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The Coming Bankruptcy Act Reform And What It Means To Landlords  

© Copyright  2000-2011

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.

The 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 plans.  A 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

It 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.

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