Individual Bankruptcy, Generally
Pursuant to Title 11 of the United States Code, better known as the Bankruptcy Code, an individual debtor may generally pursue one of two options when filing for bankruptcy, Chapter 7 or 13. Chapter 7 is a complete "liquidation" proceeding. Under Chapter 7, the Code provides protection for the debtor and insures a fair distribution of the estate to the secured and unsecured creditors. Except for certain nondischargeable debts, a discharge of the debtor under Chapter 7 will release the debtor from any further personal liability for debts existing on the date of the bankruptcy.
A Chapter 13 bankruptcy, on the other hand, is a reorganization, whereby the debtor undertakes a repayment schedule, which is approved by the bankruptcy court. Upon completion of the repayment schedule, the debtor receives a discharge from all but a few personal debts, such as alimony, certain long-term debts and criminal restitution. See 11 U.S.C. § 1328(a).
Once a debtor files a bankruptcy petition under Chapter 7 or 13, the court appoints a trustee to represent "the estate" of the debtor's assets. In a Chapter 7 proceeding, the trustee is the party responsible for the liquidation of the estate, which includes the task of determining which of the debtor's assets are to be considered part of the estate.1 The trustee is also charged with distributing, selling or transferring property of the estate for purposes of providing funds for the debtor's creditors.
The Automatic Stay and Real Property of the Estate
Pursuant to 11 U.S.C. § 362, when an individual files for Chapter 7 or 13 bankruptcy, an automatic stay is imposed, which operates as an injunction to prohibit creditors from initiating or continuing collection efforts. The automatic stay is triggered by the filing of the bankruptcy petition and it dates from the time of the filing, not from the time that a creditor receives notice or learns of the bankruptcy. See 11 U.S.C. § 362(a)(3), (4), (5) and (7). Lawsuits, foreclosure actions, wage garnishment actions and even telephone calls to demand payment must be held in abeyance by the creditor. The automatic stay also prohibits the transfer of any real property considered to be property of the estate.
Property of the estate includes not only personal assets, but will also include a debtor's ownership, possessory, or lien interest in real estate, including an interest under a contract to purchase real estate, contingent remainder interest, equities of redemption and joint ownership of property. See 11 U.S.C. § 541. Although there are exceptions to the stay, provided for under 11 U.S.C. § 362(b), whereby certain actions are allowed to continue simultaneously with the bankruptcy, these exceptions are largely limited to criminal and domestic proceedings against the debtor and actions by governmental entities.
Absent a court order granting relief from the stay or an automatic termination under § 362(c)(1), the stay can last for an extended period of time while matters in controversy are negotiated or tried. Accordingly, attorneys representing creditors will often seek relief from the automatic stay. Under § 362(d), a lien creditor can motion the court for relief from the automatic stay if the creditor can show that the debtor has no equity in the encumbered property and the encumbered property is not necessary to an effective reorganization.
Effect of Bankruptcy on Real Property
Real property of the bankruptcy estate can be affected by or disposed of through a bankruptcy proceeding in these ways: it can be abandoned, be considered "exempt," the bankruptcy can result in a discharge, or be dismissed.
Pursuant to Section 554(a), property can be abandoned by the bankruptcy trustee after proper notice and hearing. Usually, property will be abandoned when it is burdensome to the trustee or the bankruptcy estate or where it is inconsequential. Property can also be abandoned upon a creditor's petition to the court. See 11 U.S.C. § 554(b). When abandonment takes place, the property is no longer considered part of the bankruptcy estate.
Although, through abandonment, the property is removed from the bankruptcy estate, all creditors remain subject to the bankruptcy laws and the automatic stay, which prohibit creditors from taking any action which is adverse to the debtor in bankruptcy. Therefore, a secured creditor who wishes to foreclose on abandoned property must first obtain relief from the court to proceed with foreclosure or other such adverse actions.
For title insurance purposes, an attorney faced with an abandoned property should carefully examine the procedures that were followed by the trustee or secured creditor to determine that all statutory requirements under the Code were met prior to the abandonment. In addition, the attorney must ascertain that all state statutory requirements for a foreclosure have been followed and that the creditors' appeal period has expired.
The Bankruptcy Code contains no explicit definition of the terms "exemption" or "exempt property." Under § 522(b) of the Code, the debtor has the right to "exempt from property of the estate" certain property such as or including a limited value interest in real property, an automobile, household goods and jewelry. In Chapter 7 cases, a debtor who exercises the right to exempt property from the estate, removes the property from the Chapter 7 liquidation and retains the property free and clear of unsecured creditors. See 11 U.S.C. § 522(c). In Chapter 13 cases, when a debtor exercises the right to exempt property, he must pay the value of the property into the Chapter 13 plan.
Real property which is not abandoned or exempted by the debtor may be sold by the Chapter 7 trustee pursuant to § 363 of the Code. Section 363 sets forth the rights and powers of the bankruptcy trustee in selling the debtor's property. When dealing with a Chapter 7 bankruptcy, the certifying attorney must be able to certify that there has been a court order approving the sale. In an approval situation, the certifying attorney should look for the following: (1) a trustee's notice of sale (20 days notice to all creditors and debtors); (2) an order of the court after a hearing approving the sale; (3) a trustee's deed; and (4) court approval of the sale free and clear of all liens.
In a Chapter 13 bankruptcy, the attorney must ascertain if the sale was prior to, in compliance with, or after the approval of the confirmation plan. In North Carolina, each of the districts have their own rules as to whether real property can be transferred in a Chapter 13 bankruptcy. The attorney must therefore determine whether the property was sold in compliance with that specific bankruptcy district's rules as to the sale of property in a Chapter 13 bankruptcy.
When asked to insure a sale arising from a § 363 proceeding, the title insurer is mainly concerned that the trustee has been granted the authority to proceed with the sale and that all notice requirements have been fully satisfied. The certifying attorney should examine and identify any conditions set forth in the motion to sell or court order. The title company may demand proof that the conditions have been satisfied. Generally, a motion to sell will require a court order for the trustee to sell the property free and clear of all liens and transfer the liens to the sale proceeds.
A title insurer will generally not provide affirmative coverage for real property which is considered part of the bankruptcy estate, without an order from the bankruptcy court granting relief from the automatic stay and releasing the real property from the bankruptcy estate. Real property examiners must, when the owner/seller of the property is in bankruptcy, inquire further into the appropriateness of such sale. The attorney may be required to certify that each sale made while an owner was in bankruptcy was conducted in accordance with the Bankruptcy Code.
A careful review of the court order abandoning the property from the estate, or the order granting relief from the stay or the order dismissing bankruptcy, should provide an attorney with information sufficient to allow the attorney to certify title.
The transferring of real property within a bankruptcy proceeding is highly regulated by the courts in order to protect both the debtor and creditors. Any procedural mistakes in the sale of the real property will only further cloud the real property title. Therefore, for purposes of title insurance, the certifying attorney must be able to certify that all bankruptcy procedures have been fully satisfied. Anything less will most likely cause the title insurer to take exceptions on the policy.
1 Note that the estate not only consists of that property which the debtor owns at the time of the filing of the bankruptcy petition, but can also include property which was fraudulently conveyed prior to the bankruptcy.