FAQ-Bankruptcy and Closing the Real Estate Transaction

Transcription

1 FAQ-Bankruptcy and Closing the Real Estate Transaction by David M. Parnell LandAmerica Financial Group, Inc. 12 th Floor 7557 Rambler Road Dallas, Texas presented to The 16 th Annual Robert C. Sneed Texas Land Title Institute San Antonio, Texas November 30-December 1, 2006

2 DAVID M. PARNELL David M. Parnell is Senior Vice President and Regional Counsel for LandAmerica Financial Group, Inc. where he is responsible for Legal and Underwriting issues for the Southwest Region. Mr. Parnell received his B.S. degree from Tulane University, his M.B.A. degree from Southern Methodist University and his J.D. degree from the University of Texas. He is a member of the Dallas (member, Real Property Section), Texas (member, Title Insurance Subcommittee) and American (Real Property, Probate and Trust Law Section) Bar associations. 2

3 FAQ- Bankruptcy and Closing the Real Estate Transaction This paper will present some frequently asked questions in the areas of Bankruptcy and Closing the Real Estate Transaction. Some of these questions may not seem to be very complex. Nevertheless, underwriting counsel from a number of title insurance companies encounter them on a routine basis. One caveat on questions regarding Closing the Real Estate Transaction. There is a distinction between closing the real estate transaction and closing the title insurance transaction. Activities which comprise closing the title insurance transaction are set forth in Procedural Rule P-1(f). Activities constituting closing the real estate transaction are apart from these. The real estate transaction involves actual handling of the escrow and various other activities necessary to fully settle the matter. From my position as an underwriting counsel, I rarely direct independent agents on how to settle the real estate transaction, unless it somehow impacts the title insurance to be issued. Accordingly, agents should consult their own counsel regarding best practices in closing the real estate transaction, just as they should consult their own underwriting counsel in title insurance matters. BANKRUPTCY Liens: A(1). Debtor has numerous abstracts of judgment filed against him. He files a Chapter 7 bankruptcy and gives notice to all the judgment creditors. Debtor receives a discharge. He brings you a contract to sell nonexempt property he has owned since before he filed bankruptcy. He tells you not to worry about the A/Js because they were taken care of by his bankruptcy. Are you willing to insure without exception to the liens? Generally, a discharge will extinguish the personal obligation of the debtor, but under bankruptcy law, it will not remove the pre-petition lien from pre-petition property. Texas Property Code Chapter 52, Subchapter C, deals with judgment liens against debtors abstracted after September 1, The subchapter provides for the automatic release of judgment liens against pre-petition property owned by the debtor after discharge. There are, however, exceptions to this general rule. The judgment lien is not released if the property is not exempted in bankruptcy and it is abandoned during the bankruptcy. Some underwriters take the position, that if the property is not expressly abandoned by the trustee during the bankruptcy, upon discharge and closure of the bankruptcy, the judgment lien is automatically released. Other underwriters have a different view based upon Section 554(c) of the Bankruptcy Code. That section says property scheduled in the bankruptcy that is not otherwise administered, is abandoned to the debtor upon closing of the case. The thought is that upon closing, the property is abandoned. Therefore, the exception applies and the lien is not automatically released. 3

