Why short sale after bankruptcy?

July 26, 2010 

Many homeowners are watching their real estate values decline yet their mortgage balance remain the same.

The challenging real estate market and a high unemployment rate have forced many homeowners to try to get rid of their properties through a short sale. But what happens to the short sale when a bankruptcy petition is filed? Should a homeowner file bankruptcy before trying to short sale?

After filing a bankruptcy petition, the real estate becomes the property of the bankruptcy estate if the debtor has not chosen to or cannot exempt the real property. In most cases, where the debtor or homeowner has no equity, the election will not be made to exempt the property from the estate. If the debtor is behind on the mortgage payments and cannot afford the home any longer, the debtor, in most cases, will choose to surrender the collateral back to the secured lender in their bankruptcy petition.

For example, you have a homeowner who has been out of work for some time and has fallen behind on the mortgage payments. She has tried to sell the home to pay off the lender, but the real estate is worth considerably less than the mortgage balance. To add insult to injury, the debtor has a home equity line of credit secured by a second mortgage on the property.

The debtor or seller has tried a short sale but cannot get the banks to release her completely. Faced with this prospect, she files a Chapter 7 bankruptcy. The bankruptcy estate is created, and the bankruptcy trustee controls and holds the real estate by operation of law. Any attempt by the homeowner to dispose of the property is not possible at this point, so any short sale contract or negotiations for short sale are indefinitely on hold.

In most cases, the real estate has no equity value, so the bankruptcy trustee in most cases will abandon the property. However, if there is no equity value in the real estate that would be available for administration by the trustee after the sale of the real estate and payoff of all mortgages, there is no value for the estate. Once the trustee abandons this asset, ownership and control of the real estate defaults back to the original title holder.

At this point the real estate is no longer property of the estate. The debtor has filed a Chapter 7 bankruptcy to discharge her obligation under the promissory notes associated with the real estate. The mortgage holders must continue their foreclosure suit to obtain title to the real estate, but they are forever barred from pursuing a deficiency judgment once the debtor receives a discharge in bankruptcy.

So then why bother with the short sale after the debtor has received a discharge in bankruptcy? A successful short sale of the property will cut off potential liability that the debtor may incur from mere ownership of land. Any debts that the debtor incurs after the bankruptcy petition filing date are considered post-petition debts that are not dischargeable in the previously filed bankruptcy.

For example, the debtor had a condominium that he intended to surrender in Chapter 7 bankruptcy and there is no equity value in the property. The trustee abandons the property. The debtor is responsible for the ongoing maintenance assessments that come due after the petition filing date. If the debtor does not pay the assessments while title is still in his name, he may be served with a lawsuit to collect that debt after he comes out of bankruptcy.

Cynthia A. Riddell, an attorney whose practice primarily focuses on bankruptcy, real estate foreclosure, and short sales, can be reached at (941) 366-1300 or www.toomuchdebtbradenton.com.

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