Bankruptcy: Relief from Automatic Stay - Lack of Adequate Protection

     In the case of Equitable Life Assurance Society of U.S. v. James River Associates, the United States District Court at Newport News upheld a Bankruptcy Court ruling that where a creditor held a note executed by a debtor and secured by a first deed of trust on a hotel and a conference center in Williamsburg, Virginia, the creditor was entitled to relief from the automatic stay in order to foreclose because the creditor's "equity cushion" in the property was only two percent.

     In the trial of this case, the Bankruptcy Court found that the creditor was not adequately protected because 1) its equity cushion was deteriorating as interest accrued, 2) real estate taxes were delinquent, 3) the creditor had not received payments on the note for numerous months and 4) the priming lien necessary for the debtor to reorganize would further deteriorate the creditor's security position.
     On appeal to the District Court the debtor argued that the Bankruptcy Court erred in its finding that the creditor's equity cushion was deteriorating due to the accumulation of unpaid interest. The District Court opined that under the "equity cushion" theory if a debtor has equity in a property sufficient to shield the creditor from either the declining value of the collateral or an increase in the claim from accrual of interest or expenses, then the creditor is protected. The District Court ruled that the Bankruptcy Court's conclusion that the creditor was inadequately protected because of the deterioration of its equity cushion from accumulating interest was not in error. The District Court noted that although several courts had previously rejected the equity cushion theory, it did not need to decide the merits of the equity cushion theory since the Bankruptcy Court found that there were other sufficient justifications for finding a lack of adequate protection. These are detailed in the following paragraphs:
     First, the Bankruptcy Court found that the real estate taxes were delinquent for two tax years in a total amount of $264,624. The District Court ruled that the failure to pay real estate taxes may constitute a basis for finding lack of adequate protection.
     Second, the Bankruptcy Court found that there was a lack of payments to the creditor for several months, including, no payments since the bankruptcy petition. The District Court ruled that a continued failure to make monthly payments under loan documents can constitute cause for granting relief from the automatic stay. The District Court ruled that there was no error in granting relief from the automatic stay for failure to make payments.
     Third, the Bankruptcy Court found that the creditor's security position would be deteriorated by the proposed priming lien which the debtor needed to reorganize. Given the lack of an equity cushion and the speculative nature of the repayment plan, the District Court ruled that there was no error in granting relief from the automatic stay because of the deterioration of the creditor's security position due to the priming loan.
     In conclusion, the District Court concluded that the Bankruptcy Court did not err in granting the creditor's motion for relief from the automatic stay. The Bankruptcy Court properly found that the diminishing equity cushion, the delinquent real estate taxes, the lack of payments on the note for several months, and the deterioration of the creditor's security position under the priming lien constitute, both independently and together, a lack of adequate protection for the creditor.

Collections: The IRS Can be Helpful in Commercial Collections

     Can you imagine using the IRS to help in collections? I can! I have an interesting technique that I have recommended for over twenty-two years – I first ran an article on this in the May, 1992 (the 4th Edition) of Creditor’s News.  Since recently others have also begun recommending this technique, I thought that I would review it again.

     After a sufficient amount of time has passed to consider a commercial credit account "uncollectible," the creditor should consider writing off the debt as a potentially tax-deductible bad debt. The creditor's loss may then become the debtor's gain and, as such, may be reported to the IRS on Form 1099 as income to that debtor.
     Before actually writing off the debt, attempts should be made to contact the debtor and advise him of the intended action. If you do not have the debtor's social security number, try including a W-9 form with your letter. This could evoke some favorable response.
     I have a form letter that I recently revised to accomplish all of this. The letter (written from the perspective of the creditor itself) advises the debtor that his account is seriously past due despite repeated attempts to make arrangements for payment. The debtor is further advised that unless the debt is paid in full within fifteen (15) days from the date of the letter, the creditor will, at its option, report the loss to the IRS on their form 1099c. This reporting will result in taxable income to the debtor (reference IRS Regulation S1.61-12). This reporting will result in an IRS audit risk to the debtor, as the IRS routinely runs computer matches of the 1099’s filed against tax returns actually filed to insure that all income is reported; there are severe penalties if not. The letter further states that the creditor is demanding the debtor’s tax identification information; the debtor is asked to do so within fifteen (15) days. The debtor must provide this information to the creditor under penalty of federal law. I recommend that you send with the letter a copy of the IRS form W-9 evidencing the unpaid debt, and advise the debtor that if you do not receive the W-9, the creditor will, at its option, file an IRS form 1099c incomplete. This will further increase the debtor’s chances of an audit.
     Many debtors will wish to resolve the debt as a result of these actions. After all, who wants the IRS checking them out?
     If you have any questions of wish to discuss this, please call us at 545-6250. Eddie & Jennifer.

Foreclosure: Deposits

     Virginia Code §55-59.4(A)(2) permits the trustee to require of any bidder at any sale a deposit of as much as ten percent of the sales price, unless the deed of trust specifies a higher or lower amount. However, because the statute is not mandatory, the trustee is given the right to waive the deposit if he deems it appropriate, unless the deed of trust requires a specific deposit. The trustee should also consider using a fixed amount as the deposit rather than a percentage of the sales price. Using a percentage of the sales price as the method of determining the required deposit often results in confusion, and the successful bidder has either too much or too little money to deposit. A fixed deposit avoids the confusion and allows all potential buyers to know exactly how much money to bring to the sale to deposit. The fixed deposit should not be excessive, but should be of a sufficient amount to ensure that the successful bidder completes the closing of the sale.

Real Estate: Homeowners' Association Wins Damages on Owner Violations

     There has been much litigation over HOA violations in the last few years. Circuit Courts have been scrutinizing HOA violation claims very carefully. Enforcement and damages for violations can be won. The December 2011 Loudon County Circuit Court case of Lee’s Crossing Homeowners’ Association v. Zinone is a good example of such enforcement. In Lee’s Crossing, the court found that in building her home, the homeowner committed multiple violations of the plan approved by the Architectural Review Board. Ultimately, the court assessed damages in favor of the homeowners’ association on the basis of “one overriding violation,” the failure to comply with the ARB-approved application.