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BANKRUPTCY DISCHARGE AND

VIEWS: 26 PAGES: 19

									Southern Title Insurance Corporation                                                          August 13, 2008



          Bankruptcy and Its Effects on Title and Closing Real Estate Transactions

Background:

The occasional complete or partial forgiveness of debt is incorporated in many religious
beliefs and doctrines. Some states even adopted laws that allowed for forgiveness of
debts under certain limited circumstances. However, those early state laws are now
superseded by federal law – the U.S. Bankruptcy Code (“Code”). The Code has been
amended several times. Most recently, the Bankruptcy Abuse Prevention and Consumer
Protection Act of 2005 (Public Law 109-8, 119 Stat. 23, enacted 2005-04-20), attempted
to make it more difficult for consumers to discharge debt under Chapter 7 and force them
to use Chapter 13 instead.

Scope and Focus of Paper:

This paper presents an overview of the topic of bankruptcy and its affects on the status of
title and the closing of real estate transactions. It is not a complete treatise on bankruptcy
and should not be used by anyone to determine whether or not filing bankruptcy is
appropriate in any circumstance.

Overview of Most Common Types of Bankruptcies:

The Code provides for multiple types of bankruptcies depending upon the nature and
circumstances of the individual(s) or entity involved.1 Bankruptcy can be voluntary or, in
Chapter 7 or 11 cases, involuntary when initially sought by a creditor. This paper
addresses only those bankruptcies filed under Chapter 7 (under which most debts are
forgiven [or discharged]), Chapter 11 (reorganization), Chapter 12 (for farmers and
fishermen), and Chapter 13 (under which debts are repaid under a plan). Each is different
from the other in some ways and the differences for the most part determine what a title
professional needs to deal with each one.

Chapter 7 - Liquidations

Individuals, partnerships, and corporations are eligible to file a Chapter 7 petition.
Railroads, insurance companies, and some banking or financial institutions are not
eligible for Chapter 7 bankruptcies.

If a trustee is not elected at the first meeting of creditors, then the interim trustee shall
serve as trustee in the case.

The court may authorize a trustee to operate a business of the debtor for a limited time.
In that circumstance, the Trustee usually has the power of sale, the power to purchase,
and the power to finance or refinance existing loans.


1
  Chapter 9 Bankruptcy is for certain municipalities that are unable to pay their debts. Call underwriting if
you are dealing with property owned by a municipality in bankruptcy.


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Chapter 11 - Reorganization

Individuals, partnerships, or corporations (including a railroad) which are eligible to file a
Chapter 7 proceeding also are eligible to file a Chapter 11 petition. In this proceeding, the
court may appoint a trustee or may allow the debtor to “remain in possession” (called a
“debtor in possession”).

Subject to court limitations, the debtor in possession has all of the powers and duties of a
trustee to manage, collect, and protect of the estate. However, the court may appoint a
trustee for cause, including fraud or current mismanagement by the debtor.

The United States Trustee (or court where applicable) shall appoint a committee of
creditors holding unsecured claims (claims where there is no existing lien against real
and/or personal property). On request of an interested party, the United States Trustee (or
court) may appoint additional creditors‟ committees. The creditors‟ committee generally
consists of creditors with the seven largest claims of the kind represented on the
committee.

The debtor may file a plan with the petition or at any time. Any party in interest,
including creditors or a trustee, may file a plan at any time if a trustee is appointed; or
subsequent to one hundred twenty days after the order for relief if the debtor does not file
a plan within that time.

The court may confirm a plan only after notice and an opportunity for objection, and after
an actual hearing.

Chapter 13 - Adjustment of Debts of an Individual with Regular Income

Only an individual with regular income, or that individual and his spouse, who owe non-
contingent, liquidated, unsecured debts totaling less than $100,000, and non-contingent,
liquidated, secured debts totaling less than $350,000 may file a Chapter 13 petition.

The United States Trustee (or court) shall appoint one or more persons to serve as a
standing trustee in Chapter 13 proceedings (if the number of cases justifies it). If there is
a qualified standing trustee, that person shall serve as trustee in the case. Otherwise, the
United States Trustee (or court) shall appoint a trustee in the case.

Unless otherwise provided, the confirmation of a plan vests the property of the estate in
the debtor. However, the confirmation and plan alone will not invalidate a pre-existing
lien unless the lienholder consents. A separate adversary proceeding must be brought to
invalidate liens.

After the plan payments have been completed, the debtor shall be granted a discharge of
his debts, including claims based upon fraud or defalcation, but excluding debts for




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support, alimony, or maintenance of a child or spouse and debts for which future
payments will remain due under the terms of the plan.

If the payments are not completed as provided in the plan, then the debtor may be granted
a discharge from all dischargeable debts except long-term debts by the court after the
required “notice and a hearing”.

What Effect Does a Discharge in Bankruptcy Have on Recorded Liens?

Going all the way back to Long v. Bullard, 117 U.S. 617 (1886), the rule is that liens, on
non-exempt property as well as on exempt property, not avoided in bankruptcy, survive
bankruptcy. The debt may be discharged, but the lien IS NOT – except in a state where
state law provides otherwise. The lien and the debt are not the same thing. The discharge
in bankruptcy does extinguish the personal obligation of the debtor to the creditors, but
not the liens already of record against the property absent contrary state law. Unless the
property is sold "free and clear" of liens by Bankruptcy Court Order, those valid liens and
judgments remain attached to property sold either by a trustee or by a debtor in
possession.

