When a bankruptcy is executed, it aids the party with unfortunate financial circumstances in discharging all or a portion of the debt, thereby reducing or eliminating personal debtor liability. A debtor typically does not appear in court or meet with a judge. Most legal decisions are made in a formal meeting of creditors at the U.S. Trustee’s Office. In the meeting, both the debtor and creditors may appear. This meeting allows creditors and debtors to negotiate debt and to discuss any issues regarding the discharge of the debt.
A debtor’s ability to restructure their debt is defined in Article I, Section 8, of the U.S. Constitution, as a method to prevent a debtor from further financial collapse. As indicated by the federal government, bankruptcy laws established to supply individuals, including businesses, a “fresh start” from burdensome debts. The government further explains that individuals can liquidate assets to pay any accrued debts or by creating a repayment plan.
There are six common bankruptcy types:
Chapter 7: Chapter 7 bankruptcy is when the court decides to sell off assets of the person or company in debt to pay off creditors and individuals that are owed money.
Chapter 9: Chapter 9 bankruptcy is used to adjust debts of a municipality. It allows the municipality to reorganize their debts and assets to financially salvage the town, village, county, or school district.
Chapter 11: Chapter 11 bankruptcy is a reorganization of one’s debt in which the court approves to put the borrower on a repayment plan to pay off creditors.
Chapter 12: Chapter 12 bankruptcy is used to adjust the debts of a family farmer or fisherman with regular annual income that depends on nature to earn a living. This form of bankruptcy restructures debt to repay the debts over a period of time, typically within a three-year period.
Chapter 13: Chapter 13 bankruptcy is when both a debtor and a debtor’s creditor can file or make a request to force the debtor to liquidate and distribute their assets. This only applies to someone who earns a regular income.
Chapter 15: Chapter 15 bankruptcy provides a mechanism in dealing with cases of jurisdiction that crosses the border. This type of bankruptcy is used when the debt or the subject property is subject to the laws of the U.S. and another foreign entity.
Bankruptcy as it Relates to the Consumer Recovery Fund
A real estate agent that is found guilty of negligence or fraud may be able to claim bankruptcy to postpone and temporarily avoid paying fees to the Consumer Recovery Fund. This fund is responsible for paying out victims of real estate agent and broker fraud. Twenty percent of total agent and broker licensing fees are allotted to a Consumer Recovery Fund, or victim’s fund. When a licensee has insufficient personal assets to pay for the loss, the fund allows the victims to recover at least some of his or her losses. This includes when an agent claims bankruptcy to avoid paying fees to the fund.
If the Department of Real Estate pays out this type of compensation due to the negligent actions of an agent, the state will suspend the agent’s license. The suspension will not be lifted until the agent repays the fund in full. Bankruptcy will not remove the violating party’s obligation to pay off the debt, it can only postpone it.
Bankruptcy as it Relates to Foreclosure
Bankruptcy is utilized by borrowers to delay and/or prevent the foreclosure process in order to retain their property. Chapter 7 and Chapter 13 bankruptcies bar a lender from foreclosing on a property.
When a borrower files for bankruptcy, a court issues an order for relief that directs lenders to stop all collection activities. However, as bankruptcy damages a borrower’s credit for a long period of time, it is seen as a last resort.
A borrower that is in bankruptcy remains the owner of a prorprty until the debt is resolved. This can often take a significant amount of time and as such requires the lender who is owed money to be patient. Eventuially, once the legal limitations of a borrower’s strategy to delay foreclosure by using bankruptcy expires, the lender will recoup the property by foreclosing and becoming its owner. If the property has equity, the borrower will be entitled to it.
Bankruptcy as it Relates to Judgement Liens
A judgment lien is a court-ordered, involuntary lien that grants a lender the ability to take possession of a borrower’s property if the borrower fails to meet his or her financial obligations to the lender. A borrower that is in bankruptcy will not be able to refinance their property because so would put the new lenders money at risk. Because unsecured debt is difficult to collect after a borrower stops making payments, a judgment lien is the best way for lenders to recoup their losses.
A judgment lien prevents a property owner from refinancing or selling his or her property until a debt has been repaid. If a debtor does not satisfy his or her debt, his or her property may be seized and/or sold.
A lender may only place a judgment lien on a borrower’s property if the lender files a lawsuit against the borrower and wins. If the court indicates that a judgment is a proper legal remedy for the damaged party to collect their money, an abstract of judgment is issued. This written statement from the court summarizes the terms of a judgment against a borrower and/or places a judgment lien on the borrower’s property.
When a borrower does not own real property on which to place a lien, a lender has the right to place a lien on the borrower’s future real estate purchases.
Judgment liens can be terminated for the following reasons:
The borrower pays off the debt
The borrower declares bankruptcy
The borrower and lender reach a settlement
Statute of limitations is reached
If both the lender and the borrower consent to a settlement — which could be a full or partial payment of the original debt — the judgment lien may be removed. A lender will usually consider settling a debt for pennies on the dollar as a way of recouping some of their losses.
The statute of limitations for a judgment lien is ten years after its recording. If a property with a judgment lien forecloses and the borrower buys a new property within the ten year time frame, the judgment lien shifts to the borrower’s new property. If it is more than ten years, however, the lender loses the right to collect the debt.
Bankruptcy as it Relates to Trustees
Trustees can represent the interests of various parties including lenders, charities, and parties in a bankruptcy; however, with respect to mortgages, trustees deal with borrowers on behalf of the lender. Legal title is held by the trustee in a trust. The trustee has fiduciary duties owed to the party he or she represents, which means the trustee must put the goals of the party being represented over their own. If the borrower (trustor) does not pay back their monthly debt obligations, the trustee will act on behalf of the note holder to begin the foreclosure process.
The duties of the trustee are unique to the party represented and the assets being held. In the case of mortgages, the trustee is the party that administers payment collection, sending letters and bills, and answering questions on behalf of the lender.
Recouping Debt through Bankruptcy
Through a liquidation bankruptcy, the debtor’s property will be sold through public auction to cover any accrued personal debt. The trustee will organize and carry out the sale. New buyers will be given a trustee deed. The U.S. Congress is responsible for enacting bankruptcy laws through the Bankruptcy Courts.