How Chapter 13 Bankruptcy Can Help Landlords In Orange County, California Manage Rental Property Debt

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In this article, you can discover…

• How Chapter 13 can help landlords in debt retain their properties.
• Whether you can keep collecting rent during Chapter 13 bankruptcy.
• How your rental income may impact a repayment plan.

How Can Chapter 13 Help Me Catch Up On Mortgage Arrears Without Losing My Rental Property?

In Chapter 13, one of the provisions that we have in the Bankruptcy Code is that you can use the Chapter 13 plan to cure a default. If you’ve fallen behind on mortgage payments, what we can do is propound a Chapter 13 plan of reorganization and put that mortgage arrearage into the plan so that you can pay it off spread out over five years (60 months). Now, you can’t have a plan that lasts more than 60 months, but at least you’d have 60 months to do it.

If you’ve had a change of circumstances that has rendered you able to cure that arrearage, plus make every mortgage payment that comes due after the day we file the petition, Chapter 13 can be a very powerful tool for catching up on a mortgage. This isn’t just for a rental property. It can be done if you have a mortgage arrearage on your principal residence.

Now, that raises the important question that I always ask somebody who calls up and says, “I’ve got to save my house” or “I’ve got to save my property” in the Chapter 13. The question I ask is, “What’s changed?”

Because if you haven’t been able to make the mortgage payments thus far, Chapter 13 isn’t going to give you an additional source of income. Sometimes the person will say, you know, “I’d lost my job. My income dropped through the floor, but I’ve just gotten this terrific job. It pays a lot, and I can do it.” Great, let’s do it.

If you just don’t have a change of circumstances and you want to file a Chapter 13 out of desperation with no hope of being able to cure this arrearage, Chapter 13 is not going to do the trick. But it is a very powerful tool if you have the resources to cure the arrearage spread out over five years.

Can I Keep Collecting Rent While In A Chapter 13 Repayment Plan?

I’m going to take a foray into Chapter 11 for just a second, and then we’ll see what happens in Chapter 13. In Chapter 11, a very important concept is something called Cash Collateral. What is Cash Collateral? If you have a rental property and you’ve got a mortgage against that property, you can bet dollars to donuts that if you look at the mortgage contract, it has an assignment of “rents provision.”

What does that mean? It means, if you’re not making payments on the mortgage, that rental income belongs to the mortgage company. It serves as collateral for the loan every bit as much as the building serves as collateral. Hence, it’s called Cash Collateral.

You’re not allowed to use even one penny of Cash Collateral without the judge’s permission. Reason, it’s not your money. It belongs to the mortgage company. Under normal circumstances, if you’re making the monthly mortgage payments just like clockwork, nobody cares. Nobody is going to go after your rental income. But if you aren’t making the mortgage payments, then that assignment of rents provision says that money is not yours to do with as you see fit.

I’ve never really seen this pushed in Chapter 13; it’s pushed in Chapter 11. In fact, if you use Cash Collateral without being authorized by the Court to do that in a Chapter 11, the Court will automatically convert the case to Chapter 7, and you’ll lose all your assets. It’s a big deal.

As a prophylactic, I would certainly seriously think about filing a Cash Collateral motion just to get the Court’s permission to use that Cash Collateral, even if it’s a Chapter 13. So that, yes, you’re collecting that rent income; but you want the Court’s permission to use it because you need it, maybe for operating expenses or to maintain the building, whatever.

If you are using the Chapter 13 to cure the mortgage arrearage on that rental property, the lender is getting paid. You can argue that the lender has adequate protection by the plan payments, and you should be able to use that rental income. But of course, we want you to collect the rental income, because you probably need to use at least some of that, not only to maintain the building and keep things up, but also for your Chapter 13 plan payments.

What Happens To Unpaid HOA Dues In A Chapter 13 Case?

The Bankruptcy Code has a provision in Section 523(a) that says that prepetition HOA dues are dischargeable, and this does apply in Chapter 13 as well. What does that mean?

It means if you have an HOA arrearage on the dues that you incurred prior to filing the bankruptcy petition, then in a Chapter 13 plan, you don’t necessarily have to pay it in full. You’ll pay that at the same rate as the credit card debt, and whatever other general unsecured debt you have.

However, postpetition HOA dues are not dischargeable, and you need to pay them through the plan. They aren’t necessarily priority debts, but generally speaking, we want to structure the plan so they’re paid in full. Otherwise, when you get your discharge at the completion of the plan, you’ll get credit for the portion you paid through the plan, but you’ll still owe the unpaid portion.

