Perhaps surprisingly, one of the most frustrating developments in our current foreclosure crisis has to do with the stubborn resistance of mortgage lenders to carry out a foreclosure in a timely manner. Most commonly, this situation arises in a Chapter 7 bankruptcy where the debtor has determined that it is in their best interest to surrender a home.
As we all know, state deficiency laws determine whether a mortgage lender can request a deficiency judgment after a foreclosure. We also know that a bankruptcy discharge will protect that homeowner from such liability, regardless of what the debtor’s state statutes say about whether a mortgage lender can file for a deficiency judgment.
While post-foreclosure liability protection for the mortgage lender remains a powerful advantage offered by bankruptcy liquidation, a relatively new source of post-petition liability has emerged in recent years. One that too often surprises our clients if we don’t offer increasingly comprehensive advice before, during and after the filing of a bankruptcy petition.
What I’m referring to, of course, is HOA debts and, to a lesser extent, municipal water and garbage rates. As we all should be well aware, such recurring charges accumulate after the petition, and precisely because they recur after the petition, they constitute a new debt, and as a new debt, the Bankruptcy Settlement has no effect on them.
The typical case involves a Chapter 7 bankruptcy debtor who decides they cannot afford to keep a home. Perhaps this debtor is a year or more behind on the first mortgage. Perhaps the borrower today (as is common here in California) has $100,000 or more under water on the property, and the lender has refused to offer a loan modification despite months of effort on the part of the homeowner. The house will most likely not be worth the guaranteed amounts owed for decades to come. The monthly payment has been adjusted to a fee that is now sixty or seventy percent of the debtor’s household income. This house must be delivered.
The problem, of course, is that a surrender in bankruptcy does not equate to prompt foreclosure by the lender. In days gone by, say three or even two years ago, it would be. But today, mortgage lenders simply don’t want the property on their books. I often picture an analyst deep in the bowels of the mortgage lender’s foreclosure department looking at a screen that shows all of the bank’s properties in a given zip code. This would be another one, and the bank doesn’t want another bank property that it can’t sell for half of what it lent just four years ago. We could continue talking about the imprudence of the bank’s decision to have made that original loan, but that is another article. Today, property is a hot potato, and there is nothing the debtor or the debtor’s bankruptcy attorney can do to force the mortgage lender to take title to the property.
Hence the riddle. There are other parties involved here, in particular, homeowners’ associations. In many areas, HOAs have seen their monthly dues plummet as more and more of their members have defaulted. Its ability to collect the debt from the delinquent association was long thought to be ensured by its ability to bond the property and foreclose on it. Even if your lien was subordinate to a first lien, or even a second mortgage lien, in the days of home appreciation there was almost always enough equity in real estate to complete the HOA. But no more. Today, HOAs often have no hope of recovering back equity on a foreclosed property.
So where does all this leave the bankruptcy debtor who must turn over his property? Between the proverbial rock and a hard place. The lender cannot foreclose and take the title for months, if not a year, after the bankruptcy is filed. Owed HOAs, along with water, trash, and other municipal services, continue to add up on a monthly basis. The debtor has often moved and is unable to rent the property. But rest assured, the owner’s liability for these recurring charges is not eliminated by bankruptcy, as they arise after the petition. And he or she will remain pending new recurring charges until the bank finally takes title to the property. HOAs will typically sue the landlord after the termination, aggressively pursuing attorney fees, interest, costs, and whatever else they can think of to recover their losses. This can sometimes lead to tens of thousands of dollars of new debt that the recently bankrupt debtor will have no hope of repaying for another eight years, should they file for bankruptcy again.
This problem would not arise if mortgage lenders quickly foreclosed in the context of a bankrupt debtor turning over a home. We as bankruptcy attorneys can literally beg that lender to already foreclose or, better yet, accept a deed-in-lieu of foreclosure, but to no avail. They just don’t want the property. What advice, then, should we give debtors in this situation? The options are few. If the debtor can hold out until the property is actually foreclosed before filing for bankruptcy, this would eliminate the problem. But such a delay is not a luxury most debtors can afford. If this option is not available, the debtor must live in the property and continue to pay their HOA fee and municipal services, or if the property is a second home, for example, try to rent the property to cover these ongoing costs. .
Ultimately, the Bankruptcy Code never contemplated this situation. Neither did most state statutes governing homeowners associations. A remedy under the Bankruptcy Code to force mortgage lenders to take title to real property turned over would be ideal, but given the problems facing this Congress and its political orientation, we can comfortably say that the possibility of such a legislative solution is more how remote