Massachusetts Agencies

Bankruptcy Law and the Conveyancer - Traps to Watch Out For

Articles from The Massachusetts Focus

Newsletter of Stewart Title Guaranty Company, Massachusetts Offices
Summer 2003, Volume 2, Number 3

Bankruptcy Law and the Conveyancer — Traps to Watch Out For
by Gary F. Casaly, Special Counsel

In my last article appearing in The Massachusetts Focus ("Bankruptcy Law and the Conveyancer," Vol. 2, No. 2, Spring 2003) I wrote generally about various aspects of bankruptcy law that would be of interest to the conveyancer. In this edition of the newsletter I'm going to explore certain details regarding bankruptcy law that might not be obvious and that can set some traps that the conveyancer should avoid.

One thing that needs to be kept in mind when dealing with real estate that has "gone through" bankruptcy, is the effect the bankruptcy has on certain statutes of limitation that otherwise might cleanse a title of a lien or encumbrance. For example, it's common knowledge among conveyancers that an execution (or attachment or state tax lien, for that matter) will expire in six years. But what if the debtor has filed for bankruptcy? The "automatic stay" will prevent the creditor from proceeding to enforce the lien. During this period of suspension, will the creditor's lien expire? It would seem unfair to permit this to happen - tying the creditor's hands, so to speak, while at the same time permitting the lien expire. This puts the creditor between the proverbial "rock and a hard place." But the statutes and court decisions have remedied this (for the creditor) while at the same time requiring the conveyancer to be mindful of this result or otherwise fall into a trap.

Consider, for example, this language in In re Paul, 67 B.R. 342 (Bkrtcy.D.Mass. 1986):

[S]ecured creditors . . . are faced with a dilemma when a petition is filed a short time before their interests lapse. The automatic stay prevents them from taking further action to perfect their lien, but the same stay may not stem the advance of time which threatens to extinguish the perfection of their security interests existing at the time of the petition.

The Second Circuit has held that the effect of filing a petition is a two way street for creditors and debtors: "[I]n general no creditors' liens acquire validity after the filing of the petition . . . . It should equally follow, we believe, that liens good at this time do not lose their validity.

The "two way street" that is referred to in In re Paul can cause a collision or wreck if the conveyancer is not aware of it.

Likewise, The Bankruptcy Code (§108(c)) makes provision for an extension in time to enforce liens:

Except as provided in section 524 of this title, if applicable nonbankruptcy law, an order entered in a nonbankruptcy proceeding, or an agreement fixes a period for commencing or continuing a civil action in a court other than a bankruptcy court on a claim against the debtor, or against an individual with respect to which such individual is protected under section 1201 or 1301 of this title, and such period has not expired before the date of the filing of the petition, then such period does not expire until the later of-

(1) the end of such period, including any suspension of such period occurring on or after the commencement of the case; or

(2) 30 days after notice of the termination or expiration of the stay under section 362, 722, 1201 or 1301 of this title, as the case may be, with respect to such claim.

As indicated, the automatic stay can keep liens alive, where during the period of the stay the creditor is not allowed to enforce them. Another aspect of the stay that could be overlooked is its effect upon the enforcement of liens on property that has been abandoned and is no longer part of the bankruptcy estate. It's common knowledge that the automatic stay prevents the enforcement of a lien, like a mortgage, during the pendency of the bankruptcy unless and until the stay is "lifted." But the stay may prevent the enforcement of such a lien even where the property is no longer part of the bankruptcy estate. If this fact is not observed and understood the result could be taking title from a foreclosing mortgagee where the foreclosure sale is defective. The Bankruptcy Code (§362) makes provision for the automatic stay and prohibits, among other things, "any act to create, perfect, or enforce any lien against property of the estate." In addition, however, the stay prohibits (§362(a), 5, 6):

(5) any act to create, perfect, or enforce against property of the debtor any lien to the extent that such lien secures a claim that arose before the commencement of the case under this title;

(6) any act to collect, assess, or recover a claim against the debtor that arose before the commencement of the case under this title;

The above two provisions would prohibit the enforcement of a mortgage on property of the debtor during the pendency of the bankruptcy on either exempt or abandoned property then under the ownership of the debtor. The fact that the property has been brought out from under the jurisdiction of the bankruptcy court (i.e., the property is no longer part of the "bankruptcy estate") does not dispose of questions concerning the "lifting" of the automatic stay in connection with the enforcement of liens on that property.