What Happens To Unpaid Property Taxes In A Chapter 13 Case?

Tax debts are completely different story. If you owe property taxes, then the county has a lien against the property, and so it’s a secured debt. It’s also a priority tax debt, so that you must pay it in full – period; end of discussion – through the plan, spread out over the five years.

General unsecured debt like credit card debt, doesn’t get any postpetition interest in a Chapter 13 plan. See 11 U.S.C. § 502(b)(2). They just get paid whatever percentage you can afford. As for unsecured tax debt – even nondischargeable tax debt – you don’t have to pay postpetition interest through the plan unless you have enough disposable income to do so. See 11 U.S.C. § 1322(b)(10).

However, secured tax debts are entitled to postpetition interest; so the county will insist on getting interest on its claim. You can try to negotiate with the county, but you’re going to have an uphill battle. Ultimately, the property tax will have to be paid in full, plus appropriate interest, which is nowadays about 18% on property taxes. It’s dramatically higher than, for example, income taxes.

In Chapter 13, all debts must be paid through the plan. You don’t get to have little side deals. However, there is one exception: if you have ongoing secured debt payments on a car loan or a home mortgage, you will usually make those directly to the lender.

Who Do I Make Secured Debt Payments To During Chapter 13 Bankruptcy?

In the Central District of California, the prepetition arrearage goes into the plan and is paid over the life of the plan. However, you make the payments that come due after the petition date directly to the lender. There is an important caveat: Some of the Chapter 13 trustees take the position that if it looks like you’re not going to do very well in this Chapter 13 and there’s no guarantee you’re going to make those postpetition mortgage payments, they will insist on what’s called conduit payments, meaning that even the ongoing mortgage or car payments that come due postpetition are bundled into the Chapter 13 plan payment, which you send to the trustee. Then the trustee takes those payments and distributes them to the creditors according to the terms of the plan.

The problem with conduit payments from the perspective of a debtor, is that they effectively increase the plan payment because they have to include trustee fees. That’s where some prebankruptcy planning can help to avoid having the Chapter 13 Trustee saying, “This is an irresponsible debtor, your honor. The debtor needs to make these payments as conduit payments.”

Can Chapter 13 Stop Foreclosure On A Rental Property In California?

Absolutely. In fact, it stops pretty much everything. Why is that? When you file a bankruptcy petition under any chapter, just that act triggers a stay. You don’t have to do anything else, so it’s called The Automatic Stay.

The stay in law says stop. Whatever is stayed has to stop. And what’s stayed or stopped is all action by creditors against you as a debtor, against your possessions, and against the bankruptcy estate that’s created when you file your petition. In practical terms, it means the creditors can’t contact you. They can’t call you, send you bills, write you letters, sue you, garnish wages, seize money out of bank accounts, foreclose on property, repossess property.

In essence, it erects a legal brick wall around you to protect you from the depredations of the creditors. If a creditor violates that stay, after it’s gotten clear notice of your bankruptcy filing, you can sue it in the bankruptcy court. If you’re successful, the creditor has to cover your court costs and attorney’s fees, which is highly unusual in American Jurisprudence. So that will certainly stop the foreclosure.

However, the stoppage may be temporary in nature. If it doesn’t look like you’re able to propose a Chapter 13 plan of reorganization that will: (a) cure the mortgage arrearage over the five years, and (b) you will still be able to make every postpetition secured debt payment as it comes due, then the creditor may either object to the confirmation of your plan, or more likely, ask the judge to lift the stay for the limited purpose of foreclosing on the property.

Is It Ever Too Late To Stop A Foreclosure On My Home Or Property?

I sometimes will have somebody call up, “Oh, my house is going to be sold in foreclosure tomorrow morning”. Best I can say is, “I’m sorry, good luck to you,” because if you’ve waited till the last minute, I won’t do what’s called an emergency filing. This is because my view is they tend to be bad-faith filings. If somebody’s let it go that far, this is not somebody who has the resources to be able to cure.

But if you have fallen behind and maybe a couple of months before the scheduled foreclosure date, you call me and say, “I’ve got a foreclosure sale coming up. I have a new source of income. I can cure the arrearage if I can just get some time,” then my vote is, let’s pop you into a Chapter 13 and spread the curing over a five-year period.

Are There Ever Cases Where A Landlord Is Ineligible For Chapter 13 Bankruptcy?

