Taylor J. King is a bankruptcy attorney in Jacksonville, Florida.

Bankruptcy Options for Underwater Property in Jacksonville, Florida

Escalating real estate prices from 2004 to 2007 created a tremendous housing bubble throughout much of the United States. The Florida real estate market particularly saw burgeoning prices during this economic boom. The collapse of the residential real estate market, among other factors, led to what was later termed the Great Recession.  Since the subprime mortgage crisis in 2007-2008, the Great Recession has seen the bankruptcy or government bailouts of companies such as Lehman Brothers, AIG, Bear Stearns, Fannie Mac, Freddie Mac, and Chrysler. Companies and individuals that never expected to seek government assistance or bankruptcy protection found themselves with little or no other options.

Four years later, the consequences of the subprime mortgage crisis continue as many homeowners and property investors in Florida struggle to sustain mortgage payments on underwater property. Owners also continue to struggle to sell or re-finance their property, either due to negative equity or tightened credit requirements, or a combination of these factors. Some Florida homeowners have chosen to fight foreclosure proceedings in state court. Except in very rare instances, the foreclosure defense process merely delays the inevitable loss of the property. Other homeowners seek relief through a short sale, which may prove beneficial where the lender offers cash and other incentives to the homeowner in exchange for maintaining and marketing the property.  Still, short sales often are time consuming, may result in 1099 tax liability for debt forgiveness, and certainly results in loss of the home. Title 11 of the United States Code (the “Bankruptcy Code”) provides another alternative for individuals and companies in financial distress, through Chapter 7 Liquidation, Chapter 11 Reorganization, or Chapter 13 Debt Adjustment for Individuals with Regular Income.

Underwater Property and Chapter 7 – Liquidation

There are many benefits to a Chapter 7 that will be discussed in other postings. For the purposes of this article, as it relates to coping with underwater real property, there are two alternative benefits available in Chapter 7. First, for a debtor behind on their mortgage payments who does not intend to keep their home, Chapter 7 eliminates the liability for any actual or potential deficiency judgment. This is true whether the deficiency judgment occurs now or in the future. The important factor is that the note and mortgage were signed pre-petition, ie – before the bankruptcy is filed. The Chapter 7 eliminates all pre-petition debts that are not re-affirmed.  You will be allowed to remain in the property after you filed the Chapter 7, assuming a foreclosure sale has not yet taken place.

A second important benefit of a Chapter 7, in dealing with underwater property, involves property encumbered by multiple mortgages. If the property is encumbered by a first mortgage that exceeds the market value of the property, the owner may eliminate any inferior lien on the property such as a second or third mortgage. This benefit marks an important change in the law following the recent Eleventh Circuit decision, In re McNeal, No. 11-11352 (11th Cir. May 11, 2012).  Prior to McNeal, the strip-off of a wholly unsecured second or third mortgage could only be accomplished through a Chapter 13. This interpretation of the law will vary by jurisdiction, but in the state of Florida, for now, the ability to strip-off of a second or third mortgage constitutes a valuable tool for Chapter 7 bankruptcy debtors.

Underwater Property and Chapter 13 – Adjustment of Debts of an Individual with Regular Income

While Chapter 7 and Chapter 11 each permit filing by corporate or individual debtors, Chapter 13 solely applies to individuals. A Chapter 13 may benefit a homeowner by allowing the homeowner to cure mortgage arrears, obtain a HAMP modification, eliminate a second mortgage, or a combination of these three goals.

First, Chapter 13 allows a debtor to strip-off a second mortgage that is completely underwater.  An individual who is behind on their first mortgage payments or holds non-exempt personal property may opt to strip off the second mortgage through a Chapter 13 as opposed to a Chapter 7, given that a Chapter 7 does not allow a debtor to cure first mortgage arrears or keep assets whose value exceeds their exemptions. Whether a Chapter 7 or Chapter 13 would work best for you should be determined by an attorney after discussing the value of your assets and exemptions.

Second, Chapter 13 allows a debtor time to catch up on their delinquent first mortgage payments. This provision could benefit an individual who lost their job temporarily, falls behind on their mortgage payments, but then finds new employment. A Chapter 13 allows for curing of mortgage arrears even after a foreclosure suit has already been filed. In order to keep the property, a Chapter 13 case must be filed prior to the foreclosure sale, as the Debtor’s right of redemption and ownership interest expires at the time of the sale.  By eliminating credit card payments, past due medical bills, and potentially stripping off junior mortgages and/or lowering car payments, many debtors are able to begin making their regular first mortgage payments and curing their arrears over time.

Even after eliminating credit card payments and other expenses in a Chapter 13, the curing of mortgage arrears may prove difficult for some individuals, as this does require a monthly payment equal to the regular first mortgage payment plus the 1/60 of the total arrears. If a homeowner is unable to support their regular first mortgage payment, the owner may still want to consider a home loan modification, the third potential option or benefit of a Chapter 13 case for underwater homeowners. The Bankruptcy Court in Jacksonville recently implemented a new mediation program that combines the Chapter 13 process with the HAMP mortgage modification process. Even if you have been turned down for a modification before, the success rate for obtaining a modification has proven much higher when attempted in combination with the Chapter 13 bankruptcy. To determine if you qualify for a Chapter 13 bankruptcy or HAMP Modification, please contact an attorney.

