Basic knowledge of the foreclosure process is helpful to understanding the strategy behind surrendering a home in bankruptcy. Foreclosure laws vary by state. California and Nevada are primarily power of sale foreclosure jurisdictions meaning that a bank can take back a property more quickly than in judicial foreclosure states like Florida. If you would like to learn more about the timing of foreclosure, click here. But, for our purposes, let’s keep it simple: you can’t afford the mortgage……you fall behind on payments……..your property values have plumetted……the bank forecloses…….they sell your house at auction. If the foreclosure sale price does not cover the balance owed on the mortgage, you’ll owe the bank the difference. That’s right, even after the bank has foreclosed on your home, it’s possible to still owe payments on the mortgage. This is where the personal guarantee comes into play.

Let’s say for example that your house sells for $250,000 at foreclosure but you owe $450,000, a realistic scenario in some California, Florida and Nevada cities. The bank can them come after you for the $200,000 shortfall by filing a lawsuit seeking a deficiency judgment. Filing for bankruptcy completely changes the equation. Surrendering a home in bankruptcy will negate your personal guarantee on the mortgage and prevent your lender from seeking additional payment once you have given them back the keys.

In light of the Defense of Marriage Act (“DOMA”), the answer is likely no. Traditionally, the definition and regulation of marriage was an issue properly left to the states under our federalist system of government and the 10th amendment. As an unfortunate example, due to the anti-miscegenation laws, interracial marriage was illegal in some states prior to 1967.  In 1996, through DOMA, Congress broke with tradition and specifically defined marriage as a union of one man and one woman for the purpose of federal law. As a federal body of law, the Bankruptcy Code borrows its definition of the term spouse from DOMA. As a result, section 302 of the Bankruptcy Code must be read to allow joint petitions only on behalf of heterosexual couples.

In In re Kunda, 315 B.R. 123 (Bankr. W.D. Wash. 2004), a gay couple, legally married in British Columbia, challenged the constitutionality of DOMA after their attempt to file a joint bankruptcy petition was denied. Despite the argument that DOMA is an improper use of federal power that infringes upon a state’s right to regulate marriage, the Court rejected constitutional challenges on the grounds that DOMA’s definition of marriage applies only to federal law, and therefore does not interfere with a a state’s ability to simultaneously define and regulate marriage. The court reasoned that the federal government can permissibly maintain its own definition of marriage so long as state legislatures are afforded the same corresponding right. If conflicting definitions of “spouse” and “marriage” result, they can constitutionally co-exist when states retain their right to regulate marriage as well. Under the current state of the law, DOMA defines the term spouse for purposes of section 302 of the Bankruptcy Code. Like it or not, gay couples, even if legally married in their state, do not fit the federal definition and are therefore not eligible to file joint bankruptcy petitions.

John O’Connor

The whole concept of a short sale is predicated on waiver of at least some portion of your mortgage. It’s a SHORT sale, meaning the sale price is short of what you’ve guaranteed on the mortgage. Let’s be clear, you don’t owe money after a true short sale. In exchange for bringing a buyer to the table capable of taking out much of the existing mortgage (either through a new source of financing or cash) your lender agrees to release you from the remaining portion of the debt. That’s a short sale. A true short sale involves some degree of debt forgiveness. Any other arrangement, while potentially helpful to a struggling homeowner, is not a short sale. My friend was describing a situation where a bank is willing to allow a closing to proceed as long as the borrower agrees to pay back any left over mortgage debt. In this scenario, the house sells for less than what is owed on the mortgage and the difference becomes the amount the borrower will now make payments on. If $300,000 is owed on the mortgage and the house sells for $270,000, the seller will now owe the bank $30,000. Funny, that doesn’t sound like a short sale, it sounds much more like a foreclosure sale  with a corresponding deficiency judgment.

