Bankruptcy Basics for Associations/Multiple Listing Services

The nation’s current economic troubles have forced REALTOR® associations and multiple listing services ("MLS") to address bankruptcy issues, with both association members and vendors filing for bankruptcy protection. The below Q&A will outline the basics of bankruptcy, and then address specific bankruptcy issues that a REALTOR® association may encounter.

What is “bankruptcy”?

The Constitution of the United States authorized the creation of the federal bankruptcy system. Bankruptcy allows debtors burdened by financial obligations to receive a fresh start. Bankruptcy courts follow a set of rules that determine how the bankruptcy proceeds, such as which debts can be discharged and which cannot (such as taxes and student loans), establishing an order for distributing the bankruptcy estate (secured lien holders have priority), and what assets of the debtor are exempt from the bankruptcy process and therefore cannot be used to satisfy the debtor’s obligations to creditors (the exemption guidelines vary by state).

All creditors of the debtor should receive notice of the bankruptcy and information from the court on how to file a claim. Once a claim is filed, the debtor will have the opportunity to oppose the validity of the claim. At the conclusion of the case, the court will usually discharge all of the debtor’s obligations that are eligible for discharge. A bankruptcy discharge is a permanent order prohibiting the creditor from taking any action to collect the discharged debt. There are also provisions in the bankruptcy code protecting the debtor from discrimination because of the bankruptcy filing, such as an employer using the bankruptcy filing against an employee.

For a more thorough discussion on bankruptcy basics, visit the United States Bankruptcy Courts’ website.

Aren’t there different bankruptcy filings available to debtors?

Most consumers file under Chapters 7 or 13. Chapter 7 is referred to as “liquidation”, where the debtor’s nonexempt assets are liquidated and distributed to creditors. To be eligible for Chapter 7 relief, the debtor’s monthly income must be at or below his or her state’s median income level; otherwise, only Chapter 13 relief will be available to the debtor. If the debtor has no non-exempt assets for the trustee to collect, a Chapter 7 case will most likely be closed shortly after the debtor receives his or her discharge, which is usually about four months after the case is filed. If the debtor has non-exempt assets for the trustee to collect, the length of the case will depend on how long it takes the trustee to collect the assets and perform his or her other duties in the case. Most consumer cases with assets last about six months, but some last considerably longer

Chapter 13 is referred to as an “adjustment of debts”, where the debtor’s debts are restructured into a payment plan. A debtor can usually keep valuable assets under Chapter 13. In a Chapter 13 case, the debtor must submit to the court a plan for the repayment of all or a portion of his or her debts. If the court approves the debtor’s plan, most creditors will be prohibited from collecting their claims from the debtor during the course of the case. The debtor must make regular payments to the chapter 13 trustee, who collects the money paid by the debtor and disburses it to creditors in the manner called for in the plan. Upon completion of the plan, the debtor is released from liability for the remainder of his or her dischargeable debts.

The basic difference between Chapter 7 and Chapter 13 is that under Chapter 7 the debtor’s non-exempt property (if any exists) is liquidated to pay as much as possible of the debtor’s debts, while in most Chapter 13 cases a portion of the debtor’s future income is used to pay as much of the debtor’s debts as is financially feasible. The debtor’s payment obligations under the Chapter 13 plan must remain in place for at least 3 years, unless the debts can be paid off in less time.

Chapter 11 is a “reorganization” option used by commercial enterprises and certain high net worth individuals to reorganize their debts. A Chapter 11 case resembles the proceedings in Chapter 13, as the debtor will reorganize and restructure its debts during the bankruptcy process, eventually filing a plan of reorganization. The debtor will act as a "debtor in possession" during the Chapter 11, with the debtor keeping possession and control of its assets. Creditors' committees can play a major role in Chapter 11 cases and are usually comprised of the largest debt holders in various classes. A Chapter 11 case can take as little as four months from the filing to confirmation of the reorganization plan, although many cases last much longer.

REALTOR® A has filed a request for arbitration with the association over a disputed commission with REALTOR® B. REALTOR® B said that he has filed a Chapter 7 bankruptcy. What should my association do?

The first step is to verify that REALTOR® B has indeed filed bankruptcy. Ask REALTOR® B for a case number or other correspondence from the bankruptcy court.

