Bankruptcy; Discharge of Liens

Chemical Bank v. James and In re Hamilton
When a real estate transaction occurs in which the current or a former owner has gone through a bankruptcy proceeding, issues frequently arise regarding the discharge of liens. There exists a common misconception that the personal discharge of the debtor serves to avoid liens. However, this is not the case. As the court stated in Party Parrot v. Birthdays & Holidays, 289 N.J. Super. 167,174 (App. Div. 1996):
while a discharge... generally prevents further in personal actions against the discharged debtor, it does not prohibit creditors from proceeding in rem against the debtor's property.
Yet the debtor is not without a remedy. He can apply to the Bankruptcy Court for an order avoiding the lien, or he can attempt to obtain a discharge of the lien in Superior Court through an application under N.J.S.A. 2A:16-49.1. See "Title Talk" No. 52 (Fall, 2001). But what happens if the realty which is encumbered by the lien has been abandoned under 11 U.S.C. §544? Does the abandonment limit the availability of these remedies? In Chemical Bank v. James, 354 N.J. Super. 1 (App. Div. 2002), the question was presented and answered by the court as follows:
... whether N.J.S.A. 2AA 6-49.1 authorizes the cancellation and discharge of a judgment lien of record against the real property of a judgment debtor whose personal liability for the underlying judgment has been discharged in a bankruptcy proceeding, where the trustee's interest in that real property was abandoned by the trustee during the bankruptcy proceedings.
We hold that when a judgment lien was "subject to be discharged or released under the provisions of the Bankruptcy Act', and the creditor did not levy against the property of the debtor prior to the filing of the bankruptcy petition, or within one year of the debtor's discharge, relief is available to the debtor to cancel and discharge the judgment lien pursuant to N.J.S.A. 2A:16-49.1, notwithstanding the trustee's abandonment of the bankrupt's interest in the property during the bankruptcy proceedings pursuant to 11 U.S.C. §544(a).
[354 N.J. Super. at 4,5.]
The case arose from the following facts. Chemical Bank recovered a $112,000 judgment against Donald James in 1990. In March, 1994, James filed a Chapter 7 petition, in which Chemical Bank was listed as an unsecured creditor. At the time the petition was filed, defendant owned a one-half interest in a condominium unit, which was encumbered by a mortgage, which apparently exceeded the value of the unit. Accordingly, the trustee abandoned the unit in June, 1994. The debtor obtained a personal discharge in July, 1994.
In 2001, James applied to the Superior Court for an order discharging Chemical's lien under N.J.S.A. 2A:16-49.1. Chemical opposed the application, arguing that it was barred by the trustee's abandonment of the debtor's interest in the realty. The Law Division found in favor of Chemical, but the Appellate Division reversed on appeal, reasoning as follows:
Here, the issue quite simply is whether plaintiff's docketed judgment lien was "subject to be discharged or released under the provisions of the Bankruptcy Ad', despite the trustee's abandonment of defendant's real property during the bankruptcy proceeding. [354 N.J. Super. at 9.]
Abandonment of the debtor's interest in the realty did not prevent the trustee from avoiding the lien during the pendency of the bankruptcy case. "The issue of 'abandonment' does not affect the issue of whether the judgment lien was 'subject to discharge or release' at the time the bankruptcy petition was filed." [ld. at 10.] The court pointed out that the trustee could have used the powers granted him by 11 U.S.C. §544 to avoid the lien. This section of the Code gives the trustee the status of a hypothetical lienholder whose execution has been returned unsatisfied. Since under New Jersey law the first judgment creditor to execute takes priority over other judgment creditors (regardless of the date of docketing of their judgments), the trustee would have been able to avoid Chemical's judgment lien. See In re Silverman, 2 B.R. 326 (Bankr. D.N.J.. 1980). Thus, Chemical's lien was "subject to be discharged or released under the provisions of the Bankruptcy Act". Therefore, the Appellate Division reversed the decision of the Law Division.
In another recent decision, In re Hamilton, 286 B.R. 291 (Bankr. D.N.J. 2002), the court was called upon to decide if, under the circumstances, ajudicial lien could be avoided under 11 U.S.C. §522(f). This section permits the avoidance of liens which impair the debtor's personal exemption in his or her residence. The debtor filed a Chapter 7 petition. Prior to her discharge, she moved to avoid a judicial lien held by Nationsbank in the amount of $16,742. Nationsbank was "scheduled" as an unsecured creditor, because it had not obtained a writ of execution at the time of the filing of the petition. The debtor sought to use 11 U.S.C. §522(f) to obtain (in effect) declaratory relief against the creditor, so as to prevent it from attempting to anforce its lien after she had obtained her discharge.
The court agreed that upon entry of the judgment, Nationsbank obtained (or would obtain) a lien on all of the real property owned by the debtor at the time of entry of the judgment or which might be acquired by her in the future. N.J.S.A. 2A:16-1 and 2A:17-17. However, at the time of filing of the petition, the debtor did not own any real estate. And since the creditor had not obtained a writ of execution, the judgment was not a lien on her personal property. Thus, the court declined to grant the relief sought, pointing out that:
Where a judgment has not become a lien on any of the debtor's property at the filing of the bankruptcy petition, Section 522(f) cannot apply. "Lien avoidance ... cannot occur if there is no lien which has attached to the debtor's property as of the time of the bankruptcy filing which is subject to avoidance."... Section 522(f) cannot be used to avoid a lien where none existed. [Citation omitted.]
The court noted that, with respect to the debtor's personal property, she was protected by 11 U.S.C. §524 from post-discharge enforcement efforts by the creditor. Furthermore, it the debtor acquired title to real property post-discharge, the Nationsbank judgment would not present difficulties for her. She could apply for a discharge of the lien under N.J.S.A. 2A:1649.1 once one year had elapsed f rom the day she received her personal discharge.