In light of the fact that a short sale will do almost as much damage to your credit as a foreclosure and requires considerably more effort, why go to the trouble unless you’re gaining some debt forgiveness? Isn’t owing the bank after you no longer own your home a common characteristic of a foreclosure proceeding?

MORE SHORT SALE ARTICLES:

I’ve decided to file for bankruptcy, do I need to go through with my short sale?

Tax consequences of a short sale; the bankruptcy “cure.”

Short Sale Traps

The opinion has drawn heavy fire from the consumer bankruptcy bar as many fear it will significantly restrict the range of topics practicioners can discuss with clients. As Justice Roberts pointed out at oral argument, under certain circumstances, incurring debt in contemplation of bankruptcy might be perfectly appropriate. Indeed, through the earmarking doctrine, Courts have long recognized an expection to the trustee’s avoidance powers as they relate to pre-bankruptcy payments to creditors. Problem: alerting consumer clients to the existence of the earmarking doctrine is akin to recommending that they incur new debt.

In order for pre-bankruptcy payments to creditors to trigger the avoidance powers of the trustee, preference laws require property be transferred in satisfaction of an antecedent or past debt. The preference laws do not apply if property is transferred in exchange for a new debt. Under the earmarking doctrine, newly borrowed money simply passing through the debtor’s hands and designated solely to satisfy an existing debt is not an avoidable preference. In order for the rule to appply, the debtor must have no control over the property; it must be “earmarked” for payment to the existing creditor on account of the existing debt. By incurring new debt earmarked specifically for an existing creditor, the debtor does not diminish the bankruptcy estate and the preference laws are not triggered. Property of the debtor is not going to pay down debt, instead funds from a non-debtor source indepenedent of the estate are merely passing through the debtors hands. This is certainly an academic distinction but a substantive one nonetheless.

What remains to be seen is whether the prohibitions contained in Milavetz prevent advising clients of this loop hole in the preference laws.  After all, for the earmarking doctrine to apply, new debt must be incurred. Further, in the case of the consumer seeking to sheild a family member from an adversary case, it can be argued that the new debt will usually be principally motivated by the impending bankruptcy filing as it is the creation of the estate that triggers the trustee’s avoidance powers. Proper use of the earmarking doctrine should be an example of an appropriate circumstance in which a bankruptcy attorney can properly advise a client to incur new debt before filing bankruptcy. However, in light of the sweeping prohibitions contained in Milavetz, is the bankruptcy bar now prohibited from providing clients valuable information regarding the pitfalls inherent in pre-bankruptcy transfers and the trustee’s avoidance powers? Is incurring new debt pursuant to the earmarking doctrine principally motivated by the prospect of bankruptcy?

Certainly nothing in the Milavetz decision changes the analysis under the Bankruptcy Code. The earmarking doctrine will continue to exist in theory, only time will tell whether bankruptcy attorneys will be permitted to discuss its implications with their clients.

Bad legislation makes for bad jurisprudence. After all that has been said and written following Justice Satomayor’s recent incursion into the consumer bankruptcy world, perhaps this is the single most important lesson to be learned. BACPA may be a terrible piece of legislation, however, popular or not, the Supreme Court is still charged with telling all of us what it says. Out of the gates, they were given a softball for a warm up pitch. In light of ­­­­­­Heintz v. Jenkins (1995) in which the Court held that attorneys who engaged in consumer debt-collection litigation on behalf of creditor clients were “debt collectors” under the Fair Debt Collection Practices Act, Milavetz had a very tough hill to climb. The contention that the definition of debt relief agency does not apply to attorneys because the word “attorney” appears nowhere in the text of §101(12A) is attenuated at best. The provisions at controversy clearly describe and are intended to regulate the activities of bankruptcy attorneys.

