The Antidote to Zombie Foreclosures: How Bankruptcy Courts Should Address the Zombie Foreclosure Crisis

• Publication year: 2016

The Antidote to Zombie Foreclosures: How Bankruptcy Courts Should Address the Zombie Foreclosure Crisis

Amanda McQuade

THE ANTIDOTE TO ZOMBIE FORECLOSURES: HOW BANKRUPTCY COURTS SHOULD ADDRESS THE ZOMBIE FORECLOSURE CRISIS

Abstract

Bankrupt homeowners across the United States continue to struggle because of the mortgage foreclosure crisis. Although zombie foreclosures present a significant issue for individuals who filed for bankruptcy during the last few years, there is no satisfactory legal remedy. The Bankruptcy Code and bankruptcy courts may offer an overlooked solution to the problem. Due to flexibility within bankruptcy courts, bankruptcy judges have a greater degree of discretion within certain situations to fulfill their equitable powers. Bankruptcy judges can take the realities of the debtor's circumstances into account in ways that state and federal courts cannot. This Comment's recommendations demonstrate the need for both courts and Congress to reconsider the Bankruptcy Code as a solution to zombie foreclosures. With a few amendments, the Bankruptcy Code should be able to help alleviate the zombie foreclosure problem.

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Introduction

Markets across the United States suffered as a result of the 2008 recession. Perhaps outside the job market, the housing market was the most acutely affected. In the years leading up to the recession, hundreds of thousands of Americans received mortgages despite not meeting the underwriting requirements to receive such loans due to questionable mortgage securities created by a variety of banking institutions.¹ The resultant "housing meltdown" triggered the financial crisis.² While this meltdown occurred in 2008, the effects are still felt around the country as properties are foreclosed upon, or remain in limbo.

Those that remain in limbo are often called zombie foreclosures.³ The term "zombie foreclosure" refers to "when a lender goes through all the motions of foreclosing on a property, but fails to take the final step of recording the foreclosure trustee's deed that transfers legal title from the borrower to the foreclosing lender."⁴ Zombie foreclosures damage communities, home sale prices, and the debtor's fresh start.⁵ Several news articles describe how zombie foreclosures

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become blights within municipalities and how the numbers of "blights" continue to increase in a number of areas nationwide.⁶ Zombie foreclosures not only cause eyesores for communities, but they additionally affect other neighboring property values, are often surrounded by crime, and cause severe fragmentation within already struggling neighborhoods.⁷ These difficulties are not isolated incidents, but are pervasive throughout America. The complicated reality of the mortgage foreclosure crisis has been acknowledged in news articles, as well as by Congress.⁸

Zombie foreclosures represent very real challenges and concerns to debtors, creditors, and communities. As case law illustrates, these challenges include continuing liability for properties and assets that debtors believe they are no longer legally responsible for, and vacant, dilapidated houses within neighborhoods throughout a community. These results are unfair to the individual debtors and communities.⁹ Attorney General Schneiderman aptly summed up the collective unfairness when he stated "[l]eaving zombie properties to rot is unfair to municipalities and unfair to neighbors, who pay their taxes and maintain their homes . . . ."¹⁰

Given the serious nature of these challenges, it is necessary for the Bankruptcy Code to be amended or for bankruptcy courts to read the provisions in a broader fashion as they relate to zombie foreclosure. This Comment will explore

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a number of sections within the Bankruptcy Code that may offer potential methods to resolve the zombie foreclosure dilemma. This Comment will discuss bankruptcy case law that exists on zombie foreclosures and legislative commentary surrounding the foreclosure crisis.

There are two rationales that serve to justify why the bankruptcy courts need to rethink current interpretations of the Bankruptcy Code. First, the debtor's perspective is a rationale that stems from the main bases for bankruptcy law: the fresh start and fairness to creditors. Second, the community interest presents courts with an alternative rationale to support amending the way bankruptcy courts use their powers to address zombie foreclosures.

