Last week I had a discussion with one of my Chapter 7 clients about a potential wrinkle to her upcoming bankruptcy filing, commonly referred to in bankruptcy practice as a “trustee buyout”.
When this client had retained our firm back in September, 2006, she had indicated to me that her home was worth $240,000 and that she owed $209,000 on a single mortgage. She had based this $240k valuation from a refinance appraisal she’d received in March, 2006. She was current on her monthly mortgage payments and wished to keep her house through the Chapter 7 bankruptcy via reaffirmation. Unfortunately, due to an illness from which she suffers, things went delayed and we are just now getting to the point where we’re ready to file her Chapter 7 bankruptcy for her.
Last week’s new issue came to light when my client told me that a condo identical to hers in her building had sold in the last month for $250k. Concerned about the possible change in circumstances and how it may affect her future Chapter 7 filing, I did some due diligence on her behalf and checked several websites that produce “CMA’s” (comparative market analysis). The property indeed was being valued on these websites at closer to $250k than the $240k valuation she had initially told me.
When filing a Chapter 7 or Chapter 13 bankruptcy, a filer is entitled to protect a certain amount of equity in their homestead property. The homestead exemption only protects equity in a property that someone lives in. Equity is the difference between what the property is worth after cost of sale and what is owed in total on the property. While it varies from state-to-state, the homestead exemption in Illinois where I practice is $15,000 per person. (Note: The exemption doubles to $30,000 in Illinois for a married couple’s joint filing.)
My client owns her property in fee simple, which means no one else is on the deed to her house. As a general rule, a trustee will typically allow a 7-9% cost of sale deduction off of a house’s valuation to account for broker fees, taxes due at sale, etc. So in this case, with my client property being worth $250k, deducting an 8% cost of sale would leave the value at an even $230k. Remembering that my client owes roughly $209k on her condo, the equity difference between $230k and the $209k owed would be $21k. Because we can only protect $15k of equity at filing in Illinois, this means that the equity in her house is $6k above the exemption amount and could thus be perceived as an asset for liquidation by a bankruptcy trustee.
At this point, I suggested to my client that we needed to get a current appraisal on her property to determine the actual value. She did this immediately and the condo’s value was indeed appraised at $250k. I then gave my client several options on how we could proceed from here:
- We could file a Chapter 13 for her instead of a Chapter 7 to protect the exposed equity in her condo. She would be required to pay back at least $6k of the $50k in credit card debt she owed to match the amount that could be liquidated in a Chapter 7.
- She could sell her house prior to filing the bankruptcy, protect up to $15k of the equity, and spend down the remaining $6k or so on necessities, like rent, food clothing, etc.
- We could file a Chapter 7 for her and if necessary negotiate a “trustee buyout”.
My client had no interest in selling her house and much preferred filing a Chapter 7 bankruptcy to a Chapter 13 bankruptcy, so we decided together that a “trustee buyout” was her best course of action.
In a Chapter 7 where a filer has an asset worth above the allowable exemption, it is usually possible to negotiate an arrangement with the Chapter 7 trustee to pay him the cash amount equivalent to the valuation of the exposed asset and protect the asset itself. In my experience, the payment arrangement can vary in time from 3 months to a year, or even possibly a one-time lump sum payment. It is also often the case that a trustee in a Chapter 7 proceeding will choose to ignore an asset that he could potentially liquidate. If a trustee believes that he could not make a meaningful distribution to the creditors listed in the Chapter 7 proceeding, he can choose to acknowledge the asset but pass on liquidation or further action because the value of the asset is too small to make any kind of repayment dent to the creditors as a whole. Hopefully in my client’s situation above, this will be the case.