Buying Bankruptcy Homes, Assets, Houses, Real Estate & Property from a Bankruptcy Court
Many buyers of real estate know how to purchase a property using a Realtor or at a foreclosure auction, but there is considerable mystery about how to buy homes and other real estate out of bankruptcy. Indeed, a close review of bankruptcy sales shows a discount of 10 to 50% off of prices paid in the open market if there are no other buyers. If you like paying full price, read no further.
However, if you want to find a deal on real estate, below are the best tips on buying real property from a bankruptcy court through a bankruptcy auction. These tips are provided by our bankruptcy lawyers in Southern California with years of experience selling real estate in bankruptcy on behalf of numerous bankruptcy trustees.
1) How to Find Bankruptcy Property Sales Online
The first step in the process is to find a bankruptcy property you are interested in buying. However, this is not as easy it may seem. If a bankruptcy is filed in Los Angeles County, but the debtor owns a property in Texas, the sale of that Texas property would occur at the Bankruptcy Court in Los Angeles through a bankruptcy trustee in California.
Most courts post the notices of sale on their website. For example, the Central District of California has a website listing notices of sale within that court. This means that buyers of properties would need to scour the websites of 94 District Courts in the United States, with California alone having four district courts, just to find all of the sales in America.
Buyers may be under the impression that they can find bankruptcy properties on the Multiple Listing Service (MLS) provided by Realtors. However, at least in Southern California (CRMLS), there is no check box allowing listing agents to specify that a property is being sold through a bankruptcy. Nonetheless, a search of the public or private comments for the word bankruptcy may reveal a few listings.
Further, if you’re looking for commercial properties in bankruptcy, search LoopNet.com for bankruptcy properties by clicking on more filters, then using the keyword bankruptcy.
Another way to find bankruptcy properties is to follow the listings of the Realtors who end up repeatedly listing properties for Chapter 7 trustees in the area you are interested in. A review of prior sale notices will likely show who these Realtors are. If you’re not sure, contact a bankruptcy attorney in the desired area as they will likely know the names of the brokers who seem to get listings. You can also contact the bankruptcy trustees to ask about any sales they may have at that time.
Given how hard it can be to find bankruptcy properties, the website Inforuptcy.com came up with an ingenious solution of listing bankruptcy sales nationwide. While the service is not free, if you’re serious about purchasing houses or other property from bankruptcy trustees, there is no better service.
2) Contact the Bankruptcy Trustee
If you find a property that you want owned by a debtor in bankruptcy, contact or have a real estate lawyer reach out to the Chapter 7 or 11 trustee. To find the name of the trustee handling the estate for that debtor, you can find the name of the trustee on Pacer.gov. The contact information for every standing Chapter 7 trustee is on Justice.gov.
The trustee may be interested in selling the property. Sometimes, if the trustee can sell the property without a broker, they may be interested in providing a larger distribution to creditors by avoiding a broker’s fee. Often times, the trustee’s attorney may have insight on the terms required to obtain the trustee’s consent and bankruptcy court approval, such as when a bankruptcy property is lived in by the debtor after a divorce leads to a bankruptcy.
Bankruptcy Trustees Are More Powerful Than Foreclosure Trustees
As experienced real estate investor Aaron Norris explained, there are many types of real estate auctions. Some parties wonder if a bankruptcy trustee is similar to a foreclosure trustee selling a trust deed or mortgage on the courthouse steps.
These are not the same, though there are some similarities. A bankruptcy trustee owns all of the rights in the debtor’s property under the definition of property of the estate found in Section 541(a) of the Bankruptcy Code. It is duty of the bankruptcy trustee to “collect and reduce to money the property of the estate for which such trustee serves, and close such estate as expeditiously as is compatible with the best interests of parties in interest.” 11 U.S.C. Section 704(a)(1). Trustees get paid a commission on payments to creditors, and they need to sell property to pay creditors. They sell property by finding buyers, negotiating with lenders, and even filing bankruptcy adversary lawsuits to perfect title or to attack seemingly invalid liens on property.
By contrast, a foreclosure trustee simply has a duty to begin the sale of the rights under the trust deed (i.e., the property subject to any liens senior to the trust deed being sold) at the lowest bid proposed by the foreclosing lender. Of course, the foreclosing lender can demand payment of no more than they are owed, e.g., principal, interest, late fees, attorney’s fees, etc.