4 A(2). The same Debtor as in A(1) above comes back to you to sell property he acquired after he received his discharge. Since a discharge extinguishes the personal liability of the Debtor, there is no obligation to support the lien. Thus the liens should not attach to property acquired postdischarge. A(3). The same situation as A(2), but a review of the file indicates that one of the liens addressed in the bankruptcy was for unpaid child support. Same result as A(2)? Section 523 of the Bankruptcy Code lists exceptions to discharge. One of the exceptions is for a debt to a former spouse for the support of a child, arising from a divorce decree. Since the debt is not discharged, neither is the lien. When determining whether pre-petition liens attach to property acquired post-discharge, Section 523 should be taken into account. B. A bankruptcy trustee petitions the court for a sale of estate property free and clear of liens. The property to be sold is encumbered by delinquent ad valorem tax liens for the three prior years. The tax collector has received notice of the motion. The court gives the order to sell free and clear. Any problems? There are two potential problems here. One is practical and the other is legal. If the property is sold, and the delinquent taxes are not paid in full, many tax collectors take the position since there is no statutory authority to delete unpaid taxes from the rolls, they cannot do so. The result is that the insured buyer continues to get demands to pay the back taxes. The other issue arises from the U.S. Constitution. Seminole Tribe of Florida v. Florida, 517 U.S. 44 (1996), and related cases, raise the issue of states rights and sovereign immunity of the state. As a result of these decisions, it is argued that Section 106 of the Bankruptcy Code, which has a waiver of the state s sovereign immunity, is unconstitutional. C(1). A bankruptcy court enters an order to sell estate property free and clear of liens on Monday afternoon. On Tuesday morning, the parties appear at your office to close the sale. Are you ready to close? Effective December 1, 1999, Rule 6004 of the Federal Rules of Bankruptcy Procedure was amended to add subsection (g) which states: 4

5 (g) Stay of Order Authorizing Use, Sale or Lease of Property. An order authorizing the use, sale or lease of property other than cash collateral is stayed until the expiration of 10 days after the entry of the order, unless the court orders otherwise. The prior rule had no such "automatic stay". At the same time, three other rules were amended to include the automatic 10 day stay. Those rules deal with (i) confirmation of the plan in Chapter 9 or 11 bankruptcies, (ii) an order authorizing the assignment of an executory contract or unexpired lease under Section 365(f), and (iii) an order granting relief from an automatic stay. C(2). Same as C(1), but the order entered by the court expressly states that the sale may take place immediately upon entry of the order. Can you close on Tuesday morning? The rule contemplates such a waiver by the court. Some underwriters, however, still exercise caution in this area. They are concerned about the possibility of appeal, and, in that event, concerns about the BFP status of the purchaser. D. The trustee abandons a parcel of property from the estate. Now that the property is outside of the estate and not subject to the automatic stay, a judgment creditor that holds an abstract of judgment encumbering the abandoned property holds an execution sale and acquires the property. The creditor asks you it insure the sale of the property to a third party. Do you have any additional requirements? The breadth of the automatic stay that arises upon the filing of a petition in bankruptcy is governed by Section 362 of the Bankruptcy Code. This section stays the enforcement of a judgment against the Debtor or property of the estate. Although the subject property is no longer part of the estate, most underwriters will require that the stay protecting the Debtor also be lifted before proceeding. E. A customer who has recently been through a bankruptcy and received a discharge wants to sell a property he acquired pre-petition that has 1 st and 2 nd deed of trust liens encumbering it. He tells you to pay off the 1 st lien but to ignore the 2 nd, because that lender did not file a proof of claim in his bankruptcy. Ignore the 2 nd lien at your peril. Section 506(d)(2) of the Bankruptcy Code does not void a lien that is not an allowed secured claim due only to the failure to file a proof of claim. 5

