When you buy a real estate asset, you must run a bankruptcy search
on the property’s owner. As the investor, you must know whether or not the owner is in active bankruptcy, or you cannot proceed with any foreclosure. Let’s cover the flow of bankruptcy filing basics.
When a borrower files for bankruptcy forfinancial protection, it’s typically done for the purposes of removing unsecured and/or second position liens. Any foreclosure action or tax sale is put on hold until the borrower is discharged from bankruptcy. The bankruptcy court sets up a new fictional entity called a “bankruptcy estate,” and this entity has the power to transfer the property from the owner to other parties in the effort to pay off the debt declared in the bankruptcy proceedings. In almost every instance, the bankruptcy cannot remove the first position mortgage. However, the lender and borrower may execute a mortgage modification agreement while the borrower is in bankruptcy to lower the monthly payments for a certain period, giving time for the borrower to catch up on the payments for the remainder of the secured debt. Some investors in notes in bankruptcy think this is very beneficial to them, that the bankruptcy court forces the borrower to cooperate with the lender within the court framework rather than chasing the borrower outside of court to sign modification agreements. In fact, in this case, lender and borrower both win.
Junior (second, third, etc.) position mortgages or judgments may be stripped off in bankruptcy, becoming unsecured liens through the judge’s order “to strike a junior lien.” From the title search
perspective, bankruptcy search is a must-have verification of which liens, judgments and mortgages were stripped by a bankruptcy order. It should be a part of your standard note or property due diligence
not only to verify if the second lien was stripped, but to also find out if any of the unsecured judgments were removed through a bankruptcy proceeding.
Bankruptcy is really a widely discussed and popular topic. The borrower can use bankruptcy to remove any unsecured debt, such as credit card, personal judgments or junior position liens, while the first position lender can benefit from bankruptcy to force a favorable modification with the borrower ordered by a judgment with a very strict payment plan. Once the borrower pays the modified amount for a period of six to nine consecutive months, the price for the performing note/asset will be much higher than the price for a non-performing note before the bankruptcy.
Hidden Danger for Investors
We have seen a few bankruptcy cases where the attorney representing the borrower in bankruptcy sneaked the discharge of the lien into the restructuring plan for the borrower. If the lender is not well represented or not careful with bankruptcy case handling or review, the judge may approve the plan with the order to strike a lien. There is no reverse action that the lender can take to undo this chain of events.