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Confusion over Survey Corner Markers

Conflicting treatment of survey corner markers by the legislature and an administrative agency has led to confusion among surveyors, attorneys, title companies and homeowners. The problem began when the Board of Professional Engineers and Land Surveyors proposed an administrative regulation amending NJAC 13:40-5.1 (d), which, in general, requires the setting of property corner markers (ie., permanent monuments) by surveyors when a survey is performed. However, the regulation allowed the "ultimate user" (ie., the homebuyer) to waive the setting of markers. Many consumers signed waivers because the corner markers can add several hundred dollars to the cost of a residential survey. (The average cost is $100.00 per monument, so that the cost of a typical residential survey force its lien after she had obtained her discharge.
The court agreed that upon entry of the judgment, Nationsbank obtained (or would obtain) a lien on all of the real property owned by the debtor at the time of entry of the judgment or which might be acquired by her in the future. N.J.S.A. 2A:16-1 and 2A:17-17. However,
at the time of filing of the petition, the debtor did not own any real estate. And since the creditor had not obtained a writ of execution, the judgment was not a lien on her personal property. Thus, the court declined to grant the relief sought, pointing out that:
Where a judgment has not become a lien on any of the debtor's property at the filing of the bankruptcy petition, Section 522(f) cannot apply. "Lien avoidance ... cannot occur if there is no lien which has attached to the debtor's property as of the time of the bankruptcy filing which is subject to avoidance."... Section 522(f) cannot be used to avoid a lien where none existed. [Citation omitted.]
The court noted that, with respect to the debtor's personal property, she
property, she was protected by 11 U.S.C. §524 from post-discharge enforcement efforts by the creditor. Furthermore, it the debtor acquired title to real property post-discharge, the Nationsbank judgment would not present difficulties for her. She could apply for a discharge of the lien under N.J.S.A. 2A:1649.1 once one year had elapsed f rom the day she received her personal discharge.

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Action Against Terrorism: USA Patriot Act and Executive Order No. 13224

In an effort to combat the threat of terrorism, Congress enacted the USA Patriot Act, P.L. 107-56 in Octoberof 2001. The statute imposes certain reporting requirements on "financial institutions" (which, by definition, include title companies) with respect to transactions involving individuals or entities believed to be involved in terrorist activities. (Note that 31 U.S.C. §5312(a)(2)(U) clefines "financial institution" to include "persons involved in real estate closings and settlements".) in addition, President Bush has promulgated Executive Order No. 13224, effective September 24,2001 (as subsequently amended and supplemented), which prohibits transactions with persons who commit, threaten to commit, or support terrorism. As a result, assets belonging to so-called Specially Designated Nationals [SDNs] have been frozen. The Office of Foreign Assets Control [OFAC] in the U.S. Treasury Department is charged with the duty of administering and enforcing the Order. OFAC maintains a list of SDNs and Blocked Persons; ie., those persons and entities with whom transactions are forbidden: www.treas.gov/ofac.
Failure to comply with the statutory and regulatory scheme discussed above may cause difficulties for title insurers, title agents and attorneys representing the parties in a real estate closing. A transaction involving a person or entity whose name appears on the Treasury's list may be void or voidable. Furthermore, non-compliance with the reporting requirements may lead to the imposition of fines or other penalties. The responsibility for ensuring compliance seems to fall on the party who conducts the closing. In North Jersey, this would typically be the attorney for the purchaser; in South Jersey, this would usually be the title company. Most title insurers have therefore issued underwriting guidelines requiring that the website listed above be checked in order to determine if the name of each party to each transaction being insured appears on the list. If it does, a requirement may be inserted in Schedule B, Section I of the title commitment to the effect that the assets of that party may have been frozen, and that consent of OFAC to the transaction to be insured must be obtained.
In the alternative, Charles Jones, LLC, is prepared to supply searches of the list of SDNs and Blocked Persons and maintained by OFAC. These searches are obtained by the title company when ordering the customary "Upper Court" (New Jersey Superior Court and United States District and Bankruptcy Court) searches. Most title companies have chosen to order the information from Charles Jones rather than attempt to navigate the OFAC website. Unfortunately, the list of SDNs and Blocked Persons contains many common names, and thus false matches or "hits" are sometimes returned. OFAC does not seem to have a formal procedure for clearing these transactions. Based on anecdotal evidence, it appears that OFAC will provide oral assurance (eg.) that "John Smith" whose name appears on the list is not the same "John Smith" who is the record owner of the premises in question, but it will not supply a written certification to that effect. False matches will therefore have to be resolved on a case-by-case basis.

