Creditors Rights

From Commercial Lender to Residential Landlord: The Protecting Tenants at Foreclosure Act

On May 20, 2009, the United States Congress enacted the Protecting Tenants at Foreclosure Act (APTA@) which grants specific rights to residential tenants affected by foreclosure. The PTA is federal law that acts as a minimum requirement for foreclosing lenders with any additional state requirements left unaffected. Congress, in the midst of the recent Aforeclosure crisis,@ sought to enact the PTA to protect unsuspecting/innocent tenants by imposing restrictions on a foreclosing lender=s ability to evict a holdover tenant upon foreclosure. As noble a cause as it may have been, the PTA has resulted in significant post-foreclosure obstacles to lenders.


Requirements under PTA


Prior to the enactment of PTA, a residential tenant occupying a foreclosed property could be required to vacate the property on 30 days notice, under Texas law. If the tenant failed to vacate upon the expiration of 30 days, the foreclosing lender could then proceed with an eviction action. Under the PTA, a foreclosing lender is now required to provide a residential tenant remaining in the foreclosed property a minimum of 90 days to vacate. The PTA further mandates that a foreclosing lender takes title to a foreclosed property subject to an existing lease. In short, a foreclosing lender Asteps into the shoes@ of the prior landlord/borrower and assumes all of the rights, duties, and obligations under the existing lease. Therefore, if a foreclosed property is occupied by a residential tenant who is under a lease that is protected by the PTA, the lender must honor that lease for its term. Although the tenant under the existing lease must continue to make monthly rental payments, this results in a clear obstacle to the foreclosing lender=s ability to market and sell the property. The PTA allows such a property to be sold to an Ainvestor@ who agrees to honor the existing lease or to an Aend user@ (owner-occupant). A sale to an Ainvestor@ or Aend user,@ however, does not relieve the foreclosing lender of the duty to give the tenant 90 days notice to vacate.


Not all residential tenants or leases are protected under the PTA. There are situations in which the occupant of a foreclosed property does not rise to the level of a Atenant@ under the PTA and is therefore is not entitled to its protections. These occupants include, but may not be limited to, the child, spouse, or parent of the defaulting borrower. Moreover, not all leases will actually qualify as a Alease@ protected under the PTA if: (1) the lease was not negotiated at arms-length; (2) the lease is not for fair-market rent; or (3) the lease was not entered into prior to foreclosure. These situations, however, are highly fact intensive and need to be addressed on a case by case basis to ensure that the foreclosing lender is not only protecting its rights against opportunistic Atenants,@ but also complying with the PTA as to not violate the rights of protected tenants under legitimate leases. Although it may be eloquently asserted at times, it is important to note that the PTA does not provide protections to the owner/borrower on which the lender has foreclosed.


Real Effects of PTA on Foreclosing Lenders


One of the most significant effects of the PTA is that a foreclosing lender is now forced into the residential landlord business with all its attendant obligations and responsibilities. These obligations include, but are not limited to, yard/building maintenance, repairs, payment of water utilities, and safety requirements such as installation and maintenance of smoke detectors. In addition, foreclosing lenders need a strong and experienced local agent to collect rental payments and manage the property. Tenants may require a 24 hour local contact for emergency matters, and the local agent needs to be able to make decisions (such as hiring plumber or electrician) on nights and weekends without waiting for the lender=s office to open the next business day. Foreclosing lenders must also be mindful of the physical condition of the property, including the installation and maintenance of any security devices required by Texas law. These obligations alone are enough to cause concern, but what happens when these obligations remain without the reciprocal obligation of the tenant to actually pay rent to the foreclosing lender?


In the higher-end Aspec@ house market, it is not uncommon for the tenant to pre-pay lease payments for up to a year. This in turn causes substantial economic issues for a foreclosing lender. For example, a lender forecloses on a property in June 2011 that is under a written lease term from January 2011 through December 2011 and the tenant has already pre-paid rent for one year to the defaulting borrower/landlord per the terms of the lease. As a result, the lender is forced to allow the tenant (assuming the tenant is not otherwise in default under the lease) to remain in the property Arent free@ for six months. To add insult to injury, the lease terms may require that the landlord is responsible for yard maintenance and water. Now, a commercial lender has essentially been transformed into a residential landlord with no rent stream and yet saddled with maintenance expenses and obligations.


