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The Ch. 11 Bankruptcy - The Nuclear Option to Save Your Home

Ch. 11 Bankruptcy – The Nuclear Option to Save Your Home

When nothing else works, you may want to consider a Ch. 11 Bankruptcy.  If you have significant income and assets and have an investment use for your home or former primary residence (i.e., you’ve moved and now rent the property), you may qualify.

The Cramdown

The main benefit of a Ch. 11 Bankruptcy is that a mortgage debtor can “cramdown” their underwater mortgage and negotiate a new one.

Yes, you read that correctly, it is possible to eliminate your arrears, reset your mortgage to be equivalent to the value of the property, and to negotiate new mortgage terms as if re-financing the property based on its current value.

The details are, of course, critical, as to how this works.  They are also complex and far too detailed to fully explain in a short article.  This is not for everyone.  Along with the need for the property to be used for investment or business purposes there are a number of other qualifying standards for when a Ch. 11 Bankruptcy is appropriate.

But for those who do qualify to file a Ch. 11, it can be a powerful tool to restructure your debts and save a valuable real estate asset in the process.  The relief available through the Ch. 11 process is dramatic and is often far more favorable than the best outcome one can achieve through other more routine strategies for avoiding foreclosure.

Example:

You stopped paying in 2015 and are severely delinquent in your mortgage owing to economic hardship.  You owe $1,000,000 to the bank because of the high adjustable interest rate on your 2007 mortgage.  Due to declining real estate markets the property you originally purchased for $650K is now only worth $500K.

If the bank goes to Sheriff’s sale they will only get $500,000.  In a Ch. 7 liquidation Bankruptcy, they would only get $500,000 less costs.  You propose a new mortgage of 30 years at prevailing rates of 4.5% interest, lowering your prospective payment by thousands of dollars per month and leaving you generating positive equity the day the plan is confirmed.  Will it work?  Section 1129(b) of the Bankruptcy Code allows a bankruptcy court to approve a debtor's reorganization plan over the objections of a secured creditor so long as the plan is "fair and equitable" to the creditor.

The mechanics of the Chapter 11 process and garnering the necessary votes for plan confirmation are too complex for the purposes of this article.  But, suffice it to say, that the cramdown is a powerful tool to give Ch. 11 debtors significant leverage over secured creditors.

The way I like to put it is that in a traditional foreclosure/sheriff’s sale situation, the bank holds all the cards and has all the leverage.  What could be worse than the threat of kicking you out of your home?  On the other hand, in a typical Ch. 11 Bankruptcy, you hold all of the cards and have all the leverage.

Ch. 11 Basics

A Ch. 11 Bankruptcy begins with the filing of a petition.  Ordinarily, these are accompanied by a series of “first day” motions.  Ch. 11 is built for businesses and the goal of the chapter is to allow the “debtor-in-possession” – that’s you – to stabilize your operations and continue operating in the ordinary course.  So, you continue collecting rents, making repairs, paying bills, and the like.  Section 1123 of the Bankruptcy Code contains a series of detailed requirements that need to be complied with while you are in Ch. 11 status.

Like any other bankruptcy, the Ch. 11 triggers an “Automatic Stay” which stays any pending Sheriff’s Sale or any other creditor action against you until the termination of the proceedings.

Under the Bankruptcy Code, the Ch. 11 Plan must propose to pay any secured creditor at least as much as that creditor would have received if the debtor had filed a Chapter 7 bankruptcy – and these claims can be settled by mutual consent to boot.

Under Sections 1126(c) and 1129 an entire “class” of claims accepts a plan if 2/3 of the amount in that “class” or 1/2 in number vote yes.  The voting mechanisms are complex, but realistic and often help to create additional incentives for a homeowner’s plan to be seriously considered and negotiated, unlike in a normal foreclosure.

Once the plan is confirmed and the Ch. 11 case runs its course, the debtor will receive a discharge.  The plan then becomes binding on the debtor and all of its creditors.