While Chapter 13 is a powerful tool, if you are a landlord and you have rental property, it is conceivable that you’re ineligible to do a Chapter 13 because Chapter 13 has two debt ceilings. One debt ceiling is for secured debts. The other debt ceiling is for unsecured debts. Two important points:

First, the secured debt ceiling is $1,580,125. If we add up all your secured debts, including – but limited to – mortgages and car loans, and the sum exceeds the secured debt limit, you cannot do a Chapter 13. In that situation, we may need to put you into a Chapter 11.

Second, if you’re thinking that your rental business that has as the real estate will file a Chapter 13, let me disabuse you of that idea. The Bankruptcy Code is absolutely clear. Only individual debtors can seek relief under Chapter 13. Businesses are ineligible to do a Chapter 13. See 11 U.S.C. § 109(e).

So, if you’re a landlord with significant mortgage debt – perhaps because you have two or three properties – Chapter 13 may be simply off the table.

Is Chapter 11 An Option For Landlords Who Are In Debt; And What Is Involved?

Chapter 11 is not for the faint of heart. It’s much more complicated than any of the other Chapters in the Bankruptcy Code, and it’s concomitantly more expensive.

So, if you are going to do a Chapter 11, which I’d be delighted to do for you, be aware that this is a big deal. This is a big commitment. Before you consider doing a Chapter 11, take a look at your finances and see if you have the resources to get into Chapter 11, and have enough income to put forth a viable exit strategy.

This means that, spread out over the life of the plan, you have the resources to cure any of these secured debt arrearages and satisfy all the other requirements for confirmation of a Chapter 11 plan. I don’t mean to be a Debbie Downer, but I it is important to keep in mind the need for a feasible exit strategy.

What If I Have Multiple Rental Units; Can They All Be Included In The Same Case?

Now, this gets back to what I just said about, number one, being ineligible for Chapter 13 because your secured debts are too large. Number two, maybe if you have multiple rental units, you’ve stuck them into some kind of business. If you are going to file a personal Chapter 13, which is the only kind of Chapter 13 that can be filed, if you’ve got these rental properties in corporations, then the corporations are not in bankruptcy, and the assets you have are not those rental properties. They are the ownership of the stock of those corporations.

Can you file with multiple units? Absolutely, but you may end up needing to do a Chapter 11 because if you have a lot of secured debt on those rental units, Chapter 13 may be off the table. The long and short is, yes, you can certainly do a bankruptcy case if you have multiple rental units. It remains to be seen whether Chapter 13 is the appropriate chapter.

Will My Tenants Be Affected If I Filed Chapter 13?

Under ideal circumstances, the answer is no. However, if you file a Chapter 13, you’re behind on the mortgage payments, and the creditor successfully gets the stay lifted so it can conduct a foreclosure sale, then those rental units will be sold, and that will adversely affect the tenants.

If it looks like you’ll be able to cure, and the lenders are happy with the plan because you’ve got enough equity to provide adequate protection for their interests, then you just keep collecting those rent checks and use them to make the postpetition mortgage payments and Chapter 13 plan payments. The tenants are unaffected. You sail off into the sunset, servicing the debt through the Chapter 13 plan.

If necessary, we may need to file a cash collateral motion as part of the process.

But certainly, if the creditor successfully gets the automatic stay lifted and forecloses on the property, that will adversely affect the tenants because whoever buys the property may be inheriting a relationship that may not be attractive to the new owner. That opens up a whole can of worms that might be a little bit too complicated to address in just answering that one question.

Can I Evict Tenants While In A Chapter 13 Bankruptcy?

If a tenant is simply not paying the rent, that is grounds for an eviction. You’re probably going to need to get the judge’s permission to do an eviction action because the automatic stay affects everything. The first thing is to ask the bankruptcy judge for permission to do evict the deadbeat tenant. Otherwise, you could face a nasty lawsuit in the bankruptcy court over wrongful eviction.

Then the tenant might get the stay lifted to go to the California Superior Court to fight the eviction. It can be a real mess. Therefore, ask the bankruptcy judge for permission to do the eviction.

How Does My Income From Rent Affect The Repayment Plan Calculations?

Let’s assume that your debts are below the relevant debt ceilings, so that you’re eligible for Chapter 13 relief. We determine how much you are going to repay over the life of the Chapter 13 plan, based primarily on the three main requirements of a Chapter 13 plan.

The first requirement – I suppose the order in which you analyze them is somewhat immaterial – so the first one I’ll mention, is what’s referred to by a lot of attorneys as the best interests of creditors requirement. My own feeling is it’s better captured by calling it, “the Chapter 7 liquidation requirement for Chapter 13.”

