With the credit crunch effecting everyone property repossession cases are back in the headlines again and dominating the bankruptcy courts’ dockets as they did in the early nineties, but they continue to be filed with great frequency in UK. At its essence, the property repossession is a two party dispute between mortgagee and mortgagor. Repossession cases are typically filed before or after a bankruptcy. Upon learning of the bankruptcy filing, a secured creditor has a number of available options, all or some of which are exercised, depending on the facts of the case, to maximise loan recovery.

A lender can ask the court to dismiss the bankruptcy case as a “bad faith” filing. A creditor asserting bad faith must prove the subjective bad faith of the debtor and that any reorganisation by the debtor is objectively futile. For subjective bad faith, the court will examine whether the debtor invoked the protections of the Bankruptcy Code without either the intention or ability to reorganise its financial affairs. To determine objective futility, the court will examine whether there is indeed a “going concern” to preserve and whether there is any realistic chance for the debtor to reorganise. Most courts require a very strong showing to dismiss a case for bad faith at the outset of a case.

Under the Bankruptcy Code a motion for relief from stay will also be granted where the secured creditor can prove that there is no equity in the real property over and above the secured claims, and that the property is not necessary to the debtor’s effective reorganisation. This basis for relief is typically alleged as an alternative to bad faith, in the same motion. Almost all controversies surround the value of the real property, making the expert report and testimony of a licensed estate agents appraiser essential to the successful prosecution of a motion for relief from the automatic stay on these grounds. The same factors relied upon to support objective futility in the bad faith filing analysis are used to establish that the property is not necessary to an effective reorganisation.

An alternate ground for relief from the automatic stay is lack of adequate protection of the secured creditor’s interest in the property. For example, if the property is deteriorating in value and the lender is not receiving post-petition payments, the lender’s security interest in the property is not adequately protected. A creditor holding a properly perfected assignment of rents has a lien on “cash collateral” under the Bankruptcy law. If the assignment of rents was properly perfected pre-petition, it usually attaches to the post-petition rents generated by the debtor’s property. A debtor may not use cash collateral without either a court order or the consent of the secured creditor. While it is common in nonsingle asset realty cases for a debtor to negotiate a cash collateral agreement with the secured creditor before filing for bankruptcy, in single asset real estate cases, which are typically filed at the eleventh hour for the express purpose of stopping a reposssession, such negotiations are virtually nonexistent.

Unless, within the first day or two of the case, the debtor requests a cash collateral agreement with the lender, or files a motion with the court to authorise the debtor’s use of post-petition rents, a lender should immediately advise the debtor in writing that it may not use cash collateral absent an agreement. If an agreement is not reached, the debtor will usually petition the court for authorisation on an emergency basis. The lender can also petition the court to deny authorisation on the basis that the debtor lacks the ability to adequately protect its interests in the rents. In the final analysis, most secured creditors share the same objective when faced with a real estate case: to extract their collateral, including rents, from the bankruptcy as quickly and inexpensively as possible.