Bankruptcy Update: Loan Modifications - Treatment by the BK Courts
by Kent W. Plott
This article addresses loan modifications when done in conjunction with a bankruptcy case. The topic will be discussed generally, with some specific examples; however, as there are 50 states and hundreds of bankruptcy judges, readers need to consult with local counsel as to how a particular court or judge handles loan modifications.
Here’s a typical scenario: A borrower gets behind on payments and asks the lender for a loan modification or forbearance. Paperwork is sent out, and perhaps it is sent back. While this is going on, the foreclosure process begins, time goes by, and a foreclosure sale is set; but the loan modification is still not complete. Prior to the foreclosure sale, the borrower files a bankruptcy — perhaps to reorganize, or maybe simply to delay the sale so that the loan modification can be completed. In any event, the bankruptcy court system is involved now.
In most jurisdictions, a loan modification may also be done after a discharge of the debts. The key to remember in this instance is that the loan modification cannot reimpose personal liability upon the borrower. The loan modification needs to specifically recognize the discharge and indicate that the modification is not obligating the borrower personally on the debt. HAMP also works in a chapter 7 context at the discretion of the lender. In many jurisdictions, the creditor can solicit for loss mitigation, put a borrower in HAMP with the three-month trial payment period, and then modify the loan after the trial period.
In Utah’s bankruptcy district, one can solicit loss mitigation at any time during the bankruptcy case and offer to rework a loan or propose HAMP at the discretion of the lender. Plan confirmation most often occurs within 60 to 75 days of the petition filing in Utah. If borrowers are in the HAMP trial payment period, it might not be completed prior to plan confirmation, so the courts here have been continuing the confirmation hearing to allow for completion of the HAMP process. However, the chapter 13 trustee has recently proposed changing the procedure to provide for plan confirmation as though the loan modification will be approved. If the loan modification ends up being denied, the plan provides that the debtor will then have to address the arrears through a plan modification, or provide for surrender of the property. Under either scenario — depending upon approval or denial of the loan modification — an amended proof of claim would have to be filed.
Under Utah’s current approach, the plan that is ultimately confirmed and the budget that is filed are accurate, and represent the current financial snapshot of the debtor. This method also allows the lender’s proof of claim to be amended to zero at the time of confirmation. If the proposed changes in Utah go through (and in other jurisdictions where the court will not continue confirmation), the chapter 13 plan will need to treat the mortgage as being current with a provision to modify the plan to treat the arrears if the loan modification is denied, or amend the proof of claim if approved. (Note that, in Utah, loan modification approval is not requested pre-confirmation, as the new terms will be set out in the plan, and any issues can be addressed at the confirmation hearing. With Utah’s proposed changes, no approval would be necessary if the loan modification is provided for in the plan.)
Ongoing monthly payments should be paid by the debtor or, if in a conduit state, by the trustee pursuant to HAMP. If a loan modification is denied after the trial period, an amended proof of claim would have to be filed to set out the post-petition payment default that would be due, since HAMP reduces the current monthly payment obligation. A lender would not be allowed to place debtors in a post-petition payment default because they tried to qualify for HAMP.
If relief from the stay has been granted, debtors will generally not seek approval for any loan modification. Utah’s stay relief orders allow a creditor to exercise its legal rights and remedies, including forbearance agreements, loan modifications, or other workout/loss mitigation agreements.
The best practice seems to be to seek trustee and court approval for loss mitigation. As yet, there are no specific practices for dealing with HAMP. Depending on the jurisdiction, the monthly HAMP payments are made by either the debtor or trustee. Upon modification, proofs of claim need to be amended to zero or to reflect amounts already paid by the trustee. And, finally, if a loan is modified, the plan generally continues for the benefit of other creditors.
loan modification process in an ongoing bankruptcy case is a work in
progress. The industry is faced with new situations that often have not
been addressed by particular courts yet. Further, even where addressed,
another court or judge might come to a completely different conclusion.
Accordingly, it is essential that specific questions be addressed with
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