Recent Developments Affecting Lenders

Posted on by Neil E. McCullagh in Creditors' Rights, Bankruptcy and Insolvency

This month we (a) detail upcoming changes to the required notice for a foreclosure on owner-occupied residential real estate, (b) discuss the U.S. Supreme Court’s recent decision that a creditor did not violate the automatic stay in bankruptcy when it refused to surrender vehicles to the debtors, and (c) highlight the fast and growing popularity of “Subchapter V” small-business bankruptcy as it moves into its second year of existence.

Foreclosure Notice Requirements for Owner-Occupied Homes to Change Soon

New and expanded notice requirements for foreclosing on “owner-occupied residential real estate” will go into effect soon. Virginia Code section 55.1-321 was amended in Virginia’s 2021 legislative session to increase the notice period from 14 days to 60 days “in the case of a deed of trust conveying owner-occupied residential real estate”. The subordinate lienholders to whom notice must also be sent in such case will now include those who recorded their liens at least 75 days prior to the sale.

The amendments to section 55.1-321 also require that “in the case of a deed of trust conveying owner-occupied residential real estate” the notice to the owner include the following:

(i) The website address of the U.S. Housing and Urban Development's (HUD) Office of Housing Counseling with a listing of HUD-certified housing counseling agencies, the website address and telephone number of the statewide legal aid center, and the following language, or language that is substantially similar, in at least 12-point type: "This is NOT a notice to vacate the premises. You should consider contacting an attorney or your local legal aid or housing counseling agency." (hereinafter the “Agency Contact Information Requirement”); and

(ii) The date of the last payment received and the amount received; the total amount of principal, interest, costs, and fees due in arrears; and the remaining total principal balance due on the instrument.

The amended statute states that “[t]he foreclosure sale cannot go forward unless the trustee has proof that the notice has been sent.”

Further, Virginia Code section 55.1-320 was amended to add the following:

In the case of a deed of trust conveying owner-occupied residential real estate, the trustee of such deed of trust shall not sell the property secured by the deed of trust without receiving an affidavit signed by the party that provided the notice required by § 55.1-321 confirming the notice was sent to the owner, with a copy of such notice attached to the affidavit. Prior to commencing a foreclosure sale with respect to such real estate, the trustee shall provide copies of such affidavit and notice, with any personal financial information redacted, to each potential bidder.

These new requirements will become effective on July 1, 2021, except that the Agency Contact Information Requirement will become effective on October 1, 2021.

Refusal to Surrender Vehicles Did Not Violate Automatic Stay, Supreme Court Says

Creditors recently won a round in the U.S. Supreme Court, which held that a creditor did not violate the automatic stay in bankruptcy by refusing to surrender vehicles after the owners filed Chapter 13 bankruptcy. Whether a creditor needs to surrender collateral - often a vehicle or piece of equipment - to a debtor who has filed bankruptcy is a long-standing issue. Just last summer we discussed a similar case, in which the creditor refused to release a pre-bankruptcy wage garnishment (that article can be accessed here). The stakes for a creditor in these matters can be significant. A creditor who violates the automatic stay can find itself liable for damages including the debtor’s attorney fees, emotional distress damages, and punitive damages.

The Supreme Court case is City of Chicago, Illinois v. Fulton, et al. The case arose from the City’s practice of impounding cars based on the owners’ failures to pay outstanding fines. Each of the vehicle owners involved in the case filed Chapter 13 and requested that the City return their vehicles. The City refused, and the lower courts all held that the City’s refusal violated the automatic stay because it was an “act … to exercise control over” the debtors’ property, which is forbidden by subsection (a)(3) of the automatic stay.

The Supreme Court saw things differently. First, the Court looked at the language of subsection (a)(3) and found that an “act” to “exercise” control implies an affirmative act that changes the status quo, as opposed to merely retaining possession of the vehicles, which maintains the status quo.