Minimizing the Impact of PTA


Many foreclosing lenders have discovered that Acash for keys@ provides a clean, cost-effective means of obtaining a vacant property in order to prepare and market the property for sale prior to the expiration of 90 days. Although the pre-paid tenant in the above example is not likely to accept a Acash for keys@ deal, many tenants under a month-to month lease or an expired lease are all too happy to hand over the keys for a reasonable sum (this sum should be determined by the foreclosing lender via a cost/benefit analysis based on factors unique to the specific case). To a foreclosing lender, the idea of passing out money to an occupant of property already owned by the lender may be of little attraction, but given the requirements under the PTA and the possibility of a quick sale to a third-party, Acash for keys@ can provide a sensible solution to the post-foreclosure problems created by the statute.


Prior to foreclosure, lenders should be aware of the status of the property and whether it is occupied by a residential tenant who will be protected under the PTA (often, commercial builders will lease properties that they are unable to sell without notifying the lender). Many times copies of any leases can be obtained by request to the borrower or borrower=s counsel. Knowing the terms of a lease in connection with a property prior to foreclosure can provide invaluable information to a foreclosing lender and may even affect the liquidation strategy depending on the terms and whether rent has been pre-paid as in the above example.


There are numerous nuances to the PTA and an infinite number of directions a case can take upon foreclosure of a property that involves a residential tenant. This article is aimed merely to provide a general overview of the statute=s requirements and a sample of its effects. As with all situations involving a new area of law, there are many legal issues that may arise at different stages of the foreclosure process involving property with residential tenants, and each and every issue requires examination and analysis to ensure that the foreclosing lender=s rights are maintained and the tenant=s rights are protected within the confines of the law.


Author: By Michael P. Menton

Creditors Rights

Creditors Beware: Potential Pitfalls of Automatic Stay Violations

The “automatic stay” is one of the principal immediate benefits of filing bankruptcy. Upon filing a bankruptcy petition, the automatic stay springs into effect to stop any creditor’s debt collection efforts, lien enforcement actions, lawsuits and a host of other actions against the debtor and the debtor’s property. It is primarily designed to maintain the status quo while the court examines the debtor’s financial situation. The automatic stay is often likened to “closing the windows and locking the doors” to prevent any property from leaving the newly-created bankruptcy estate. As its name implies, the automatic stay is effective without any further action by the debtor or the court, and the court will eventually monitor the gathering and distribution of the debtor’s assets. However, until that time, or until the stay is lifted, creditors are generally precluded from taking any action against the debtor or the debtor’s estate.

Pursuant to the Bankruptcy Code, 11 U.S.C. 362(b), there are exceptions to the stay such as civil actions involving the establishment of paternity or the collection of a domestic support obligation. However, the exceptions outlined in § 362(b) are often narrowly construed, and the courts have broad powers to extend the reach of the automatic stay even further when necessary.

Most creditors readily acknowledge that the automatic stay applies to them, but they ask the court to lift the stay via a “motion for relief” under 11 U.S.C. § 362 of the Bankruptcy Code. Such motions commonly allege a lack of adequate protection of an interest in estate property, or lack of an adequate “equity cushion,” or, alternatively, that the debtor does not have equity in the subject property and that the property is not necessary to an effective reorganization in bankruptcy. If the court grants the creditor’s motion for relief, the creditor may repossess and foreclose upon its collateral; however, the creditor is still prohibited from pursuing any actions against the individual debtor. The stay continues until the earlier of the dismissal or the closing of the bankruptcy case, and any actions in violation of the stay are void in Texas. See In re Pierce, 272 B.R. 198, 204 (Bankr. S.D. Tex. 2001).

Not only are actions taken in violation of the stay void in Texas, but they may also be punishable by the court, particularly where the court finds that the creditor willfully violated the automatic stay. See In re Repine, 536 F.3d 512 (5th Cir. 2008). For example, Section 362(k) creates a private cause of action for a debtor to file suit against a creditor who willfully violates the automatic stay to the injury of the debtor. If the creditor is aware of the stay and intentionally acts in violation of the stay, the law provides that the debtor shall recover actual damages, including costs and attorney’s fees.

