Pub. 9 2019 Issue 3

5 ISSUE 3. 2019 The Recession’s Impact The recession had deep and lasting impacts on many states. Arizona was hit hard. Many people lost their jobs. Anyone in a construc- tion-related business felt the impact. Real estate development came to a screeching halt. Developers shut down projects. The trickle-down effect was felt by contractors, sub-contractors, suppliers, investors and anyone who did business with those companies. Thousands of Arizonans turned to bankruptcy as a way out of the financial night - mare they faced. In addition to losing jobs, accompanied by the loss of income and the depletion of savings, many people lost hundreds of thousands of dollars in paper equity in real estate holdings. During the boom days, investors bought up lots, houses, strip centers and more in the expectation that values would continue to rise. It was like a game of musical chairs. When real-estate investments went bad in 2007, many of these individuals were left standing with no place to sit. They lost jobs. They depleted their savings, and the equity they thought they had in their real estate investments simply disappeared – virtually overnight. Bankruptcy became an option for many people. Some used the bankruptcy laws to reorganize and try to keep assets. Larger investors used Chapter 11 to restructure debts over a longer period of time and reduce the amount owed to lenders to the fair market value of the properties. Those people were able to save the prop - erties through debt reduction. Time will tell whether their gamble was successful. Homeowners who were not real estate investors and who only had their family residence faced difficult choices. During the years in which real estate values were rising, they took out lines of credit and secured them by consensual liens on their homes. Those funds were sometimes used for home improvements and sometimes just to supplement income for living expenses. After the recession hit, their homes were no longer worth what was owed. Some houses weren’t even worth what was owed on the original mortgage. Many people were out of work and unable to service the debts. Bankruptcy pro- vided some options for them. Many homeowners filed for relief under Chapter 13. A Chapter 13 bankruptcy is similar to a Chapter 11 but was designed to be faster and less expensive. It is a reorganization for individuals (no corporations, partnerships or LLCs can file for relief under Chapter 13) and requires that the debtor pay back debt by making monthly payments to a trustee for between three and five years. A debtor in Chapter 13 commits to use his or her disposable income for the life of the plan to pay back creditors in an amount at least equal to the value of their non-exempt property. In exchange, the debtor is per - mitted to keep the non-exempt property and has rights and powers similar to those of a Chapter 7 or 11 trustee or a Chapter 11 debtor in possession. One of those powers is the ability to “strip” liens that were wholly unsecured. In other words, a Chapter 13 debtor has the power to get a court order removing a consensual lien on their home if there is no equity to secure that loan. Those debtors stopped paying their second mortgages and filed mo - tions or adversary proceedings in the bankruptcy court to avoid the liens for which there was no equity. The lienholder was treated as a general unsecured creditor and had its debt discharged at the end of the Chapter 13 proceeding. 1 A discharge in bankruptcy is a perma- nent injunction against the attempt by a creditor to collect money on a pre-bankruptcy debt. A discharge is an “ in personam ” remedy. It merely enjoins a creditor from trying to collect money. It is not an “ in rem ” remedy – it does not void a lien. Therefore, even if a debt is “discharged,” the lien survives unless it is removed by specific court proceedings. When a Chapter 11 or Chapter 13 debtor is able to strip a lien due to a complete lack of equity to secure the lien and then completes the case and gets a discharge, the debt is no longer collectible, and the lien is removed. Those homeowners were able to capture for their own benefit the increase in value after the end of the recession and had no further obligation to the junior lienholder. They were the lucky ones. However, most homeowners simply filed for relief under Chapter 7, did not reaffirm the mortgages on their homes, and obtained a dis - charge. A reaffirmation is a post-petition agreement between a debtor Continued on page 6 The recession had deep and lasting impacts on many states. Arizona was hit hard. Many peo- ple lost their jobs. Anyone in a construction-related business felt the impact. Real estate de- velopment came to a screeching halt. Developers shut down projects. The trickle-down effect was felt by contractors, sub-contractors, suppliers, investors and anyone who did business with those companies.