Understanding Loss Mitigation

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Understanding Loss Mitigation and Bankruptcy

by Glen D. Rubin, McCurdy & Candler, L.L.C.

I. WHAT IS LOSS MITIGATION?

Any act and/or agreement between the lender and borrower conducted to resolve a default other than through an adverse foreclosure by the lender.

1. General Types of Loss Mitigation/Workouts and Concerns
   1. Deed in Lieu of Foreclosure. Borrower deeds the property to the lender in satisfaction of the secured debt.
      1. Deed-in-Lieu process should be faster than a foreclosure action.
      2. Property should have been listed for sale at market value for brief period of time before choosing this alternative.
      3. Title search should be conducted to assure that there are no junior liens, judgments, federal tax liens, etc.
      4. Property inspection should be performed.
      5. Obtain prior approval from investor/mortgage insurer, if required.
      6. Determination that pursuit of deficiency will not be practical.
      7. Be sure to deal with issue of intervening or “gap period” liens.
   2. Short Sale/Pre-Sale. Borrower sells property to third party and lender accepts less than the full amount owing on the secured debt as complete satisfaction.
      1. a. Determine appropriate marketing period for property.
      2. b. Verification as to other liens that may exist.
      3. c. Assure proper maintenance of property until it is sold.
      4. d. Review the offer with a qualified real estate professional.
      5. e. Obtain investor/insurer approval.
   3. Forbearance/Repayment Plan. Lender postpones exercise of foreclosure remedy while leaving the delinquency status of the loan unchanged or offering a repayment option on curing the delinquency.
      1. Verify borrower’s reduction in income or financial hardship.
      2. Establish whether property should be marketed.
      3. Assess borrower’s ability to repay and establish parameters of repayment plan.
   4. Loan Modification/Refinance. Lender and borrower agree on a formal loan extension, renewal or material change in loan agreement (i.e., interest rate, frequency and amount of installment and maturity date).
      1. Assess or verify borrower’s financial ability.
      2. Reach agreement with the Borrower on modification terms.
      3. Subordination agreements may be necessary in many states if there are junior liens.
      4. Make assurances that all proper taxes are paid prior to recording modification or you may not be able to foreclose under state law.
2. Why Emphasize Loss Mitigation?
   1. Allows borrowers an opportunity to stay in their homes, eliminates the estimated average loss per REO property of $25,000.00, and reduces the legal expenses associated with lengthy bankruptcy/foreclosure proceedings.
      
3. Why Attempt Loss Mitigation In Bankruptcy?
4. There are several outstanding aspects of bankruptcy proceedings that make them suitable for loss mitigation. The caveat, however, is that many of those positive aspects also create hurdles for the lender. An experienced bankruptcy professional can help you navigate through the process and complete loss mitigation.
   
1. The Borrower in Bankruptcy is Always a Better Loss Mitigation Candidate.
   1. The “automatic stay” becomes your own weapon if solicitation is carefully made because you have the borrower’s attention.
   2. Unsecured debt is discharged.
   3. Other liens on real property may be avoided if exemptions are impaired.
   4. Burdensome contracts and leases can be rejected.
   5. Certain pre-bankruptcy transfers can be undone.
2. Financial Information Regarding the Borrower is More Readily Obtainable in Bankruptcy.
   1. Borrower submits Schedules of Assets & Liabilities and Statement of Financial Affairs under penalties of perjury.
   2. Borrower submits to an examination conducted by the Trustee (341 Meeting).
   3. Detailed investigation of Borrower’s finances available to any creditor (Rule 2004 Examination).
3. The Court, Trustee, and Bankruptcy Laws Have the Effect of Controlling the Borrower.
   1. The Borrower is generally prohibited from any extraordinary financial activity without prior Court approval.
4. Bankruptcy is Not an Effective Loss Mitigation Alternative.
   1. Bankruptcy is costly to a lender as a result of payment delays, attorneys’ fees and overall higher servicing costs.
   2. Bankruptcy laws leave a lender in a reduced bargaining position and generally lack the creativity and flexibility of the loss mitigation alternatives.
   3. Bankruptcy Courts tend to be overly pro-borrower when interpreting the bankruptcy law, which itself is designed to be pro-borrower.
   4. Bankruptcy repayment plans don’t work (less than 20% of all repayment plans are successfully completed).

