• Bankruptcy Effect
  • February 1, 2010 | Authors: Michelle C. Lombino; Valerie L. Marciano
  • Law Firm: Jaburg Wilk, P.C. - Phoenix Office
  •     During the boom years of 2002 to 2005, many people bought not just one investment property, but numerous properties, with the intention of either flipping them for a quick profit or renting them out to generate an income stream.  Often times, the investors took out loans from institutional or private lenders to purchase their investment properties.  The investors planned to repay the loans from proceeds generated from the sale of the assets, or from the rental income received from tenants.


        The ease of Arizona laws allows investors to form limited liability companies to hold each of their investment properties.  Holding each of the investments in a separate distinct limited liability company or LLC may have provided liability protection or some tax advantage.  When the market fell flat, the investors found themselves in an untenable position.  They were unable to rent, much less sell their holdings, whether it was 3 properties or 10 or more different properties.  Without the ability to liquidate the investments, the investors had three possible options. 


        First, if possible, the investors relied upon their income from their “day jobs” to pay the debt service on the investments, which was never their intention.  As can be imagined, the “day job” income has not stretched far enough to cover all the payments to the lenders.  Second, the investors have allowed the investments that were “under water” to go back to the lenders.  Finally, and what has been noted as a current trend, the investors are filing for personal bankruptcy, even though each of the investment properties are held in separate, distinct entities, such as an LLC.


        The lenders are finding themselves identified as “creditors” in personal bankruptcy proceedings even though their true “borrowers” are the LLC entities.  If the lenders are asleep at the switch in the bankruptcy cases, the investors have been able to modify the payment terms owed to the lenders, and reemerge from bankruptcy still holding the investment properties in the separate, distinct entities.  If, however, the lenders are proactive in the personal bankruptcy proceedings, the lenders have been successful in their requests to have the Bankruptcy Courts lift the “automatic stay”, and declare that the investment properties are not part of the bankruptcy case, leaving the lenders to recover the properties through foreclosures.  Depending upon whether the property is the type subject to the “anti-Deficiency Statutes”, the lenders may or may not be able to pursue the borrowers for the deficiency.


                If you are an investor in a situation described above, you should seek legal assistance in determining whether you can preserve some or all of your assets.  On the other hand, if you are a lender, and find yourself involved in a bankruptcy of someone that was not your “borrower,” beware and take the necessary steps to learn whether you can extricate yourself from the reach of the Bankruptcy Court. 


    About the authors: 


        Valerie Marciano is a partner at the Phoenix law firm of Jaburg & Wilk.  She assists clients with business disputes, workouts and distressed holdings.  Val can be reached at 602.248.1025 or [email protected].


        Michelle Lombino is a partner at the Phoenix law firm of Jaburg & Wilk. She assists clients with non-bankruptcy workouts, including loan modifications, deeds in lieu of foreclosure, forbearance agreements and bankruptcy proceedings. Michelle can be reached at 602-248-1028 or [email protected].