Filing a Short Form Bankruptcy to Stop a Foreclosure of Your Home Can Be a Very Bad Idea.[1]

People in imminent danger of losing their homes to foreclosure are often, and understandably, desperate.  Some use the internet to search for solutions.  And some, with advice gleaned from the internet or elsewhere, make a “short form” Chapter 7 filing.[2]  This can temporarily stop foreclosure by imposing the automatic stay of 11 U.S.C. § 362, unless there are certain kinds of repeat filings.[3]  Doing this in the expectation that the case will be dismissed later is ill-advised.

In a “short form” filing, the clerk of the bankruptcy court will file and serve a Notice of Deficient Filing that gives the debtor one or more deadlines to correct filing deficiencies.  This Notice will include a statement that failure to comply may result in dismissal of the case without further notice.  Some debtors make “short form” filings with the expectation that the bankruptcy case will be dismissed, but only after the filing of the case imposed the automatic stay long enough to thwart a foreclosure sale of the debtor’s residence.

As soon as a Chapter 7 bankruptcy petition is filed, a Chapter 7 trustee (“Trustee”) is appointed, who will quickly do a search for assets, including real estate, particularly if the bankruptcy is a “short form” filing.  If the Trustee finds real property, such as the debtor’s residence that is subject to a foreclosure proceeding, the Trustee may file a pleading opposing the automatic dismissal of the bankruptcy case, on the basis that he might be able to administer (sell) the residence for the benefit of unsecured creditors.  Thus, the debtor might succeed in stopping a foreclosure sale of his residence, only to have the Trustee sell it.

And debtors should not assume that the Trustee won’t try to sell a residence just because there is little or no equity in the residence.  A Chapter 7 trustee has tools available by which he might obtain a return for unsecured creditors by selling the residence pursuant to bankruptcy court order, even if the liens exceed the net sales value.  In Washington, a sale for less than the amount of liens may be allowed because a bankruptcy trustee may sell the property free and clear of liens.[4]

To justify a sale in such circumstances, the Trustee must be able to obtain a meaningful distribution for unsecured creditors, not an obvious outcome when liens exceed the anticipated net sales proceeds.  But the Trustee may be able to achieve this by negotiating a voluntary “carve-out” agreement with the secured creditor, where the secured creditor agrees to pay a portion of the proceeds of its lien (the “carve-out”) to the Trustee.  This is commonly referred to as a “short sale.”  Bankruptcy courts in the Ninth Circuit may approve a short sale provided that the secured creditor and the Trustee and his professionals agree that the “carve-out” amount will be divided between a meaningful payment to unsecured creditors, and the fees and costs of the Trustee and his professionals.[5] 

In summary, filing bankruptcy without understanding the consequences can lead to unintended results.  It is important to remember that just because information is posted on the internet does not mean the information is accurate.  If you are considering filing bankruptcy, consult an attorney with bankruptcy experience.

 
[1] This article is written only to discuss a possible unexpected outcome for a pro se debtor filing a “short form” Chapter 7 petition.  It is not intended to provide advice on whether or how to file a bankruptcy petition.
[2] In a “short form” filing, a Debtor may file only the petition and a list of creditors, without the other forms required by the Bankruptcy Code.
[3] For example, if a prior bankruptcy case was dismissed for failure to abide by orders of the court, for instance failure to make required filings, then the stay will not apply if another Chapter 7 bankruptcy petition is filed within 180 days after the prior case was dismissed.  11 U.S.C. §§ 109(g) and 362(b)(21)(A).
[4] Under 11 U.S.C. § 363(f)(5) the Trustee can sell property free and clear of liens of an entity if “such entity could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest.”  See In re Jolan, inc., 403 B.R. 866, 870 (Bankr. W.D. WA. 2009), referencing RCW 61.12 and RCW 61.24, which govern both judicial and non-judicial foreclosures.
[5] See In re Selander, 2017 Bankr. LEXIS (Bankr. WDWA 2017) (not for publication); see also In re KVN Corp., 514 B.R. 1, 6-7 (9th Cir. BAP 2014)