6 Exemptions: F. S is the debtor in a Chapter 13 bankruptcy. The property he wants to sell has been classified as exempt. Is any action by the court or trustee required before you will insure the sale? Generally, once property is classified as exempt, it is outside the bankruptcy estate and the debtor can deal with it as he wishes. If, however, the plan includes payment by the trustee of delinquent mortgage payments, some underwriters deem it prudent to modify the plan to reflect the mortgage payoff, or obtain the consent of the trustee. G(1). Your seller has listed his residence as exempt property in his bankruptcy. The sales price is $250,000, and the mortgage payoff is $175,000. You review the bankruptcy file a see the debtor has claimed the federal bankruptcy exemption. There was no objection to the claimed exemption by the creditors. Are you ready to close the sale? Unfortunately for this debtor the current federal homestead exemption is limited to $18,450 of equity. Is this instance, that leaves $56,550 in equity as part of the bankruptcy estate. You will need to involve the trustee in this sale to properly dispose of this portion of the bankruptcy estate. G(2). Your customer wants to sell her million dollar house which she has listed as exempt in her bankruptcy. A review of the title indicates that she acquired the property in August 2005 for cash. The property sits on one-half an acre, and she has wisely chosen the Texas state exemption in her filings. Do you have any concerns? The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 made significant modifications to the Bankruptcy Code. Section 522 of the Code was modified to address the mansion loophole. The Code now limits the exemption claimed to $125,000 in value if the interest was acquired during the 1215 day period preceding the date of filing of the petition. The statute does allow the rolling in of equity from a previous residence acquired prior to the 1215 day period. Without further investigation, however, you will not know if the entire million dollar equity is exempt. Preferences: H(1). A mortgage lender tells you it is going to take a deed in lieu of foreclosure from its borrower and wants you to insure ownership of the fee when it is accomplished. Do you have any concerns? 6

7 Although the Texas Supreme has declared that there is no such thing as a deed in lieu of foreclosure, that does not prevent a conveyance from a borrower to its lender. It means that such a conveyance does not extinguish inferior matters that would be removed from title by a formal foreclosure. Even if there are no inferior matters to worry about, a subsequent bankruptcy filing by the borrower may present problems. If the borrower files for bankruptcy within 90 days of the transfer (or up to a year if the creditor was an insider), the trustee may seek to avoid the conveyance as a preferential transfer under Section 547 of the Bankruptcy Code. In Texas, however, the Creditor s Rights Exclusion must remain in the policy. This exclusion removes the claim from coverage. H(2). The transaction in H(1) occurs and you insure it, but now the lender wants to sell the property to a third party. This new policy will also have the Creditor s Right Exclusion, so you feel safe to forge ahead. Some additional consideration may be prudent here. The mentioned exclusion does not cover Any claim which arises out of the transaction vesting in the person named in paragraph 3 of Schedule A the estate or interest insured by this policy by reason of bankruptcy or other insolvency laws. But here, the problematic transaction is not the one vesting title in the third party, but rather the prior transaction. Thus it may be argued that the exclusion is applicable to the third party insured. I. You receive a deed of trust from a closing in New York City. The transaction has funded, and you have been asked to record the lien document. The form of acknowledgment is not the Texas standard form, and you are not sure whether it is valid in the State of New York. You vow to research the issue when you return from your month long vacation. If you determine the acknowledgment is valid, you will record. What s the worry? The policy will have a creditor s rights exclusion in it. Section 547 of the Bankruptcy Code needs to be consulted in this situation. If the transfer between debtor and creditor is not perfected (here by recording the deed of trust) with 30 days of the date of funding, the transfer is deemed to occur when it is perfected. Thus the trustee may be able to avoid the lien as a preferential transfer to secure an antecedent debt. Even the creditor s rights exclusion will not bail you out of this one. The exclusion does not apply where the preferential transfer results from the failure of the Company or its issuing agent to timely file for record the instrument of transfer to the insured after delivery. 7