If REALTOR® B has filed for bankruptcy, then the “automatic stay” will prevent the association from proceeding with the arbitration. The automatic stay prevents any attempt to collect money from a debtor during the pendency of a bankruptcy, and it also prevents the commencement of any judicial or other proceedings against the debtor. All efforts to collect money from the debtor must immediately cease, and there are severe penalties for creditors who willfully fail to respect the automatic stay.

Arbitration clauses are enforced during bankruptcy proceedings, and so either REALTOR® A or the association could seek to have the bankruptcy court lift the automatic stay to allow the association to conduct the arbitration. Whether REALTOR® A would want to do that would depend on where the disputed commission is being held. If REALTOR® B is holding the commission, then even if REALTOR® A succeeds in arbitration, she will still only have an unsecured claim against the debtor's estate (and so collection of the commission would depend on whether the debtor's assets are sufficient to pay unsecured claims). However, if the money is in escrow, then the money is not part of the bankruptcy estate and REALTOR® A could possibly collect the commission amount if she succeeds in the arbitration.

Also, note that disciplinary charges cannot be filed against REALTOR® B over his failure to participate in an arbitration hearing because of his bankruptcy filing.

Another important issue to consider here and in all of the below scenarios is that debtors usually have 60 days from the filing of a bankruptcy to accept or reject all executory contracts. Both the association membership agreement and the MLS participation agreement are executory contracts. So, the association could also wait until the end of the 60 days to determine if REALTOR® B accepts or rejects the membership agreement. If REALTOR® B assumes the membership agreement during the bankruptcy, then REALTOR® B has not rejected the agreement and so is subject to the rules of the association like every other association member. REALTOR® B would be required to arbitrate the commission dispute with REALTOR® A if he assumes the membership agreement.

If REALTOR® B rejects either (or both) of the agreements, the association/MLS can terminate his association membership and/or MLS participation. If the association membership agreement is rejected, then REALTOR® A would likely be unable to pursue the arbitration proceeding if she did not seek to have the automatic stay lifted, as the commission dispute will likely be discharged during the Chapter 7 proceedings.

In addition to filing an arbitration request, REALTOR® A has also filed an ethics complaint against REALTOR® B and also alleged violations of the MLS rules. Can my association consider these allegations through the normal processes?

The automatic stay will prohibit the association from conducting hearings or considering the alleged rules violations. The association/MLS could seek to have the automatic stay lifted, allowing the association/MLS to conduct proceedings in accordance with its rules and procedures. If REALTOR® B assumes the association membership and/or MLS participation agreement, then he is obligated to participate in the proceedings and satisfy any discipline imposed upon him. If he rejects either agreement, he is no longer a member of the association or MLS.

REALTOR® B also has unpaid fines from prior Professional Standards hearings and previous MLS Rules violations. Are we prevented from collecting these fines from him?

The association and MLS can file claims with the bankruptcy court. The claims will be unsecured and will be paid in the same way all other unsecured creditors are paid in a Chapter 7, unless REALTOR® B assumes the association membership agreement and the MLS participation agreement. If REALTOR® B assumes either agreement (or both), he must become current with all contractual obligations and so will need to promptly pay all unpaid fines. If REALTOR® B fails to pay the unpaid fines or any later fines, his membership can be terminated without any consideration to his bankruptcy filing.

The association also recently sent REALTOR® B its dues billing statement and its quarterly MLS fee invoice. How will REALTOR® B’s bankruptcy affect his membership and ability to participate in the MLS?

The automatic stay will prohibit any attempt to collect the fees from REALTOR® B in the short term. However, if REALTOR® B assumes the membership and MLS participation agreements, then he must meet his payment obligations with the association and MLS. If he rejects either (or both) agreements, then he is no longer a member of the association or an MLS participant.

Also, there is language in Article V, section 2 of the model NAR bylaws which gives the association the ability to reject a membership application if the applicant has recently filed for bankruptcy, assuming certain criteria are met. The association can also convert a member who has filed for bankruptcy to a cash basis going forward.

What if REALTOR® B had filed under another section of the Bankruptcy Code?

The main issue under all sections of the Bankruptcy Code will remain whether or not REALTOR® B (or his brokerage, for Chapter 11) assumes either the membership agreement or MLS participation agreement. If he assumes the agreements, then he must comply with the obligations of membership. If he rejects the agreements, his membership/participation is terminated.

