Bankruptcy Basics

Introduction

Filing for bankruptcy will impact many aspects of a pending real estate transaction, including the ability 1) to close the transaction; and 2) to provide title insurance to prospective purchasers and lenders. It is strongly recommended that one seek the advice of an attorney for a full understanding of this complex process.

The Code (found at Title 11 of the United States Code) is federal law and recognizes two forms of relief for the debtor, namely liquidation and reorganization. Within Title 11 there are several different types of relief available to the debtor, commonly known by the name of the chapter of the Code under which the bankruptcy filing is made.

The type of bankruptcy filed by the debtor will determine, to a large extent, the requirements a title company will impose in order to close and insure a real estate transaction. This article is not all inclusive and is for informational purposes only.

The bankruptcy process begins
The bankruptcy process begins when the petition for bankruptcy is filed.

Either the debtor can file for bankruptcy (a “voluntary petition”) or a creditor can file for a debtor’s bankruptcy (an “involuntary petition”).

Once the petition is filed, a bankruptcy estate is created. This estate is a separate legal entity from the debtor, and it holds title to the debtor’s pre-bankruptcy assets. The property of the estate generally includes all of the debtor’s legal and equitable interests in property at the time the bankruptcy was filed.

Here is a snapshot of the main types of bankruptcy:

Chapter 7 – Liquidation
Chapter 7 bankruptcy, also known as liquidation, allows some of the debtor’s unsecured debts to be discharged. The debtor must meet certain eligibility requirements under a “means test” to file for Chapter 7.

The bankruptcy court will appoint a trustee to act on behalf of the estate, to take control and collect all assets and to distribute any assets left, after administration of the estate, to the creditors based on a statutory scheme of priority in the Code.

Chapter 11 – Reorganization
Chapter 11 bankruptcy, also known as the “reorganization bankruptcy,” provides for the reorganization of the debtor’s finances through a plan that will provide for the continuation, retention or disposal of the debtor’s assets. This plan must be confirmed by the bankruptcy court.

Unlike in a Chapter 7 case, the debtor automatically remains in control of all assets after the commencement of the Chapter 11 bankruptcy, the “debtor in possession.”

Chapter 13 – Reorganization
Chapter 13, similar to a Chapter 11 plan of reorganization, provides for an individual debtor to reorganize their finances through a repayment plan and to obtain a discharge of debts.

Unlike a Chapter 11 bankruptcy, a Chapter 13 trustee is appointed to administer the case, investigate the debtor’s financial affairs, account for the assets and collect and disburse payments made under the plan.

How Title and Closings May Be Impacted
Bankruptcy can impact real estate transactions in several ways. For title insurance purposes, a final, non-appealable order of the court will be required in order to insure a sale under any of the below procedures:

Pending contracts for the sale of real property
If a contract for the sale of residential real property has not yet been completed, and either the seller or buyer files for bankruptcy, the Code provides that the trustee, or debtor-in-possession, may assume or reject the contract (referred to as an “executory” contract). If the debtor has filed under Chapter 7, the trustee has 60 days to assume or reject the contract. If the debtor has filed under Chapters 11 or 13, the debtor-in-possession or trustee has until the confirmation of the plan to assume or reject the contract (unless the court orders otherwise).

If the contract is assumed, the contract continues under the existing terms and conditions of the contract. The contract must be assumed in its entirety and cannot be assumed in part and rejected in part.

Sales during bankruptcy
During the bankruptcy process, the trustee or debtor may decide to sell property of the estate.
In Chapter 7, 11 and 13 cases, the trustee or debtor is authorized to sell property of the estate in two ways: 1) in the ordinary course of business, without notice or hearing; 2) other than in the ordinary course of business, after notice and hearing.

A sale of property of the estate may be made, free and clear of liens, under certain conditions. In reorganization cases, under Chapters 11 and 13, the approved plan may provide for the sale of the property.

The trustee or debtor may also abandon property of the estate, which revests the property in the debtor, who is free to deal with the abandoned property without any further reference to the Code.

Disclaimer: This publication is designed to provide accurate and authoritative information regarding the subject matter covered at the time of publication. It is distributed with the understanding that the publisher is not engaged in rendering professional services or advice. If professional advice or expert assistance is required, the services of a competent professional should be sought. ©Copyright, 2024, by Land Title Guarantee Company.