Written By: Alan S. Wolf Published in Autumn USFN Report 2007
The dictionary defines myth as “an unfounded or false notion or a thing having only an imaginary or unverifiable existence.” In the mortgage servicing world, and especially in regard to the servicing of loans involved in bankruptcy, there are a variety of myths that have developed in our industry. Instead of a proper analysis based on current law and fact, these myths are based on the premise that the practice must be correct “because it has always been done that way.” Here is a list of the top 10 bankruptcy myths, which is presented in true David Letterman format, from the lowest-rated to the highest-rated myth. Here they are:
10. In a Chapter 7 case, a No Asset Report grants relief from stay as to the estate.
In a Chapter 7 case, the stay automatically terminates as to the debtor when the debtor is discharged and as to the estate when the case is closed or when the property is abandoned by the estate (11 U.S.C. § 362(c)). Many servicers are under the mistaken belief that a mere No Asset Report (NAR) is an abandonment of property by the estate. Thus, armed with a discharge order and a NAR, the stay has completely terminated and they can proceed. That’s a myth. A NAR is NOT an abandonment by the trustee. Rather, it is merely a report indicating that the trustee believes there are no nonexempt assets to distribute to creditors. In order to abandon property, there must be a motion to abandon property filed under 11 U.S.C. § 554 and an order of abandonment. Fortunately, some NARs also contain an order providing that the estate is closed or that the stay has terminated as to the estate. However, where the NAR contains no such additional language, loan servicers may be unknowingly violating the stay by proceeding to foreclosure based on the discharge order and the NAR alone.
9. Sending a communication to debtor’s counsel instead of the debtor is protection from a stay violation.
Generally, any act that can be construed as an act against the interests of the debtor is a bankruptcy stay violation. Mortgage servicers are generally good at avoiding stay violations. However, a myth has developed in mortgage servicing that communications to debtor’s counsel, as opposed to the debtor, somehow protect a servicer from a stay violation. This notion is simply false. Debtor’s counsel is an agent of the debtor. And under agency laws, anything communicated to debtor’s counsel is like speaking to the debtor directly. Thus, anything that might be said to the debtor that is a stay violation is similarly a stay violation if said to debtor’s counsel. There is no free pass.
This is not to say that communications should be sent directly to the debtor. The Fair Debt Collection Practices Act requires communication with debtor’s counsel as opposed to directly with the debtor. But servicers need to be careful that the communication itself does not violate the stay even though it is sent to debtor’s counsel rather than directly to the debtor.
8. There can be no collection efforts or loss mitigation after a Chapter 7 discharge.
Many servicers stop all collection and loss mitigation efforts after a discharge based on a false belief that since the loan has been discharged it no longer exists. A Chapter 7 discharge means that the personal liability under the debt is gone. As a practical matter, that merely indicates that the mortgage lender cannot sue the borrower for a deficiency judgment. Otherwise, the loan is fully intact, even after the discharge, and collection action and loss mitigation can continue as long as those efforts make clear that there is no personal liability under the debt. Loan servicers are missing tremendous opportunities by not seeking loss mitigation after a Chapter 7 discharge.
7. When a judge has a certain view, that’s it; you’re stuck with the decision.
Loan servicers seem to believe that because a bankruptcy judge has a certain set view that is adverse to our industry, they’re stuck with it. That’s simply not the case. Our legal system recognizes that judges are not infallible, and thus there are appellate courts to review lower court decisions. Loan servicers seem reluctant to take advantage of the appellate process, and this unwillingness has caused tremendous damage. By failing to appeal adverse bankruptcy court decisions, we are faced with a hodgepodge of harmful rulings, creating tremendous complexity and enormous expense as we attempt to both service nationally and follow the nuances of individual judges. In short, wouldn’t it be better to have one consistent rule rather than hundreds of different ones? By appealing damaging rulings, at the very least uniformity is created, even if we lose. And by carefully choosing the cases that are appealed, those losses should be kept to a minimum.
6. When there is a local rule, or a preset Chapter 13 plan, you’re stuck with it as well.
As a corollary to the prior myth, there is also a false belief that local court rules, which are often accompanied by preset Chapter 13 plans, are the law of the land, cast in concrete and unavoidable. Wrong! Local procedures are merely a court’s interpretation of what the Bankruptcy Code allows — they hold no greater weight than any other interpretation. Put another way, the Bankruptcy Code trumps all local rules, all local plans, all local everything. Accordingly, if there is a local court rule, or a preset Chapter 13 plan, that is adverse to the position of our industry (e.g., a local court rule saying that the loan is deemed current upon Chapter 13 discharge) a determination based on that local rule can and should be appealed.
