February 2011 Archives

February 23, 2011

Reaffirming Car Loans in Bankruptcy

If you file for Chapter 7 bankruptcy, the lender may require you to reaffirm your car loan in order to keep the car. Here's why, and what happens if the reaffirmation agreement is, or is not, approved by the bankruptcy court.

When you are making payments on a car, your car note has two different parts -- the promissory note that makes you personally liable for the debt and the security agreement that allows the lender to repossess the car if you default on the payments. To be enforceable, the security agreement must be registered with the DMV or other state registry -- which results in a lien being placed on your car.

When you file Chapter 7 bankruptcy you can get rid of the promissory note (the amount you owe pursuant to the promissory note is discharged in the bankruptcy) -- and your personal liability -- but you can't get rid of the lien. This means you will have to continue making your payments if you want to keep the car, even though you don't actually owe anything on it. If your head is spinning by now, don't worry. It's hard to get a grasp on this principle.

Many Lenders Require Reaffirmation Agreements

Lots of lenders don't like the idea of borrowers being off the liability hook for the car note, especially if the loan is for a new model car. Not surprisingly, lenders look for ways to keep borrowers on the hook, so that the borrower is liable for any deficiency if the car is turned in or repossessed after the bankruptcy.

In 2005 Congress gave lenders the option of requiring borrowers to sign a reaffirmation agreement in order to keep the car after bankruptcy. In bankruptcy, reaffirmation simply means that the borrower will be liable after bankruptcy on the debt that is reaffirmed, whereas the borrower will not be liable without the reaffirmation.

If the lender requires you to reaffirm, you'll have to sign an agreement the lender will send you, and file the agreement with the court. The court will give you a date for a court hearing at which the judge will decide whether you can afford to make the car payments.

The Best Case Scenario: The Judge Doesn't Approve the Reaffirmation

If the judge decides you can't make the car payments, the judge will disapprove the reaffirmation agreement and you'll be off the hook. But what if you remain current on the payments, even though there is no reaffirmation agreement? In this case, you can keep the car.

Here's the rule: If the only reason you don't reaffirm the car note is because the judge has disapproved the agreement, you can keep the car just as if the lender had not required the reaffirmation the first place. If you want to read an explanation of this confusing and non-intuitive process, read the opinion in In re Moustafi, 371 Bankruptcy Reporter 434 (Bankr. Ariz. 2007). 

This means the best case scenario is that the judge disapproves the reaffirmation agreement. If the judge approves it, you'll be on the hook for the car note after your bankruptcy, which can be catastrophic if you later default on your payments and have the car repossessed.

To learn more about reaffirming a car loan in bankruptcy, and your other options for keeping your car in bankruptcy, read Nolo's article Your Car in Chapter 7 Bankrupty.

February 15, 2011

Bankruptcy and Second-Mortgage Liens

If you file for Chapter 7 or Chapter 13 bankruptcy, what happens to second or third mortgages and liens on your home? The real estate crash, and the resulting depreciation in home values, may mean that as a practical matter, many people won't have to worry about those liens. Here's why.

The Real Estate Crash Has Resulted in Many Unsecured Second and Third Mortgages

Because of the real estate crash, many people have second and third mortgages on their homes that are no longer secured by the home's value. For instance if your home is now worth $200,000 and you owe $200,000 on your first mortgage and $50,000 on your second mortgage, your home's value secures the first mortgage, but after that, there is no equity left to secure the second mortgage.

What Happens to Those Mortgages if You File for Bankruptcy?

In Chapter 7 bankruptcy, your bankruptcy discharge will eliminate your personal liability on the second mortgage but will not eliminate the lien. In Chapter 13 bankruptcy, you can eliminate both your personal liability and the lien in a procedure called lien stripping. The basic lien stripping rule is: You can eliminate a lien that has no security in the home, but you can't eliminate the lien if part of it is secured by the home's value.

Here's an example. Say your home is worth $210,000, your first mortgage is $205,000, and your second mortgage is $25,000. You can't strip off the second lien because it is secured by at least $5,000 of your home's value.

What if a Lien Remains on Your Home After Chapter 7 Bankruptcy?

Although you can't lien strip in a Chapter 7 bankruptcy, the lien may have very little effect on your future financial affairs. The Chapter 7 bankruptcy will discharge your personal liability for the second mortgage (meaning you can't be sued for money owed on it). And, absent value in the house securing the second mortgage, the holder wouldn't benefit from a foreclosure (since all the value of the home would go to the first mortgage holder in a foreclosure sale).

This means there won't be negative consequence from the lien remaining on the home after your bankruptcy -- unless of course your home's value comes back to a point that would allow you to sell the home or support a foreclosure action by the second mortgage lender. This is clearly less likely when your home is way underwater (50% is common) than when you are just a tad underwater.

The bottom line? Even though you might have a better result in Chapter 13 -- where you can lien strip -- from a practical standpoint, people with severely underwater second mortgages may do just as well in a Chapter 7 bankruptcy.

In some cases it needn't be one choice or the other. It used to be that you could file a Chapter 7 bankruptcy, discharge your personal liabilities and then immediately file a Chapter 13 bankruptcy to strip off the lien. This was called a "Chapter 20" bankruptcy. Now it's not quite that simple. You are still entitled to file a Chapter 13 bankruptcy right after your Chapter 7 discharge but you won't qualify for a Chapter 13 discharge. Still, at least one bankruptcy court said that you don't need a discharge to strip off a second lien in a Chapter 13 case filed on top of a Chapter 7 case, as long as you filed the Chapter 13 in good faith. 