If a brokerage files for Chapter 13 bankruptcy protection, a debtor must assume or reject all executory contracts by the time it files its plan. A debtor usually files a plan within 1-3 months in a Chapter 13 case, so the timing for assumption or rejection of executory contracts in Chapter 13 won't vary much from a Chapter 7 case.

If a brokerage files for Chapter 11 protection, the time for accepting or rejecting executory contracts may last longer than 60 days. The debtor has 120 days within which to file its plan, and this time is often extended. An association can file a motion with the bankruptcy court seeking an order to compel the debtor to accept or reject the membership agreement and/or MLS participation agreement within a certain timeframe. In the motion, the association would argue that the harms resulting from the uncertainties over the debtor's bankruptcy require the need to set a timeframe for the debtor to assume the executory contract.

What if REALTOR® B is a salesperson and REALTOR® A seeks arbitration with REALTOR® B's broker?

In this scenario, the disputed commission is paid to REALTOR® B's broker ("Broker"). The Broker would then pay REALTOR® B his portion of the commission. Broker is also the party responsible for arbitrating the commission dispute with REALTOR® A. Therefore, REALTOR® B's bankruptcy would not affect the association's ability to arbitrate the dispute between Broker and REALTOR® A. If REALTOR® A prevails at the arbitration and the Broker has paid a portion of the commission to REALTOR® B, the Broker still must pay REALTOR® A the full amount of the award. The Broker would then need to file a claim in REALTOR® B's Chapter 7 bankruptcy to recover the amount of B's commission that it paid to A.

An arbitration panel awarded a commission to REALTOR® A.  Because the association had adopted Sections 53 (c-f), REALTOR® B was required within ten days to either pay REALTOR® A the amount of the award or deposit this amount with his association.  REALTOR® B failed to make either payment, and so the association suspended him indefinitely until he either paid the award or deposited the funds with the association.  Soon thereafter, the REALTOR® B filed for Chapter 7 bankruptcy.  The arbitration award was discharged during the bankruptcy proceedings.  Following the bankruptcy proceedings, REALTOR® B sought to rejoin the association.  Can the association reject his membership because of his indefinite suspension?

A debt’s discharge in bankruptcy is a permanent bar on any future attempt to collect this debt.  Therefore, the association cannot require REALTOR® B to pay the arbitration award amount in order to rejoin the association and so the member should be allowed to rejoin, absent special circumstances.  The special circumstance which could allow the association to consider REALTOR® B still suspended would be if the arbitration award was not listed as a debt during the bankruptcy proceedings, and neither the association or REALTOR® A received actual or constructive notice of the bankruptcy proceedings.  Absent those special circumstances, REALTOR® B should be allowed to rejoin the association. An association should work with its association counsel if it is considering not allowing the member to rejoin, as there are severe sanctions for violating the bankruptcy court’s discharge provisions.

What other bankruptcy issues could the association face?

Another bankruptcy issue that the association/MLS could face is the recoupment of “preferential payments” by the bankruptcy trustee. While it is unlikely that this would happen in an individual bankruptcy filing by a member due to the relatively small amount of money involved, an association could face this situation with a vendor who files for bankruptcy protection. An example of a “preferential payment” would be a payment from a vendor to an association for booth space at an association’s trade show.

A “preferential payment” is a payment made within 90 days of the bankruptcy filing. Once the payment is recovered by the trustee and placed into the debtor’s estate, the person who received the payment can then file a claim and will receive the same payment amount as all other creditors within that class. This section is designed to assure that all creditors are treated equally during the bankruptcy process. So, the association and/or MLS could receive a letter seeking to recover payments made by a vendor to the association within 90 days of the filing.

If the association receives a letter to seeking to recover money received from a vendor who made payments to the association, the association/MLS should consult with a bankruptcy attorney to determine how best to respond to the letter. The association will have two defenses available to it. First, it can raise the “ordinary course” defense, which is an argument that payments are not preferential if they are simply made in the ordinary course of the parties’ business. Another defense available to the association may be the “new value defense”, which provides for a dollar-for-dollar defense to the extent of any new value, in the form of goods of services, that the defendant provided to the debtor after the allegedly preferential payment was received, and for which the defendant was not paid.