The U.S. Bankruptcy Court of the Southern District of New York recently sanctioned a mortgage servicer for violating a bankruptcy discharge injunction when it required a debtor to sign a subordinate mortgage and note—pursuant to FHA’s partial claim process—as a condition of a loan modification agreement, after the debtor’s personal obligation on the underlying loan had been discharged in bankruptcy.
The case concerned a bankruptcy debtor who was granted a discharge of her personal liability on the mortgage loan in question, but the lien securing the loan remained on the property. Four years after the debtor’s bankruptcy case closed, the debtor and mortgage servicer engaged in loan modification discussions to resolve the debtor’s default on insurance and real estate tax obligations and allow her to avoid foreclosure. The servicer proposed a loan modification agreement which reduced the debtor’s monthly mortgage payment, monthly escrow payment, and interest rate. As part of the agreement, the servicer added arrearages for interest and costs—including unpaid taxes, insurance premiums, and other expenses of the underlying loan—to the new unpaid principal balance and re-amortized the new loan over a 30-year period. As a requirement of the loan modification agreement—and in order to be able to file a partial claim with FHA—the servicer required the debtor to execute a subordinate note and mortgage in favor of the HUD Secretary, which would make the debtor liable to the Secretary for money the government paid to the servicer as part of the partial claim.
The debtor accused the servicer of “double dip[ping]” and effectively attempting to collect her pre-petition debt by modifying the underlying loan to include arrearages for interests and costs and making an FHA-HAMP partial claim. The debtor argued that the HUD guidelines only allowed lenders to impose one or the other. She also complained that the amount of the new subordinate note and security instrument were more than double the arrearage costs added to the new unpaid principal, and further, accused the servicer of making “a partial claim to HUD for these same fees in the maximum amount” refunded by HUD in order to collect “over and above the amount of…fees, costs, and interest.” Subsequently, the debtor: (1) moved to reopen her closed bankruptcy case in order to seek sanctions against the servicer for willfully “attempting to reaffirm a discharged debt” in violation of the bankruptcy case’s discharge injunction; and (2) asked the court to direct the servicer to honor the loan modification agreement without requiring her to execute the subordinate note and subordinate mortgage.
The servicer argued that specific language in the loan modification document showed that there was “no attempt to impose personal liability” on the debtor for any previously-discharged obligation, and that the debtor’s motion simply reflected her misunderstanding of the partial claim process for a loan modification under HUD guidelines. As a defense, the servicer also contended that language in the loan modification agreement releasing the debtor from all personal liability extended to the subordinate note and subordinate mortgage as well.
The bankruptcy court held the servicer in contempt for “attempting to collect on” a portion of “a discharged debt.” The court found that the servicer’s loan modification proposal sought to “take advantage of” the partial claim program by using a subordinate note and mortgage to recoup—from the debtor—the same amount it was able to draw from HUD as a partial claim. Additionally, the court found that requiring the debtor to agree to repay a third of the amount of her discharged, unpaid original mortgage balance to the Secretary by allegedly restructuring the original debt as a subordinate loan under the partial claim program merely deferred the repayment of that portion of the debt, rather than releasing the debtor from all obligation to pay the debt as was required by the discharge order. Further, the court rejected the servicer’s argument that the release of personal liability stated in the primary loan documents extended to the subordinate loan: it took issue with the fact that the primary loan documents did not reference the subordinate documents, and speculated that the servicer “could have easily included the language in the subordinate loan documents” in order to show that it was not attempting to reaffirm a discharged debt—especially after the debtor voiced “objections and concerns.” The court held that after the debtor filed for chapter 7 bankruptcy, the servicer’s sole remedy to collect on the original note was to foreclose on the property—a servicer may not demand payment or remuneration as to the note. The court reasoned that contempt was appropriate because “to the extent the…subordinate note represent[ed] a portion of the discharged debt,” the servicer had “actual knowledge of the debtor’s bankruptcy case and discharge,” yet still asked the debtor to pay discharged debt as part of a post-discharge loan modification. Consequently, the court imposed sanctions and awarded the debtor $9,134.91 for costs—including attorneys’ fees—incurred in bringing the motion.
The decision, In re Eppolito, can be accessed here.