The filing of bankruptcy by someone in your chain of title, and the final discharge of that
person, only relieves the owner of personal liability associated with a judgment, deed of
trust or mortgage. The property remains encumbered by the judgment, deed of trust or
mortgage and must be handled as if no bankruptcy had ever been filed. There is one
general exception to this rule:

             a sale during the pendency of bankruptcy that has complied with the proper
              procedures for a „sale free and clear of liens‟ will allow the filed judgment,
              deed of trust or mortgage to be ignored. However, this type of sale involves
              special filing and notice procedures along with rights of appeal for the
              affected lien creditors. Our underwriting department will help you determine
              if the sale meets all the necessary requirements to fall within the exception.

Commencement of Bankruptcy Proceedings

Voluntary Proceedings - A voluntary proceeding is commenced by the filing of the
petition. The commencement constitutes an order for relief.

Joint Case - A joint case is commenced by the filing of a single petition by both spouses.

Involuntary Proceeding - An involuntary proceeding may be commenced only under
Chapter 7 (liquidations) or under Chapter 11 (reorganization). It may be commenced on
the petition of:

         (a) three or more entities with non-contingent, unsecured claims totaling at least
         $5,000; (b) one or more holders of claims whose claims total at least $5,000 if
         there are fewer than twelve holders; or (c) fewer than all general partners of the



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         partnership in question, or any general partner or holder of a claim or the trustee if
         all general partners are debtors for whom an order for relief has been granted.

The debtor in an involuntary case retains control and possession of all property unless the
court orders otherwise, or until an order of relief (that the bankruptcy case proceed) is
granted, or until the interim trustee is appointed. So, if the debtor in an involuntary case
is offering to sell property before the order of relief is granted, we require a copy of the
notification of the proposed sale, certification by the party mailing the notice that notice
of the proposed sale was sent to all interested parties, and a final order of the bankruptcy
court authorizing the sale.

Conversion to Different Chapter - Conversion of a case to a proceeding under a different
chapter constitutes an order for relief. However, conversion terminates the services of a
trustee or examiner appointed before the date of conversion. Court orders lifting stays,
approving stipulations, rejecting executory contracts and other matters are not negated by
an order of conversion. Consequently, if a sale or loan has not been consummated prior
to the conversion of a case to a different chapter, the procedure for the transaction must
be reinitiated: A new entity controls the estate and that entity must comply with the
procedures for sale, loans and other matters.

Trustee or Debtor in Possession?

In a Chapter 7 proceeding, a trustee is in charge of the estate.

In a Chapter 11 proceeding, a debtor in possession generally controls and manages the
estate and sells the property. However, it is possible that a trustee may be appointed.
Therefore, you must review the docket sheet to verify whether the debtor controls the
estate as a “debtor in possession” or whether a trustee has been appointed. If the debtor
in possession is selling, verify that the debtor retains authority to sell property. It is
possible that the debtor may be deprived of his or her authority or may have his or her
power to sell specifically limited by the court.

In a Chapter 12 proceeding, the debtor is usually a debtor in possession, with the power
to sell property in accordance with the procedures of Section 363. The debtor‟s authority
may be limited by the court or the debtor may be “removed” as a debtor in possession. In
that event, the trustee manages the estate. Therefore, you must review the docket to
verify that the Chapter 12 debtor has had no limits placed on the debtor‟s power. If a sale
is made free and clear of liens under section 1206 of the code, the trustee must join with
the debtor on the deed and also be authorized to sell.

In a Chapter 13 proceeding, a trustee is appointed for the estate of a debtor. However, the
debtor is the party empowered (subject to the requirements of “notice and hearing”) to
sell property of the estate not in the ordinary course of business or free and clear of a lien
or interest of another party.




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Qualification of the Trustee - A person qualifies as trustee, after appointment, by filing a
bond in favor of the United States, subject to United States trustee (or court) approval of
the surety and amount on the bond.

Initial Meeting of Creditors - There shall be a meeting of creditors after appropriate
notice, within a reasonable time after the order for relief.

Subsequent death or insanity of debtor - Once the estate is created, no interests in
property of the estate remain in the debtor. Therefore, if the debtor dies or becomes
insane after the commencement of the case, then only exempt property, abandoned
property, or certain property acquired by the debtor after the case began will be subject to
control and administration by the debtor‟s personal representative. The bankruptcy
proceeding will continue in rem as to the bankruptcy estate property.

Reopening cases - A case may be reopened in the same court to administer previously un-
administered assets or for other causes as necessary.

Finality of Orders Relied Upon - You should be satisfied that the order in the bankruptcy
court on which you are relying is not being contested and that the order is final. This can
be verified by letter from counsel, review of the file and docket sheet, or a clerk‟s
certificate as to finality (after 10 days following entry of an order of sale, mortgage, lease
or confirmation; after 30 days on other orders).

Appeals from the appellate panel or district court are made to the circuit court of appeals.
Appeal from a district court to a court of appeals must be made by filing a notice of
appeal within 30 days after date of entry of the judgment or order appealed from.

Even if an order is final, it may be set aside (generally, subject to a one-year time
limitation) if there is an extreme case of abuse of discretion, fraud, mistake, or gross
inadequacy of the original sales price in comparison to a later substantially higher sales
price.

What is the Bankruptcy Estate?

Land of the Debtor - Upon the filing of a bankruptcy, an estate is created. The estate
includes all land owned by the debtor or in which the debtor has an interest (subject to
exempt property and abandoned property exceptions).

Partnership Property - The partnership and a partner are treated as separate entities and
their interests are separate.

             If a partnership owns property, then the filing of a bankruptcy by an individual
              partner does not vest the partnership property in the estate. However, if a
              partnership is the record owner, you should secure joinder of or consent by the
              debtor-partner (or trustee) to the sale pursuant to a final court order or after
              notice to all interested parties of the estate.



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             The bankruptcy estate of a partner consists only of the partner‟s personal
              property interest in the partnership. Thus, the automatic stay does not prevent
              foreclosure of a lien against the partnership property merely because a partner
              files a bankruptcy.