BACPA defines a debt relief agency as: “any person who provides any bankruptcy assistance to an assisted person . . . for. . . payment . . . , or who is a bankruptcy petition preparer.” Under § 101(4A), bankruptcy assistance refers to goods or services “provided to an assisted person with the express or implied purpose of providing information, advice, counsel, document preparation, or filing, or attendance at a creditors’ meeting or appearing in a case or proceeding on behalf of another or providing legal representation with respect to a case or proceeding.” The definition is clearly intended to cast a wide net. Let’s face it; consumer bankruptcy practitioners have been voluntarily disclosing their status as debt relief agencies for years post-BACPA. “We are a debt relief agency, we help people file for relief under the Bankruptcy Code.” This common practice represents an already well established understanding that since 2005, bankruptcy attorneys are now also debt relief agencies. The tortured, government speak term does leave one scratching their head, but not for long if they’re even marginally familiar with the workings of our Congress. Indeed, under the law Satomayor and Co. were charged with interpreting, it is difficult if not impossible to argue that bankruptcy attorneys, in representing their clients, do not provide bankruptcy assistance (advice, counsel) and therefore do not qualify as debt relief agencies. Bankruptcy petition preparers, the only class of professionals Milavetz contended qualified as debt relief agencies are prohibited by law from giving legal advice. Kudos to Milavetz for trying, but whether they would admit it or not, their quest was more an assault on BACPA as an unpopular piece of legislation, rooted in a vague and as yet somewhat undefined equitable undercurrent that still refers to the 5 year old law as “new” and hasn’t adjusted to its rather unpleasant after taste. It remains to be seen whether the government won the battle but will lose the war. The issue is not as much with the way BACPA broadly defines debt relief agencies as much as it is with the strictures of BACPA itself. It would be fair to say that consumer bankruptcy attorneys by and large are “not fans” of the legislation with its onerous document production requirements and draconian income guidelines. However, the Milavetz decision goes further than imposing nonsensical busy work on attorneys; it creates dangerous ambiguity as to how they can appropriately advise their clients. The preliminary skirmish over the definition of a tortured, almost Orwellian phrase, “debt relief agency”, was the gateway to the larger discussion of whether BACPA impermissibly infringes upon the First Amendment rights of the consumer bankruptcy bar. If bankruptcy attorneys are not considered debt relief agencies under BACPA, there is no reason to address whether section 526 and 528 are constitutional as applied to attorneys.

John O’Connor

HAMP receives most of the mortgage modification attention because it is ostensibly focused on reducing principal payments for family’s trying to stay in their homes. However, another federal program aimed at helping stave off foreclosure by reducing interest rates has received less publicity but appears to be producing results that the anemic HAMP can only dream of. Enter HARP. The Home Affordable Refinance Program is designed to help people who can’t do a traditional refinance because their home has lost value. Borrowers must be current with monthly payments. According to a Charlotte Observer article, last month, the U.S. Treasury Department reported that HARP has enabled more than 4 million borrowers to refinance, with an estimated average savings of $150 per month. HARP can mean getting a lower interest rate, which lowers payments. The refinancing program also can get people out of interest-only loans, which typically call for increased future payments or a balloon.

In lieu of legislation that would allow bankruptcy judges to forcibly modify mortgages, perhaps a program like HARP that focuses on a more market friendly refinance is the best solution to the persistent housing crisis.

CAN’T REFINANCE?

If you can’t refinance because your home is worth less than you owe, the Home Affordable Refinance Program might help. Learn more and check your eligibility at www.makinghomeaffordable.gov.

Robert Frost

Robert Frost is my favorite American poet. Carpe Diem and To a Thinker (scroll all the way down) are poems that have influenced me greatly. And so as I was reading some of Frost’s work last night, I stumbled across the above quote and thought immediately how applicable the cynical stab at banks is to today’s economic woes. Despite accepting billions in public funds to stay afloat, the same banks that recklessly lent money during the blue sky housing boom are not accountable in the bust. Mortgage modification and foreclosure prevention programs have largely been a failure due to lender’s unwillingness to participate coupled with mindless beauracracy. It’s  now raining and alot of people are getting wet. Once again, Mr. Frost had it right.