It says that over the life of the plan, you have to repay your creditors at least as much as they would have gotten if you had done the Chapter 7 liquidation.

In the Chapter 7, we list all of your stuff, and divide it into exempt and nonexempt categories. In a Chapter 7, you keep the exempt stuff. The Chapter 7 trustee takes the nonexempt stuff and liquidates it for the benefit of creditors.

We determine whether something’s exempt or nonexempt by appealing to one of two exemption tables. One table is for homeowners with equity in their principal residence, not in a property they are renting to someone else. The other table is for everybody else, what I colloquially refer to as the renter’s table.

Each table has a list of various categories of possessions. Some categories have dollar limits. Others have no dollar limits. Our goal, as we list your stuff, is to stick it into these categories, so that it’s protected from the depredations of the Chapter 7 trustee.

In a Chapter 13, you keep all your stuff, but we still go through the exercise of listing all of your possessions and dividing them into exempt and nonexempt categories because whatever the dollar value is of the nonexempt assets is the minimum that you can get away with repaying your creditors over the life of the plan with some exceptions, such as secured debts and priority debts.

Those arrearages, if you have those, have to be paid in full–perhaps with interest and tax debts have to be paid in full, unless they’re dischargeable tax debts. I don’t want to get too far afield on some of the ins and outs there. But the point is, that’s the first thing that we look at is, what’s the value of your non-exempt assets? Whatever that is becomes the floor of the minimum you have to repay.

As an aside, the concept of asset exemption is peculiar to individual debtors. The is no analogue for business debtors. And as I’ve already mentioned, Chapter 13 is unavailable to businesses.

The second requirement is the plan has to be fair, which is as vague a term as can be. But in this case, we can make it extremely precise.

How Is It Determined Whether Or Not A Landlord’s Repayment Plan Is “Fair”?

There are two possibilities:

First, you propound a 100% plan, meaning that over the life of the plan, you will pay back 100% of your total debt. If you propound a 100% plan, that, by definition, is fair. You never have to pay back more than 100%. But I will say 100% plans are somewhat unusual. I have put people in 100% plans, but they’re not the norm.

Second, if propose to pay less than 100% through the plan, then each month for the life of the plan, you have to devote what’s called your disposable monthly income to the plan. There is a technical definition of disposable monthly income, but the gist of it is: We take your gross income, minus what you’re paying in taxes and social security, and your reasonable living expenses. What’s left over, is disposable monthly income – what you have available to make plan payments.

Part of that income is the rental income, unless all of that rental income is being devoted to just paying on the mortgage. Will that rental income play a role? Absolutely, because that is part of the disposable monthly income calculation, which may be necessary to fund the Chapter 13 plan.

The third requirement – which I’ve already adumbrated – is the plan has to be feasible. That is, you must have enough disposable monthly income to satisfy the first two requirements – the Chapter 7 liquidation requirement and the fairness requirement – and to pay special creditors the way they’re entitled to be repaid. These special creditors include secured creditors and priority creditors. They must be paid in full through the plan, unless they agree to less favorable treatment.

To understand feasibility a bit better, it helps to see what can go wrong. Here’s a simple illustrative example.

Suppose you owe $35,000 in priority tax debt, and you have disposable monthly income of $500; so you propose a Chapter 13 plan that pays $500 per month for sixty months. Will that work? No. Why not? Since $500 x 60 = $30,000, you plan fails to pay the priority tax debt in full over the live of the plan. It is therefore infeasible because you don’t have the income to satisfy this third requirement.

So, long-winded answer, but I think it helps to get the bigger context that yes, the rental income will play a role in the Chapter 13 plan.

Ending Remarks:

If you are in another part of the country, not in California, and specifically not in the Central District of California and you’re watching this video, I’m really pleased. Thank you for watching. However, I cannot give you legal advice. It’s true. I can give you legal advice if you’re in California, although I really only serve the Central District of California primarily handling Orange County and Los Angeles County cases.

So, if you are in Michigan, I appreciate that you are enjoying these videos. I appreciate that you’re finding them helpful. But, I cannot help you. If you call me and ask for legal advice, I will have to say, no, I can’t give you legal advice because I’m not licensed to practice in your state. To give legal advice in a state where you’re not licensed to practice, is practicing law without a license. That’s a crime. So, enjoy the videos, but I can’t help you.

But if you are in Los Angeles County or Orange County in California, I can help you. Please call, let’s chat.

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