What Happens to Home Warranties if the Builder Files for Bankruptcy
It is typical in the home building industry that home builders provide their buyers with warranties for replacing or repairing defects or other components in the new residential units. However, with a rising number of home builders going into bankruptcy, a pressing issue is: what happens to these warranties if the builder subsequently files for bankruptcy?
General Unsecured Claims
Generally, claims by home buyers under these warranties are treated as pre-petition general unsecured claims in bankruptcy proceedings. Simply put, they are at the bottom of the acash waterfalla, since post-petition proceeds from assets sales and liquidation would go first to senior secured lenders and then vendors holding mechanics’ liens. Recovery on general unsecured claims is typically low (or near 0%), especially if the builder ended up in Chapter 7 liquidation.
Warranty Insurance Proceeds
There are larger home builders such as Dunmore Homes which provided buyers with warranties insured by its own captive insurance company as well as third party insurers. Recoveries on warranty claims are more viable in these cases, e.g., Dunmore Homes stated in its Disclosure Statement that claimants, albeit considered unsecured creditors in the classification of claims, would receive payment equal to the amount of warranty insurance proceeds received by its liquidation trustee.
Builder in Reorganization, Liquidation or Sale?
Another important question which home buyers should ask when monitoring the developments in a builder’s bankruptcy proceedings: is the builder likely to be reorganized and emerge from bankruptcy? Alternatively, is the builder going to be liquidated, or sold off to another company?
Why is this important?
One thing which bankrupt builders can do in bankruptcy proceedings is to file a court motion requesting permission to honor warranty claims and other pre-petition customer obligations. A typical motion of this kind would request court authorization for the matter, but providing flexibility for the builder by leaving it in aits sole discretiona.
From our review of 2007-8 cases, this motion is rarely filed by builders going into liquidation. These builders are usually focusing their attention on responding to banks and other lenders filing motions for relief from stay to pursue foreclosure.
