USFN Report: Complexities of Loss Mitigation & Bankruptcy

By Phyllis A. Ulrich, Esq.
Carlisle Law*
USFN Member (OH, IN, KY)

As published in the Spring 2024 USFN Report

Navigating Loss Mitigation and Loan Modifications in Bankruptcy Cases

Individuals may use the bankruptcy process to address overwhelming debt. However, the bankruptcy process is complex. Debtors filing for bankruptcy face a myriad of challenges. One critical concern for debtors often is the preservation of their assets — particularly their homes. Loss mitigation by creditors play pivotal roles in helping debtors retain their homes while navigating bankruptcy proceedings.  

Loss mitigation refers to strategies employed by creditors and debtors to minimize financial losses associated with delinquent loans. It encompasses various options aimed at preventing foreclosure and preserving homeowner rights. Common loss mitigation techniques include: (a) loan modifications, (b) forbearance agreements, (c) short sales, and (d) deed-in-lieu-of-foreclosure arrangements. In this article, I delve into the intricacies of the loss mitigation practice of loan modifications within the context of bankruptcy cases. 

A loan modification is a contractual agreement between a borrower and a lender that alters the terms of an existing mortgage to make it more manageable for the borrower. In bankruptcy cases, loan modifications are powerful tools for debtors seeking to restructure their debts to avoid foreclosure.

In Chapter 13 bankruptcy, debtors propose debt repayment plans to the court, typically spanning three to five years. Debtors can include mortgage arrears in the debt repayment plan to resolve a pre-petition default in payments.  They can also seek to negotiate modifications of their mortgage loans with their lenders, thereby potentially lowering monthly mortgage payments, extending the loan term, or even reducing the principal balance owed.

Bankruptcy courts often impose specific requirements for loss mitigation efforts, particularly in Chapter 13 cases. Debtors must provide accurate financial disclosures. Also, debtors and creditors are typically required to engage in good faith negotiations. Moreover, some bankruptcy jurisdictions mandate mediation or settlement conferences to facilitate communication between debtors and creditors regarding loss mitigation options.

A Chapter 7 bankruptcy, also known as liquidation bankruptcy, involves the sale of nonexempt assets to repay creditors. While Chapter 7 of the Bankruptcy Code does not address loan modifications, debtors may still pursue loss mitigation options outside of bankruptcy court. For instance, debtors can negotiate loan modifications with their lenders or explore loss mitigation programs offered by government agencies. Some creditors obtain orders granting relief from stay that include language allowing the pursuit of loss mitigation in Chapter 7 cases, which ensure there is no violation of the Chapter 7 discharge injunction.

The U.S. Department of Housing and Urban Development (“HUD”) offers another type of loss mitigation – the HUD partial claim – for loans which are insured by the Federal Housing Administration, which is an agency of HUD. The HUD partial claim is effectively an interest-free loan from HUD to satisfy past due payments. In sum, HUD advances funds on behalf of the borrower to bring the mortgage current. This creates a “partial claim” lien on the property. The borrower then signs a promissory note in the amount of the partial claim, and HUD places a second lien on the property to secure the repayment of the promissory note. The borrower must repay this amount, when they sell the home, pay off the original mortgage, or within a shorter, specified, timeframe. 

The treatment of HUD partial claim mortgages in the bankruptcy process can vary, depending on the specific circumstances of the bankruptcy case and the applicable bankruptcy laws. In a Chapter 13 bankruptcy, for example, the borrower may be able to include the balance of a HUD partial claim in their repayment plan, allowing them to pay it over the course of the bankruptcy. However, this is atypical, since the HUD partial claim does not usually mature until after the repayment plan is scheduled to be completed. It is important to note that partial claim mortgages offered to debtors in Chapter 13 bankruptcy require bankruptcy court approval, much the same as loan modifications. On the other hand, in a Chapter 7 bankruptcy, the treatment of the HUD partial claim may be different, because the borrower may not be able to discharge the debt associated with the HUD partial claim.

State of Loss Mitigation in Bankruptcy

What is the current state of loss mitigation in bankruptcy cases? I surveyed the members of USFN’s Bankruptcy Section to identify nuances among bankruptcy courts around the country and their treatment of loss mitigation. Though it was more anecdotal than scientific (it would be impossible to cover all bankruptcy court jurisdictions in a single article), the following represent some of the nuances identified.

According to Christopher P. Kennedy of Carlisle Law, the Southern District of Ohio, which is a Carlisle Law jurisdiction, has a specific secure online portal to facilitate its Mortgage Modification Mediation Program (“MMM”). The MMM can be triggered by the debtor filing a motion to enter the portal for loss mitigation purposes. Such portals ensure security for any personal identifying information as the exchange of documents and communication between the parties is conducted through the portal. Unless and until the parties agree to a loan modification, little appears on the court’s public docket during the loss mitigation application and negotiation process. If the parties agree to a loan modification, the parties file a motion with the court to approve the loan modification. 