II. CHAPTER 7

1. General Overview.
   1. A liquidation proceeding where the debtor’s non-exempt assets are liquidated and he/she obtains a discharge of personal liability on the loan and obtains a “fresh start.”
2. Utilizing Bankruptcy Statements and Schedules.
   1. Determine the Debtor’s intentions to retain or surrender property (Statement of Intention).
   2. Determine Debtor’s valuation of property (Schedule A).
   3. Determine junior liens/other secured or unsecured debts (Schedule D & E).
   4. Review Debtor’s budget to determine feasibility (Schedules I & J).
3. Types of Loss Mitigation Techniques.
   1. If Borrower Wishes to Surrender.
      1. Deed-in-Lieu of Foreclosure
         1. Obtain consensual relief from the automatic stay.
         2. Be certain that Trustee has abandoned interest in the Property.
         3. Be certain that it will not be faster to foreclose.
         4. Determine if borrower has made attempts to market the property.
      2. Short Sale or Pre-Sale
         1. Obtain Consensual Relief from the Automatic Stay.
         2. Determine value of the property.
         3. Review Borrower’s attempts to market the property
         4. Check for other liens on property.
   2. If Borrower Wishes to Retain.
      1. Reaffirmation Agreement pursuant to 11 U.S.C. § 524(c) waives the Debtor’s right to discharge personal liability for the debt.
         1. Reaffirmation may or may not be required depending on jurisdiction.
         2. Is it worth preserving your deficiency rights?
         3. Agreement must be voluntary and comply with 11 U.S.C. 524(c).
         4. Debtor does not have to be current. Reaffirmation agreement can contain repayment plan provisions.
         5. File Motion to Lift Stay and enter into Consent Order where lender gets relief but agrees not to foreclose for a certain period of time while loss mitigation is pursued.
4. Protecting Your Rights When Workout is not Obtainable.
   1. File Motion to Lift the Stay.
      1. Time is of the essence.
      2. Generally will be granted if there is a delinquency on the loan and the Trustee has no objection.
   2. Property may be released automatically after discharge coupled with Trustee abandonment.
   3. Object to the Debtor’s Discharge or Dischargeability of the Debt.
      1. Must be filed prior to established deadline.
      2. Usually must prove fraudulent acts of Debtor.
   4. Collect from Co-Obligor.
      1. No Co-Debtor automatic stay in Chapter 7.

III. CHAPTER 13

1. General Overview.
2. A consumer reorganization process where Debtor contributes all his/her disposable income into a repayment plan which is filed at the outset of the case and must be approved by the Court. Currently available to consumers with up to approximately $1,200,000.00 in debt. The Plan generally pays a lender’s pre-petition arrearage claim over a “reasonable” period of time (60 months) while maintain ongoing payments. In rare cases, the plan may alter the terms of the loan over a lender’s objection (“cramdown”).
   1. Debtor files a petition and repayment plan in an attempt to reorganize affairs over a period of 60 months.
   2. A confirmed Plan will prevent collection efforts unless there is non-compliance and the Court grants relief from stay or the case is dismissed.
   3. Upon release, the loan reverts back to contractual terms for collection.
   4. A successfully completed Plan generally will not result in a discharge of the mortgage debt unless the entire debt was satisfied under the Plan (i.e. total debt, cramdowns). However, a lender may be barred from collecting any charges that existed prior to the bankruptcy filing if the Debtor adequately dealt with the claim through the Plan.
   5. Plan may not modify mortgage terms (i.e. payoff, interest rate etc.) if loan is secured by property that is Debtor’s principal residence. Caution: Courts now allow modification of loans if there is no equity and it can be shown that the loan is wholly unsecured whether it is secured by the principal residence or not.
3. Utilizing Bankruptcy Documents.
   1. The Chapter 13 Plan - Review terms with counsel to assess feasibility and analyze delays and losses. While the overwhelming majority of debtors file Chapter 13 cases to retain their home, it is possible to see a Plan which surrenders the property.
   2. Determine Debtor’s value of property (Schedule A).
   3. Check for junior liens/other debts (Schedules D & E).
   4. Review Debtor’s budget (Schedules I & J). Keep in mind many Debtor’s underestimate expenses so that they can show enough disposable income to make their plan’s work on paper.
4. Types of Loss Mitigation Techniques.
   1. Borrower Wishes to Retain.
      1. Lender by agreement formally modifies the loan in exchange for requested relief (i.e., case dismissal, modification order, stay relief, § 109(g) provisions).
         1. Get a modification and bankruptcy release all in one.
         2. Get relief from stay for the express purpose of modifying the loan.
      2. Monitor Borrower’s bankruptcy plan which is usually tantamount to a 60 repayment agreement
   2. Borrower Wishes to Surrender.
1. Short Sale - Debtor motions Court pursuant to 11 U.S.C. § 363 to sell property free and clear of all liens in full satisfaction of debt.
2. Deed in Lieu – Obtain relief from the automatic stay for the expressly for the purpose of entering into a Deed in Lieu of foreclosure. Terms of the Deed in Lieu should be approved by the Court under 11 U.S.C. § 363.
   
