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The ins and outs of short sales

Many of us have now become familiar with the term “short sale” in the context of the current real estate market. For those less familiar, this is a transaction where the seller agrees to sell the property for less than the balance owed on the seller’s mortgage. This is subject to the approval of all lien holders on the property, to the short payoff and release of the lien encumbering the property to enable the seller to deliver clear title to the buyer.

A short sale typically presents an opportunity for a buyer to purchase a property at a discount. The opportunity cost of the short sale for the buyers, however, is time. Buyers often endure many months of waiting before the seller’s lender approves the short sale. But what happens to the short sale contract if the seller files for bankruptcy protection before the short sale closing occurs?

At the time the seller files for bankruptcy protection a “snap shot” of all the seller’s assets and liabilities is taken. All of the seller’s property, except that protected by law, becomes part of the bankruptcy estate and is subject to being sold by the assigned bankruptcy trustee in the case to pay creditors. All uncompleted contracts also are listed in the bankruptcy filing, and this would include both the contract between buyer and seller as well as the contract between seller and broker. The seller lists the real estate in question in the bankruptcy petition, indicates intentions regarding that real estate, which, in the case of a property in a short sale contract under Chapter 7 bankruptcy, would typically be to abandon the property, and it is up to the assigned bankruptcy trustee then to make a determination as to whether to attempt to sell the property for the benefit of creditors or to abandon it again.

Because short sale real estate typically offers no equity for the seller, in other words, they owe more on any mortgages than the current fair market value, there is generally nothing for the bankruptcy trustee to administer or liquidate for the benefit of unsecured creditors. Because the bankruptcy trustee represents the interests of the seller/debtor’s unsecured creditors, he or she would also be likely to abandon the property after a review of its value and the liens encumbering it. The reason is that those liens must be satisfied, to the degree

they can be, from sale proceeds, leaving nothing for unsecured creditors.

In a case where there is no short sale or where the trustee abandons the property, the lender will, with the bankruptcy court’s permission or upon completion of the bankruptcy case, proceed in state court with its foreclosure remedy. The lender may even pre-empt the trustee and request that the court permit the lender to proceed in state court prior to the trustee’s determination that the property will yield nothing for the bankruptcy estate.

After the state court foreclosure action, the bank will take title to the real estate, sell it and apply the proceeds to the mortgage balance. The bankruptcy discharge prohibits the lender from making any attempt to try to force the seller/debtor to make up any shortfall between the sale price of the property and what was owed on any liens against it.

However, seller’s/debtor’s attorney may also request that the bankruptcy court permit the debtor permission to go forward with the short sale transaction while the bankruptcy case is pending. The seller’s bankruptcy attorney will bring a motion in the bankruptcy court to sell the real estate. Once the court has heard the motion, an order to sell the real estate may be granted so long as the trustee has not determined that there is value in the property for the unsecured creditors and no creditor objects. Any lien holders on the property are made aware of the bankruptcy filing, as creditors in the seller’s bankruptcy, may object. However, many lenders may not object, and may continue on to approve the short payoff and the closing can still occur. This may benefit the lender because the longer the property lies empty, the lower the value the lender will receive once it finally finishes its foreclosure and then liquidates the property. It is better, then, to have a willing buyer at an acceptable price to present to the lender for short sale approval.

Although the seller cannot be held liable for the liens on the property post-discharge, there is still a possibility that he or she could incur liabilities for personal injuries on the property or code violations. Accordingly the short sale, which quickly removes title to the property from the seller’s name to that of buyer, protects the seller from such post-bankruptcy filing liabilities.

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