Handling Bankruptcy in a Short Sale Part 2

After a Chapter 7 bankruptcy is filed, a “341 hearing” is set where the creditors have an opportunity to question the debtor about, and the bankruptcy trustee reviews the list of assets and debts, as well as income/expenses, to ensure accuracy. Creditors are provided 60 days after this hearing to object to the discharge.

Chapter 13, on the other hand, is known as reorganization. This typically is used by individuals who don’t qualify for Chapter 7 or who want to actually keep their non-exempt property. Typically they’ll come up with a plan and then pay into the bankruptcy trustee for a period of 3-5 years. They’ll make one monthly payment to the trustee and then the trustee will pay the creditors.

For a Chapter 13 filing, the debtor will develop a repayment plan, with of course the government receiving all of its money back (considered a priority claim over others). The court will using living standards, provided for by the IRS, to determine what would be considered reasonable for housing, food, and other expenses.

But, after reviewing both Chapter 7 and 13, does it really matter if your client is in preforeclosure and is a short sale candidate?

Let’s remember why they are a short sale … they have no equity, right? In that case, they shouldn’t be a part of the bankruptcy proceeding, as the Trustee would just assume not have this as part of the bankruptcy proceedings if the bank is willing to take the haircut. But the key is dealing with the bank.

Typically the bank will just shut down negotiations. In the case of bankruptcy, you still can make things happen for a short sale, but you have to 1) have a valid offer from someone willing to wait it out, and 2) you need to be in contact with the bankruptcy trustee and explain what’s going on. Often your client just wants to “move on with life,” but in this case it is important to tell them that most bankruptcy reorganizations fail, meaning that they’ll then have both a bankruptcy and foreclosure on their record. That’s not something they want, that’s for sure.

So make sure you can convince the Trustee that there legitimately is no equity. In 2008, that’s probably not hard to do given market conditions. But is bankruptcy a death knell for your deal? It will slow it for sure, but if you know how to maneuver the court system, talk with the trustee, and get a patient buyer, you’re off to make another sale.