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 [...]
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.
One of the best options for people facing foreclosure is the “deed in lieu of foreclosure,” or as it’s more frequently referred to, “deed in lieu.” Essentially, this is the fancy legal term for what most folks would describe as “mailing the keys to the lender,” or as it’s being called lately, “jingle mail.” Giving the the house back to the bank instead of waiting for it to foreclose. There are some good reasons for doing this if you have the option.
One of the best options for people facing foreclosure is the “deed in lieu of foreclosure,” or as it’s more frequently referred to, “deed in lieu.”
Essentially, this is the fancy legal term for what most folks would describe as “mailing the keys to the lender,” or as it’s being called lately, “jingle mail.” Giving the the house back to the bank instead of waiting for it to foreclose. There are some good reasons for doing this if you have the option.
The best reason for doing it is that you avoid any risk of the lender seeking a deficiency judgment for the amount by which the loan balance exceeds the property value. (That’s assuming the lender has that right, which, in most cases in California at least, they probably don’t. But that’s a whole different issue and beyond the scope of this post.) The reason is that the deed in lieu documentation will include a release…That’s the quid pro quo that you get from the lender in exchange for saving themthe cost, legal expenses, time and procedural brain damage of having to go through the foreclosure process. This is critical: Do NOT do a deed in lieu if you don’t get the release!!!
The other good reason is that it expedites what is a painful and stressful process that most people would rather avoid. You can be in and out fairly quick.
However, generally, it won’t work if you have more than one loan. The reason is that, by taking the property by deed, rather than by foreclosure, the lender accepting the deed takes subject to the continuing obligation to pay any other existing encumbrances. This is true whether the lender is in first, second or third position; if you get deeded a property, you take subject to the continuing obligation to pay other existing loans which are still of record. In this current environment, most people have two or more loans, making the deed in lieu an impossibility. The foreclosure process actually wipes out junior deeds of trusts, or loans.
So if you’re considering a deed in lieu, or if some cocktail party lawyer has suggested it, before getting too excited about it, the two big questions to answer are whether you need it, or whether it is even possible.
Now, first off, I know that the title I’ve chosen for this post is about as unsexy and non-juicy as it can be. That’s okay. I can take it. It’s boring. I can hear marketing consultants hollering about how I need to make my title more grabby, sticky, etc. Yawn. What can I say? Trying to [...]
Now, first off, I know that the title I’ve chosen for this post is about as unsexy and non-juicy as it can be. That’s okay. I can take it. It’s boring. I can hear marketing consultants hollering about how I need to make my title more grabby, sticky, etc. Yawn. What can I say? Trying to make this stuff fun and exciting is like trying to turn a root canal into a spectator sport. And besides, if you’re reading this, you didn’t come here to be entertained. Maybe someday I’ll change the title but for the moment it stays.
So, anyhow, on the subject of deficiencies…
Far and away the most common question I get asked by clients and potential clients is whether they will be liable for what’s called a “deficiency” after they let a property go in foreclosure. Please note that the discussion below is limited to California law. If your property is not in California–it doesn’t matter where you are; what matters is where the property is–then the discussion below will not apply to your situation because the laws in each state about foreclosures and deficiencies is unique to each state’s laws.
First, what is a deficiency anyhow?
A deficiency is, simply defined, the difference between what you owe on your loan(s) minus the value of the property at the time of the foreclosure. Here’s an absurdly over-simplified example: You owe $250,000 on the loan. At the time of the foreclosure, the property value is $200,000. If the lender is entitled to a deficiency (and that’s a HUGE “if” in California) then it would be calculated at $50,000 ($250,000 – $200,000 = $50,000)
Lots of people right now are trying to weigh their options about whether they want to let a property go in foreclosure, file bankruptcy, do a “short sale,” try for one of those “deeds in lieu” or even try to work something out with the lender. (Right!) What I am seeing quite frequently is that decisions are being made based on completely wrong information about the extent to which they are at risk for
Next, how do you evaluate the risk of being chased for a deficiency by a lender after foreclosure?
Here are the rules in as simple a way as I can articulate them. Remember: THESE APPLY ONLY TO LOANS SECURED BY PROPERTY IN CALIFORNIA. If you don’t live in California, then these rules DO NOT apply to you.
1. There can be no deficiency on a purchase money loan. Ever. This means that if the loan was used to purchase the property, then no deficiency is possible. It doesn’t matter if the holder of the first, second or third forecloses. If the loan on which a lender is trying to get a deficiency is a purchase money loan, then no deficiency is possible. There are wrinkles in this: A HELOC can be purchase money. A loan taken out to refi a purchase money loan cannot. If you have multiple loans, then you have to think about the purpose of the loan. Let’s say you have a purchase money first, and then you later took out a second. The second, because the loan proceeds weren’t used as “purchase money,” that lender is not barred from pursuing a deficiency in a lawsuit.
2. There can be no deficiency if the lender exercises its power of sale and conducts a non-judicial foreclosure by the mechanism of a trustee’s sale. In order to get a deficiency, the lender MUST file a judicial foreclosure action. That means that they have to sue you in Superior Court. Some people seem confused about whether that piece of paper then got in the mail was a lawsuit or something else. It’s hard to miss: It’s a big 8.5? x 11? document called a “Summons,” and it says in unambiguous writing: “Notice to Defendant….You Are Being Sued By Plaintiff.” See a copy of one on my post “Second Mortgages in California: Deficiencies Not Usually an Issue.”