My survey found that many other bankruptcy courts utilize the MMM or a program much like the MMM. Brooke Sanchez of McPhail Sanchez, LLC, stated that the Northern District of Florida uses this program. Arizona, Nevada, and the Middle and Southern Districts of Florida, and Southern, Eastern and Middle Districts of New York also have MMM programs, according to Greg P. Campbell of Aldridge Pite, LLP. Renee M. Parker of The Mortgage Law Firm confirmed the Central District of California has a type of MMM program, which she helped revamp. Kennedy of Carlisle Law indicated the Western District of Pennsylvania has a program like that of the Southern District of Ohio.

The Northern District of Illinois and Eastern and Western District of Wisconsin each also use a program called the “DDM Loss Mitigation/Stretto” portal to handle loss mitigation, according to Peter Bastianen of Codilis & Associates PC. Bastianen mentioned other jurisdictions with similar programs, and he commented, “I get the sense that these programs are not used often because, like loss mitigation processes in general in a non-bankruptcy context, they require a lot of documentation and updating when documents get stale, and the debtor’s bar does not want to get involved because it creates a lot of work.” His sentiment rang true among the other attorneys I polled.

Leah Freedman of the BWW Law Group, LLC, indicated that D.C. added its Mortgage Modification Program (“MMP”) in 2023. Mark Meyer of Rosenberg and Associates, LLC, noted that because D.C. has a low volume of bankruptcy cases, to date, no debtors have elected to take part in the D.C. MMP program. Freedman asked Bankruptcy Judge Elizabeth Gunn, who sits on the bench in the District of D.C., for her thoughts on the MMP. Judge Gunn commented that the MMPs are only as successful as the parties that use them.

“Our Court added a program at the end of the COVID pandemic in order to prepare for the fallout, but even now in 2024, there are still some HAMP funds available, property values are high (allowing for refinances), and foreclosure proceedings are backlogged in the state Court. Thus, despite passing the program in 2021, I’ve only had a few participants,” said Judge Gunn. ”I still believe it can be a very valuable and useful tool in the toolbox for debtors and their attorneys, but one that has only been appropriate in a few cases. I hope that as we move further towards a more ‘normal’ situation, more parties will find it to be a useful tool and take advantage.”

Richard Mulligan and Randall McHugh of Brock and Scott, PLLC, commented on the District of Rhode Island, which last overhauled its loss mitigation program in 2017. That program can be triggered with the debtor checking a box located on the local form Chapter 13 Plan, or by the debtor requesting loss mitigation in response to the filing of a motion for relief from stay by the creditor.

The mortgage modification mediation program trend is still catching on. Lance Olsen of McCarthy Holthus, LLP, says Northwest states, such as Oregon and Washington, do not have loss mitigation programs because those states have pre-foreclosure programs available to debtors. This is true in the Northern District of Ohio, which is one of the Carlisle Law jurisdictions. Brooke Sanchez indicated Alabama, Mississippi, and Tennessee do not have MMM programs. 

Challenges in Bankruptcy

Despite the benefits of loss mitigation and loan modifications, challenges may arise during bankruptcy proceedings. Lenders may be reluctant to approve loan modifications, especially if the debtor’s financial situation remains precarious. Additionally, navigating the complex legal framework surrounding loss mitigation in bankruptcy requires competent legal counsel and thorough documentation. Further, bankruptcy courts must approve any loan modification or HUD partial claim that occurs post-filing. Having competent counsel ensures the creditor will receive that court approval. With some exceptions, bankruptcy courts are averse to approving loan modifications and partial claim mortgages that have already been entered into between the debtor and creditor post-filing. Seeking approval before the agreement becomes effective is usually essential. 

Loan Modification Volume in Bankruptcy

What about loan modification volume in bankruptcy cases? Has there been an increase? Most of the Bankruptcy Section members polled mentioned no noticeable increase in the number of loan modifications. But Marcy J. Ford of Trott Law (Michigan) says she has seen an uptick in loan modification agreements, which she attributes to Homeowner Assistance Funds (“HAF”). HAF funds are a product of the American Rescue Act implemented during the COVID-19 pandemic. 

According to Jason Giguere of Orlans PC, while HAF funds have been exhausted in many states, he is seeing lingering HAF issues. One example relates to HAF funds obtained for post-petition defaults because often the amount of HAF funds a debtor receives exceeds the post-petition default amount. Giguere says “[O]nce the funds were received there was significant confusion as to how the funds should be applied. Should they be applied exclusively to pre-petition amounts? Should they be applied to post-petition amounts, and then the remainder to pre-petition amounts?” In his opinion, the former application “is problematic in the confines of a confirmed cure/maintain case as such application does not provide an immediate benefit to the debtor because the post-petition default persists.”

In summary, loss mitigation and loan modifications offer valuable avenues for debtors to preserve homeownership and alleviate financial distress during bankruptcy proceedings. Whether through Chapter 13 repayment plans or negotiations outside of the bankruptcy process, debtors have options to restructure their mortgage obligations and avoid foreclosure. With competent legal counsel who understand the intricacies of loss mitigation and loan modifications, and through diligent communication and compliance with court requirements, debtors can better position themselves to achieve financial stability and retain their homes amidst challenging circumstances.