Part IV: Modifications Post-Discharge
Welcome to Part IV of our series on servicing discharged mortgage debt. This part will discuss modifying a borrower’s loan post-discharge. (If you missed Part I, Part II or Part III, go ahead and catch up.) Part III discussed the legal ambiguity surrounding loan modifications when the borrower discharges personal liability in bankruptcy. However, as a practical matter, regulators, investors, and many bankruptcy courts expect lenders and servicers to evaluate borrowers for possible loan modifications post-discharge (whether such an expectation violates the Contracts Clause is a question for the academics among us). Notwithstanding this expectation, lenders and servicers should proceed with caution when processing post-discharge requests for loss mitigation assistance, as courts are unlikely to accept widespread industry practice as a defense to discharge injunction violations. Set forth below are some items to consider regarding loss mitigation practices for discharged borrowers.
1. Templates exist for a reason, but consider whether adjustments would mitigate risk.
Investors often provide templates or required language to document loan modification agreements. Some specifically may include language to reflect a bankruptcy discharge. For example, the FNMA loan modification agreement (Form 3179) provides:
Notwithstanding anything to the contrary contained in this Agreement, Borrower and Lender acknowledge the effect of a discharge in bankruptcy that has been granted to Borrower prior to the execution of this Agreement and that Lender may not pursue Borrower for personal liability. However, Borrower acknowledges that Lender retains certain rights, including but not limited to the right to foreclose its lien evidenced by the Security Instrument under appropriate circumstances. The parties agree that the consideration for this Agreement is Lender’s forbearance from presently exercising its rights and pursuing its remedies under the Security Instrument as a result of Borrower’s default thereunder. Nothing in this Agreement shall be construed to be an attempt to collect against Borrower personally or an attempt to revive personal liability.
If templates do not include similar disclaimers, servicers should strongly consider discussing and seeking approval from the investor to incorporate such disclaimers in their forms. Alternatively, servicers could consider sending separate correspondence to the borrower confirming that personal liability has been extinguished by the bankruptcy discharge and perhaps including some acknowledgement to that effect to be signed by both parties.
2. Evaluate treatment of borrowers who have surrendered.
Courts generally view a borrower’s intent to surrender the property — via statement of intention or confirmed plan — as evidence that the borrower no longer wants to continue the relationship with the servicer or stay in the property. To mitigate risk, it may be advisable to avoid soliciting and entering into loan modifications following a borrower’s stated intent to surrender the property. However, such broad prohibitions are likely impractical. Many “surrender” discharged borrowers continue to make voluntary payments and may even seek loan modifications. Additionally, some states — such as California and Nevada — have pre-foreclosure requirements that may include loss mitigation solicitation.
Servicers should develop robust procedures regarding solicitation of discharged borrowers for loss mitigation to avoid borrowers who have surrendered. Within these procedures, servicers should carefully consider and outline their process for credit pulls – even soft credit pulls – for borrowers who have indicated an intent to surrender. In the event such borrowers initiate and request loss mitigation, carefully tailored communications are critical to minimize the risk of violating the discharge injunction. Servicers should consider drafting and reviewing these communications on a one-off basis, rather than relying on forms, to ensure all of the borrower’s circumstances are considered. Personalized, individual analysis decreases the likelihood of borrower complaints or litigation for post-discharge conduct relating to modification outreach.
3. Beware of court-specific loss mitigation requirements.
Among the nearly 100 bankruptcy courts across the country, approximately two dozen courts or individual bankruptcy judges have adopted local rules, entered administrative orders or published formal guidelines permitting debtors and creditors to engage in loss-mitigation negotiations under court supervision. These bankruptcy loss-mitigation programs share some common traits, such as the entry of an order setting deadlines and establishing certain ground rules for the loss-mitigation process. However, many variations exist, including the use of an electronic portal for all communications related to the loss-mitigation process and the appointment of a mediator. While many post-discharge loss mitigation efforts occur after a bankruptcy case has closed, it is important for servicers to stay apprised of all local court requirements related to loan modifications.
4. Conduct specialized training for customer-facing employees.
To mitigate risk, it is critical that lenders and servicers develop and conduct cross-department training to educate employees on the complexity and risks of solicitation and loan modifications for discharged borrowers. Key concepts can also be memorialized in FAQ or talking points, particularly for employees handling calls or customer complaints.
We hope that you have enjoyed our series on servicing discharged debt and gleaned helpful information to better assess decisions on servicing of these accounts. If you have any suggestions for further posts or series on servicing bankruptcy accounts, please let us know.