             Foreclosure on partnership assets is not stayed by a bankruptcy of a partner.

             Unfortunately, it is not clear if a debtor in possession succeeds to management
              authority formerly held as a general partner. It does appears that a trustee
              cannot assume management powers, but since we are concerned about the
              trustee‟s scrutiny of any transaction, we require trustee consent to sales.

Interests in Contracts and Leases - The interest of the debtor in a lease or contract (as
lessor, lessee, purchaser, or seller) vests in the estate upon the filing of the bankruptcy.
Therefore, in order to insure a purchase money mortgage (and/or issue an owner policy to
a purchaser) on the closing of the contract if the debtor enters a contract to purchase
property before the bankruptcy commences and if the property is not yet abandoned or re-
vested in the debtor (pursuant to a confirmed plan), you must require a court order
authorizing the completion of the contract and execution of the mortgage. And, you must
except to the effect of the automatic stay on foreclosure of the purchase money mortgage
being insured.

Trustee and Trusts - If the debtor has title to property as a trustee (of a private trust), the
bankruptcy estate will succeed to the property (subject to the interests of the
beneficiaries). The estate cannot exercise the fiduciary powers of the trustee of a private
trust. There-fore, you must require the abandonment of the property or joinder of the
trustee or debtor in possession in the bankruptcy proceeding, and joinder of all other
necessary parties in accordance with the trust documents.

Community Property - If only one of the spouses files a bankruptcy petition and that
debtor-spouse owns community property, then the community property under the sole or
joint management of the debtor and other community property which is liable for claims
against the debtor (to the extent of liability) are part of the estate. The non-debtor spouse
has a right of first refusal to buy that property. The separate property of the non-debtor-
spouse and the community property under the sole management of the non-debtor (where
there are no claims against the debtor which could extent to that property) shall not be
subject to the bankruptcy proceeding. However, our company policy is that if a non-
debtor spouse is conveying community property held only in that person‟s name, secure
joinder by the bankruptcy estate. If the debtor (or trustee) is offering to sell nonexempt
community property of the debtor, require joinder of the non-debtor spouse. If joinder by
the non-debtor spouse is not possible, you must be satisfied that the property was under
the sole management (where state law provides) of the debtor and that the non-debtor
spouse is not exercising the right of first refusal (such as by calling or notifying the
spouse of the scheduled closing and by verifying that spouse makes no tender in the
bankruptcy).



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After-acquired Interests –

             Any property acquired by the debtor by gift, devise, or inheritance, or as a
              result of a property settlement agreement in a divorce within 180 days after
              the filing of the bankruptcy shall become property of the estate. The debtor
              cannot avoid this provision by disclaiming or renouncing a bequest or devise.
             Any property acquired during the bankruptcy as proceeds of property of the
              estate (e.g., distribution of corporate assets if stock is owned by estate) shall
              become property of the estate.
             Contingent or vested remainder interests owned by the debtor at
              commencement of the case are property of the estate.
             Property that a debtor in a Chapter 12 or Chapter 13 proceeding acquires after
              the commencement of the case and before the closing or conversion
              (including earnings) becomes property of the estate (until re-vested in the
              debtor in accordance with the confirmation and plan if the plan or order does
              not provide otherwise).

We will not require court orders on purchase money mortgages executed on property
acquired by the debtor by contract entered after the confirmation of a Chapter 12 or
Chapter 13 plan, or after the commencement of a Chapter 7 or Chapter 11 proceeding.

If a debtor acquires property and executes a purchase money mortgage in a Chapter 12 or
Chapter 13 proceeding before the plan is confirmed, then the court should approve the
transaction (since this property is arguably property of the estate), and any mortgagee‟s
policy should be issued subject to the effect of the automatic stay in the bankruptcy
proceeding (which extends to all property of the estate). If the debtor enters a contract
after the commencement of a Chapter 12 or Chapter 13 proceeding and before the plan is
confirmed and thereafter executes a purchase money mortgage after the plan is
confirmed, you must review the plan to verify that the property is re-vested in the debtor
in order to insure the purchase money mortgage.

If it is clear that the mortgagor is the debtor, a disclosure of a pending bankruptcy should
be made to the lender in any case where the debtor is acquiring property.

Unscheduled Property - The property of the debtor vests in the estate and is subject to the
bankruptcy proceeding regardless of whether it is listed on the schedules and regardless
of whether schedules are actually filed. If the property is not scheduled, the case is
closed, and the property is not otherwise administered or abandoned, then it remains
subject to the jurisdiction of the bankruptcy court. It is possible to have the case
reopened to administer or abandon the property.

Therefore, you should seek a court order reopening administration of the property and
authorizing sale or abandonment of the property, after notice to interested parties if (1)
the property was acquired by the debtor before the proceeding was filed or was otherwise




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Southern Title Insurance Corporation                                              August 13, 2008



part of the estate of the debtor and (2) the case has been closed, and (3) the property was
not formally abandoned or dealt with and (4) the property was not scheduled.

Escrowed Funds - If the debtor has placed funds in escrow prior to the filing of a
bankruptcy in order to satisfy certain claims at a later date, there is a possibility that the
estate will be able to claim the funds by turnover order. Consult with our legal staff
before accepting indemnities and related escrows of funds to secure the indemnities.

Sale of Property

Abandoned Property - If property has been properly abandoned by the estate, then you
can secure a deed from the debtor (with any necessary corporate resolutions) without any
need for a motion, notice, or order of sale. If the debtor is selling the abandoned property
while the bankruptcy is pending and is to receive cash proceeds (in excess of lien payoffs
and closing costs), you should require joinder by the trustee (after notice), or notice to the
estate creditors (if the debtor is a debtor in possession). The abandonment may otherwise
be attacked.

