While loan servicers are typically willing to explore various foreclosure alternatives with respect to delinquent borrowers, often a foreclosure on collateral is the only realistic option available to the servicer.  When faced with an imminent foreclosure, certain delinquent borrowers will take affirmative steps to stave off a foreclosure, including filing lawsuits against their loan servicer or filing a bankruptcy.  This article briefly addresses certain bad faith bankruptcy strategies employed by delinquent borrowers to halt a foreclosure, and steps that the servicer can take to deal with this abuse of the bankruptcy process.

As a matter of background, the filing of a bankruptcy petition under any chapter of the United States Bankruptcy Code generally gives the debtor the protection of the “automatic stay”, which is an automatic injunction that halts many actions by creditors. Under 11 U.S.C. § 362(a) of the Bankruptcy Code, the automatic stay begins the moment the debtor files a bankruptcy petition. The automatic stay precludes creditors from enforcing pre-petition judgments against the debtor, perfecting or enforcing pre-petition liens, foreclosing on collateral, or taking any number of additional actions against the debtor or its property. See 11 U.S.C. § 362(a) (setting forth the full list of actions prohibited by the automatic stay).

In a typical bankruptcy, the automatic stay remains in place until the bankruptcy court or debtor dismisses the bankruptcy, or until the debtor receives a “discharge”. (i.e., debt forgiveness.)  It should be stressed that a debtor generally cannot receive a discharge of secured debt, which would invalidate a lien on real property.  Ordinarily, a bankruptcy discharge only absolves a debtor from repaying unsecured debt such as credit card balances, medical bills, and other forms of credit that were extended without a collateral requirement. 

Sophisticated creditors know that a violation of the automatic stay is a serious matter that could result in sanctions imposed by the bankruptcy court; accordingly, the filing of any bankruptcy by a debtor often causes loan servicers to suspend foreclosure activity in knee-jerk fashion.  While the practice of suspending the foreclosure upon the filing of a bankruptcy is generally a prudent “best practice”, the automatic stay provision is subject to certain exceptions and limitations to curb abuse of the bankruptcy process.  Creditors should therefore consult with their attorney whenever a debtor files for bankruptcy to see if an automatic stay exception applies.

For example, if a debtor has filed a previous bankruptcy within the last 365 days, the automatic stay for the new bankruptcy will only last for 30 days. See 11 U.S.C. § 362(c)(3)(A).  After that period, a loan servicer may resume its foreclosure activities.

Furthermore, if a debtor had two bankruptcy cases dismissed within the preceding 365 days, then no automatic stay arises at all. See 11 U.S.C. § 362(c)(4)(A)(i)); see also, Pierce v. CitiMortgage, Inc., 2012 U.S. Dist. LEXIS 170713, *5-6 (N.D. Cal. 2012).  In other words, if a delinquent borrower has already had two bankruptcies that have been dismissed within the last year, another bankruptcy filing will not shield this borrower from foreclosure proceedings. 

To circumvent the above statutory provisions enacted to discourage serial bankruptcy filings, debtors sometimes manage to time their bankruptcy filings so that each bankruptcy petition gives rise to automatic stay protection.  Yet even if bankruptcy filings are adequately spaced out so that the debtor is afforded full protection by each filing, there are steps that loan servicers can take so that they can resume foreclosure proceedings with the blessing of the court. 

A loan servicer seeking to lift the stay must file a “motion for relief from the automatic stay”, brought pursuant to Section 362(d).  If this motion is granted by the bankruptcy court, the servicer may resume the foreclosure even though the bankruptcy is still pending.

The most common ground for obtaining relief from the automatic stay is set forth in Section 362(d)(1), which states that relief from stay may be granted “for cause, including the lack of adequate protection of an interest in property. . .”  Secured creditors, and certain other parties that have an interest in property of the bankruptcy estate, are entitled to “adequate protection” to ensure against the diminution in value of a security interest.  If a creditor is entitled to adequate protection, but the debtor is unable or unwilling to make periodic payments during the pendency of the bankruptcy, this is a basis for relief under Section 362(d)(1) of the Bankruptcy Code.

When abuse of the bankruptcy process is particularly egregious, a secured creditor should seek prospective relief from the court under Section 362(d)(4), often known as “in rem” relief.  Pursuant to Section 362(d)(4), in rem relief is appropriate if a bankruptcy filing “was part of a scheme to delay, hinder, or defraud creditors. . .”  From the date that in rem relief is obtained, the prospective relief is binding and effective as to the real property for a period of two years.  In rem relief attaches to the parcel of real property and not just the debtor, so that any subsequent bankruptcy filing during the next two years – by any person or entity – will not create automatic stay protection that would prevent foreclosure on the property in question.

A frequent scenario in which a motion for in rem relief is appropriate is where joint owners of real property stagger their bankruptcy filings as a “tag-team”, so that each individual owner enjoys protection from the other’s bankruptcy filing.  Another scenario warranting a motion under Section 362(d)(4) is where a debtor transfers a fractional interest in the property to a third party, who then files for bankruptcy.  Once in rem relief is obtained, the loan servicer can proceed with the foreclosure without the worry of another bankruptcy within the next two years that would halt a trustee’s sale.