhavingtheirloansmodifiedifboth:

(1)thepropertysecuringthelienisthedebtor'sprincipal

residenceand

(2)thereisanyvalue,even$1,tosupportthelien.2



ExpectedProcedureinChapter13Cases

Inpractice,adebtormayfileachapter13caseandmovethe

courttoavoidhersecondtrustdeedon14to21days'notice.

Thesemotionsareusuallysupportedbyadeclarationofthe

debtorstatingsomeself‐servingbeliefthatherresidenceis

worthafewthousanddollarslessthantheamountowedonthe

firsttrustdeed(soastoavoidtheanti‐modificationprovision).

Prudentbanksandcreditunionswill

(1)quicklydeterminewhetherthereisanyequitytosupport

theirsecondtrustdeeds3and

(2)ifso,fileanoppositiontothedebtor'smotion(oftendue

within7to14daysofthenotice)andrequestanopportunityto

appraisetheproperty.



Bankruptcycourtstypicallyrespondtoobjectionsbycontinuing

thehearingondebtor'smotionandsettingan"evidentiary

hearing"toallowthepartiestofiledeclarationsofappraisers

(withfullappraisalreports)andrequestcross‐examinationof

theotherside'sappraiser.Theseevidentiaryhearingscanbe

costlyandextremelyriskytobothsides(andthejudgesoften

disdainhearingthem).Inessence,ifthebankruptcycourtfinds

anyequitytosupportthesecondtrustdeedthentheentireloan

ispreserved.Butifthecourtfindsnoequity,thentheentire

loanisavoided.Inessence,bankruptcylawcreatesanall‐or

nothingpropositionthatoftencan(andshould)beavoided.



StrikingDealstoGetAroundtheAll‐or‐NothingProposition

Withincreasedfrequency,informedbanksandcreditunions

makedealswithborrowerstoreducethecostandriskof

evidentiaryhearingsforbothsides.Forexample,ona$100,000

HomeEquityLineofCreditwitha10percentinterestrate,the

bankorcreditunionmayagreetopaymentsof$1,000/mo.Over

fiveyearsinfullsatisfactionofthenote,4netting$60,000onthe

loanandgivingthedebtorsubstantialdebtreliefthroughan

effectivelyinterest‐freeloanthatissatisfiedinfiveyears—

insteadof15‐30years—wheretotalpaymentsarelessthanhalf

ofwhatwouldotherwiseberequiredunderthepromissory

note.Banksandcreditunionsunderstandablypreferpayments

whilethedebtor(wholikelyfiledchapter13andamotionto

avoidthesecondtrustdeedinordertosaveherresidence)still

reallywantstheproperty.Strikingareasonabledealcanresult

inthequintessentialwin‐winsituationforbothsides.



OvercomingHurdlestoPreservetheDeal

Intheory,everyonebenefitsfromadealasoutlinedabove,

includingthebankruptcycourtfornothavingtodecideanall‐

or‐nothingproposition,othercreditors,whogenerallymustbe

paidmoreinchapter13thanachapter7liquidationcase,and

thechapter13trustee,whocontinuestogetcommissionson

planpaymentsover3‐5years.Inpractice,however,some

trusteesinsistthatwherepaymenttermsaremodified,

paymentstothebankorcredituniononsecondtrustdeeds

mustbemadethroughtheplan,withthechapter13trustee's

commission,often11percent,assessedthereon.



Althoughthebankruptcycode,5localbankruptcyrules6and

trusteeguidelines7intheCentralDistrictofCaliforniaallsuggest

directpaymentsintheseinstancesisproper,trustees(and

judges)maybereluctanttoallowthisout‐of‐the‐boxapproach.

Thisistruedespiterelevantappellatelawgivingbankruptcy

courtsconsiderablediscretioninallowingthesepracticaldeals

inchapter13plansandrequiringarticulatedstandards

wheneverdirectpaymentsarenotallowed.8



Evenintheseinstancesinwhichthetrusteeandcourtare

reluctanttoallowdirectpaymentsfromthedebtortothebank

orcreditunion,opposingcounselwilloftenagreetoeither

dismissthechapter13caseorconvertittooneunderchapter7.

Bydoingso,thedebtorkeepsherproperty(whichisusually

thereasonforfilingchapter13inthefirstplace)andthebank

orcredituniongetspaymentsinadealthatsubstantially

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