Exempt Property - Rule 4003 specifies a 30-day limit after conclusion of the creditor‟s
meetings to file objections to the scheduling of property as exempt. If no objections are
made and if the time to object is not extended, the property (or equity) which is scheduled
as exempt is not property of the estate.

             If property has been fully exempted (not simply an equity interest) and set
              aside to the debtor, you can rely upon the evidence (schedule as exemption
              without objection for 30 days after meeting of creditors is adjourned) that it is
              exempted and you may insure a deed from the debtor without further court
              order.

             If only an equity interest is exempted (e.g., portion of gross value), then you
              should require that the remaining interest be abandoned. If only an equity
              interest is exempted and the remaining interest is abandoned, you may not
              insure the sale if the net proceeds to the debtor exceed the equity exemption.

             Exempted property may not be sold by the trustee. If the trustee is offering to
              sell property in connection with the estate of an individual debtor, you should
              verify that the property is not scheduled as exempt.

             If a debtor in a Chapter 12 proceeding schedules farmland as exempt, you
              should require that a sale with notice to interested parties be made. The
              farmland is essential to the plan in most cases.




Procedure on Sale of Property in the Estate



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The trustee will sell property of the estate in a Chapter 7 proceeding or, if he is qualified
and has been appointed, in a Chapter 11 proceeding. A debtor in possession in a Chapter
11 proceeding will sell property of the estate, subject to any limitations set by court order.
The debtor in possession will sell property of the estate in a Chapter 12 proceeding,
subject to any limitations by court order, and subject to joinder by the trustee on sales
free and clear of liens pursuant to Section 1206. The debtor will sell property other than
in the ordinary course of business in a Chapter 13 proceeding.

Ordinary Course of Business - The debtor in a Chapter 13 proceeding, the debtor in
possession subject to any court limitations in a Chapter 12 proceeding, the trustee in a
Chapter 7 proceeding if authorized, and the debtor in possession (or trustee if appointed)-
-subject to any court limitations in a Chapter 11 proceeding--can sell real property in the
ordinary course of business without notice or court order. You will see this when a
builder or developer is in bankruptcy.

However, it is very unusual to have an ordinary course of business sale of real estate in a
Chapter 12 or Chapter 13 proceeding. Please contact underwriting counsel in this case.

Not Ordinary Course of Business - Most real estate sales will not be in the ordinary
course of business. Some may be sales where property is sold free and clear of liens.
Sometimes, there are other co-tenants. There may be an adverse claim or claim to an
equitable interest in the property, perhaps reflected by a suit and lis pendens. The trustee
in a Chapter 7 proceeding, debtor in possession (or trustee if appointed) in a Chapter 11
proceeding subject to any court limitation, debtor in possession in a Chapter 12
proceeding subject to any court limitations, and the debtor in a Chapter 13 proceeding
may sell real estate other than in the ordinary course of business.

Such sales must be “after notice and a hearing” which means that the trustee or debtor is
to give notice in accordance with the Bankruptcy Rules and that no actual hearing or
order is needed unless there is an objection and request for hearing. However, if the sale
is made free and clear of liens, a hearing must be held.

When “notice and a hearing” is required, then the court may refuse to sign a “comfort
order” (an Order . In that case, a suitable procedure exists whereby a clerk‟s certificate
for recording purposes may be obtained, which certifies that no objections or requests for
hearing were filed.

The trustee or debtor is not required to file an adversary proceeding--which is time-
consuming and requires or allows answer by a third party after service--except where the
interest of a co-owner (such as a tenant by the entireties, joint tenant or tenant in
common, all if the land is not exempt) is also being sold. In that case, an adversary
proceeding must be filed against the co-owner and we require:

             Proof of personal service on the co-owner
             A specific final order requiring and determining necessity of partition by sale



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             A separate notice to interested parties of proposed sale
             A separate motion to sell and a separate order of sale should also be secured
              or in the alternative, the complaint and notice of sale to all interested parties
              should be combined in the adversary proceeding

Remember, the right to sell free and clear of other interests does not allow the estate of a
partner to sell partnership assets.

The trustee or debtor must, in a sale not in the ordinary course of business, give notice of
the proposed sale which reflects the terms and conditions of the sale and the time fixed
for filing objections. In lieu of the notice, the trustee or debtor may send a copy of the
actual motion in accordance with local rules. The trustee or debtor must give notice of
the proposed sale (in accordance with the local rules) of not less than 20 days by mail to
interested parties unless the court shortens the time for notice. The court also may order
that the notices be mailed only to committees and to interested parties filing a request for
notices. However, the court may not dispense entirely with notice on a sale not in the
ordinary course of business.

The debtor can sell all or substantially all of the assets of the estate under Section 363(b)
if there are specifically articulated business reasons. The notice to parties in interest
should disclose that the sale will terminate the business, the terms of sale, name of buyer,
why the price is reasonable, and why a sale before confirmation is in the best interest of
the estate. The court should also consider the good faith of the buyer.

Sale Free and Clear of Liens - To sell free and clear of liens the sale must have
reasonable promise of realizing excess value over the existing liens. At best this “rule” is
ambiguous; it can be argued that the “value” or amount of the liens cannot exceed the
value of the property. Notice of a sale free and clear of liens must be given in accordance
with Rule 9014. For example, to sell free of an IRS lien, notice must be given to the
United States Attorney for the district where the action is brought, to the Attorney
General, and to the IRS. Yes, those liens as to which a sale can lawfully be made free
and clear include even federal tax liens.

If a lien creditor fails to object to the sale after notice, it may be deemed to “consent” to a
sale free and clear of liens under Section 363(f).