February 7, 2011

Lawsuits Allege Banks Broke Promises to Homeowners Facing Foreclosure

Two recent lawsuits, in Washington and California, use "promissory estoppel" (a legal theory in contract cases) to get monetary damages from banks that broke their promises to homeowners facing foreclosure

The Washington Case: Promissory Estoppel as a Cause of Action

Abuses by mortgage banks and servicers committed while dealing with homeowners seeking foreclosure relief or mortgage modifications have been well documented. They are especially and eloquently detailed in a class action lawsuit filed on January 10, 2011 in the State of Washington. Reading the Introduction to the complaint (if not the whole document) will be well worth your while. 

Among the claims contained in the class action complaint is a type of breach of contract known as promissory estoppel. Promissory estoppel may seem like an impossible-to-understand example of legal jargon but i'ts actually relatively simple. It means that a party making a promise is prevented (estopped) from reneging on the promise. You can sue for promissory estoppel if 1) someone makes you a promise that is clear and unambiguous, 2) your reliance on the promise is reasonable and foreseeable, and 3) you suffered damages as a result of your reliance. 

You can't hold someone to a naked promise just by itself. In other words forget about suing your parents who failed to deliver on their promise to send you to Harvard. But if you go through all the motions of enrolling, signing a lease for your housing, and buying textbooks, and your parents had good reason to believe that you would act on their promise, you may have a winning case to recover, at the very least, your out-of-pocket expenses, and possibly even for other liabilities you incurred. 

In the class action complaint the promissory estoppel claim deals with a common practice in the mortgage industry. There the bank promised the named plaintiff a permanent mortgage modification if she completed a trial period during which the modified payments were to be paid to the bank. The plaintiff did, in fact, complete the trial period but the bank refused to give her the modification as promised. Here, the requirements for promissory estoppel were clearly met. The bank promised a permanent modification in exchange for three (or more) trial payments. The homeowner reasonably and foreseeably relied on the promise and made the payments. The bank reneged on the promise, and the homeowner suffered damages in that the trial payments would not have been made absent the promise.

You might wonder why this isn't a common-variety breach of contract case. For a contract to be enforceable both sides have to receive something of value (called consideration) in exchange for their agreement to perform the terms of the contract. Also, there has to be an offer and an acceptance. In the situation where the bank makes a promise to modify, it's arguable that only the homeowner is receiving consideration and so a valid contract has not been made. But the law, through the doctrine of promissory estoppel, eliminates the need for mutual consideration and will, under the appropriate circumstances, enforce the promise or award damages if it is not carried out.

Promissory Estoppel in a Recent California Foreclosure Case

The doctrine of promissory estoppel was recently applied to a mortgage workout situation in a California appellate court case titled Claudio Aceves v U.S. Bank (Court of Appeal, Second Appellate District, Div One (1/27/11)). Here Ms. Aceves fell behind on her mortgage and filed for Chapter 7 bankruptcy after the bank served a Notice of Default, a required step in the California foreclosure process. She decided to convert the case to chapter 13 bankruptcy and raise the necessary money to reinstate the loan and pay off the arrearage over the course of the chapter 13 plan. The bank told her they would work with her and that she needn't pursue her Chapter 13 remedy. Relying on this representation, Ms Aceves did not file Chapter 13 and also did not object when the bank filed a motion in her Chapter 7 case to lift the automatic stay (which legally enabled the bank to continue with its foreclosure remedy).

In fact the bank failed to enter into good faith negotiations and instead completed the foreclosure. Ms. Aceves sued the bank alleging a cause of action for promissory estoppel, among others. She argued that 1) the bank's promise to work with her in reinstating and modifying the loan was clear and unambiguous, 2) the bank in fact failed to negotiate the modification, 3) she relied on the bank's promise by forgoing bankruptcy protection under chapter 13 and failing to oppose the motion to lift the stay, 4) her reliance was reasonable and foreseeable, and 5) she suffered damages in the form of losing her house. 

The lower court dismissed the action but the court of appeals ruled that in fact Ms. Aceves had stated a claim for promissory estoppel and should be allowed to proceed with her lawsuit in the trial court. In making its ruling the court specifically found that "U.S. Bank never intended to work with Aceves to reinstate and modify the loan. The bank so promised only to convince Aceves to forgo further bankruptcy proceedings, thereby permitting the bank to lift the automatic stay and foreclose on the property."

As long as this case remains published (and isn't ordered de-published by the California Supreme Court) it provides great precedent if you decide to sue your mortgage lender or servicer for breaking its promises. If you can't find an affordable lawyer, you might consider doing your own state court lawsuit with the help of Nolo resources such as Represent Yourself in Court, by Paul Bergman and Sara Berman-Barrett, and Everybody's Guide to Small Claims Court, by Ralph Warner.

While you may be invited to join a class action, those types of cases usually are much more  beneficial to the lawyers bringing them than they are to the plaintiffs. If possible, you should consider going your own way. However, sometimes a class action is the only way to find a lawyer without parting with an arm or a leg and if that is your situation, and self-help is not an option, by all means sign up as a class action plaintiff. .