Bankruptcy can be a problematic element of note investing if the investor doesn’t fully understand the process, rules, and regulations of bankruptcy and the implications it may have on their particular investment. Our company recently bought two notes from the same borrower which had filed Chapter 11 Bankruptcy, which is a re-organization of an entity or company (similar to Chapter 13 which is for an individual). The borrower had over 11 properties that they she was surrendering and had declared she wanted to keep her homestead only. In my mind I thought it was the perfect scenario, the borrower was pending an approval of their Ammended plan, and contact with their bankruptcy attorney indicated they were willing to provide a deed in lieu on the properties. We decided based on the evidence from her case, we would buy the notes and have a quick and easy turn around on both notes.
Shortly after our purchases, both the borrower and attorney went AWOL, I mean NO response after multiple attempts! Although the workout is taking MUCH longer than expected, and the dreaded foreclosure had to be implemented, we are still going to make a nice profit on the two deals, and have learned a lot along the way.
We realized that although we were aware of bankruptcy and believed we understand how it effected us that there was a lot we still had to learn. I wanted to write this post to help you understand what to be aware of before buying a note with a borrower in bankruptcy.
Timeline for Bankruptcy
Chapter 7 ( Typically 4 – 6 months)
Chapter 13 or 11 (Average of 3 – 5 years)
Contact with Borrower
When a borrower is in bankruptcy you are legally prohibited from contacting the borrower directly and must speak with their attorney or trustee until a lift of stay has been filed and approved.
Even if the property has been surrendered (the owner does not want it anymore) or the debt itself is observed, you still need a Deed In Lieu or Foreclose on the property to gain title.
How that effects you…
In order to initiate contact with the borrower and potentially start the process of the “workout” you will need to file a lift of stay. After a lift of stay has been requested it typically takes 30 – 60 days to be given a court date to have the hearing to receive approval. So this could extended the workout timeline on your note.
Automatic stays are put into motion after the borrower enters Bankruptcy. It is intended to prevent creditors from further contacting, harassing, or attempting to collecting debts from the borrower. You must apply for this to be “lifted” and be granted approval within the BK court. It is typically granted to creditors that have collateral that is not properly being protected so they can take the next steps to protect their asset such as foreclosure.
How that effects you…
Although applying for a lift of stay is rather easy, being approved for it in court can be more of a challenge. For instance, the court will not lift the stay when an unsecured debt will be included in the debtor’s discharge (so for Chapter 11 or Chapter 13 plans). If you’re early on in the plan or your borrower files for Chapter 11 or 13 right before the final judgement (this actually happens a lot more than you’d like to know), it could take up to a year or longer before their plan is approved and you start to see some form of payment or workout solution. In the mean time you’re stuck waiting with a note you can’t do anything with!
Proof of Claim and Transfer of Claim
In Chapters 7 and 13 and 11 bankruptcy cases, all unsecured creditors must file a proof of claim for their claim to be allowed. Certain secured creditors, however, do not have to file proofs of claim to participate in a bankruptcy case. For example, lien holders and other secured creditors do not have to file a proof of claim to preserve their liens in a bankruptcy case. You have 90 days after the first meeting of the creditors to file this claim.
Transfer of Claim happens when a creditor has changed, for example if the note is purchased from the current lender on file, you need to file a transfer of claim to prove you are the new creditor.
How it effects you….
I suggest checking with an attorney that is familiar with the bankruptcy process in the state the borrower is located within to find out if you a required to file a claim or not. This is especially important if your borrower is in Chapter 11 or 13 and a payment plan will be made to the creditor on file for the specific property. You want to ensure that your note/property will be properly addressed in their plan.
A payment plan is created in both the Chapter 11 and Chapter 13 BK cases. This must be approved formally by the court before set into motion and can take up to two years before it is formally approved. It outlines the exact amount secured creditors will receive in the form of payments and for how long.
How it effects you…
Reviewing the plans before buying a note that has a borrower in BK is extremely important. If a payment schedule has been created within this, it will allow you to see what you are expected to be paid per month, for how long, and at what interest rate. If you are buying this note as a “re-performing loan” then this is the sole determining factor of your ROI and must be looked at carefully. There can be amendments to the original plan, so make sure to look for that as well. It’s also important to know if the plan intends for you property to become a part of their repayment plan, or if it is being surrendered. If it’s surrendered then a foreclosure or DIL is necessary before you are able to do anything with the property.
Now there are other elements to be aware of within Bankruptcy and many rules and regulations that were not discussed in detail here. If you want more information, glossary, or tips with BK, I suggest you take a look at the BK “Cheat Sheet” and Due Diligence checklist we provide to our paid members of NoteInvestingClub.com for more help. Let me know any questions you may have about this post or bankruptcy itself below!
Remember, I am not an attorney. This post does not provide legal advice and the Provider is not a law firm. None of our customer service representatives are lawyers and they also do not provide legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a lawyer if you want legal advice.