Although Rule 6004 requires a hearing on a sale free and clear of liens, our opinion is
that no hearing is required in the absence of a filed objection to the sale.

Notice of a proposed sale is presumed received if mailed to the correct address. However,
the presumption of receipt of properly mailed notice may be overcome by testimony of
non-receipt combined with standardized procedures of processing mail.

If a not-in-the-ordinary-course-of-business sale is not made free and clear of liens, then
we will require only a certified copy of the notice of sale, a recordable certificate
evidencing notice to all interested parties, and a bankruptcy court clerk‟s certificate or



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certificate of attorney of the debtor that no objection or request for hearing has been filed
on or before the date of the certificate (which should be dated at least 21 days after notice
of the proposed sale, subject to any reasonable order shortening notice).

However, if the sale involves all or substantially all of the assets of the estate in a Chapter
7, 11 or 12 proceeding, require the notice of sale and a certificate of service and a final
court order approving the transfer.

If the sale is to be made free and clear of liens, we will require:

             the notice by the trustee or debtor in possession and order specifically
              describing the liens as to which the sale is free and clear;

             recitation in the order that the lien(s) (which must be specifically described)
              attach(es) to the proceeds;

             evidence that the lienholder received notice (for example by return receipt, or
              by appearance of the creditor at the hearing, or by conference with the
              creditor);

             there must be a recited justification under Section 363(f) in the court order to
              allow the sale free and clear except in a Chapter 12 proceeding where the
              trustee joins pursuant to court order. For example, search for a recitation that
              the lien is in dispute (of so, the dispute must be specified) or that the
              lienholder consents, or that the sales price exceeds (the value of) all liens or
              verify that the sales is only a portion of land covered by the lien;

             there must be a court order authorizing the sale and it must be final as
              evidenced by a clerk‟s or attorney‟s certificate;

             the liens as to which the sale is free and clear cannot be ad valorem tax liens,
              or hazardous waste clean-up liens, or other governmental assessments or
              charges (unless you secure home office approval);

             the sale must not be made to a party related to the debtor; and

             the property may not have been scheduled as exempt.

             Note: the lien creditor may bid at the sale (and offset its debt) unless the court
              orders otherwise.

Generally, the sale becomes final and cannot be reversed on appeal if an order confirming
the sale has been entered and if a stay of the sale is not obtained. However, an appeal is
not moot due to the lack of a stay unless the trial court had found that the purchaser acted
in “good faith” or paid “value”. The good faith rule also will not protect a third party if
there was denial of procedural due process due to failure to give notice to unsecured



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creditors. So, you should never close on a transaction where there is a contest and
pending appeal of the sale since the issue of “good faith” could be litigated. You can
verify the order is final or is not being contested by discussing this issue with the
attorneys in the transaction, and by reviewing the file, and by securing a clerk‟s or
attorney‟s certificate as to the finality of the order.

Sale of Community Property or a Sale Free of a Co-owner’s Interest - When such as
sale, or one free of dower or curtesy or homestead rights occurs, the debtor‟s non-debtor
spouse (provided there is no joint filing) and any co-owner have a right of first refusal.
Therefore, you should always verify that the right of first refusal of the non-debtor-
spouse was not exercised by reviewing the bankruptcy for notice of any exercise of first
refusal, getting a clerk‟s certificate, getting a letter from the attorney, contacting the co-
owner or spouse if possible and/or getting an affidavit from the debtor or trustee.

Sales in an Involuntary Case - In an involuntary case, the debtor may continue to operate
the business and use, acquire, or legally dispose of property as if the involuntary case had
not been filed unless the court orders otherwise and until an order for relief is granted.
However, because of our concern over possible fraudulent conveyances, we require a
final order of the bankruptcy court authorizing a sale after an involuntary proceeding is
commenced and before the order for relief is granted.

Procedure on Liens Executed By Estate

The debtor or trustee can obtain credit and execute a mortgage or lien on property which
is either an inferior mortgage or a new mortgage prior to any outstanding liens after
notice and a hearing. In order to secure first lien financing on encumbered land, the
debtor must establish that:

    1. the prior lender whose lien is subordinated to the new financing is adequately
       protected and

    2. the debtor has made every effort to seek financial assistance by other means.

Adequate protection of the prior lender may be shown by an equity cushion, a third party
guaranty, or substitute collateral. Not every available lending institution need be
contacted but several attempts apparently must be made to establish unavailability of
other financing. The court cannot dispense with notice; some notice and opportunity for
hearing must be furnished.

Therefore, you should have in your file a certified copy of the notice and motion,
certificate of service and evidence of receipt of notice (by contacting the parties or by
return receipt) by the creditors secured by current liens on the property if the new lien is
to have priority over them. The order from the bankruptcy court must be final. It must
authorize the execution of the mortgage, and contain specific provision for adequate
protection of the current lien-holders (due to other collateral, or pay-down of loan) the
new lien is to have priority over them. The lien must secure only new advances and will



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Southern Title Insurance Corporation                                           August 13, 2008



not be insurable to the extent it is to have priority over tax liens or government
assessments.

Abandonment of Property

The trustee, or the debtor in possession (under Chapter 11 or Chapter 12) may abandon
property after giving notice to all interested parties of the proposed abandonment. All
interested parties, not simply the secured party, must be notified of the proposed
abandonment. An objection must be filed within 15 days of the mailing of the notice or
within the time fixed by the court. If objection is made by a party in interest to the
proposed abandonment of the property, the court shall set a hearing and an order shall be
entered; otherwise, no order is necessary. Any other interested party may move that
property be abandoned, but must secure an order compelling the trustee or debtor to
abandon.

