Will bankruptcy filing by sellers affect my title after closing?

Full question:

I have a cash real estate closing for a home this Monday. I have heard that these sellers plan to file for bankruptcy shortly after we sign the closing documents (days) but before the papers are filed showing that their mortgage lien has been released by the lender. Will their filing for bankruptcy cloud our title?

• Category: Bankruptcy
• Date: 04/07/2025
• State: Florida

Answer:

If the sellers file for bankruptcy shortly after closing, it could potentially cloud your title. This situation raises a concern about a legal concept called "reasonably equivalent value." In some states, if a property is sold for less than its fair market value shortly before the seller files for bankruptcy, creditors may challenge the sale. For example, if a home worth three hundred thousand dollars is sold for two hundred fifty thousand dollars, creditors might argue that the fifty thousand dollars in equity should be part of the bankruptcy estate.

In bankruptcy, the trustee can review sales to ensure they are not fraudulent. If the sale is deemed to be a "fraudulent transfer," it could be voided. Therefore, it’s crucial to conduct thorough due diligence, including a title search, before the purchase.

Additionally, when a seller is in bankruptcy, the sale must typically receive approval from the bankruptcy court, especially if it falls outside the seller's ordinary business operations. To protect your interests, the purchase contract should require the seller to file for court approval immediately after closing.

To ensure the sale is free from creditors' claims, the court order should state that the sale is free and clear of all liens and encumbrances, and that you are a "good faith purchaser" under the Bankruptcy Code. This helps safeguard the validity of your purchase against any future challenges. It's advisable to work closely with your title company to ensure all necessary protections are in place for a clean title policy at closing.