Loan Modification during Chapter 13 Bankruptcy Cases
by Maria Tsagaris
McCalla Raymer, LLC - USFN Member (GA) (the following is
purely for educational purposes)
The real estate market is saturated with
homes individuals cannot afford, and foreclosure is a
doomsday most homeowners are desperately trying to avoid. As
a result, the number of post-BAPCPA (Bankruptcy Abuse
Prevention and Consumer Protection Act) bankruptcies is
dramatically increasing as borrowers attempt to stave off
foreclosures.
Currently, principal residence mortgages are
the only debt that cannot be modified in a Chapter 13
bankruptcy. 11 U.S.C. § 1322(b). The legislative history
behind the enactment of 11 U.S.C. § 1322(b) reveals a
response to the perception that lenders were performing a
valuable service through their loans by encouraging
homeownership and needed special protection against
modification of their loans. Grubbs v. Houston First
American Sav. Assn., 730 F.2d. 236 (1984).
As U.S. Supreme Court Justice Stevens stated
in his concurring opinion in the Nobelman case, the
“favorable treatment of residential mortgages was intended
to encourage the flow of capital into the home lending
market.”
Nobelman v. American Sav. Bank,
508 U.S. 324, 332 (1993). However, there is legislation
pending, such as the Foreclosure Prevention Act of 2008 S.
2636, that proposes an amendment to the Bankruptcy Code
allowing courts to modify mortgages on principal residences.
Due to the record numbers of homeowners
facing foreclosure, there is a groundswell of support by
politicians, consumer groups, and attorneys for a change to
the Bankruptcy Code. Consequently, lenders must take a more
proactive approach to loss mitigation programs in Chapter 13
cases. In some situations, lenders are limited by investor
guidelines and government-sponsored entities. However, if
all players in the industry do not establish ways to assist
debtors in Chapter 13 cases with loss mitigation options,
Congress may soon make this necessity a moot point.
In the majority of Chapter 13 cases, debtors
are seeking to keep their homes. Loss mitigation during a
debtor’s bankruptcy case can provide an opportunity for the
restructuring of the home mortgage. Loss mitigation is any
act or agreement between the lender and borrower intended to
resolve a default other than through an adverse foreclosure
by the lender. The most common types of loss mitigation
include: deed-in-lieu of foreclosure, short sale,
forbearance, and loan modification.
Loan modifications are the preferred
long-term solution for borrowers who cannot afford payments
under the original loan terms. A modification is the
lender’s or the investor’s agreement to adjust the terms of
a loan, such as the interest rate, and allow the borrower to
stay in the property under new terms. In 2007, out of the
37,000 workouts of Fannie Mae loans, 70 percent were loan
modifications, while 21 percent were forbearance plans. [Allnutt,
Jason; Testimony before the House Subcommittee on Housing
and Community, April 16, 2008,
http://www.fanniemae.com/media/pdf/allnutt_testimony_041608.pdf;jsessionid=GBQHoNND2A1DXJ2FECISFGA]
Even after a debtor files bankruptcy, he may
face the situation where an adjustable rate mortgage payment
resets and the change in monthly payments becomes more than
he can pay. In many cases, the traditional Chapter 13 plan
offering repayment of pre-petition arrearage over 3-5 years
no longer provides the long term relief that will allow a
debtor to achieve the much needed “fresh start.” It is
imperative that lenders look beyond the historical
hesitation of pursuing loss mitigation opportunities with
borrowers in bankruptcy.
The automatic stay arises upon a bankruptcy
filing and prevents creditors from any collection or
activity against a debtor, including any act to obtain
possession of the property of the estate (11 USC § 362(a)
(3)). Lenders often take the position that loss mitigation
is an alternative to the collection activity of foreclosure
and, therefore, once a bankruptcy is filed, the automatic
stay causes all loss mitigation efforts to cease. Lenders
are hesitant to discuss loss mitigation options with debtors
because of their fear of violating the automatic stay. In
the majority of cases, the lender pursues loss mitigation
outside of bankruptcy protection. If the debtor becomes
delinquent in post-petition payments, then the lender may
file a motion for relief from the automatic stay under 11
U.S.C. § 362 (a). After an order granting stay relief has
been entered and the borrower qualifies for loss mitigation,
the lender may then pursue a loan modification outside of
bankruptcy.
After a debtor files for bankruptcy, there
are several ways a debtor can learn about loss mitigation
opportunities, including, receiving a solicitation package
from the lender or its attorney, contacting the lender
directly for loss mitigation options, and in a growing
number of cases, the bringing together of the parties by the
bankruptcy judge or trustee. Many lenders solicit loss
mitigation at the filing of the case. However, it does
appear that another opportune time may exist at the time the
debtor becomes delinquent post-petition and a motion for
relief has been filed, or is imminent. At this point in the
case a debtor is eager for a last effort to save his home
and prevent foreclosure.
One benefit of a bankruptcy filing is that a
creditor can more readily learn about a debtor’s financial
condition. A debtor must file Schedules of Assets &
Liabilities and a Statement of Financial Affairs with the
court under penalties of perjury. This information can
further assist the lender in analyzing whether the debtor
qualifies for loss mitigation. Moreover, at the 341(a)
meeting of creditors, which generally takes place a month
after the petition filing, creditors have the opportunity to
question the debtor. To qualify for loss mitigation, the
debtor will generally have to provide some information about
the reason for the default and evidence of an ability to
meet future obligations with respect to the loan. Once the
debtor submits the lender’s required documentation, the
lender (or its attorney or agent) reviews the loss
mitigation package and notifies the debtor’s attorney about
the approval.
Debtors’ attorneys are concerned that once an
order granting stay relief is in place, the lender may not
necessarily pursue the loan modification and will proceed
with a foreclosure action instead. As a result, there is a
small growing trend by debtors’ attorneys to seek loan
modifications for their clients while keeping the automatic
stay in place. Once the loan modification is approved, the
lender may then have its counsel file a motion for relief
from the automatic stay under 11 U.S.C. § 362 (a) for the
limited purpose of the loan modification. The order
following the motion then needs to indicate: (1) the motion
was filed for the purpose of the loan modification; (2) the
loan modification terms; and (3) if a proof of claim was
filed regarding the secured debt, then the proof of claim
needs to be amended to correspond to the new loan
modification or be withdrawn if appropriate. This procedure
not only assists the debtor in obtaining the loan
modification he is seeking, but also ensures that the
automatic stay remains in effect during the remainder of the
bankruptcy case unless otherwise ordered.
Thus far, the sanctity of the note and home
mortgage instrument cannot be modified, altered, or
otherwise changed during a Chapter 13 bankruptcy case.
However, as mentioned, groups are advocating revision of the
Bankruptcy Code provision. It is imperative that lenders and
investors work with debtors to modify their loans during the
bankruptcy process. A loan modification during a Chapter 13
bankruptcy is beneficial to both the lender and the borrower
by allowing the debtor to keep his home and also provide the
lender with a stream of payments. Lenders should consult
with their counsel concerning the best loss mitigation
options available in a particular state.
© Copyright 2008 USFN and McCalla Raymer,
L.L.P. All rights reserved.
October e-Update