Consequently, if a motion or notice is filed by the debtor in possession or trustee, then
you should be furnished a certified copy of the notice of intent to abandon, a certificate
that all interested parties were notified, and a clerk‟s certificate, review of file, or
attorney‟s letter evidencing that no objections or requests for hearing were filed within 15
days after notice. However, if any other party files a motion to abandon property, an
order is required under rule 6007 and section 554. In that case, also secure a certified
copy of the motion, certificate of service, order of abandonment, and clerk‟s certificate or
other evidence that no notice of appeal or motion extending time for appeal was filed
within 30 days after entry of the order.

If property is scheduled but is not administered before the case is closed, then it is
deemed abandoned upon the closing of the case. Remember, the case is not closed
simply by the filing of a no asset report of the Trustee; the case is closed when the court
enters an order closing the estate. If property is not scheduled or specifically abandoned
and is not administered in the case, then it is not abandoned by the closing of the case.
Instead, it remains subject to the estate.

Any abandonment by the Trustee may be reversed if information concerning the property
value was not properly disclosed so that the Trustee could make an informed decision.
But without unusual and compelling circumstances, or a particularly egregious fact
situation, the court should not vacate the abandonment.

Curiously, the abandonment of property does not lift the stay prohibiting an action
against the property of the debtor.

Exempt Property

Federal And State Exemptions - Debtors are given the choice of using state exemptions
or, if the state does not prohibit federal exemptions, federal exemptions of $7500 (plus
wildcard of $400) of equity. Joint debtors must choose only state or federal exemptions.
If they cannot agree, they will be deemed to have chosen the federal exemptions if the



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Southern Title Insurance Corporation                                             August 13, 2008



state has not opted out. There is conflict as to whether spouses in a joint filing can
separately claim the exemptions of state law or are entitled only to one set of exemptions.

Some state‟s laws explicitly prohibit election to select the federal exemptions. They are:
Alabama, Alaska, Arizona, Arkansas, California, Colorado, Delaware, Florida, Georgia,
Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine, Maryland, Missouri,
Montana, Nebraska, Nevada, New Hampshire, New York, North Carolina, North Dakota,
Ohio, Oklahoma, Oregon, South Carolina, South Dakota, Tennessee, Utah, Virginia,
West Virginia, and Wyoming.

Proceeds Selection - If the comparable state exemptions apply only to an equity interest
or value or if the federal exemption is used, then the encumbered portion of the property
(being that portion equal to the secured debt) remains subject to the bankruptcy until
abandoned or until the case is closed. That interest will not be exempted merely by
approval of the exemptions or by court order setting aside the exemptions. Therefore, if
an equity interest is scheduled as exempt, verify the exemptions are applicable due to
lack of objections more than 30 days after conclusion of creditor‟s meeting by clerk‟s
certificate, attorney‟s letter, or file review. Also require the trustee to abandon the
encumbered portion of the property by notice, secure a certificate of notice to all
interested parties, and require a certificate that no objection was made within 15 days. If
only an equity is exempted and the remaining interest is abandoned, you may not insure
the sale if the net proceeds to debtor exceed the equity exemption.

Exempt Property Procedure - The debtor shall list the property claimed as exempt on the
schedules. An amendment of the schedules to revise the claimed exemptions may be
filed at any time before the case is closed, unless delay in doing so causes prejudice. The
exemptions are deemed allowed without court order. Creditors may object within 30
days of the amendment. The trustee or creditor may file objection to the property
claimed exempt within 30 days after the meeting of creditors concludes (which meeting
may be adjourned and extended) or within 30 days of the filing of any amendment to the
scheduled exemptions unless the court within the 30 day period grants further time. An
objection can be evidenced by assertions in a complaint in an adversary proceeding or by
a motion to lift stay filed within the time for objections. A creditor may not be bound by
the 30-day limit if the schedule is not made in good faith or if the exemption has no legal
basis.

You should obtain a certified copy of the listed exemptions together with verification of
passage of 30 days beyond the meeting for creditors as adjourned with no objection
having been filed. Verification can be reflected by a clerk‟s certificate, attorney‟s letter,
or file review. Unless a party in interest objects, the property or equity interest claimed is
exempted. If an equity interest is exempted the remaining interest of the estate should be
abandoned or sold by the trustee or debtor in possession. You should be satisfied that the
claimed exemption does not exceed the maximum allowable by the applicable federal
exemption or by applicable state law before relying upon a sale of the land by the debtor.




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Southern Title Insurance Corporation                                            August 13, 2008



Chapters 12 And Chapter 13 Exemptions - If the property is scheduled as exempt and
time for objections has passed, you should verify that the proposed (or confirmed) plan, if
any, filed does not treat the property inconsistently by providing that it is to be conveyed
to a creditor, to remain part of the estate, or to be sold to pay debts after notice.

Judicial Liens on Exempt Property - Under Section 522(f), a debtor may avoid a judicial
lien on his exempt property to the extent the lien impairs his exemption. In every case
involving lien avoidance, we will require a final court order. The court cannot dispense
with notice. The order is not final until 30 days after entry. Finality should be evidenced
by a certificate of the clerk or counsel. Do not rely merely on the scheduling of property
as exempt (without objection) as determinative of whether a judgment lien attaches to the
land. Note: This section cannot be used as to a judicial lien attaching before the
enactment date of the Bankruptcy Code of 1978 (November 6, 1978).

However, a dismissal under Section 349 reinstates any judicial lien avoided under section
522(f). Therefore, a lien avoidance order generally should not be relied upon unless the
discharge has been granted in Chapter 7, 12, or 13, or unless the plan is completed in a
Chapter 11 or unless the order recites that, in accordance with state law, the lien never
attached to the property.