Second, the Court stated that even if the language of subsection (a)(3) is ambiguous, the ambiguity must be resolved in the City’s favor because the bankruptcy code includes a separate provision, section 542, that expressly concerns when a creditor has to turn over property to the debtor. In other words, to hold that subsection (a)(3) always requires a creditor to turn over property would render section 542 superfluous. On this point, the Court’s ruling is consistent with its 1995 decision in Citizens Bank v. Strumpf that a bank did not violate the automatic stay by placing a temporary administrative hold on a debtor’s account because section 542 authorized the bank to do so in order to preserve its right of offset.

The Court’s decision in favor of the City was unanimous. By itself, this might lead one to think that there is now little doubt that a creditor can retain possession of collateral without violating the automatic stay. However, as emphasized in a concurring opinion by Justice Sotomayor, the Court’s ruling is quite narrow - it concerns only subsection (a)(3) of the automatic stay, which contains seven other subsections - and debtors are now likely to rely on other subsections to argue that a creditor has violated the bankruptcy stay. On this point, Justice Sotomayor wrote that “the City’s conduct may very well violate one or both of” subsections (a)(4) and (a)(6) of the automatic stay, which respectively bar “any act to create, perfect, or enforce any lien against property of the estate” and “any act to collect, assess, or recover a claim against [a] debtor.” Indeed, the bankruptcy court that first heard the case concluded that the City had violated subsections (a)(4) and (a)(6), but the Supreme Court did not consider that issue because the intermediate court of appeals had not considered it.

The Court’s silence regarding subsections (a)(4) and (a)(6) leaves open the possibility that a slight alteration in the factual scenario could lead to a different outcome for a creditor. Accordingly, notwithstanding the Court’s ruling, creditors who take possession of collateral and then learn of a bankruptcy filing should continue to exercise caution and consult counsel before speaking to their debtor or taking any other action. Requesting that the bankruptcy court order adequate protection of the creditor’s interest in the collateral may be the best course of action.

Subchapter V Small-Business Bankruptcy Off to a Strong Start

In two previous articles we discussed the new “Subchapter V” of the bankruptcy code, which creates a streamlined Chapter 11 bankruptcy process for small businesses that resembles the Chapter 13 process that individuals use to adjust and repay their debts. Those articles can be accessed here and here. Subchapter V became effective February 19, 2020, just in time for the COVID crisis, and Congress promptly increased the Subchapter V debt limit from approximately $2.7 million to $7.5 million in light of the crisis. The $7.5 million debt limit was scheduled to sunset on March 27, 2021, but President Biden recently extended it for another year.

Data provided by the American Bankruptcy Institute and Epiq suggest that Subchapter V is off to a strong start and gaining popularity. As of March 30, 2021, 1,763 Subchapter V cases have been filed nationwide. March 2021 saw 185 new Subchapter V cases, an increase of roughly 52% over March 2020 (the first full month in which Subchapter V was in effect) and by far the highest monthly number of Subchapter V filings so far (the previous high was 160 filings in September 2020).

In Virginia, 20 Subchapter V cases were filed in 2020. Although there were 201 total Chapter 11 filings in Virginia in 2020, 130 of those filings were connected to five major Chapter 11 cases (Pier 1, J. Crew, Ann Taylor, Lord & Taylor, and Intelsat). Hence, Subchapter V cases comprised 28% (20 out of the 71) of the remaining Chapter 11 cases, even though Subchapter V was new and in effect for only a little more than 10 months in 2020.

The speed, simplicity, and inexpensiveness of Subchapter V relative to a regular Chapter 11 case surely make it appealing to small businesses and their counsel, and that popularity will likely only continue to grow. It is therefore to be expected that Subchapter V will be a prominent part of the bankruptcy landscape going forward.

About the Author

Neil E. McCullagh is an attorney who works with banks on a wide variety of issues, including lending, insolvency, workouts, creditors' rights, bankruptcy, and collections.

Spotts Fain publications are provided as an educational service and are not meant to be and should not be construed as legal advice. Readers with particular needs on specific issues should retain the services of competent counsel.