With the proposed amendments to the Bankruptcy Code placed on temporary hold by Congress until at least late April, it seems appropriate to take a step back and examine the possible unintended consequences of the passage of such a law.
While providing troubled borrowers with an effective tool to rework their mortgage terms under the protection of the Bankruptcy Code, is it possible that the mere threat of such a modification by a borrower could lead an increasing number of lenders to agree to rework the loan terms outside of the bankruptcy process?
Debtor’s counsel have always operated with the knowledge that, while they have the ability to tie up a pending foreclosure for months or even years by aggressively opposing the case, the reality has always been that mortgage lenders held the upper hand once a Chapter 13 bankruptcy was filed. A borrower could not alter the terms of the loan, but could only seek breathing room to bring delinquent payments current.
If the proposed amendments become a reality, the leverage will clearly shift into the borrower’s favor, which may lead more and more lenders to seek a negotiated modification prior to bankruptcy, saving both sides from litigating over valuation of the home and risking assessment prior to plan confirmation. The end result could be a decrease in Chapter 13 filings within the pool of borrowers who, but for their mortgage delinquency, might not be in financial difficulty.
Of course, the flip side to this argument would be that with all the economic indicators clearly showing a downturn, the actual number of borrowers whose only financial difficulty consists of their mortgage, is likely becoming smaller and smaller each month. Therefore, it is likely that even with the offer of a voluntary loan modification by the lender, the vast majority of borrowers will still seek bankruptcy relief.
Last night, the House of Representatives approved H.R. 1106 by a vote of 234-191, permitting bankruptcy judges to cram down residential mortgages to their current value, modifying variable interest rates to a fixed annual rate and extending the repayment period of up to 40 years. This part of the bill contains identical language to other bills pending in the House. One big change is a built in sunset provision; the only loans that can be modified are those dated before the statute takes effect. Future loans may not be modified under this statute. In addition, the debtor must certify that he or she has attempted to contact the lender regarding modification of the mortgage at least 15 days before the petition is filed, unless a foreclosure sale is scheduled within 30 days. If a foreclosure sale is pending or if the debtor wants to modify a mortgage covered by a confirmed plan, the debtor must first attempt to contact the lender and try to work out a loan modification. Nothing in the statute explains how the debtor is to prove that the attempt to contact the lender was actually made.
The legislation would be immediately effective and would apply to all pending, but not closed, cases. The value of the property is the value as of the hearing date, not the date the petition was filed. This would give debtors the option to ask for mortgage cram downs on plans that have already been confirmed, even those that are four years old. The only limitation on the provision is that the court must determine that the debtor has proposed the modification in good faith and that the debtor has not been convicted of obtaining the extension, renewal or refinancing of loan by actual fraud.
If the debtor sells the house for more than the crammed down value within five years, the lender would share in the net proceeds.
The Chapter 13 trustee’s fee on modified loans is capped at 4%, which will encourage more debtors to make regular mortgage payments through the trustee. The court may also waive the trustee’s fees for certain low income individuals.
Furthermore, there are provisions that protect servicers who agree to modify mortgages from liability to owners of interests in securitized loans. The terms of some securitization agreements will be changed, declaring certain provisions to be against public policy. This could have the effect of allowing many servicers to go forward with loan modifications, which have not been possible in the past.
All eyes are now on the Senate. If the legislation that passes in the Senate is not identical to the House version, the bills will go to a conference committee to hammer out a compromise. The compromise bill would then go back to both houses for approval and then to the President for signature.
Bankruptcy Modifications
The Administration will continue to influence change in the bankruptcy rules to allow individuals to pay the fair market value under Court order. Currently, the Administration is in talks with Congress and predicts a swift enactment of the reformed bankruptcy law. Such reformation includes the following:
- Debtors’ mortgage loans will be crammed down to the current value of the property (with the remaining balance being treated as unsecured)
- Bankruptcy Judges will have the power to, “develop an affordable plan for the homeowners to continue making payments”
- Debtors who have existing mortgages under Fannie Mae and Freddie Mac conforming loan limits must ask their servicers/lenders for a modification first before seeking a modification in bankruptcy. Also, the debtor requesting the modification must certify that he or she, “complied with reasonable requests from the servicer to provide essential information.” (The reason behind this requirement is to not allow millionaire homes in bankruptcy. However the program as worded would require an extra step for non-millionaire homes but not for millionaire homes.)
- FHA and VA will provide partial claims in the event of bankruptcy or voluntary modification, “so holders of loans guaranteed by the FHA and VA are not disadvantaged”
