As lenders know, when a borrower files for bankruptcy, the act of filing clamps down on any and all collection efforts against that borrower and her property– the automatic bankruptcy stay is immediately in effect.
Do Not Pass Go, and most certainly, Do Not Collect $200.
In order to continue your collection efforts, you will need court permission in the form of an order granting relief from the automatic stay.
Usually, when underwriting a loan, the lender requires certain debt-to-equity ratios. That ratio is simply determining what percentage of the property value would be security for the loan.
For example, a commercial building in Mountain View could be valued at $2M, and if the loans against it totaled $1M, that property would have a 50% debt-to-equity ratio, or equity cushion of $1M. But when the property value is declining as we have seen in the Bay Area for the last few years, that equity cushion that protected the lender shrinks to an alarmingly thin level.
A lender whose promissory note is secured by a deed of trust against the property is a secured creditor if the borrower files for bankruptcy. Secured creditors requesting relief from the automatic stay need to demonstrate there is insufficient equity and that the lender is not adequately protected.
Pursuant to 11 USC § 362(d) the court may grant relief from the stay if the creditor’s interest is not adequately protected. A debtor generally cannot adequately protect a creditor if the debtor has no equity in the property and if the debtor cannot continue making payments to the creditor while in bankruptcy.
In the Northern District of California Bankruptcy courts and throughout the Ninth Circuit, judges who are considering a creditor’s motion for relief or adequate protection payments generally look for an equity cushion below 20% and that the debtor has not made post-petition payments before granting the motion.
This means that if borrower owns a San Jose property originally valued at $800k when the lender made the $500k interest only loan, there was $300k of equity (37%) in the property, absent any other liens.
Now, if the property value has declined to $600k, the $500k loan leaves only $100k of equity (16%) in the property. The security of knowing you, the lender, had $300k of protection feels far from comforting when you know your protection is now only $100k and dwindling daily.
Since an understanding of the value is required to evaluate the equity in the property, the court will need to determine the value before granting the secured creditor relief from the stay.
As a rule, the court relies on the debtor’s valuation of his or her property as s(he) reported in his or her schedules. You can imagine how a debtor wishing to keep the home or rental property will value that property as high as s(he) possibly can in an effort to keep a sufficient equity cushion, at least on paper.
The debtor will use whatever she can to show the property is still worth $800k in an attempt to demonstrate that the secured creditor in this example still has $300k of equity (37%) to protect him.
Therefore, if the secured creditor seeks relief based on insufficient equity, the burden is on the creditor to prove the value is not what the debtor asserted and that insufficient equity exists to protect the lender from further decline in value or accumulation of debt.
The best way to prove this is to submit a recent appraisal to the court. The appraisal report should be by a licensed appraiser, and one who can testify as to value if necessary. A broker’s price opinion (“BPO”) or “windshield appraisal” often has less weight unless the broker or appraiser supplies also additional testimony (which can be in the form of a declaration).
If a creditor can demonstrate that the value of the property has declined and is now only $600k, your position arguing an insufficient equity cushion of 16% is much stronger, and much more likely to get the judge’s attention.