In October, 2008 I wrote a blog post called “Are ‘Short Sales’ they worth the hassle?” My answer was a resounding and unequivocal “No!” (In fact my view was so lopsided that I think it could be said that it was really “Hell No!) Have things changed? Well, I have received some boots-on-the-ground intel that suggests that there may be some circumstances where the effort may pay off. I’m not ready to do a 180, but there may be circumstances where it’s worth a look. (The italics and bold of all those “mays” and “suggests” is intentional.)
First, let’s go back to the basis premise, which is that most people who bother with short sales do so out of a desire to “do the right thing.” An admirable motive in nearly any business endeavor. But it may not always be in one’s best interests. My objections to short sales is that they (1) Trigger too much effort and frustration, (2) Are prone to falling apart at the last minute, (3) Don’t do much to really salvage one’s credit rating and (4) Require the homeowner to do all the work for the bank. But the part that concerns me most is that in order to get a short sale approved, the homeowner has to open his financial books and records to the bank which may then turn around and use that very same information against the homeowner in a later lawsuit to recover a deficiency. Importantly, in California, a litigant cannot get financial information about the other party during the litigation. This protects litigants from allowing their financial condition to be the tail that wags the dog of the lawsuit: If someone can find out that the defendant is wealthy, they may press a frivolous lawsuit harder in the hopes that the wealthy target will cough up some money to make the problem go away. By giving a bank this information in the process of trying to get a short sales approved, you have now given them a possible road map to an easier recovery. For example, letting a property go in foreclosure forces the lender to consider a bankruptcy risk in their negotiating strategy; if you’ve told them that you have $100k in the bank or a stock portfolio, you have now minimized at least some part of that risk to the bank, and they’ll feel emboldened by knowing that you actually have something to lose. (For a related post on deficiencies after short sales, see my recent blog post about the new California statute CCP §580e which precludes a lender on a first deed of trust from pursuing a deficiency after approving and getting paid off in a short sale. This is a helpful development, but it doesn’t cover all situations.) Of course, the borrower’s ultimate financial exposure is never any greater than what the bank could get in a Chapter 7 or Chapter 13 payout, but making that determination is part of the analysis.
So what has changed? Well, I have been told that, anecdotally, letting a home go by short sale may enable a borrower to re-qualify to buy a new home sooner than would likely be the case in the event of a bankruptcy or foreclosure. In other words, a short seller takes a smaller hit on their credit profile than one who lets the property go by straight foreclosure. Again, this is only anecdotal and I have no proof or verification from any lenders or credit agency that this is true. But I have been told this by enough reputable real estate and loan brokers to believe that there might be something to it.
But don’t make this decision on your own: You need to know your risk of being sued before you make the decision. Get legal help. You should do a complete financial analysis so you know just how tempting a target you make to a bank. A $500 legal check-up may save you tens thousands of dollars–tens of thousands in some places–in later exposure.
Of course, you should never let a short sale go to close of escrow unless the bank gives you a complete waiver of a deficiency, but in the fog of war and after months of exhausting haggling with a bank, these things sometimes go unnoticed.
Call a lawyer before you close a short sale. Seriously. Do it.
My clients get tired of hearing me say it, but if the mantra for real estate values is location, location, location, then the mantra for bankruptcy petition and schedule preparation is disclose, disclose, disclose. This isn’t Chicken Little screaming about the sky falling; it’s real and it can have real consequences.
The 8th Circuit Court of Appeals recently decided the case of In re Barrows. In that case, the debtors borrowed money from their 401(k) just before their bankruptcy petition was filed, and deposited the funds into their bank account. They didn’t tell their lawyer about it. On their bankruptcy schedules, they disclosed–under penalty of perjury–that their combined bank balance was $325 on the day of filing. The trustee requested bank statements, and those statements revealed the additional funds. When their lawyer sought to amend the exemption schedules to include the additional funds apparently mistakenly omitted, the Court denied the amendment and the debtor’s appealed. They lost the case and, therefore, their $13,000.
The Court of Appeal reasoned that, because the debtors signed their schedule under penalty of perjury, such omissions can’t be cured by simple amendments. The Court upheld the lower court decision, and the debtor’s lost the $13,000.
The most painful–and truly absurd–irony of this tale, however, is that, because the money was borrowed from the debtor’s 401(k) retirement account, and would have been exempt if either a) They had waited until after filing to borrow the money, or b) Correctly disclosed the bank balance and source of the funds. The important issue for the Court of Appeal wasn’t whether the funds would have been reachable by the creditors or the trustee, but the debtor’s “bad faith” in failing to be truthful in the schedules. In other words, the doctrine of “no harm, no foul” doesn’t apply. This kind of stuff drives me nuts because it is so easily avoidable.
I take three lessons from this:
1. Don’t expect post petition amendments to cure material omissions without the threat of some possible consequence.
2. Truth matters. A lot. Innocence alone doesn’t vitiate inaccuracy.
3. If you are untruthful in your schedules, you should expect to be caught.
Here in the Northern District of California, Judge Alan Jaroslovsky of the Santa Rosa Division wrote an Open Letter to Debtors and their Counsel in 1997 with regard to the casual assumption that inaccuracies can be easily cured with later amendments. You can read the original order here.
But to quote the most important message from the 1997 Open Letter, Judge Jaroslovsky says:
Whatever your attitude is toward the schedules, you should know that as far as I am concerned they are the sacred text of any bankruptcy filing. There is no excuse for them not being 100% accurate and complete. Disclosure must be made to a fault. The filing of false schedules is a federal felony, and I do not hesitate to recommend prosecution of anyone who knowingly files a false schedule.
That’s worse than losing $13k.