Another "trap" that can arise in connection with a title that comes through bankruptcy is the situation where the debtor acquires property after the bankruptcy has been filed. The issues here revolve around questions concerning what kind of property gets bound up in the bankruptcy and whether the conveyancer would be aware that the bankruptcy is even pending. Most property that is acquired post-petition is not part of the bankruptcy estate. But there are exceptions. For example, The Bankruptcy Code (§541(a)(5)) provides that included in the estate is:

Any interest in property that would have been property of the estate if such interest had been an interest of the debtor on the date of the filing of the petition, and that the debtor acquires or becomes entitled to acquire within 180 days after such date-

(A) by bequest, devise or inheritance;

(B) as a result of a property settlement agreement with debtor's spouse, or of an interlocutory or final divorce decree;

(C) as a beneficiary of a life insurance policy or of a death benefit plan.

And the Bankruptcy Code (§1306) provides that with respect to a Chapter 13 bankruptcy:

(a) Property of the estate includes, in addition to the property specified in section 541 of this title-

(1) all property of the kind specified in such section that the debtor acquires after the commencement of the case but before the case is closed, dismissed or converted to a case under chapter 7, 11 or 12 of this title whichever occurs first; and

(2) earnings from services performed by the debtor after the commencement of the case but before the case is closed, dismissed or converted to a case under chapter 7, 11 or 12 of this title whichever occurs first.

It's important to know what kinds of post-petition property are included in the estate. But another question is whether the title examiner would know if a bankruptcy was pending, even if a notice was filed at the registry of deeds. If property was acquired by inheritance, would the examiner be careful enough to check the records before the acquisition was made to see if a bankruptcy had been filed? Certainly, with such liens as federal tax liens, this is done routinely, but it's just as important in the case of a bankruptcy filing. Though the search period is shorter (180 days, except in the case of a Chapter 13 filing), it should not be overlooked.

One thing that might go unnoticed when it comes to a bankruptcy is whether the property at issue was scheduled as an asset of the debtor's estate. This becomes important in order to determine if the particular property is or is not still under the jurisdiction of the bankruptcy court after the case has been closed.

All property of the debtor vests in the bankruptcy estate, whether or not it is scheduled. If a certain piece of property is not administered in the bankruptcy proceedings then, upon the closing of the bankruptcy estate, title to the property will revert back to the debtor, provided it was scheduled in the bankruptcy proceedings. It is the property that has not been scheduled that presents a problem, because this property does not get the benefit of the closing of the estate, but remains "tied up" in the jurisdiction of the court. It is important, therefore, to actually check the schedules filed in the bankruptcy proceedings to make sure that the property was in fact scheduled.

Bankruptcy Glossary

Below are some of the common terms you might encounter when reading articles about bankruptcy.

Abandoned Property
Property that the trustee in bankruptcy jettisons and revests in the debtor because it is burdensome or lacking in value.

Automatic Stay
A prohibition against the creation, perfection or enforcement of a lien by a creditor that also prevents a court from entertaining an action against the debtor.

Discharge in Bankruptcy
A permanent injunction against creditors from enforcing their rights against the debtor personally. A discharge in bankruptcy does not affect liens upon any property even if the debt secured by the lien has been specifically listed and discharged.

Exempt Property
Property that the debtor claims is entitled to not be included in the bankruptcy estate for distribution among creditors.

Fraudulent Conveyance
A transfer made within one year of filing for bankruptcy by a debtor (i) to hinder, delay or defraud creditors or (ii) while the debtor was insolvent, if the debtor received less than reasonably equivalent value.

A transfer made within 90 days of filing for bankruptcy by an insolvent debtor for or on account of an antecedent debt (for example, deed in lieu of foreclosure).

Relief from Stay
A bankruptcy court order permitting a creditor to create, perfect or enforce a lien.