Avoiding Powers

Party Bringing Avoidance Actions - Such actions normally are brought by the trustee or
by a debtor in possession under Chapter 11 or Chapter 12. Any avoidance action is an
adversary proceeding under Rule 7001 et seq.. The trustee cannot avoid the lien simply
by noting his “intent” to avoid it by reference in the proposed plan and disclosure. You
should not rely on an avoidance proceeding (sections 544, 545, 547, 548, 549) as to
exempt property being sold unless the discharge has been granted or denied in Chapter 7,
12, or 13, or until the Chapter 11 plan is completed.

If nonexempt property is being sold where a lien was avoided and the discharge is not yet
granted (in Chapter 7, 12 or 13) or plan (Chapter 11) is not completed, you should require
a sale free and clear of the previously avoided interest. Any sale free and clear of the lien
must be made pursuant to the procedural requirements for sale. The sale order must
provide that it is made free of the lien (with adequate verification that the lender received
notice of the proposed sale).

Powers As Purchaser or Creditor - The trustee or debtor in possession is treated as a
bona fide purchaser and lien creditor in order to set aside various transfers; thus, the
trustee can set aside unrecorded liens, deeds, contracts, and suits for which no lis pendens
has been filed. These suits or transactions are not void but are simply voidable in an
adversary proceeding. Therefore, it is extremely important to file all documents quickly.

Statutory Liens - Certain statutory liens may be avoided under Section 545 of the
Bankruptcy Code. However, mechanic‟s liens cannot be set aside if they relate back to a
time prior to the filing of the bankruptcy even though they are recorded after the



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Southern Title Insurance Corporation                                             August 13, 2008



bankruptcy. Judgment liens are not avoidable under Section 545 (but may be voidable
preferences).

Statutory governmental liens which are not perfected by filing a notice in the property
records may be avoided under Section 545(2).

Limitations on Avoidance - Under Section 546, actions to set aside transfers or liens
under Section 544, 545, 547, 548, or 553 must be commenced within two years after
appointment of the trustee or before the case is closed or dismissed, whichever is earlier.
According to one view, the two-year period runs from appointment of the first permanent
trustee, regardless of whether a successor is thereafter appointed. The limitation period
may be irrelevant if the lien is avoided pursuant to Section 506 because it is a preference,
fraudulent transfer or other voidable transfer.

However, if a cause of action for avoidance exists under state law, longer state time limits
(for example, fraudulent conveyances) will control. Indeed there may be no time limit if
an applicable creditor is a governmental unit. Time limits of this Section do not apply to
debtors in possession. Even if the time limit has passed to set aside a voidable lien or
other transfer, the court may reject the claim and merely void the lien or other transfer.

An action under Section 549 to recover a post-petition transfer by a debtor is governed by
a two year limit after the transfer, regardless of whether there is a trustee and regardless
of whether the Bankruptcy is converted to a different chapter. Confirmation of a plan
does not bar a subsequent avoidance action, particularly where the possibility of action
was disclosed in the Disclosure Statement and Plan.

Preferences - A preference occurs where a transfer was made when the debtor was
insolvent and where the transfer is made for or on the account of an antecedent debt (such
as a deed in lieu of foreclosure). The transfer must be made within 90 days of the
bankruptcy. If the recipient of the deed or transfer is an insider (such as a partner), the
transfer must occur within one year of the bankruptcy. Where the debtor pays or satisfies
debt which is guaranteed by an insider third party (e.g., stockholder), the payment of debt
may be a transfer benefiting an insider of the debtor. In that event, the transfer to satisfy
the debt may be voidable as a preference if a bankruptcy is filed within a year (e.g., after
a deed in lieu of foreclosure). The preference must enable the recipient to receive more
than it could in a Chapter 7 liquidation proceeding. Insolvency is presumed within 90
days of the bankruptcy.

A judgment lien could be a voidable preference. A foreclosure sale may be an avoidable
preference if occurring within 90 days of the debtor‟s bankruptcy (or within one year if
the lender is an insider or if a guarantor of the debtor is an insider of debtor) if the bidder
receives property valued in excess of the amount bid. A bid in excess of 70% of fair
market value may still be a voidable preference. A deed in cancellation of existing
indebtedness may constitute a voidable preference. A substitution of collateral is not a
voidable preference, at least where the value of the collateral is approximately the same.




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Southern Title Insurance Corporation                                            August 13, 2008



A voidable preference has not occurred if the creditor receives no more than it would in a
Chapter 7 liquidation. For example, if the secured debt exceeds the value of the property
at the time of the foreclosure or deed in lieu of foreclosure, there is no preference.

A transfer is not a voidable preference if it is made for substantially contemporaneous
consideration. However, a delay of two months in recording the security document will
prevent it from being substantially contemporaneous. Where the security documents are
not recorded contemporaneously (possibly within 10 days) with the loan, then the
encumbrance may be a preference. If the loan is made to enable the purchase of the
collateral described in the security document, one line of cases holds that the documents
must be perfected within ten days to be contemporaneous; another line holds that the ten-
day limit of 547(c)(3) is not controlling and that other factors can be considered.

A mortgage granted on the eve of Bankruptcy to secure previously unsecured debt may,
in addition to characterization as a preference, be considered a fraudulent transfer since it
hinders, delays, or defrauds creditors.

Deeds not recorded in timely fashion may constitute voidable preferences.

Fraudulent Conveyances - Under Section 548, a transfer made within one year before the
bankruptcy may be set aside as a fraudulent conveyance if the debtor was insolvent or
had insufficient capital at the time and if where the debtor received less than reasonably
equivalent value. The one-year period commences from the recordation of the deed or
mortgage which evidences the fraudulent conveyance.

The estate may, instead of recovering property fraudulently transferred, recover the value
of the property.

A voluntary transfer by a debtor within one year of bankruptcy while insolvent for less
than reasonably equivalent value is a fraudulent transfer.

