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Creditor's Rights

Mr. Houts has a background in these areas, but is now practicing general business law.  The following is not advice on a particular matter, not updated, and is provided for information purposes only.

When Bankruptcy Intervenes - Relief from the Automatic Stay

If you're either suing someone or attempting to enforce a judgment, the borrower/judgment debtor may file a Bankruptcy petition.  This will raise a legal injunction to creditor action of all kinds called the Automatic Stay as of the date the Bankruptcy was filed.  If you have collateral for your loan, such as a deed of trust on real property or your company's name on a vehicle certificate of title as lienholder, and the debtor is in default or stops paying, you may be able to have the stay imposed by the Bankruptcy lifted by filing a Motion for Relief from Stay.  If the stay is lifted, you can utilize non-bankruptcy law and self-help to recover your collateral and sell it to generate funds to satisfy the loan, if you so choose, as if the Bankruptcy did not exist.  Of course, there are some limitations and requirements to obtain relief from the stay.

In short, you can file for relief "for cause, including a lack of adequate protectionusing 11 USC 362(d)(1)or when the debtor "has no equity" in your collateral and the collateral is "not necessary for the debtor's reorganization" under 11 USC 362(d)(2).

Filing for Cause 

If you are oversecured because your collateral is worth more than your loan balance, your "cause" for relief can be found in a lack of "adequate protection."  Your lawyer will determine the value of the collateral as of the date you could have exercised creditor remedies in the absence of the Bankruptcy (In re Deico Electronics, Inc.).  Your loan balance (and the balance of any loan senior to yours) will be subtracted from the fair market value of the collateral.  7% of the value of the collateral will also be deducted from the value (La Jolla Mtge. Fund v. Rancho El Cajon Assoc.)  The resulting amount will be divided by the value to yield a percentage of equity over and above your lien.  This is called the creditor's "equity cushion."  In the 9th Circuit (California), if the creditor has an "equity cushion" of 20% or more, the court will not grant relief from stay (In re Mellor).  In some circumstances, the numbers may permit the creditor to argue that its cushion will imminently drop below 20% if it does not receive payments from the debtor (called adequate protection payments).  Under the Mellor case, the court can order the debtor to make payments to preserve the equity cushion if it is about to fall below 20%.

Filing when there is a Lack of Equity and the asset is not necessary to reorganization


Effect of the Automatic Stay on Foreclosure

A creditor with a lien on real property in California will usually, but not always, elect to pursue a non-judicial foreclosure if the borrower doesn’t pay.  Non-judicial foreclosure is a procedure outside of the court system, commenced when the creditor (or a servicing agent for the creditor) records and mails out a Notice of Default (NOD).  Under applicable law, the borrower has 90 days from the recordation date to reinstate the loan by curing the default in payments.  To do this, they borrower will have to pay all sums delinquent and any fees the lender has incurred.

Reinstatement halts the foreclosure and puts the loan current again.  If the borrower happens to default on a balloon payment or if the note has accelerated, however, the borrower can’t reinstate except by paying the full loan balance.  Although paying the loan in full is more traditionally called redemption, the terms “reinstatement” and “redemption” are often used interchangeably.

Once the 90 days runs out, the creditor can publish a Notice of Sale (NOS) which will set a sale date out at least 20 days (it can be more).  Under a California statute, the “reinstatement” period is extended past the 90 days until 5 days before the sale date.  If the borrower doesn’t pay the loan off before then,  there will no longer be a right to compel the lender to accept payment the debt and no way to stop the sale, except by a bankruptcy filing or by obtaining the foreclosing creditor’s agreement to stop or extend.

So let’s examine the effect of a Chapter 7 or 11 Bankruptcy filing on this process.  Filing a Bankruptcy case gives rise to the automatic stay and temporarily halts certain parts of the foreclosure process but not others.  For example, the stay may prevent a notice from being recorded, but it may not stop (“toll”) the running of time periods that do not constitute “actions to enforce a debt” like the reinstatement period.  I wish I could state this more simply, but I can’t:

1.  A Bankruptcy filing before the NOD is recorded stops the recording of an NOD (until the creditor gets relief from stay)
2.  A Bankruptcy filing after the NOD is recorded does not toll the reinstatement period (Napue v. Gor-Mey, 175 Cal. App. 608)
3. A Bankruptcy filing before the Notice of Sale (NOS) is recorded stops the recording of the sale notice (until the creditor gets relief from stay)
4. A Bankruptcy filing after the Notice of Sale (NOS) is recorded stops the actual sale (until the creditor gets relief from stay), but does not toll the reinstatement period unless the sale is continued more than 5 business days (counting Saturdays), in which case the reinstatement period is tolled
5. A Bankruptcy filing after the 5 day period before sale has begun will stop the sale (until the creditor gets relief from stay), but you will no longer be able to reinstate/redeem
6. A Bankruptcy filing after the sale date will not stop the sale.

These are general rules, but they cover many of the situations that will arise.  Always take your specific facts and the actual documents to your lawyer and have them analyze your position before deciding what you can do or what you will do.

Any action which interferes with or denies the borrower’s reinstatement or redemption rights is likely to be a violation of the law.  For example, I once saw a lender take a quitclaim deed along with a deed of trust.  The quitclaim (“deed absolute”) gave the lender the right to record the quitclaim on the debtor’s default in payments.  I believe there is adequate authority that so circumventing the debtor’s reinstatement rights is unlawful and use of a quitclaim executed at loan inception can be enjoined.  If the quitclaim were taken sometime after loan inception and there was separate consideration for it, such as forbearance by the lender to proceed with a foreclosure, the quitclaim could be used.  Ref: CC 2953, 2899; Hamud v. Hawthorne (1959); C.W. Beeler v. Amer. Trust Co. (1944).

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