5. Protecting Your Rights When Workout not Obtainable
   1. Object to Confirmation.
      1. Failure to make post-petition payments.
      2. Plan not proposed in good faith. Multiple Chapter 13 filings.
      3. Plan not feasible.
      4. Plan fails to provide for cure within a reasonable time.
      5. Plan exceeds 60 months.
   2. File Motion for Relief from the Stay.
      1. Monitor compliance with the Plan. Should Debtor fall 2 payments or more in arrears it is appropriate to seek relief.
      2. Use prospective relief (prohibits imposition of stay in all future cases by that Debtor) or in rem relief (prohibits imposition of stay in all future cases involving property) when appropriate and available in cases involving multiple filers, bad faith or abuse.
   3. Move to Dismiss Case with Prejudice under 11 U.S.C. § 109(g). Generally must prove “bad faith,” failure to abide by Court Orders, or failure to properly prosecute case.

IV. CHAPTER 11

1. General Overview
   1. A reorganization proceeding geared toward businesses but available for individuals, especially those who exceed the debt limitations of Chapter 13. Unlike Chapter 13 the reorganization plan is not filed at the outset of a case and therefore Debtor’s are not compelled to continue monthly payments or cure their arrearage upon filing.
   2. The Plan may not modify the terms of a loan secured by the Debtor’s principal residence, similar to Chapter 13.
   3. The Plan, once confirmed, becomes a binding and permanent modification of the loan terms (in effect a “formal” loan modification.
   4. For the Plan to be confirmed, it must:
      1. Meet all disclosure and voting requirements.
      2. Meet all requirements for confirmation set forth by the Code. As a secured Creditor, you not only have the right to file an Objection to Confirmation, but also to vote against the Chapter 11 Plan.
   5. The filing of the petition effectuates an automatic stay. All collection efforts must cease. Confirmation of a Plan constitutes a release from bankruptcy, but you must adhere to the terms of the confirmed plan.
   6. Since the Debtor often does not make post petition contractual payments until ordered by the Court, it is advisable to analyze whether to file a Motion for Relief from the Automatic Stay at the very outset of the case with your counsel. Courts will be particularly concerned with whether or not there is equity in the property. If there is little or no equity in the property, the Court may order the Debtor to begin making adequate protection payments to the lender.
2. Types of Loss Mitigation Techniques and Strategies.
1. Attend Meeting of Creditors. Since you have no way of gauging the Debtor’s intentions with respect to the property give serious thought to attending the meeting of creditors (341 Meeting) which will be scheduled within the first 45 days of the case. This may be the best opportunity to question the Debtor under oath to assess reorganization prospects, feasibility and workout strategies.
2. Loss Mitigation Alternatives.
   1. Chapter 11 cases tend to run longer and cost more for a lender to service than Chapter 13 cases because the process is more complex and less certain.
   2. Loss Mitigation alternatives mirror those of Chapter 13 but should be favored because of the heightened delays and costs associated with Chapter 11 cases.
   3. Attorneys for both the Debtor and Creditor can mutually agree on workout terms then seek approval of the compromise or modification by the Court, or wait and seek to have the terms of the modification incorporated into Debtor’s Plan.
   4. A Motion for Approval of Modification. Creditors are given an opportunity to object. If no objections are filed, the Court will generally approve the modification. The modified payments may begin once the modification is approved by the Court. Here it would be advisable to have the Debtor executed loan modification documentation.
   5. Modification Through Plan Confirmation. The exact terms of the loan modification are incorporated into the Debtor’s Chapter 11 Plan which is confirmed by the Court. Although the terms of the Plan are binding, you may also consider having loan modification documents executed for ease of recordkeeping.
3. Short Sale/Pre-Sale.
   1. Many Chapter 11 Plans are actually liquidating plans.
   2. Debtor motions Court under 11 U.S.C. §363 to sell property free and clear of liens in full satisfaction of the debt. Sale terms may also be incorporated into the Plan of Reorganization in a similar manner to a loan modification.
3. C. Protecting Your Rights when Workout not Obtainable.
   1. Move for Relief from the Automatic Stay.
      1. Generally must prove that there is no equity in property and that it is not necessary for the Debtor’s reorganization (i.e. there is no reorganization in prospect).
      2. Once relief is granted, you may approach Debtor about Deed-in-Lieu or Modification.
   2. File Motion to Dismiss Case. Generally must prove “bad faith” or that the Debtor has no prospects to reorganize.
   3. File Motion to Convert Case to Chapter 7. Generally is granted if there is equity in assets that will benefit unsecured Creditors.
   4. File Motion to Appoint a Chapter 11 Trustee. Generally is granted if there is fraud by the Debtor or gross mismanagement.
   5. Vote and/or Object to Disclosure Statement or Plan.
      1. It is imperative that a Creditor participates in the Confirmation process because once a Plan is confirmed it constitutes a “new contract” to which all parties are bound.
      2. Voting alone will not be sufficient. A written objection must be filed.
   6. File a Completing Plan. This can be done after the expiration of the Debtor’s “exclusive period” to file a plan (generally first 120 days of the case). Since the confirmation process is both costly and lengthy, this alternative should only be considered if the lender has a significant investment at stake.
   7. Collect from Co-Obligor