While a bankruptcy trustee must maximize the value of the estate for the benefit of creditors, a foreclosure trustee has no such duty.
Offer to Pay the Trustee an Amount that Will Pay All Secured Creditors, Adminstrative Expenses and Provide a Benefit to Unsecured Creditors
Finding a creative solution for the trustee can help you buy an asset from a bankruptcy trustee.
However, a bankruptcy trustee generally must sell the property for an amount that pays all lenders in full. However, a bankruptcy trustee can reach an agreement with a lender to take less than the full amount or for the lender to give the trustee a “carve out” whereby part of the sum owed to that lender will be paid to the trustee for the benefit of the bankruptcy estate. This allows a trustee to sell an underwater property by providing a benefit to creditors.
Without payment in full or the consent of any lender being paid less than the full amount, a trustee generally cannot sell the property, at least not within the Ninth Circuit. Clear Channel Outdoor, Inc. v. Knupfer (In re PW, LLC), 391 B.R. 25 (B.A.P. 9th Cir. 2008); see 11 U.S.C. section 363(f).
In other words, unlike a foreclosure trustee who has the authority to sell the property at a given price such that the property will be sold at that price (and perhaps taken back by the lender if no other bidders appear), when a bankruptcy trustee wants to sell property, they must receive a certain amount of money to sell that property.
That amount of money constitutes the total of all liens, the costs of sale, all administrative expenses, payment of the homestead exemption to the debtor, if any, plus some additional amount intended to benefit unsecured creditors.
3) Become the Stalking Horse Bidder by Submitting a Purchase Offer to the Bankruptcy Trustee
The trustee will accept an offer to purchase that they deem sufficient, even if they wouldn’t mind more. This buyer, known as a stalking horse bidder, is then presented to the Bankruptcy Court as the proposed buyer in a motion to approve a sale under 11 U.S.C. Section 363. Not only must the price be sufficient, but the terms must also be sufficient.
Don’t Scare Off the Bankruptcy Trustee with Contingencies
The bankruptcy trustee will be more likely to accept the offer with the fewest contingencies, such as a financing contingency or inspection contingency. Indeed, repair contingencies are very difficult for a trustee to perform because, in most cases, the trustee does not have any money in the estate to perform such repairs. Even further, hiring someone to perform a repair may require court approval, which requires considerable attorney time, likely costing thousands of dollars. The benefit to the estate and its creditors of hiring such professionals can be questionable, so avoiding these complications will make your offer stronger.
You Can Finance Bankruptcy Property (But Cash is Still King)
Generally, a trustee, like any other seller, would prefer an all-cash buyer over a buyer who needs financing. However, if the buyer can fund a loan to buy the property through during escrow after the sale motion is approved by the court, then this is deemed sufficient. Like with any seller, feel free to provide documentation to the bankruptcy trustee showing the financial ability to consummate a sale.
Bankruptcy Sales Allow Buyer Protections Like Escrow and Inspections
Many buyers are wary of buying at a foreclosure auction where title is taken as-is with no refunds if the property is not as expected. Indeed, a foreclosure trustee accepts the money directly from the buyer in cash or money orders, then records the deed.
However, a bankruptcy trustee generally opens an escrow in which the trustee deposits a deed, and the buyer deposits the necessary funds and releases contingencies. Buyers are welcome to negotiate the terms of a purchase, including inspection of the property and ordinary time to review title insurance to see that all issues are resolved. If something goes wrong, the buyer can back out, often times with the trustee retaining the earnest money deposit.
Buyers should not be afraid to add protections in their offer to make sure they get what they expect.
How to Deal with Occupants at the Property
If you really want to sweeten the deal to get a great price, offer to take the property in its current condition, which may even mean accepting any occupants at the property.
However, you can ask for a court order stating that there are no long-term leases in place at the property since such leases could hinder your ability to obtain an unlawful detainer (eviction) against those tenants in state court after the hearing. Even further, a buyer may want to ask for a court order that there are no lawful tenants at the property such that the buyer could change the locks after the sale is closed. With such an order, a buyer could even obtain a further order that the United States Marshall Service turnover possession to the buyer, thereby avoiding an unlawful detainer in state court.
