It is commonly known that a bankrupt’s real property is a divisible asset in their bankrupt estate. It vests in the same way as all other divisible property, but has the quirk of legal title registration not found in most other assets. Trustees in bankruptcy will generally have to ‘enter transmission’, which is transferring the legal title to their name to enable them to sell the property under their own signature.
Dealing with real property is really no different from dealing with any other divisible asset. The trustee will want to find the value of the property and what amounts are secured against it. These securities may range from your simple housing loan supported by a registered mortgage to other creditors holding equitable mortgages supported by caveats.
Once the trustee has gathered all of these figures, he or she will be able to do a calculation of the equity in the property. They do this primarily to determine whether any equity exists and how that equity is divided between the bankrupt estate and any co-owner.
It is necessary to differentiate between the concepts of the legal interest that the trustee has in the property and the equity or the value of that interest. Even though there may be no equity (the secured creditors are owed as much or more than the value of the property) the trustee still has a legal interest in the property. It is just currently not worth anything. We use the word “currently” for a reason.
If there is equity in a property at the time of the bankruptcy, the trustee will move to sell the property to realise that valuable interest. That sale may be to a co-owner or on the market. The guiding principle behind this is that the asset (the equity) should be realised as soon as practical for the benefit of the estate’s creditors.
But what if there is no equity at that time? Does the trustee just walk away?
No. The trustee still retains the legal interest. In some cases the mortgagee will move to sell the property and the matter will come to an end with that sale. In some cases secured creditors do not move to sell the property (usually because the loan is being kept up to date) and the trustee will stay vested with that (zero-value) legal interest.
In many cases the trustee will attempt to ‘sell’ the legal interest to any co-owner for some amount once the equity has been calculated, or for a nominal amount if the equity has no value. At times this will not be possible because either the co-owner either does not want to buy or is unable to buy.
What happens then?
The trustee will not move to sell the property because there is no equity.
The bankrupt and the co-owner will generally keep living in the property and maintain the mortgage.
The trustee will notionally attribute the mortgage payments from the bankrupt and the co-owner as rent for his or her share of the property.
The interest stays vested in the trustee.
From time to time the trustee will recalculate the equity position. Given that the mortgage is being paid down and the value of the property may be rising, it is not uncommon for significant equity to be generated over time. At some point the trustee will be able to realise it commercially. Remember that the trustee still has a legal (now valuable) interest in the property.
We have a number of recent cases where this has occurred. Two are worth mentioning.
In one case the husband and bankrupt wife owned a property. At the time of the bankruptcy there was minimal equity and we offered to sell the estate’s legal interest in the property to the husband for that amount. He declined to buy it at that time. Three years later the value of the equity in the property had increased significantly. The husband recently paid the estate $25,000 to buy the estate’s interest. This was ten times the amount he would have had to pay three years ago.
Similarly in another estate, two years after discharge there was finally sufficient equity to be realised commercially. The co-owner was surprised that our interest was not extinguished at discharge, even though we had written to him at the time clearly stating that it would not. It cost him about $40,000 to buy the estate’s interest to save the house being sold.
Like every other asset, the discharge of the bankrupt will not affect the trustee’s interest and their ability to realise the property. The revesting provisions are quite clear that the trustee has at least six years after discharge (that is nine years from the start of the bankruptcy) to deal with property without having to seek extensions to do so.
In these and several other cases, the co-owners could have quite rightly bought our interest in the property at a greatly lower price years before they eventually did, but believed that we would never be in a commercial or legal position to enforce our interest in the property.