When in doubt, imagine yourself on an episode of MTV Cribs (for those who don’t know, MTV Cribs is a documentary show that films celebrities as they tour their homes). As you stroll from room to room, camera crew in toe, any items of property worth noting should be disclosed to your attorney and eventually the Court. Start in the living room, move to the kitchen. Go through each room in your house and make a list of the stuff that fills each room. When revewing your schedules prior to filing, make sure everything you’ve disclosed ends up on Schedule B. Don’t forget to list intangible property such as stocks and bonds. The viewing audience may not be interested but I guarantee the Trustee will be.

John O’Connor

Enter bankruptcy. Bankruptcy is never the first option for anyone, however, it does provide the underwater homeowner with the option of surrendering a home and walking away with no deficiency judgment and no tax consequences. A bankruptcy filing wipes away your personal obligation to pay debt, meaning the basis for a deficiency judgment (the personal guarantee on your mortgage) is wiped off the books. Your lender’s only recourse is to take back the collateral for the loan (your home). They cannot come after you for a deficiency judgment. Further, debts discharged in bankruptcy are not taxable events. The bankruptcy will show up on your credit report, but if you’re already delinquent on your mortgage your credit has likely already suffered. If you can no longer afford your home, it may be wise to consult a bankruptcy attorney to discuss your options.

John O’Connor

Morality is of paramount  concern to many faced with the decision of whether to file for bankruptcy. Most who incur debt intend to pay it back, hence waving the “financial white flag” and meeting with a bankruptcy attorney can be difficult, it just doesn’t “feel right.” Is filing for bankruptcy immoral? Odd as it may seem, I believe Francis Ford Coppola’s classic The Godfather is instructive on the subject. I can hear the reaction of my reading audience……”John, what can a crime novel/movie teach us about morals? Give me a break.” Before you dismiss the argument out of hand, consider the priorities of Don Corleone and his ultimate successor and beloved son Michael Corleone. The Corleones espoused family above all else. Armed with the conviction (no pun intended) that higher authority was corrupt, Don Corleone did whatever it took to provide for his family. Of course this article is not intended to condone murder for hire, prostitution or the use of an olive oil business as a front to launder money. It is to say that when deciding if bankruptcy is the right option, consider what is best for your family.

For most Americans, family comes first, the Corleones being no exception. Losing a monthly struggle to cover the mortgage or credit card bills while worrying about where the money to pay for groceries is going to come from is not acceptable. Relief is available. Rooted in equity, the Bankruptcy Code exists in recognition of the fact that sometimes times are tough and starting over is necessary. The availability of liberal bankruptcy laws has been shown to encourage entreprenuership. Whether bankruptcy is the “right thing to do” can only be determined after an evaluation of the benefit to your family vs. the perceived moral detriment of not paying back some of your debts. Take a page out of the Corleone playbook and make this a dispassionate, business oriented analysis. Make no mistake, your creditors deal with you and your account in the broader context of a well established business model. Even if you are being routinely harassed by collection calls, the motivation is business, never personal. Your creditors are attempting to strengthen their bottom line. Perhaps at the last board meeting incessant phone calls were once again determined to be the most effective way of squeezing additional money out of past due accounts. Your current treatment as well as the terms upon which your loan was made are based on clinical company procedure.

The same banks that happily accepted taxpayer bailouts refuse to modify taxpayer’s mortgages. Why? The financial incentives still aren’t there. Modifying mortgages en masse isn’t good business. Furthermore, the risk of delinquency and bankruptcy is factored into your interest rate. The color of your hair has nothing to do with it. There is nothing wrong with filing for bankruptcy if you have encountered unexpected financial hardship and can’t find a way out. Don’t let a vague sense of obligation stand in the way of relief that can help your family. As Michael Corleone would say: “it’s not personal, strictly business.”

Still not convinced? See what the Bible has to say about bankruptcy.

John O’Connor