Can I keep my home in bankruptcy?

can I keep my home in bankruptcy?
Can I keep my home in bankruptcy?

“Can I keep my home in bankruptcy?” This is the first question people ask when they meet with a Licensed Insolvency Trustee for their initial assessment. In order for a Trustee to answer this question, she will need to examine the following factors:

  1. The fair market value of the home. She will arrange for an opinion of value from a real estate agency or a full appraisal from a professional real estate appraiser.
  2. The current balance owing on any secured loans against the property (e.g., mortgage, home equity line of credit).
  3. The current balance owing to the municipality where the house is situated for any unpaid property taxes.
  4. Real estate commission and legal fees that would have to be paid if the house was sold.
  5. The bankrupt individual’s ownership interest in the home.
  6. Exemptions that may exist in the province where they house is situated. For example, in Alberta, a bankrupt individual can keep up to $40,000 of equity in his home.

 

HOME HAS EQUITY

In the following example, Ted is thinking about filing for bankruptcy but is concerned about losing his home. During his consultation meeting with a Licensed Insolvency Trustee named Sarah, he provides the following information:

  • The fair market value of his home is $500,000
  • The mortgage balance is $400,000
  • There is $2,500 owed to the city for unpaid property taxes
  • Real estate commission would be $28,250
  • Legal fees related to a sale of the home would be $1,000
  • Ted’s home is located in a province where there isn’t an exemption for home equity
  • Ted is the sole owner of his home

Sarah explains to Ted that upon his filing bankruptcy, she would have a legal interest in any equity in the house, which she must realize upon for the benefit of his creditors in his bankruptcy proceedings.

Sarah calculates that if she physically sold Ted’s home to realize upon the equity, she would receive net proceeds of $18,250:

Fair market value of property $500,000
Mortgage 450,000
Property taxes payable 2,500$47,500
Notional costs
Real estate sales commission $28,250
Legal fees 1,00029,250
Net realization $18,250

So, will Ted lose his home if he files for personal bankruptcy? Well, Sarah could cut a deal with Ted whereby Ted can pay to Sarah $18,250 in return for her relinquishing her interest in the home. They could enter into a written settlement agreement whereby Sarah would disclaim her interest as Trustee in Ted’s home in return for $18,250 from Ted. Such an agreement would require the approval of Ted’s creditors during the bankruptcy proceedings.

Upon receiving the $18,250, Sarah would deposit the funds in the bankruptcy trust account for the benefit of Ted’s creditors. Accepting $18,250 from Ted would provide Sarah with the same result as if she were to physically sell his home. So this would save Sarah the time and hassle of actually having to list  Ted’s home for sale.

There are however, a couple of complicating factors:

Time to pay settlement

What if Ted can’t pay the entire $18,250 up front? In that case, Sarah could arrange for Ted to pay out the $18,250 over several months or even several years while he continues to live in the home. In order to secure payment of the $18,250 from Ted, Sarah will enter into a security agreement with him and shall register a lien against Ted’s home with the assistance of a lawyer.

Notional costs

You’ll see in the table above that notional costs – real estate commission and lawyers fees totaled $29,250. And yet, because Sarah and Ted are entering into a settlement, the property isn’t actually being physically sold and the notional costs won’t actually be paid by Sarah.

Ted’s creditors might question why Sarah is giving Ted a $29,250 abatement in the calculation of the proposed settlement amount if the property isn’t even being physically sold. After all, it’s Sarah’s job as Trustee to maximize the realization of assets for the benefit of Ted’s creditors.

This is the exact issue that was dealt with in several court cases where creditors objected to the Trustee giving bankrupts an abatement for notional costs such as real estate commission and legal fees when calculating a proposed settlement for the equity in a home. The well known cases are cited in the footnotes below.

The conclusion of the court in these cases is that the Trustee is required to drive a “hard bargain” when negotiating a settlement with the bankrupt, based on these guiding principles:

  • the Trustee has a duty to maximize the yield from all assets subject to practicalities and honesty;
  • it is impractical to sell assets at greater than fair market value;
  • special circumstances may require the sale of an asset at less than appraised or fair market value;
  • it is improper for a trustee automatically to reduce fair market value by the full sum of disposal costs; and
  • it is improper for the trustee to announce in advance that all he/she seeks is the fair market value minus debt and disposal costs.

So in the case of Sarah and Ted, Sarah should not have given Ted a $29,250 abatement for notional costs. She should started negotiations by proposing a settlement of  $47,500 (the property’s fair market value minus the mortgage balance minus unpaid property tax). She should have also instructed Ted to seek independent legal representation for the purpose of negotiating with Sarah the final amount to be settled, which would need to be approved by Ted’s creditors in his bankruptcy proceedings.

In practice, the final settlement amount would be somewhere between $18,250 (Ted’s desired outcome) and $47,500 (Sarah’s desired outcome).

HOME HAS NO EQUITY

Now let’s look at Ted’s case again, but suppose that the fair market value of his home is $400,000:

Fair market value of property$400,000
Mortgage 450,000
Property taxes payable2,500$-52,500
Notional costs
Real estate sales commission$22,600
Legal fees1,00023,600
Net realization $-76,100

As you can see in the above table, if the value of Ted’s home was $400,000, he would have negative equity since the balance owing on his mortgage exceeds what his home is worth. Since there is no equity, Sarah would have no interest in Ted’s home. Indeed, if Ted’s home was actually sold, there would be a shortfall owing to the bank of $76,100.

So in this case, Sarah would inform Ted that she has no interest in his home and it won’t have any impact on his bankruptcy proceeding so long as he continues making his mortgage payments to the bank.

PROVINCIAL EXEMPTIONS ON HOME EQUITY

Please note that certain provinces have exemptions for the equity in principal residences. For example, in Alberta the equity you have in your home is exempt from realization by the trustee if it’s below $40,000.00 (this is reduced if you’re a co-owner). Therefore, the information outlined above is subject to the exemption limits in your province. Here is a link to a list of provincial exemptions.

Footnotes

[1]  Re Malathy Manoharan (23 September 2015), Toronto 31-1812407 (ON Bankruptcy Court) [hereinafter Manoharan].

[2] Re Brisco, 2006 CarswellOnt 2770 (S.C.J.).

[3] Re Rassell, 1999 CarswellAlta 718 (C.A.).

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