Underwater Property and Chapter 11 Reorganization

When considering the topic of Chapter 11, names such as American Airlines, Lehman Brothers, or Chrysler may come to mind. In actuality, a much greater percentage of Chapter 11 filings stem from small business and individuals. Chapter 11 offers the opportunity for Florida companies and individuals to retain their property by reducing the mortgage principal balance, re-amortizing the mortgage debt, and obtaining a lower, fixed rate of interest.

An individual who owns multiple investment properties might want to consider a Chapter 11 reorganization. As an example, consider an individual who owns ten residential investment properties in Jacksonville. Each of the properties is significantly underwater. Through a Chapter 11 Plan, the individual would propose a new mortgage with a principal balance based upon the current market value of the property, a fixed rate of interest of 4.0%, and a new thirty year amortization. The Chapter 11 Plan, once approved by the court, would essentially create a new mortgage based upon the current market value of each property. This may occur either upon agreement with the lender, or the court may “cramdown” the Chapter 11 Plan proposal over the creditor’s objection. In a non-consensual scenario, the court determines the value of the property based upon testimony of the the parties’ respective appraisers.

After determining market value, the court determines the appropriate interest rate based on the Wall Street Journal Prime Rate, which was 3.25% as of September 2012. The court then adds a risk factor, generally between 1-3%, based upon dicta in the Supreme Court’s decision in Till v. SCS Credit Corp,541 U.S. 465 (2004). Although Till involved a Chapter 13 debtor, its rationale applies equally in the Chapter 11 context where no credit market exists as to a particular debtor and particular loan. In determining an appropriate risk factor under Till, courts look at a number of factors, future cash flow, other liens encumbering the collateral,  and risk of future default on the modified mortgage. If the Debtor carries its burden of proof on the risk factor issue, a risk factor of 0.75% would result in a new fixed interest rate of 4%.

In order to obtain court approval of a Chapter 11 Plan, an individual debtor must satisfy the best interest of creditors test and, if an unsecured creditor objects, pay projected disposable income for a period of five years. The best interest of creditors test provides that creditors must receive a greater dividend through the Chapter 11 Plan than they would in a hypothetical Chapter 7.  Thus, if a Chapter 11 debtor held $75,000 worth of equity in non-exempt assets and only proposed to repay unsecured creditors $10,000 over the life of the Plan, or $166.66 per month, the Plan would not satisfy the best interest of creditors test. The debtor must prepare a liquidation analysis in each case to ensure the Plan satisfies the best interest of creditors test.

In addition to determining liquidation, an individual Chapter 11 debtor must prepare a projected budget to compare their future income and expenses in order to fix their amount of disposable income. If an unsecured creditor objects to the Chapter 11 Plan, 11 U.S.C. 1129(a)(15) requires the debtor pay future disposable income for a period of five years. For an individual with multiple investment properties, the necessary expenses include the new mortgage payments, among other things. If the liquidation value and disposable income are minimal, unsecured creditors may receive only a few dollars a month. Finally, once the other confirmation requirements are met, the court decides if the Plan is feasible. If the Debtor carries its burden of proof to show that he or she can afford the new payments, the Plan is put into effect through a Confirmation Order. The Confirmation Order outlines the new mortgage payments, which are binding on the debtor and creditors.

Important distinctions exist in the Bankruptcy Code as it applies to corporate Chapter 11 cases as opposed to individual Chapter 11 cases. Discussed in more detail above, the best interest of creditors test applies in both contexts. The requirement of 11 U.S.C. 1129(a)(15), which requires payment of disposable income to unsecured creditors, applies only to individual debtors. Similarly, the Bankruptcy Code does not require a corporate Debtor to contribute future earnings to fund a Plan, as may be required for an individual under 11 U.S.C. 1123(a)(8). Perhaps the most important distinction involves the applicability of the absolute priority rule. The applicability of the absolute priority rule in corporate Chapter 11 cases makes it difficult to reduce mortgage debt on underwater property. Corporate debtors must look to adjusting the interest rate and term of amortization in order to obtain reduced monthly payments and maintain cash flow. An amendment to the Bankruptcy Code in 2005 created an exception to the absolute priority rule for individual debtors. Much debate has occurred regarding the scope of that exception.

Courts are split as to the applicability of the absolute priority rule with respect to individual Chapter 11 debtors. Given the split of authority, debtors must carefully consider the law applied in their jurisdiction. The leading decision in the Middle District of Florida is the case of SPCP Group LLC v. Biggins (In re Biggins), 2011 U.S. Dist. LEXIS 107728, 2011 Westlaw 9841 (Bankr. S.D. Fla. 2011). This decision applies to cases filed in the Middle District, which covers Jacksonville, Orlando, Tampa and the surrounding areas. The federal court, in an opinion issued by Judge Susan C. Bucklew, decided that the absolute priority rule did not apply with respect to individual Chapter 11 debtors. Judge Bucklew affirmed the decision of the bankruptcy court, which approved the Debtor’s Chapter 11 Plan over the objection of unsecured creditors.  The decision in Biggins and the inapplicability of the absolute priority rule proves particularly helpful to individual investors with underwater real estate.

Legal Disclaimer: The above article is for informational purposes only. Do not construe the information contained in this article as legal advice. Consult with an attorney before filing bankruptcy.  Should you require legal advice regarding bankruptcy, contact Mickler & Mickler by calling (904) 725-0822 or sending an email to bkmickler@planlaw.com .