Covet Thy Neighbor’s Apartment: Chapter 7 Bankruptcy Trustees selling rent-stabilized, rent-controlled and unsold units from co-op and condo conversio

As if the economy was not bringing enough bad news to debtors, recent developments in the Southern District of New York (which covers New York (Manhattan), Bronx, Westchester, Putnam, Rockland,Orange, Dutchess, and Sullivan counties) are making it more difficult to file for personal bankruptcy. A recent case, In re Goldman, Case No. 11-11371 (SHL), involved an attempt by a Bankruptcy Trustee to sell the rent stabilized co-op unit of a long-time resident at 420 Riverside Drive in the Morningside Heights neighborhood of Manhattan. The case was a Chapter 7 bankruptcy filing assigned to Judge Lane, who recently entered a consent order permitting the Bankruptcy Trustee to have the U.S. Marshals Service evict Mr. Goldman from his apartment, and then the rights to the lease on the co-op unit would be sold back to the landlord, who would pay the Bankruptcy Trustee $60,000 when the apartment was delivered free and clear of all tenancies, including that of Mr. Goldman, the rent-stabilized tenant.

In the way of background, this is the third decision permitting a rent-stabilized apartment to be sold by a Bankruptcy Trustee to a landlord in the Southern District of New York. The other two cases are In re Stein, 281 B.R. 845 (Bankr. S.D.N.Y. 2002) and In re Toledano, 299 B.R. 284 (Bankr. S.D.N.Y. 2003). In both of these cases, the debtors lived in luxury apartments just south of Central Park–171 West 57th Street, Apartment 3C and 230 Central Park South, Apartment 9/10B.

Many people will be surprised by these decisions, however the Bankruptcy Code and Rules seem to allow the result. Section 541 of the Bankruptcy Code states that when a debtor files for bankruptcy, a hypothetical estate is created, and all property of the debtor (with certain exemptions created by state and federal statute) is owned by the Bankruptcy Trustee. Section 365 of the Bankruptcy Code allows a debtor or a Bankruptcy Trustee to assume and assign (sell) a lease to a third party. Additionally, bankruptcy is federal law, and federal law generally primes (supersedes) state law. When you put this all together, the transaction looks as follows:

A Bankruptcy Trustee will review a bankruptcy petition and determine how many years the debtor has lived in the apartment, the rent that the debtor is presently paying under the rent-stabilized lease and the market value rent if the apartment was not rent-stabilized. The Bankruptcy Trustee will then contact the landlord or owner of the unit and offer to evict the tenant and deliver the apartment broom clean for a certain sum of money.

In the Goldman case, the landlord and the Bankruptcy Trustee entered into a stipulation that was “so ordered” by the Bankruptcy Court, which provided that the landlord would pay the Bankruptcy Trustee $60,000, which would be held in escrow until the Bankruptcy Trustee had the U.S. Marshals Service evict or remove the debtor from the apartment and delivered possession of the apartment to the landlord. The Bankruptcy Trustee receives a commission and legal fees are paid to the Bankruptcy Trustee’s counsel. The balance of the monies is distributed to the debtor’s unsecured creditors. While the result may seem harsh and surprising to many, three Bankruptcy Judges have ruled that these sales are allowed. None of these cases have been appealed to the Second Circuit Court of Appeals or the Supreme Court.

An individual who is contemplating filing for bankruptcy and lives in a rent-stabilized unit must go through the following analysis:

1. How many years has the debtor lived in the apartment?
2. What rent are they paying under the rent-stabilized lease and what is the market value rent if the apartment was vacant and not rent-stabilized?
3. Is the apartment in a gentrifying area or a high income area, such as the Upper East Side, Central Park West or Central Park South?
4. Has the apartment building recently undergone a condo or co-op conversion? And did the debtor decline to buy the unit, and therefore become a non-purchasing tenant?

There is one recourse for the debtor. The Bankruptcy Code allows the debtor to match the offer (in this case, $60,000) and pay that money to the Bankruptcy trustee to keep the apartment unit. Few individuals filing for bankruptcy have that type of money, however they may be able to borrow that money from friends or family to keep the unit. Additionally, if a husband and wife are married and only one elects to file for bankruptcy, or two people who are unmarried live in the apartment and both names are on the lease, since the Bankruptcy Trustee would only be able to assign the unit for the individual who filed for bankruptcy, the result may be that a landlord would be unwilling to pay a significant sum of money in that scenario, because the other party remaining in the unit would still be rent-stabilized. However, other than those two scenarios, this situation is a significant risk, and we are seeing more and more of these cases.

It would seem that either the New York State legislature or Congress needs to address this issue, and create some type of a safe harbor. Again, debtors in rent stabilized apartments must proceed with caution and consult an experienced bankruptcy attorney before filing for bankruptcy. Any individuals who are contemplating bankruptcy and live in rent-stabilized or rent-controlled apartments or unsold rental units in buildings that are being converted to condo or co-op ownership should feel free to contact Shenwick & Associates for an analysis of their situation.