8 Closing the Real Estate Transaction Acknowledgment Issues: A. S comes to close a sale in your office Monday morning. Her purse, with all of her identification inside was stolen on Saturday. How can you take her acknowledgment? You can acknowledge her signature if you actually know her. The Texas Civil Practice and Remedies Code Section (a)(1) also says that you can acknowledge her signature based on the oath of a credible witness personally known to you. For example, if you personally know her Realtor, and believe the Realtor to be a creditable individual, you may rely on the Realtor s oath. What if you don t know the seller or her Realtor? While there is always some additional risk in relying on an acknowledgment taken outside of the title office, perhaps there is a licensed notary in the area who actually knows the seller. Maybe a loan officer at the seller s bank would be willing to take her acknowledgment based on personal knowledge. B. S, a Canadian citizen, comes to your office to close a sale. Her only identification is a Canadian passport. Any problems with this situation? If you cannot rely on one of the conditions set forth in B(1), you may have a problem. Section referenced above says an officer, unless he knows the acknowledging person may accept only (i) an oath as mentioned above, or (ii) "a current identification card or other document issued by the federal government or any state government that contains the photograph and signature of the acknowledging person. C(1). The Canadian in example B above resides in Canada and will not appear in your office for the closing. How can her signature be acknowledged? Again, Section of the Civil Practice and Remedies Code provides the guidance. An acknowledgment can be taken outside the United States or its territories by (1). a minister, commissioner or charge d affaire of the U.S., if he resides and is accredited in the country where the acknowledgment is taken, or (2). a consul-general, vice-consul, commercial agent, vice- commercial agent, deputy consul or consular agent of the U.S. who is a resident of the country where the acknowledgment is taken. C(2). The seller doesn t want to travel to the US Consulate. Can she just appear before a Canadian notary public? Section (c)(3) of the above referenced statute allows an acknowledgment to be taken outside of the U.S. by a notary public or any other official authorized to administer oaths in the jurisdiction where the acknowledgment is taken. 8

9 C(3). The Canadian seller has her execution acknowledged before a Canadian notary public and delivers it to you for closing? How do you know that a Canadian notary public is authorized to administer oaths in the jurisdiction in which the acknowledgment was taken? The Hague Convention of 5 October 1961 Abolishing the Requirement of Legalisation for Foreign Public Documents is useful for cutting through the red tape in authenticating documents. Between contracting states to the Convention, the only procedure required to authenticate a document is to attach an apostille signed by the Competent Authority of the appropriate country. The website at has a listing of the contracting parties and their Competent Authorities. There are currently 91 contracting states to this Convention, unfortunately, Canada is not one of them. The Canadian notary s acknowledgment must be authenticated by the U.S. Embassy or a consulate in Canada. If the notary s signature and seal are already on file with the U.S. the U.S. official can authenticate the acknowledgment, if not, the provincial Canadian authority responsible for notarys public must first authenticate the signature and seal to the U.S. official. D. A civilian contractor in Iraq wants to sell his house, so he has the necessary documents acknowledged by a commissioned officer in the U.S. Army. Are you satisfied with this procedure? Section (d) of the Civil Practice and Remedies Code recognizes acknowledgments taken by commissioned officers of the United States Armed Forces. Unfortunately for your civilian contractor, the statute provides the commissioned officer can only take the acknowledgment of a member of the armed forces or the member s spouse. E. A Realtor representing the seller in a transaction tells you her client has been in an accident and now has a physical disability that makes it impossible for him to sign the conveyancing documents, or to even make his mark on them. How should you proceed? Section of the Government Code addresses the signing of documents by physically disabled persons. A notary may sign the name of the disabled person, if directed to do so by the disabled person in the presence of a witness. The witness cannot have any legal or equitable interest in the property that is the subject of, or is affected by the document being signed. The notary must require identification from the witness in the same manner as from an acknowledging person. The notary must write below the signature the following: Signature affixed by notary in the presence of (name of witness), a disinterested witness, under Section , Government Code. 9