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Payments to Attorneys and Others: 1099-MISC Reporting

In 1997, Internal Revenue Code ["IRC"I §6045 was amended to require that any person making a payment in the course of his or her trade or business to an attorney in connection with legal services must make a 1099" filing, regardless of whether the services are performed for or on behalf of the person making the payment. The IRS subsequently issued proposed rules which suggest that title companies or others (including attorneys) who are making payments in connection with real estate transactions must file a 1099-MISC [Miscellaneous Income] form with respect to same. 26 U.S.C. §6045tf); proposed Reg. §1.6045-5.
It was originally anticipated that the rules would apply to real estate closings or settlements taking place after December 31, 2000. However, the IRS has not so far issued a final version of the proposed rules. Thus, it appears thatthe requirement will not take effect earlier than some time in 2003, or possibly even later. When the rule is finalized, title companies conducting settlements, and attorneys conducting closings, will presumably be required to file a 1099-MISC form with respect to any attorneys' fees paid from the closing proceeds.
Meanwhile, the IRS has issued a final version of the rules affecting the so-called "middleman" reporting requirements of IRC §6041, effective January 1, 2003. It provides that "... a person who performs management or oversight functions in connection with the payment..." is required to file a 1099-MISC form. This excludes "... a person who performs mere administrative or ministerial functions such as writing checks at another's direction". Similarly, one who " ... has a significant economic interest in the payment ..." must fulfill the reporting requirements. This phrase is explained by the Regulation to mean "... an economic interest which would be compromised if the payment were not made, such as by creation of a mechanics' lien on property to which the payment relates, or a loss of collateral 26 U.S.C. §6041; Reg. §1.6041-1 (a) (eff. Jan. 1, 2003). See Fed Reg., Vol 67, No. 144,48754 etseq. It appears that title companies conducting settlements will
not be required to file a 1099-MISC form with respect to many third-party "middleman" payments made from the closing proceeds, because the settlement agent is usually acting in a ministerial fashion. However, the obligations of attorneys may not always be as clear. In addition, the effect of the "significant economic interest" portion of the Regulation lacks clarity. What if (for example) the failure to make a payment to a contractor - as directed by the parties - would result in the filing of a construction lien claim? Such matters will have to resolved on a case-by-case basis, as indicated by the IRS in its commentary. As noted above, these Regulations are adopted pursuant to IRC §6041. It is unclear what effect, if any, the same will have on the reporting of attorneys' fees under under iRC §6045(f). However, as noted above, the final version of the attorneys' fees regulation is not yet in place, so there is currently no obligation to report attorneys' fees under that section. Note that the information contained herein has no effect on 1099-S reporting of real estate sales and exchanges under IRC §6045(e).

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Endorsements Approved by DOBI

The Commissioner of the Department of Banking and Insurance [DOBI] has recently approved two endorsements at the request of the New Jersey Land Title Insurance Rating Bureau [NJLTIRB]: Mezzanine Financing and Going Concern. The forms were approved as of January 6 and March 3,2003, respectively, and are used in connection with commercial transactions.
Despite its name, the Mezzanine Financing Endorsement is attached to an owner's (rather than a loan) policy insuring a commercial site. It has the effect of adding the lender in a mezzanine financing transaction as a loss payee or additional insured of the owner's policy (to the limited extent set forth in the endorsement). The interest of a mezzanine financing lender who has secured this endorsement may be loosely compared to that of a mortgage lender who is named as a beneficiary underafire insurance policy obtalned by the owner of the realty.
"Mezzanine financing" is so called because it fills the gap between the existing mortgage indebtedness and the equity interest of the project's owners. It is frequently secured by a pledge of the owners' equity interests or cash flow in the project. Mezzanine financing is typically not secured by a mortgage, usually because there is insufficient equity in the realty to support the mezzanine loan. Thus, the lenders interest cannot be insured by the issuance of a loan policy; hence the endorsement is attached to an owner's policy. The Commissioner has approved a premium surcharge of 30% for the issuance of this endorsement. In other words, the charge is equivalent to 30% of the premium charged for the owner's policy to which the endorsement will be attached. The amount of the mezzanine loan is therefore irrelevant. In most cases, mezzanine financing will be secured at some time after the owner's policy has been issued. ALTA Owner's Policy (1992), Conditions and Stipulations, 7(a) (ii) states that in the event of a loss "... the liability of the company shall not exceed the least of: ... (ii) the difference in value of the insured estate or interest as insured and the value ...subject to the defect, lien or encumbrance The Going Concern Endorsement modifies that portion of the policy to provide that, in the event of loss,"the etermination of the value of the insured estate or interest ... shall include consideration of the use or uses to which the land is being put at the time of loss". In other words, the value of the land must be considered in light of its use when computing the loss suffered by the insured.

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