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Let's say you have a recourse loan on a commercial property, which as I understand it means that a creditor/bank can come after your other assets to make themselves whole if you were to default on your loan and the collateralized property is not enough to cover the debts. However, does this change if you file for bankruptcy? Does this prevent the bank from being able to come for your other assets and only take the property? If all you have is a primary residence and single car can they actually take anything from you?

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    Where? Bankruptcy law vary widely between jurisdictions.
    – Dale M
    Sep 30, 2022 at 1:48
  • Yes, should have specified. I'm asking in the United States in general, nothing too specific to states, even though I know the laws differ state to state.
    – Davis Owen
    Oct 1, 2022 at 2:59

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Let's say you have a recourse loan on a commercial property, which as I understand it means that a creditor/bank can come after your other assets to make themselves whole if you were to default on your loan and the collateralized property is not enough to cover the debts.

Yes, correct. This is opposed to a ''non-recourse'' loan where the creditor can only take the collateral.

However, does this change if you file for bankruptcy? Does this prevent the bank from being able to come for your other assets and only take the property?

No, this does not change - why should it? If you default on a recourse loan, the bank can take the collateral, and any remaining debt will remain as regular debt. At that point it is usually no different from other debt, and as such the debt may or may not trigger a bankruptcy, and in a bankruptcy, usually everything will be liquidated (with exceptions depending on situation & jurisdiction).

What will change is that in a bankruptcy, no creditor can take enforcement action anymore (such as seizing & selling property). In a bankruptcy, only the (usually court-appointed) trustee or official administering the bankruptcy may do this - but yes, they may and typically will seize and liquidate everything they can.

So in a bankruptcy the bank cannot take your house, but the administrator can.

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In a U.S. bankruptcy proceeding where there is a recourse mortgage loan present on commercial real estate the analysis works roughly as follows:

  1. The secured lender is entitled to receive economic value from the bankruptcy equal to the fair market value of the collateral securing the loan. This can be achieved by a turnover of collateral with no equity to the lender, from a sale of the collateral with the proceeds paid to the lender (up to the amount owed on the loan), or providing the secured lender with a substitute for the collateral that provides the lender "adequate security" in some other asset (e.g. a different parcel of property that is worth just as much after any prior encumbrances).

  2. If the collateral is worth less than the amount owed on the loan, the lender gets two separate claims in bankruptcy from the same debt, a secured claim equal to the value of the collateral given the treatment above, and an unsecured general creditor's claims for the amount of the loan that exceeds the value of the collateral.

  3. In a Chapter 7 bankruptcy, once secured claims are paid, the assets left over in the bankruptcy estate are used to pay claims given priority in the bankruptcy process such as the costs of administering the bankruptcy case, certain tax claims, and certain claims for back wages. After the available assets are used to pay secured claims and priority claims, the remaining claims go into one big "pot" of assets that is compared to the amount of general unsecured claims outstanding.

  4. If the pot is sufficient to pay all general unsecured claims (which can happen, for example, if the bankruptcy was triggered by lack of liquidity rather than by insufficient assets, or if the bankruptcy was triggered because a lawsuit was pending against the debtor but not finally resolved and the lawsuit is ultimately resolved favorable for the debtor after the bankruptcy is filed), expressly subordinated unsecured claims (like many junk bonds) are paid next, with the balance after those claims, if any, are paid in full paid to the debtor.

If the pot is insufficient to pay all general unsecured claims, each general unsecured claim is paid the same percentage of the claim from the assets still available in the pot. Then, the unpaid balance of the general unsecured claims, including deficiencies arising from collateral on a loan being less than the amount owed on a loan, are discharged and forgiven (if the debtor is a natural person, entities don't get their debts discharged in Chapter 7 bankruptcies).

  1. In a Chapter 11 reorganization it doesn't work in quite the same way. The debtor makes up a "plan of reorganization" regarding who gets paid first, second, etc., which debts are discharged in bankruptcy, and which debts remain in force after the bankruptcy. Then, the court reviews the plan and the creditors get to vote on it to the extent that the creditors of a particular class are getting paid less in the Chapter 11 plan than they would have received in a Chapter 7 plan (in which there was no ongoing income from the continued operation of the business as a going concern). If the plan is approved by every class of creditors entitled to vote upon it because they get a worse deal than they would in a Chapter 7 plan, then the plan, rather than bankruptcy law, controls what happens.

Usually, a debt like a deficiency on a recourse secured loan will end up being treated very similarly in a Chapter 11 plan than in a Chapter 7 liquidation except that usually in a Chapter 11 plan "trade creditors" of the business which are necessary for the ongoing operations of the business will be paid in full, while long term debt creditors will be paid somewhat less or will be paid more slowly over time or will have their debt converted to equity in the reorganized company.

Sometimes, a Chapter 7 bankruptcy will leave the mortgage on the real estate in place rather than selling the property, but will discharge the obligation of anyone on the loan other than the continued rights of the lender against the collateral, once the bankruptcy is over, wiping out the ability of the secured lender to seek a deficiency judgment if there is a foreclosure of the collateral.

In other words, often a Chapter 7 bankruptcy will convert an undersecured mortgage from a recourse mortgage to a non-recourse mortgage.

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  • Thanks for the comment. Just a follow up, it sounds like in Chapter 7, once all assets are liquidated, there is no garnishing of future wages, correct? I suppose you could have garnishing of wages in a Chapter 11 but given that the debtor proposes the plan I imagine that basically never happens.
    – Davis Owen
    Oct 1, 2022 at 3:08
  • @DavisOwen There could be future payments in either a Chapter 11 or a Chapter 13 and it actually happens rather frequently. A Chapter 13 is usually done in an effort to preserve a home. Individual Chapter 11s are done for a variety of reasons and are the most common option for entities. The means test in individual Chapter 7 cases also means that not contributing future income is sometimes not an option.
    – ohwilleke
    Oct 1, 2022 at 3:35

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