How Chapter 7 Real Estate Sales Benefit Insiders
Randa filed Chapter 13 bankruptcy in March 2019. She was hoping to be able to save the family home, by catching up the mortgage over five years. Her husband was recovering from a long illness and was able to work full time again, making the catch up payment possible.
As it turned out, the husband did not recover from his illness; he died. So, Randa moved out, to live with her adult son. And the bankruptcy case was converted to Chapter 7.
The Chapter 7 trustee told creditors and the court that this would be an “asset case.” He hoped to be able to sell the property and use the equity to at least pay off part of the tax debt of Randa and her husband.
In this case, there will be no money to pay anyone—except the “professionals.”
In March 2019, when the bankruptcy was started, Randa valued the house at $476,000. That was what the house next door had sold for. The Chapter 7 trustee listed it for sale at $484,900. But the best offer was $450,000.
(Real estate in bankruptcy will often sell for less than the going market. The family has NOT fixed it up for sale, and likely has put off maintenance during the financial, or medical, distress.)
The mortgage on the house was $403,500. (Randa has estimated $400,000; not far off.) At the real estate closing, each real estate agent, for buyer and seller, collected 3% commissions: $13,500 each. There were miscellaneous costs of around $1000.
That left $18,000 for the bankruptcy trustee. Does that money go to pay the IRS taxes? Well, no.
Why No Money goes to pay the taxes
The Chapter 7 Trustee is entitled to commissions totaling $24,750. (The trustee fee is $5750 on the first $50,000 of the sale and 5% after that. For cases where there are no assets sold, the trustee gets $60.00. So it’s easy to see why trustees want and need these real estate sale cases.)
In addition, the trustee hired himself (actually his own law firm) to handle legal matters—at $580.00 an hour. That bill will be about $5800.00.
No money is left for anyone else.
The trustee’s real estate agent, who originally listed the property at $484,900, makes $13,500. The trustee and his law firm will take a “haircut.” They will get only get $18,000 out of their $30,550 bills.
There’s no money to pay the taxes, or anybody else.
In this case, insiders are winners, but there are no losers. Randa had moved out and didn’t care about the house. The IRS got nothing, but lost nothing.
Does the Chapter 7 trustee sell the house that people want to keep?
Here’s what sometimes happens instead.
The trustee’s agent projects a high listing price: high enough that the creditors would get paid a little something. (If this house had sold for the original listing price, there would have been around $20,000 to pay the taxes.)
The Chapter 7 trustee uses that high estimate to invite the bankruptcy debtors to “buy back” the equity in the house, by making a cash payment to the trustee of say $10,000.00. (This assumes the debtor is able to round up $10,000.)
One of the Chapter 7 trustees in Alexandria can be very aggressive in demanding buy-backs from debtors. Even in cases where the creditors would get nothing in a sale. And the Chapter 13 trustee can use high estimates of real estate values, to demand higher payments into Chapter 13 plans. That gets debtors into Chapter 13 payments they can’t afford, and they end up losing their homes in Chapter 13.
The trustee who sold Randa’s house, almost never sells property where there’s no actual equity. (I’m confident he genuinely believed there would be money to pay the taxes. But there wasn’t.)
It is tough for a Chapter 7 debtor to resist a trustee demand for a buy-back. They can ask the judge to compel an abandonment of the property. But it’s easy for the judge to just say, “let’s see what it sells for.” Once the house is listed for sale, it’s hard to stop. So, the pressure to agree to a buy-back can be unbearable.
Where there’s a buy-back demanded and paid, the Judge signs off on the compromise, without having to consider whether the agreement is extortionate, rather than voluntary.
There were 4,453 bankruptcies filed in the Alexandria division in 2019. That’s down from a high of 10,953 in 2010. On that reduced volume, Chapter 7 trustees can’t survive on the $60.00 fees they get for each case. So each year the pressure on the trustees to generate big fees from real estate cases gets higher and higher.
Can anything be done?
Debtors in Chapter 7 bankruptcy cases in Virginia are able to protect up to $5,000 in real estate equity. That’s the lowest of the 50 states and the District of Columbia. The Virginia General Assembly is considering legislation to raise that $25,000—which would still be among the lowest in the nation. That would help in many cases prevent transactions where the creditors get little or nothing, while debtor families either pay the buy-back or lose their homes.
The bankruptcy case number is 19-10800-KHK.