The flow of funds into new mortgages may be greatly reduced unless something is done about "the pervasive threat of bankruptcy proceedings" to the real estate lending community, Edward J. Kulik, Massachusetts Mutual Life Insurance Co. senior vice president, warned last week.
Kulik was testifying before a Senate subcommittee on behalf of a group of mortgage bankers and thrift institutions. The panel is attempting to draft a uniform bankruptcy act, the first revision of the bankruptcy system in 40 years. Kulik emphasized that large commercial real estate enterprises, not individuals, were causing the trouble: a sudden large increase in the number of Chapter XII (real property) reorganizations in the past two years.
Since 1975, the law has allowed a debtor to keep possesion of the property. Previously a trustee was appointed immediately. The Senate bill would allow - but not require - a trustee for a private company. Moreover, filing for bankruptcy also triggers an automatic stay of foreclosure proceedings.
The result is that after filing, the owners often divert income earned by the property to their own use, the property deterioraties, and tax liens are created against it, according to Kulik. By the time a judge decides there is no hope of reorganization and orders liquidation - something the owners had counted on from the moment of filing - the interests of the secured real estate lenders (the banks holding title) have diminished.
The automatic stay has been used by sydicated partnerships - which orginally entered into the transaction for tax benefits - to recapture substantial amounts of accelerated depreciation taken earlier. Kulik urged that lenders be empowered to take physical possession of the property in the case where a limited partnership, formed for that property exclusively, declares bankruptcy. The Senate version calls for the automatic stay to be thrown out when the debtor has no equity in the property.
The method of determining a property's real value long has been disputed.At the depth of the 1974-75 recession, Pine Gate, a Georgia apartment complex financed through a limited partnership, went bankruptcy. The court ruled that the two lender banks had to accept the current market value of the property which, of course, was depressed. This precedent and the law as now written make it impossible for a secured creditor to recover the full debt even if the real estate market returns to normal, Kulik told the subcommittee. As a result of the Pine Gate ruling, the mortgage industry is encountering a large number of such bankruptcies, he said.