A termination of a lease or other contract may be a fraudulent transfer.

An award of property in a divorce decree may be a fraudulent transfer if the debtor does
not receive reasonably equivalent value.

A guarantee secured by a deed of trust will not be a fraudulent transfer if the party
receives benefits (direct or indirect) from the loan and the benefits are reasonably
equivalent to the obligation. The basic issue involving guarantees is whether the
consideration flows downstream (e.g.,. a stockholder mortgages its property to secure a
loan to its wholly owned corporation) or upstream (a corporation mortgages its assets to
secure a loan made to its parent stockholders). If the proceeds flow downstream, the
mortgagor generally has received the benefits of the loan by advances to its owned entity
and no fraudulent transfer has occurred. However, if the proceeds flow upstream, a
possible fraudulent transfer has occurred. Similarly, a guarantee by an affiliate may, in
appropriate circumstances, constitute a fraudulent transfer.



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Southern Title Insurance Corporation                                                      August 13, 2008




Financing of a leveraged buyout of a corporation or partnership (by mortgaging of the
target corporation‟s assets to fund a loan to buy out its owners or by sale of the target
corporation‟s assets or stock) may be a fraudulent transfer. If a transferee from a
purchaser in a leveraged buyout is a bona fide purchaser for value without notice, then
the transfer is not subject to avoidance.

Actual intent to defraud creditors may be evidenced by a mortgage to an insider
(including a “close friend”) to secure pre-existing debt when the mortgagor was
insolvent. Actual intent to defraud creditors was found where substantially all of the
assets of the debtor were transferred to a successor corporation but one of the significant
debts of the debtor was not assumed by the successor. Indicia of fraudulent intent also
include corporate transfers to directors and transfers for inadequate consideration
between closely related entities.

Dismissal

A dismissal occurs only upon court order, not by notice of the trustee or debtor and lack
of objection. A dismissal serves to reinstate all transfers avoided under most sections of
the Bankruptcy Code, including fraudulent conveyances and voidable preferences. The
dismissal vests the property of the estate in the entity in which this property was vested
immediately before the case.

Discharge

A mortgagee‟s lien survives a discharge even though no claim is filed in a Chapter 7
proceeding. The mortgagee may proceed to foreclose as to properties of the debtor (not
remaining in the estate) without violating the automatic stay after the discharge. The lien
is enforceable even though no claim was filed. The majority view is that an adversary
proceeding may be brought in a Chapter 7 proceeding pursuant to Section 506(d) to avoid
a lien to the extent it exceeds the value of the property. The scheduling of the debt as
unsecured is not res judicata and will not void the lien.

After a discharge, a creditor retains his perfected lien unless the lien has been avoided by
an adversary proceeding, judgment, or other court order. Therefore, we will not rely on a
discharge or plan confirmation to waive liens. The discharge and plan confirmation do
not extinguish a pre-existing lien.2

Effects of Confirmation

Chapter 11 Proceeding - A Chapter 11 proceeding may provide for a sale of all, or
substantially all, of the assets of the estate. However, except as otherwise provided in the
plan, or in the order confirming plan, confirmation vests all the property of the estate in
the debtor.

2
 Exception – Texas judgment liens abstracted after 9/1/93 are cancelled by Section 52.041 TX Property
Code


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Southern Title Insurance Corporation                                                August 13, 2008



No order of the court is necessary to sell property if the property is vested in the debtor
and if the plan and order do not preclude a sale. The plan and confirmation should be
carefully reviewed to verify this. However, in any sale of all or substantially all of the
assets of the debtor after confirmation of the plan but during the case, we should secure
court approval. The sale may be considered a liquidation or modification of plan.

Upon the confirmation of the Chapter 11 plan, the automatic stay of Section 362 usually
ceases as to pre-existing liens on debtor‟s property: the confirmation usually re-vests title
in the debtor and grants a discharge; at that time, the automatic stay ceases as to property
of the debtor. On the other hand, a discharge is not granted in a Chapter 12 or Chapter 13
until completion of the plan. The stay remains in effect until that time.

Even though the stay ceases as to property of a debtor in a Chapter 11 proceeding upon
confirmation, provisions in the plan or confirmation decree stating that the bankruptcy
court retains exclusive jurisdiction of the proceedings to determine controversies and
disputes, and to effectuate payments, may be construed as requiring authorization of the
court before foreclosure.

If a mortgagee seeks to foreclose on a Chapter 11 debtor after confirmation of the plan
without a lifting of the stay, please call our legal department. We will verify by review of
the plan and confirmation that the court has not retained jurisdiction over claims or the
property.

Chapter 12 Proceeding - Unless otherwise provided, the confirmation vests all property
of the estate in the debtor. Thereafter, it is not necessary to secure an order of the court to
sell property if it is vested in the debtor. In any sale of all or substantially all of the assets
of the debtor after confirmation of the plan but during the case, we should secure court
approval. That sale may be considered a liquidation or modification of the plan.

Chapter 13 Proceeding - Section 1303 provides that the debtor has the right to sell
property of the estate other than in the ordinary course of business. The plan may
provide for the vesting of property of the estate in the debtor or in any other entity upon
confirmation or at a later time. Property of the estate vests in the debtor upon the
confirmation unless the plan or the order confirming plan states otherwise.

If the debtor offers to sell, no order of sale is necessary nor is any court proceeding
necessary if the property has vested in the debtor and is not subject to the plan in a
Chapter 13 proceeding and if the court has not provided that the property shall remain
subject to the court jurisdiction until the discharge.

If the debtor defaults in payments on a residential mortgage to be paid outside the plan,
the appropriate relief of the lender is a lifting of the stay even though no default has
occurred under the plan.




Handout for Lunch „n‟ Learn Session                                                        Page 19

								
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