United States: Mortgagee Relief From The Automatic Stay: "Cause" Is In The Eye Of The Beholder – Namely The Court

Last Updated: December 27 2013
Article by Vicki Harding

In re Doug Wilson Ins. Agency, Inc., 495 B.R. 428 (Bankr. E.D. Ark. 2013) –

A debtor that owned several properties filed a chapter 11 bankruptcy proceeding on April 1st.  A bank that had mortgages on two of the properties moved for relief from the automatic stay on April 2nd.  The bankruptcy court focused primarily on whether there was "cause" for relief.

The properties at issue were described as an unfinished rent house and a strip mall.  They secured two notes in the original principal amounts of $150,000 and $495,000.  No payments had been made on the bank's debt in over two years.  The first note was due in September 2010, and as of April 2013 the amount outstanding was ~$193,000.  The second note was due in May 2007, and as of April 2013 the amount outstanding was ~$555,000.  So the total debt secured by the properties was ~$748,000.

The debtor also did not pay real estate taxes on the strip mall for more than three years, and failed to insure the strip mall so that the bank was required to obtain its own insurance.

The schedules filed by the debtor listed the value of the strip mall as $729,000, and listed the unfinished rent house (under an incorrect schedule) with a value of $100,000.  No other evidenced of value was offered by either the bank or the debtor.  So, the court concluded there was an equity cushion of ~$81,000 as of April 2013.  Normally an equity cushion may provide adequate protection for a lender's interest in collateral.  However, the debtor's prior history of litigating for more than two years without making payments had caused the equity cushion to diminish, and it was continuing to diminish with the accrual of interest.

The debtor filed bankruptcy schedules that were incorrect in several ways:  (1) it failed to include a cause of action pending against the bank, (2) it failed to include the unpaid property taxes, (3) the rent home was not reflected as an asset on Schedule A – Real Property, and (4) initially the schedule of unexpired leases was incorrect.

The debtor claimed that it was receiving $2,000 a month income from the strip mall.  The bank contended that the assignment of rents was absolute, and thus the debtor no longer had any interest in the rents since it had defaulted.  The court declined to resolve this issue since if the bank had a security interest (as opposed to absolute right to the rents), at best the rents constituted cash collateral so that the debtor would be entitled to use the rents only if it obtained either the bank's consent or a court order.  Since the debtor had neither consent nor an order, it was not entitled to use the rents.

The court also discussed its views on the debtor's likelihood of being able to reorganize.  The court did not think very highly of the debtor's prospects.  Although the debtor waited to file bankruptcy for two years after the bank commenced foreclosure, it did nothing to prepare in the interim.

The only exhibit provided by the debtor regarding a potential plan of reorganization was described as "Projected income and expenses."  This was a one-page document prepared the week of the hearing, "suggesting a hasty preparation."  The projection included income and expenses from a post office property (which was not property of the estate and was subject to a pending foreclosure action), the unfinished rent house, the strip mall and another rent house that was subject to a mortgage in favor of a different bank.  The projection did not address unpaid taxes and did not address debt service for either of the banks.  Further, the debtor's projection of future income was not supported and was insufficient to adequately service the secured claims.

The court noted that "cause" for relief from the stay under Section 362(d) of the Bankruptcy Code includes lack of adequate protection of a creditor's interest.  In addition, the court found that the failure to pay a secured creditor for a substantial period of time coupled with an unsupported proposal to satisfy the debt after plan confirmation may constitute cause.

Given this litany of facts, the court concluded that there was cause and ordered that (1) the bank was entitled to relief from the automatic stay with respect to both the unfinished rent house and strip mall, and (2) this property was abandoned by the bankruptcy estate.

Usually it is difficult to obtain relief from the stay at the very beginning of a bankruptcy case.  Courts generally want to give a debtor an opportunity to make a case for reorganization.  However, as illustrated by this case, if the facts are egregious enough there are exceptions.  It is interesting to see the facts that this court focused on in ruling against the debtor.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Vicki Harding
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