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USFN 25th Anniversary

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Loan Modification during Chapter 13 Bankruptcy Cases

by Maria Tsagaris
McCalla Raymer, LLC - USFN Member (GA)

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,;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.

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