10 HUD-1 Issues: F. The escrow officer has prepared the final settlement statement which shows net proceeds of $75,000 to be paid to him. The new lender and buyer have approved the HUD-1. The seller then comes to you and asks you to pay $30,000 directly to John Smith, his friend who helped him put the deal together. When you balk, the seller says, What s the problem? It s my money and I can do whatever I want to with it. If you comply with the seller s request, the settlement statement and the HUD-1 will not show identical disbursements. While it is the seller s money there are at least two things you should consider before complying with the request. First of all you sign a certification which says The HUD-1 Settlement Statement which I have prepared is a true and accurate account of this transaction. I have caused or will cause the funds to be disbursed in accordance with this statement. While you could say the seller s funds were divided at the request of the seller, why put yourself in the position of having to defend your actions. Another reason arises from a case currently pending before the Texas courts. In that case the lender complained that the settlement agent failed to tell it about the diversion of a part of the seller s funds to a third party. If it had known about the diversion of proceeds, it may not have made the loan. G(1). On a home equity loan, the lender approves the final settlement statement and you forward it to the borrower on Monday. On Wednesday, as the borrowers arrive at your office to close, the lender faxes you a revised settlement statement which shows an additional $275 in closing costs to be paid by the borrower. The closing instructions require the issuance of a T Procedural Rule P-47.B.(12) requires the Company to delete subparagraph (l) of paragraph 1 of the T-42.1 if it does not provide each property owner with the final settlement statement at least one calendar day before the business day or subsequent calendar day that the owner executes the insured mortgage and note. G(2). Same as G(1), but the revision shows a reduction in closing costs to be paid by the borrower of $275. The Finance Commission of Texas has adopted Rule under Title 7 of the Texas Administrative Code that interprets the meaning of bona fide emergency or other good cause that would allow the delivery of a modified settlement statement to the borrower on the day of closing. Consequently, some lenders believe they fit within the parameters and want you to close on the same day the final settlement statement is prepared. 10

11 This is another case where the procedural rule governing the issuance of coverage is stricter than what may be allowable under the law. I suggest, notwithstanding the Commission s interpretation, that the result here should be the same as under G(1). H. A lender offers its borrowers no closing cost loan transactions. The lender proposes to pay certain of the closing costs with its funds outside of closing. It sends the necessary funds to you and asks you to pay the appropriate parties. How can you handle this transaction? The lender wants you to reflect these charges as P.O.C. on the HUD-1. Since the money will flow through your escrow account, the Texas Department of Insurance requires that the HUD-1 reflect these payments so that the settlement statement and the disbursement sheet will be consistent. Use of the form T-63 will satisfy all parties. Unfortunately, I have seen numerous TDI audit reports which reflect the failure to use the form. Federal Tax Issues: I. When the seller comes to closing, you request his Taxpayer Identification Number (TIN) so that you can file the 1099-S that the IRS requires. The seller says he doesn t have one yet. How can you proceed? Instructions from the IRS state that you may provide a written statement to the seller similar to: You are required to provide (name of settlement agent) with your correct taxpayer identification number. If you do not provide (name of settlement agent) with your correct taxpayer identification number, you may be subject to civil or criminal penalties imposed by law. The solicitation must contain space for the name, address and TIN of the seller, and the following certification: Under penalties of perjury, I certify that I am a U.S. person or U.S. resident alien and the number shown on this statement is my correct taxpayer identification number. Keep the form for four years. Generally, if you follow this procedure, the IRS may waive any fine against you for failing to provide the TIN. J. Husband and wife come to you to close the sale of their house. The husband says he and his wife have TINs, but he doesn t want you to file the 1099-S. What is the best way to proceed? If the sales price is $500,000 or less ($250,000 if the sale is by a single person), the seller can sign a certification which, will eliminate your need to file the 1099-S. A form of certification is included in the appendix. 11

12 Earnest Money Contracts: K. Seller brings you an earnest money contract to sell property, which you receipt along with the buyer s earnest money. The closing date comes and goes. You send the standard termination letter, but you hear nothing from the buyer. The seller brings you a second contract with a different buyer. He wants to close on this second contract, because the first one has terminated. You still hear nothing from the first buyer. Is it OK to close the second contract? Your action here is somewhat dependent to your aversion to risk. Has the first contract truly terminated? You still have the earnest money. What discussions were held between seller and buyer that you are not privy to? What agreements may have been reached? Some title people follow the rule of thumb that they will not close a second contract while they still hold earnest from the first, unless the first buyer acknowledges they no longer want the property. 12

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