In addition to economic loss, emotional damages also qualify as actual damages. For example, in a recent appeal before the Fifth Circuit, the Court found that emotional distress damages may also be awarded in the appropriate case, but the plaintiff is required to set forth “specific information” concerning damages caused by his alleged emotional distress rather than relying only on “general assertions.” Repine, 536 F.3d at 521—522. For example, in Repine, the creditor was an attorney for the Debtor’s ex-wife in connection with a child support enforcement action wherein the family court held the debtor in criminal contempt for failure to pay child support and ordered that he be incarcerated until he paid the amounts due and owing to his wife and child. The parties eventually negotiated options for settling the child support enforcement action and securing the debtor’s release from jail, and the court entered an agreed order lifting the automatic stay to enforce the settlement terms. Specifically, the agreed order provided that attorney’s fees due and owing to the ex-wife’s attorney shall be provided for as a priority unsecured claim to be paid through the debtor’s Chapter 13 plan.

In light of the bankruptcy court’s entry of the agreed order, the family court held a hearing regarding the debtor’s release from jail, where the attorney opposed the debtor’s release, as she was concerned that her fees would not be paid. After the hearing, the debtor remained in jail since he had still not paid child support, during which time his father passed away. Also, the attorney threatened in a fax that she would refuse to appear in court to submit an agreed order releasing the debtor from jail, despite her client’s wishes, until she received “a copy of the certified checks” for her attorney’s fees. Subsequently, the attorney’s client and the debtor jointly moved to enforce the bankruptcy court’s agreed order, and the court ordered the attorney to appear and show cause why she should not be held in contempt for attempting to collect her attorney’s fees in violation of the automatic stay.

Despite being personally served with the show cause order, the attorney failed to appear, and the bankruptcy court issued a warrant for her arrest. The U.S. Marshal took the attorney into custody, and the bankruptcy court admonished the attorney to cease any and all collection efforts. Nevertheless, the attorney continued her efforts to collect her attorney’s fees and continued to refuse to consent to the debtor’s release from jail so he could attend his father’s funeral. Consequently, the ex-wife and debtor commenced an adversary proceeding seeking damages and attorney’s fees for the attorney’s willful violation of the automatic stay. After a two-day trial, the bankruptcy court awarded the plaintiffs actual damages (including $4,400.00 for emotional distress, punitive damages and attorney’s fees.) The attorney appealed; however, the district court affirmed the bankruptcy court’s decision.

Subsequently, the Fifth Circuit Court of Appeals vacated the bankruptcy court’s decision in part, finding that the debtor’s general testimony that he felt “very upset” at what his sons would think of him for being in jail and that it was “very traumatic” for him to miss his father’s funeral was insufficient evidence to support an award of emotional damages. Repine, 536 F.3d at 522. However, it is important to note that such an award is available to the plaintiff who makes specific, supportable assertions of emotional distress.

Furthermore, Section 362(k) provides that, in “appropriate circumstances,” a debtor may recover punitive damages. 11 U.S.C. 362 (k). In defining “appropriate circumstances,” the Fifth Circuit recently ruled that an “egregious” intentional misconduct is required on the violator’s part in order to impose punitive damages. Repine, 536 F.3d at 521. In Repine, the Fifth Circuit affirmed the bankruptcy court’s award of punitive damages, finding that the attorney’s violation of the stay was particularly egregious, “reckless,” and “arrogant,” especially since the attorney ignored the court’s orders and her client’s wishes, and she persisted in her collection efforts despite the bankruptcy court’s admonishment.

Accordingly, once a creditor becomes aware of a debtor’s bankruptcy filing, it is imperative that all collection efforts and communications of any kind with the debtor cease immediately in order to prevent any violation of the automatic stay. Once a creditor is aware of the stay and acts in violation of the stay, the debtor likely becomes entitled to actual damages and, in certain cases, may be awarded punitive and emotional damages. Such consequences may be easily avoided with a quick bankruptcy search of the subject obligor(s) prior to any communications, demands or other debt collection acts.

Creditors should consult with legal counsel soon after a bankruptcy filing in order to obtain advice for promptly and effectively protecting such creditors’ rights.

By David M. O’Dens and Kerry M. Hayden

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