Surrendering Your House in Chapter 7 Bankruptcy

Many clients “surrender” their house as part of their Chapter 7 bankruptcy and assume that said act will allow them to put their homeowner’s “experience” totally in their rear view mirror. Unfortunately, in the context of dealing with secured debt (such as mortgages or car loans) in bankruptcy, the term “surrender”does not mean what many people think it does. The act of “surrendering” someone’s collateral in bankruptcy only means that you no longer intend to make the mortgage or car loan payments associated with the collateral. Although receiving your bankruptcy discharge does eliminate your personal obligation to repay the note and mortgage, you still own the collateral (the house or car) until something happens which divests you of such ownership interest, such as a foreclosure sale, short sale or deed in lieu of foreclosure.

The perception that a Chapter 7 Trustee will take control of all property surrendered by a debtor is simply not true in most instances. The Trustee’s goal is to liquidate assets (ie., sell property) in order to generate funds for a distribution to the creditors. However, if the property in question has no non-exempt equity, the Trustee will abandon the estate’s interest in the property and no liquidation will occur. Further, discharging your personal obligation to repay the mortgage does not somehow make the bank the new owner of the property. The bank will only become the owner of the property (1) if their foreclosure process is completed and the bank is the successful bidder at the auction sale, or (2) if they accept from you a deed in lieu of foreclosure.

There are “pros” and “cons” to remaining the owner of your “surrendered” house after bankruptcy. The “up side” is that, if you choose to do so, you should be able to live there for quite a while without making any mortgage or rent payments, which should help in your efforts to get back on your feet financially (although we do recommend that you continue to keep liability insurance on the property). The “down sides” are numerous, especially if you have vacated the property and moved on with your life:

• First, as the property owner you will remain liable for any injuries sustained on the property, such as if a neighborhood kid wanders on to the property and gets hurt. This is effectively dealt with by maintaining (and paying for) your own liability insurance policy on the property. The bank will maintain its own policy insuring the building’s structure against things such as fire, but said policy normally will not protect you from persons getting injured on the property.
• Second, you must still comply with all municipal ordinances regarding property ownership. If someone creates an eyesore on the property by storing old tires or junk cars on it, etc., it is the property owner who will (1) receive a citation from the municipality to remedy the problem and (2) be fined if such remediation does not occur in a timely fashion (as determined by the municipality). This can be difficult to deal with, especially if you have moved far away, hopefully to greener pastures. A caveat to this is that in certain circumstances where the mortgage holder has taken an egregiously long period of time between the entry of a Judgment of Foreclosure and Sale and the conducting of the auction sale (ie., 29 months in one reported case), the mortgage holder can be fined by the municipality if tenants in the property become endangered due to conditions on the premises that are allowed to develop and not remedied by anyone. There is a paucity of reported law on this issue, and we do not suggest that it provides a “safe harbor” for property owners whose abandoned property remains titled in their names.
• Third, if the property in question is a condo or townhouse or part of any community having a homeowner’s association, you will remain liable for all post-bankruptcy HOA dues and assessments. We recommend that you continue to pay the HOA fees after the bankruptcy filing, since homeowner’s associations tend to be very quick about suing those property owners who are in default.
• Fourth, unless you have a tax escrow with the bank, you will continue to receive your property and school tax bills from the taxing authorities. You should immediately forward all such bills to the bank holding the mortgage, as they should pay the taxes in order to protect their interest. You will stop receiving these tax bills once there is a new owner.

You cannot force a bank to accept from you a deed in lieu of foreclosure, and in many instances they will simply refuse to do so, especially if there is a second mortgage or other liens on the property. Further, a recent First Circuit Court of Appeals case made it clear that as long as the bank is not trying to squeeze payments out of you, a lender’s failure to commence and prosecute a foreclosure proceeding does not violate the Discharge Injunction. In short, you cannot force the lender to foreclose, so you might be “stuck” for a while with the burdens of property ownership. Bankruptcy can be a very effective tool for discharging debt, including mortgage obligations, but it is less effective when it comes to undoing all of the incidents of property ownership. Like most things, you take the good with the bad.

If you need help with a bankruptcy or foreclosure matter in New York, contact the team of attorneys at Hayward, Parker & O’Leary today.