5. In the standard Fannie/Freddie loan documents, a mortgage lender is not entitled to the recovery of interest on pre-petition arrears paid through a Chapter 13 plan.
Many years ago, a U.S. Supreme Court case provided that lenders were entitled to interest on the pre-petition arrearage paid through Chapter 13 plans. For example, if the arrears were $10,000 on the date of bankruptcy filing, the lender would receive that amount plus additional interest (often paid at 10 percent or more) over the three- to five-year term of the plan. The additional interest paid through such Chapter 13 plans was not only significant, in many cases it exceeded all the other servicing income combined.
Congress changed the law in 1994 by adding Bankruptcy Code § 1322(e), which provides that for loans executed after October 22, 1994, a mortgage lender is not entitled to interest on pre-petition arrearage unless allowed under the loan documents and state law. Since the standard Fannie/Freddie documents do not provide for interest on interest, the loan servicing industry has concluded that it is not entitled to interest on pre-petition arrears. That belief is a partial myth; while mortgage lenders using the standard Fannie/Freddie documents are not entitled to the interest on the interest component of pre-petition arrearage, they are still permitted interest on all advances. This is because the standard Fannie/Freddie documents uniformly provide for interest on advances. Pre-petition advances can be significant. The failure of mortgage servicers to claim interest on pre-petition advances is a loss of substantial income.
4. When a loan is current, you don’t need to take part in the bankruptcy case.
Many servicers believe that when a loan is current, they need not participate in the bankruptcy case. This can be a serious mistake. Despite a loan being current, the property is still property of the estate, and a bankruptcy plan can adversely affect your rights. For example, even if a loan is current, a Chapter 13 or Chapter 11 plan can modify your rights through a strip-down or other modification. The bottom line is that you need to protect your rights in the bankruptcy case, even if the loan is current.
3. When the stay is terminated on a particular property, the property is no longer subject to the bankruptcy.
Most servicers believe that when the stay terminates, they are free of the bankruptcy. That’s a myth because even with termination of the stay, the property is still property of the estate. Therefore, despite termination of the stay, a plan can modify the rights under the mortgage contract, there can still be a sale free and clear of liens, and, generally, the bankruptcy court continues to have jurisdiction over the property. It is only after (1) the estate abandons its rights in the property, (2) the case is closed, or (3) the property is sold (e.g., through voluntary sale or foreclosure) that the property ceases to be property of the estate and is no longer subject to the bankruptcy.
2. There is a discharge of mortgage debt at the end of a standard Chapter 13 case.
Most mortgage servicers believe that a Chapter 13 discharge is like a Chapter 7 discharge in that the personal liability under the mortgage debt is discharged. In fact, long-term mortgage debt is not discharged in the typical Chapter 13 case. Bankruptcy Code § 1328(a) specifically precludes from discharge long-term mortgage debt. Thus, in the typical case, a Chapter 13 discharge has no effect on mortgage debt.
1. You must file your bankruptcy proof of claim immediately.
Many servicers are under the mistaken belief that a bankruptcy proof of claim must be filed immediately. Most have a requirement that the proof of claim be filed within one week of the time that the bankruptcy referral is made to the attorney. There is no legal justification for this position, and the practice can lead to problems where, in the rush, the proof of claim contains errors. Bankruptcy Rule 3002 provides that the proof of claim must be filed within 90 daysafter the first meeting of creditors (which generally occurs 30 days into the case). Thus, the industry’s dash to file is based on a false deadline. In addition, case law and the new bankruptcy legislation provide substantial penalties for errors in a proof of claim. Servicers need to take their time in filing proofs of claim and get it right.
Conclusion
Just because a lot of people believe something to be true, doesn’t mean that it is. Keep this in mind the next time you hear about a business strategy, tip, or procedure that “everyone” seems to be following. In the meantime, be aware of the nuances in each of these 10 myths from the realm of bankruptcy. Doing so should help to save time and avoid future headaches that — unlike myths — can be all too real.