Bankruptcy reform, which has been seriously pursued since at
least 1997, is now inevitable. Both houses of Congress have passed their
own versions, nearly identical to the one that recently died on Bill Clinton’s
desk. The differences between the House and Senate versions are largely
trivial, and as of this writing, it seems clear that they will be worked out in
conference and that President Bush will sign the resulting bill into law.
It’s got bankruptcy lawyers in an uproar, and landlords should be glad to see
a new law that favors them.
reforms will showcase the following major changes in the law, along with a large
number of smaller ones not mentioned here and of interest mostly to Bankruptcy
practitioners. First, Chapter 7, the proceeding in which debts are
discharged and the debtor receives a fresh start, will be means tested and those
with the ability to pay some or all of their outstanding debts will be denied
access to this remedy. Second, Chapter 13 payment plans will be governed
by more stringent rules. Third, debtors will be required to go through a
credit counseling program, a sort of traffic school for bankrupts. Fourth,
there are stronger residency requirements, quadrupling the amount of time a
debtor must reside in a jurisdiction before being able to file there and avail
himself of its exemption laws, in order to reduce forum shopping. Fifth,
the operation of the automatic stay will be changed. Sixth, there may or
may not be rules preempting individual states’ homestead exemption laws.
Seventh, there will be new requirements for Chapter 11 business reorganization
section-by-section analysis of the House version is available in PDF format.
While most of the bankruptcy reforms are not of immediate importance to
landlords, there are a few that are, and we discuss them below.
Landlords will immediately notice a radical change in the operation of the
automatic stay. When a bankruptcy petition is filed, a restraining order
is immediately issued staying all efforts, direct or indirect, to collect most
types of debts. This restraining order is referred to as the “automatic
stay.” Once the stay is in effect, that is, at filing, all creditors are
prohibited from contacting the debtor for the purpose of dunning, pursuing legal
collection proceedings, continuing informal arbitration proceedings, sending
letters, and the like, and, the greatest irritant to landlords, following
through with eviction or dispossession proceedings.
The Good News –
No More “Automatic Stay” for Eviction Process
is now necessary to initiate an adversary proceeding in the bankruptcy court to
obtain leave of the bankruptcy court to evict. Although the purpose of the
automatic stay is to protect general creditors by making sure that none of them
get more than their fair share by cutting up the bankruptcy estate before the
Trustee can gain control of it, the result in too many cases was to permit the
debtor to withhold access to certain property from creditors who had a perfect
right to it, such as landlords evicting tenants for nonpayment of rent or for
other reasons. In the best of circumstances, this could result in delay
that was both unnecessary for the protection of the general creditors and
inequitable to the landlord. In the worst of circumstances bankruptcy
“clinics” in many jurisdictions used the stay, originally intended to
protect the general creditors, as a device to keep the debtor in possession of
rental property without paying rent for weeks or months. In some cases,
serial bankruptcy filings created a procedural nightmare, extending the delay.
Many Bankruptcy Judges tried a variety of fixes for this abuse, but this was
done on a district-by-district or even branch-by-branch basis and the results
were spotty. The reform act provides that eviction proceedings are not
subject to the automatic stay. In other words, the landlord may continue
his eviction in his state’s court and ignore the automatic stay. This is
not the case for things like distraint, wage garnishments for back rent, or
other rent collection efforts, however, so, presumably, the landlord must still
look to the bankruptcy proceeding for collection of his money.
The Good News Continues – Tenants Right to Discharge (eliminate) Money Owed
Landlord for Rent, Damage and Attorney Fees has been Curtailed
If the tenant is
gone but owes you money for back rent, attorney’s fees, damage to your rental
unit, or other sums, his right to discharge his obligations in bankruptcy has
been curtailed. Both Chapter 7, liquidation, and Chapter 13, composition,
have been affected.
Until now, a debtor had the option of simply erasing his debts under Chapter 7.
He was entitled to retain all of his property that Federal law or his state’s
law made legally unavailable to creditors for satisfaction of judgment, referred
to as “exempt property.” To the extent that he owned property over and
above his state’s exemption laws, a rare occurrence indeed, he would have to
come up with the difference or surrender the excess property to the Trustee.
The reform bills means test Chapter 7 relief by denying it to anyone whose
income exceeds his state’s median income or can, after deduction of reasonable
living expenses, determined on a state by state basis by the IRS, afford to pay
$100 or more per month on his outstanding debts and pay 20% or more of them in a
five year period. Thus, about half, those who earn above the state median,
will be ineligible for Chapter 7 at any given time. Those ineligible for
Chapter 7 relief will have to rely on Chapter 13. Thus, it will be much
more difficult for ex-tenants to zero out what they owe you.
Chapter 13 is a forced composition with creditors, permitting repayment of the
whole or a part of what is owed to unsecured creditors over time, regardless of
the terms of the payment agreement between the debtor and the creditor.
Under old law, the debtor was required to present a plan that featured either
complete repayment of his unsecured debts, or payment of an amount that equaled
the total net value of his non-exempt property, plus Trustee fees and interest,
over a three to five year period. This could result in repayment to
unsecured creditors of pennies on the dollar. The new Chapter 13 is very
different. Under the reformed bankruptcy law, the debtor must pay all of
his disposable income, that is, everything over and above IRS determined
reasonable living expenses in his state, for a three year period, if his income
is below the state median, or a five year period, if his income is at or above
the state median, or until all the unsecured creditors are paid in full.
You, in practically all cases being an unsecured creditor, can expect a much
larger payout if your ex-tenant opts for Chapter 13.
The homestead exemption has been subject to debate in all recent reform
proposals. Typically, this becomes an issue only for landlords who have
rented commercial space to a business that has gone under. The residential
tenant does not usually own homestead property or he would not be renting,
though this is not always the case, as, for example, a suburban tenant who uses
the landlord’s city apartment as a pied a terre. In any event, under the
old law, the state homestead exemptions determined how much of the value of the
debtor’s home he could retain upon filing and how much had to be turned to the
benefit of creditors. Individual states varied with most having dollar
limitations on their homestead exemptions, e.g., $35,000 of the equity in the
home, to others, like Texas that exempted the homestead regardless of total
equity. The older versions of the reform act limited the amount of the
value of the homestead property for bankruptcy purposes to the $100,000 range.
Congress has eliminated that limitation in the current bills and reverted to the
rules under the old law. Rep. Pete Sessions of Texas says: “This
version of the bill does not contain the amendment from the 1998 version that
could have effected drastic changes in our Texas homestead provision by capping
the exemption at $100,000.” At least his press release says he said
that; God knows what he actually said, if anything. No one knows whether
this change, probably made to satisfy President Bush who was outspoken in his
dislike of the $100,000 cap, will remain. If it does, it will reduce the
amount the landlord can expect to see from a Chapter 7 or 13 filed by a former
tenant who owns a home.
That covers the matters of immediate concern
to landlords and their businesses. Time will tell how, in practice, these
reforms will affect the landlording business. We have not discussed all of
the changes to the bankruptcy laws proposed in the new legislation, and those
interested are invited to refer to the complete analysis to be found at the link
in the first paragraph. It should also be noted that bankruptcy reform is
a two edged sword. It is going to be much more difficult for over extended
landlords to reorganize under Chapter 11, for example. While this is not
the place to editorialize about the wisdom of the changes now on the table, we
will venture the opinion that, even if the reform as now drafted is enacted and
receives the President’s signature, we will not have heard the last of changes
in the law. We think that the Bankruptcy Abuse Prevention and Consumer
Protection Act of 2001 is a pendulum that has swung a bit too far. There
will be great pressure to reform the reforms within a short time.