Bankruptcy and Sheriff Sale Purchases

As a professional real estate developer or someone with an interest in purchasing real estate at a sheriff sale, you need to understand how the bankruptcy and foreclosure laws work together. Foreclosure is a process by which a private party (a bank for example) or a municipality bring a lawsuit to collect monies that are past due. This can be taxes or other fees owed. Once a judgment is entered, the sheriff will schedule a sale to satisfy the money owed at a public auction. This is known as a foreclosure or sheriff’s sale. Can a bankruptcy filing stop a foreclosure? The simple answer is yes. However, the investor that fails to perform simple due diligence can make a foreclosure sale purchase a very costly and time consuming proposition. Before turning to this, a little background on the bankruptcy laws.

Bankruptcy: The Automatic Stay.

The day a debtor files bankruptcy (Chapter 13, for example), is the petition date. On the petition date, a legal wall comes down known as the automatic stay. All creditors are now required by federal law to stop collection efforts for debts owed prior to the petition date. This includes all demand letters, lawsuits and sheriff sales. So long as the petition date is prior to the “gavel falling” at the sheriff sale, the real estate remains with its original owner. However, if bankruptcy is filed after foreclosure, even one day after, the real property passes to the successful bidder. The real property is then not part of the debtor’s bankruptcy estate.

Best Practice Tip: When Purchasing at Sheriff Sale, Do Your Own Bankruptcy Search.

Problems arise however when a real estate investor buys real property at a sheriff sale but is not aware that the owner filed bankruptcy before the sale. The law is very clear- if the owner filed bankruptcy before the hammer falls at the sheriff sale, it is as if the sale never happened. The bankruptcy term is void ab initio meaning “to be treated as invalid from the outset.” Knowing this, it is a best practice to determine on three separate occasions if the property owner filed bankruptcy.

Initial Search.

First, run a search to see if the property owner(s) has filed bankruptcy immediately upon identification of a potential property. If the sheriff sale is a non-starter, it’s best to know from the beginning. Why waste your time and money on the rest of your due diligence?

Research During The Process.

It’s important to search the day before the sheriff sale to make sure the property owner still has not filed. You will be doing a lot of research as a part of your due diligence during the process. It’s easy to miss this step- Don’t. Frequently a property owner files bankruptcy at the 11^th hour to save the property from sheriff sale. The sheriff may not be aware of a bankruptcy that was filed the day before the sale. If the sale is continued, another check before the continued date is recommended as well.

Final Check.

Check again right before you make the final payment to the sheriff. In Pennsylvania, a successful bidder needs to pay ten (10%) percent of its bid at the actual sale. The remaining balance is due thirty (30) days after the sale. I always recommend to my investor clients to check one final time before they tender the remaining ninety (90%) of their winning bid. Otherwise you may face an unfortunate situation where the sale is set aside. That will leave you the difficult task of trying to recover your bid from the sheriff. Worse yet, maybe you made improvements to the property? Who benefits from these improvements? If the debtor keeps the property, does he/she have any money to pay you for these? Remember, the debtor is in bankruptcy and has very limited funds.

If you still believe checking is not necessary, I leave you with one recent war story. A client I represented came into my office with a motion to set aside a sheriff sale filed by a municipality. The motion was filed 16 months after the sheriff’s sale. The investor just finished with renovations and was ready to rent the triplex to tenants. Before the town served the motion, my client was not aware the prior owners filed bankruptcy. Of course, while the sheriff is required to refund the amount paid to my client, nothing was mentioned concerning the $75,000 my client spent improving the triplex. The debtor certainly did not have money to repay the investor. As of the posting of this blog, negotiations are still ongoing regarding this issue.

Searching for a Bankruptcy Filing.

This could all have been avoided if my client performed its own bankruptcy due diligence prior to bidding at the sheriff sale or before it paid the remaining balance. To accomplish this, simply run a search through an online search program called PACER. It is important to conduct the PACER search in the correct bankruptcy court for each party identified on the deed. This means doing the search in the bankruptcy court where the property is located. If the debtors do not live at the property in question, then another search must be performed at the location they reside at as well. Another very useful website is the United States Courts’ website that provides a link to every bankruptcy court in the United States. To reach this website, click here.

If you have other questions regarding how to invest in real estate through the sheriff sale process, please feel free to call us at Danziger Shapiro, P.C. We look forward to hearing from you.

This entry is presented for informational purposes only and does not constitute legal advice.