Creditors Rights

Texas Foreclosure Legislation: A Trip Through the Sausage Maker

Once in every generation the “perfect storm” hits the Texas Legislature. The ongoing financial crisis and the resulting “foreclosure crisis” have created a flood of proposals in Austin during the 2009 legislative cycle.

Presently, Texas has one of the fastest and easiest foreclosure processes in the nation. Typically, with respect to a residential asset (which is not a home equity loan), a foreclosure can take place in as little as two months with a 20-day notice of default and a 21-day notice of sale. Texas is a non-judicial foreclosure state, with little if any oversight of the foreclosure process by the state government or courts. Foreclosure sales have historically been a “private” matter between the lender and the owner.

Pending Texas legislation seeks to change this and takes primarily four forms.

First, there are timeline bills. The purpose of these bills is to enlarge the timeline for the notice of default (issued with residential properties) and the notice of sale (the document posted at the court house). In general, these timelines are proposed to be enlarged to 45 days (notice of default) and 60 to 90 days (for notice of sale).

Second, there are “process” bills. These bills fall into two types. With respect to residential loan assets, it is proposed that notice of default will be given on a form mandated by the Texas Attorney General which contains various types of information about the foreclosure process and the loss mitigation alternatives available to the borrower. These bills also typically require that the lender attempt to make telephone contact with the defaulted residential consumer in order to counsel the consumer on loss mitigation options. The second type of process bill is more far reaching and attempts to change Texas from a non-judicial to a judicial foreclosure state. This would be a substantial departure from our historically hands-off foreclosure process requiring little, if any, governmental intervention. Judicial foreclosure bills are being strongly opposed by both the lending industry as well as the Texas judiciary, who do not desire to see a new influx of lawsuits into their courts.

Third are bills which attempt to aid tenants in property following a foreclosure. Under present Texas law, a tenant in a property following a foreclosure must vacate the property within 30 days of being requested to do so by the lender. Various bills seek to enlarge this time from 30 days to 60 or 90 days. And one pending bill even seeks to require an individual who acquires a property through foreclosure to honor a tenant lease.

Fourth are consumer protection bills. These bills seek to describe something called a “sub-prime” loan. Some of the “sub-prime” loan features are not normally associated with sub-prime loans. Sub-prime loans would include loans not only with a higher then average interest rate (measured against the prime lending rate), but also would include loans with balloon features and pre-payment penalties, as well as certain adjustable rate loans which allow for the interest rate to increase more than two percent per year. These consumer protection bills either outlaw loans within these features or severely restrict the lender’s ability to foreclose such a loan in default.

We are also keeping our eye on significant federal legislation. Specifically, a “cram down” bill could pass allowing residential consumers in bankruptcy to have a bankruptcy court reset the customer’s interest rate to a lower level. In addition, this “cram down” bill could allow a loan secured by a property with negative equity to be stripped of any debt in excess of the value of the property at the time the bankruptcy is filed. This session of the Texas Legislature draws to a close on June 1, 2009. Over seven thousand bills were filed by the filing deadline, and a great many of these bills will not become law. Nevertheless, with the economic crisis and foreclosures at record levels, we believe it likely that some form of foreclosure reform and consumer protection will be adopted by the Texas Legislature. After the Legislature adjourns, watch for a follow-up article in an upcoming SettlePou newsletter discussing the final set of laws enacted by the Legislature.

By Barry D. Johnson

Creditors Rights

Lease Obligations in Bankruptcy

Very few tenants enter into leases without the intent to pay all of the rent when due. But lease defaults are a reality. While nonpayment of the rent is bad enough for a landlord, in a commercial tenancy, a tenant’s default has far reaching consequences that may affect other tenants (by reducing traffic) or affect the project in general (by making a project appear less attractive). Therefore, a quick resolution to lease defaults is always in the landlord’s best interest.

Many times, after falling behind on lease payments and other financial obligations, a tenant will seek protection under the United States Bankruptcy Code in order to try and salvage the business. In recent years we have heard many horror stories about bankruptcies in general, but the good news for a landlord is that a debtor’s options in bankruptcy as toward the landlord are very limited. Below are a few important bankruptcy concepts and tenant alternatives in bankruptcy for a landlord’s use in evaluating and reacting to a tenant bankruptcy.

At the outset, the filing of a bankruptcy case imposes an “automatic stay.” Thus, although the tenant must pay all rent that is due from the date of the bankruptcy going forward, the automatic stay prevents the landlord from taking any action, including, for example, use of the landlord’s “self help” remedies. The automatic stay is designed to preserve the debtor’s estate either for reorganization or liquidation. In general, the debtor’s affairs are supervised by the bankruptcy court, and action cannot be taken against the debtor without permission of the court or obtaining “relief from the automatic stay.” Therefore, even in the circumstance where a tenant stops paying rent after filing bankruptcy, a landlord must first obtain relief from the automatic stay before exercising
any of the landlord’s normal default remedies such as lock out, taking possession of collateral securing the lease for non-payment, or suing the tenant for past due rent.

Of primary importance in a Chapter 11 reorganization bankruptcy, a lease obligation is referred to as an “executory” contract. Executory contracts are a special type of contract wherein the parties have some continuing mutual obligation to one another. So, for example, in a lease, the landlord has a continuing obligation to provide the space to the tenant, and the tenant has a continuing obligation to make rental payments. Executory contracts are subject to special rules under the Bankruptcy Code and present the Bankruptcy Court and the debtor with essentially a “binary” option. The debtor must either “accept” or “reject” an executory contract. Acceptance of an executory contract means just that — the contract is affirmed in all of its respects and the debtor is required to make all payments and perform all the actions that are required under the terms of the contract. Rejection, on the other hand, means that the debtor is refusing to continue the contract and surrendering the space to the landlord. It is important to understand from this discussion that the debtor does not have the opportunity to renegotiate a lease obligation.

With an executory contract, the debtor’s only decision is to accept or reject the lease. If the landlord elects to negotiate a “workout,” then that is the landlord’s choice. But the landlord cannot be ordered to amend or modify the lease on behalf of the debtor.

When confronted with a tenant in bankruptcy, a proper landlord’s strategy is aimed towards forcing the debtor to make the acceptance or rejection decision as early as possible in the bankruptcy process. While the Bankruptcy Code provides set deadlines for this decision to be made, in many bankruptcies, the debtor will attempt to delay the decision for some period of time. In a Chapter 11 Bankruptcy, especially, a debtor may attempt to delay the decision until confirmation of the plan. However, even if delayed for some period of time, the fact remains that at some point the debtor must accept or reject the executory contract. If the
tenant accepts the lease, the tenant must bring the lease obligations current. If the tenant elects to reject the lease, the landlord gets the property back and has an unsecured claim for unpaid rent.

While bankruptcy is often viewed as a negative event, landlords and other property owners in a leased property can take some comfort in the fact that their contracts will largely survive as is or be rejected. Bankruptcy can actually be a good event in a landlord-tenant context, because it requires the tenant to either bring the account current or give the property back. And ultimately, this is what landlords are looking for — some “closure” for a defaulted obligation.

By Cliff Wade and Barry Johnson