Over the years, the tenets underlying the bankruptcy system have been consistently clear despite changes to the Bankruptcy Code.¹¹ As Justice Stevens acknowledged in a 2006 opinion, "[t]he principal purpose of the Bankruptcy Code is to grant a 'fresh start' to the 'honest but unfortunate debtor.'"¹²

Similarly, along with this interest in the debtor's fresh start, bankruptcy laws have demonstrated an identifiable concern for creditors.¹³ Specifically, "the Court has long recognized that a chief purpose of the bankruptcy laws is 'to secure a prompt and effectual administration and settlement of the estate of all bankrupts within a limited period.'"¹⁴ According to a House Committee Report, "preference provisions facilitate the prime bankruptcy policy of equality of distribution among creditors of the debtor."¹⁵

After considering the larger policy ramifications and the ever-increasing hardships of the national mortgage foreclosure crisis, it is time to determine an alternative venue for debtors to address zombie foreclosures. Bankruptcy courts arguably offer a unique venue to identify a resolution to zombie foreclosures and the subsequent vacant lots across the United States. Bankruptcy courts differ from other courts because judges under the Bankruptcy Code are given greater levels of flexibility that allow them more wiggle room within their decision making process than other federal judges. In a recent bankruptcy case out of the Western District of North Carolina, In re Rose, the court attempted

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to address the Debtor's Motion for Authority to Transfer Real Property to Secured Creditor by Quitclaim Deed.¹⁶ The facts of the case are similar to many zombie foreclosure stories across the country, and requests similar to the one at issue "are becoming more and more common."¹⁷ Given the prevalence of similar cases, bankruptcy courts need to be able to offer debtors an alternative path to a resolution.

The community interest basis of analysis highlights the public policy challenges underlying zombie foreclosures. Given the financial and social difficulties posed by vacant lots associated with zombie foreclosures, bankruptcy courts need to find a way to address the issues. For policy reasons in addition to reinforcement of key bankruptcy tenets (the debtor's fresh start and fairness to creditors), bankruptcy courts offer a readily available forum that, with slight changes, could potentially resolve the ever-growing problem of zombie foreclosures.

This Comment will offer real world possibilities for bankruptcy courts to consider when faced with a zombie foreclosure. Beyond pointing out relevant sections and interpretations the bankruptcy courts should employ when making decisions, this Comment will also address potential amendments to the Bankruptcy Code that could settle the debates around the usage of certain sections in the future. This Comment will demonstrate that zombie foreclosures are a problem that needs to be addressed—the time has come.

I. Background

Within the Bankruptcy Code, the present definitions of key terms acutely impact the outcome for a debtor faced with a zombie foreclosure. Many of these sections are discussed at length in bankruptcy cases such as In re Rose.¹⁸ The specific way each of these terms ties into the Bankruptcy Code will be discussed at length during the Analysis section of this Comment.

A. "Zombie" Foreclosures

Zombie foreclosures occur on all sorts of property. The focus of this Comment, however, is on the zombie foreclosures on residential properties within

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chapter 13 bankruptcy filings.¹⁹ While zombie foreclosures can occur with commercial real estate, residential zombie foreclosures pose greater issues to communities and individual debtors.

Outlining the usual steps involving a mortgage that is discharged in a confirmed chapter 13 plan aids in understanding the ramifications of zombie foreclosures. Depending on the state, there are judicial and non-judicial foreclo-sures.²⁰ Roughly forty percent of states only offer judicial foreclosures and sixty percent are non-judicial foreclosure states.²¹ For judicial foreclosure states, "the court governs the foreclosure process from default to final sale."²² During foreclosure through a confirmed chapter 13 plan, in a judicial foreclosure state, the bankruptcy court agrees to lift the automatic stay so that the creditor can initiate a foreclosure proceeding.²³ Non-judicial foreclosure states do not involve the court in foreclosures.²⁴

From the perspective of the debtor, zombie foreclosures are the "plight of people who walked away from their homes not realizing that their names remained on the deed and that they were financially liable for taxes and other bills related to the abandoned property."²⁵ Zombie foreclosures affect the debtor's ability to move forward after bankruptcy and the landscape of the community surrounding the property at issue.²⁶

As a result of the mortgage crisis and subsequent housing crash, zombie foreclosures have become a prevalent problem across America.²⁷ The foreclosure crisis shows up in Congressional reports and discussions as early as

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2008,²⁸ and began to appear frequently in mass media in 2013.²⁹ From the community perspective, zombie foreclosures lead to a number of problems, including how communities in crisis deal with the very complex realities of vacant homes, including "[s]quatters, crime, declining property values, and ultimately, demolition."³⁰

B. Congressional Commentary on the Mortgage Foreclosure Crisis

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