CASE STUDY: LOAN DEFAULT

Case Snapshot

Parties;

Client is a private, secured lender in first position whose loan was used, or supposed to be used, for purposes of developing residential property in San Diego County. The borrower is a limited liability company seeking to develop the property.

Amount:

Secured in excess of $1M.

Dispute:

Borrower defaulted on client’s secured loan. When client initiated nonjudicial foreclosure proceedings, borrower filed for Chapter 11 Bankruptcy. Client subsequently pursued its secured loan proceeds through the Chapter 11 proceeding.

Background Facts

In 2018, client made a loan to its borrower for borrower’s use in developing vacant residential land. The loan was memorialized in a Promissory Note, which was secured by the above-referenced residential land in San Diego County. In 2019, client agreed to a Modification of the Deed of Trust and Note, which increased the principal and monthly payments. Notably, the Modification reflected a loan maturity date of June 2020.

Borrower defaulted on its monthly payments late in 2019. Over the next several months, client attempted to work with borrower and held off on foreclosure proceedings based on borrower’s assurances that it would obtain financing to pay off client’s loan. When borrower failed to make its required payment by the maturity date, client proceeded with nonjudicial foreclosure proceedings. Notably, borrower’s sole asset was the property securing the loan; thus, client’s best and only option to collect on the loan was by foreclosing on the property.

Client proceeded with a nonjudicial foreclosure through the recordation of a Notice of Default and Election to Sell and, subsequently, a Notice of Trustee’s Sale. On the eve of the scheduled trustee’s sale, borrower filed for Chapter 11 Bankruptcy. At the time, the payoff on client’s loan was in excess of $800,000.

Issue Presented

As a secured lender, client’s typical remedy would be to foreclose on the property acting as security for the loan and, depending on the outcome of the trustee’s sale, either take the sale proceeds as payment in full for the loan or take the property.

The filing of a bankruptcy by the borrower, however, triggers an automatic stay of any foreclosure proceedings pursuant to Section 362 of the U.S. Bankruptcy Code. In other words, the nonjudicial foreclosure proceedings, including any pending trustee’s sales that would result in payment to the lender, must immediately cease until either the lender obtains relief from the stay or receives payment through the bankruptcy proceeding.

Thus, the issue became how to maximize client’s recovery through the bankruptcy proceeding where multiple creditors were making claims on the bankruptcy estate.

Solution

In order to recover the client’s investment, Blake Law Firm filed a Proof of Claim for the entire pre-petition arrearage, which included documentary evidence of the secured debt. Additionally, the loan documents called for late fees, penalties, interest, and attorney’s fees, all of which were claimed by client. The borrower filed an objection to client’s proof of claim challenging the validity of client’s loan documents and the initiation of its nonjudicial foreclosure. The borrower subsequently filed an adversary action seeking hundreds of thousands of dollars from client for wrongful foreclosure.

Our initial strategy resolved around forcing a sale of the property that had secured client’s loan. We were successful in doing so and the sale resulted in proceeds exceeding the total amount of creditor claims against the bankruptcy estate. After months of heated litigation, both in the bankruptcy proceeding and adversary proceeding, we were able to reach a settlement of the adversary proceeding resulting in a dismissal of borrower’s claims against client with prejudice. The settlement specifically excluded attorney’s fees incurred in the adversary action. As such, we submitted an amended proof of claim incorporating additional interest and attorney’s fees, including those incurred in the adversary action. Borrower objected to this amended proof of claim arguing, inter alia, that client was not entitled to all of the interest it claimed and was not entitled to attorney’s fees.

The borrower’s objection to client’s amended proof of claim came on for hearing before the bankruptcy court. Of the $135k+ in attorney’s fees requested by client, the court awarded all but $7k of those fees, including all of the fees incurred in the adversary proceeding. Where at the time of foreclosure, client was claiming $800k, client ultimately received over $1M in payments through the bankruptcy proceeding.

Outcome & Impact

Blake Law Firm recovered a total payoff in excess of $1M for its client, which includes penalties, late fees, interest, and attorney’s fees.

 The information provided above does not, and is not intended to, constitute legal advice. All information, content, and materials are for general informational purposes only and do not create an attorney-client relationship. The experienced and knowledgeable attorneys at Blake Law Firm are available to answer your questions and help you navigate your real property issues.