Free and Clear of All Liens
Some buyers wonder whether a bankruptcy sale wipes out junior liens similar to a foreclosure sale. The issue of junior liens is essentially irrelevant, as the bankruptcy trustee is selling the property, not the position of a particular lien holder.
The term “free and clear” comes from Bankruptcy Code Section 363(f), which allows the sale of an encumbered asset whereby the liens on the property are extinguished as to the property, but attach to the proceeds of the sale.
The sale should be consummated through escrow wherein the buyer and trustee will obtain title insurance so that there will not be any issues as to any liens remaining after the sale. Absent something unusual, which would likely be stated in a sale motion or a title insurance preliminary report, whatever would happen in a normal sale on the open market can happen in a bankruptcy sale.
A break-up fee is monetary compensation to a stalking horse bidder should the sale be ordered to a different party. The break-up fee would be required to be approved by the Bankruptcy Court. The argument is that a break-up fee is fair compensation to the stalking horse bidder for the risk, effort and expense to enter into the proposed sale.
Good Faith Purchaser
Under Section 363(m) of the Bankruptcy Code, even a reversal on appeal of a sale order would not not affect the validity of a sale a good faith purchaser.
“Though the Bankruptcy Code and Rules do not provide a definition of good faith, courts generally have followed traditional principles in holding that a good faith purchaser is one who buys ‘in good faith’ and ‘for value.’ Typically, lack of good faith is shown by ‘fraud, collusion between the purchaser and other bidders or the trustee, or an attempt to take grossly unfair advantage of other bidders.'” In re M Capital Corp., 290 B.R. 743, 746 (B.A.P. 9th Cir. 2003).
4) How to Overbid at a Bankruptcy Sale (Auction)
While the bankruptcy trustee is the seller, the trustee acts only under court authority through an order approving a motion to sell the property under Section 363 of the Bankruptcy Code. To ensure that the sale is fair to creditors, the sale motion will generally provide the procedures to overbid. An overbidder is a potential buyer of bankruptcy property who requests to pay more than the proposed buyer identified by the bankruptcy trustee in the sale motion.
Always review the sale motion filed by the trustee to understand the procedures for overbidding at the hearing. The sale notice will provide instructions on any pre-qualification, which may involve providing the trustee with a cashier’s check to the deposited with escrow if that overbidder is the highest bidder and agreeing to execute a purchase and sale agreement similar to that of the stalking horse buyer. The cashier’s check would be refunded if the overbidder does not ultimately prevail in the bidding process.
The sale motion will provide the date, time and location of the hearing, as well as the minimum overbid (sometimes five or ten thousand over the proposed buyer) and bidding increments (perhaps a few thousand dollars). For example, if the proposed buyer offered $500,000, and the minimum overbid is $10,000 more, with bidding increments of $5,000, the first overbidder would need to offer $510,000, with the next bid required to be at least $515,000. Generally, the court will allow agents, such as a real estate agent or attorney for the bidder, to bid on behalf of an overbidder.
When the time comes for the auction, the judge will call the case usually by announcing the name of the debtor whose property is being sold. The court will usually ask if there are any over-bidders present at the hearing. Whether the court asks or not, be sure to announce yourself by phone or proceed to the lectern in court to indicate that you are present to overbid on the property being sold.
If an overbidder appears, the bankruptcy judge will generally act as the auctioneer of the property. Don’t expect the judge to bring the excitement you might find at an auction on television. However, the judge will ensure fairness in the process.
The real excitement for a buyer happens when no overbidders appear as a property can sell for tens or hundreds of thousands of dollars less than the property might sell for if there is an overbidder. Based on the experience of the author of this article, bankruptcy property with no overbidders will sell for about 5% to 45% less than market value. This discount will be more extreme with less liquid assets, like vacant land or expensive homes, and less pronounced with more liquid assets, such as a single family home with no major defects selling around the median sales price in the area. When an overbidder appears, the discount drops to to about 10% or sometimes to no discount. Effectively, the overbidder creates a market for the property whereby it is sold for close to fair market value.
The court will generally approve both the highest bidder, at the highest bidder’s price, and a backup bidder, at the backup bidder’s highest price. This is done so that no further court order is required if the highest bidder decides not to purchase the property for any reason. This allows the bankruptcy trustee to sell the property to the backup bidder without any further court order.