NUTS AND BOLTS OF A
FORECLOSURE ACTION
Sponsor: Young Lawyers Division
CLE Credit: 1.0
Wednesday, June 17, 2015
2:25 p.m. - 3:25 p.m.
Elkhorn A-D
Lexington Convention Center
Lexington, Kentucky
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The materials included in this Kentucky Bar Association Continuing Legal
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TABLE OF CONTENTS
The Presenter .................................................................................................................. i
Nuts and Bolts of a Foreclosure Action ........................................................................... 1
Foreward ............................................................................................................. 1
Introduction .......................................................................................................... 2
Foreclosure Process ............................................................................................ 3
THE PRESENTER
Bill L. Purtell
Lerner Sampson & Rothfuss LPA
120 East Fourth Street, Suite 800
Cincinnati, Ohio 45202
(513) 619-6522
[email protected]
BILL L. PURTELL is an attorney with Lerner Sampson & Rothfuss LPA in Cincinnati
and practices in the areas of foreclosure, real estate and collections. He received his
B.A. from Thomas More College and his J.D. from the University of Cincinnati College of
Law. Mr. Purtell is a member of the Kentucky, Ohio and Sixth Circuit – Federal Bar
Associations. He is also a member of the Legal Aid Society of Cincinnati – Volunteer
Lawyers Project, Mortgage Bankers Association and USFN Attorney Network.
i
ii
NUTS AND BOLTS OF A FORECLOSURE ACTION
Bill L. Purtell
I.
FOREWARD
A Kentucky lawyer sought to foreclose a loan for a client who had a mortgage on
a parcel split from an old family farm. The Master Commissioner's report stated
that the foreclosure would be recommended if the lawyer could prove satisfactory
title to the parcel of property split from the master deed. The title to the original
farm dated back to 1792, which took the lawyer three months to track down. After
sending the information to the Master Commissioner, the lawyer received the
following report:
Upon review of the memorandum adjoining your client's motion for
judgment, I note that the request is supported by an Abstract of
Title. While I compliment the able manner in which you have
prepared and presented the application, I must point out that you
have only cleared title to the original deed back to 1792. Before
judgment can be recommended to the Court, it will be necessary
to clear the title back to its origin.
Annoyed, the lawyer filed an objection to the report as follows:
Your report regarding title in Case No. 15-CI-01234 has been
received. I note that you wish to have title extended further than
the 213 years covered by the present Abstract of Title. I was
unaware that any educated person in this Commonwealth would
not know that Kentucky seceded from Virginia in 1792, the year of
origin identified in our motion for judgment.
For the edification of the Commissioner's office, the title to the
land prior to Virginia's statehood was obtained from England,
which had acquired it by Right of Conquest from Spain. The land
came into the possession of Spain by Right of Discovery made in
the year 1492 by a sea captain named Christopher Columbus,
who had been granted the privilege of seeking a new route to
India by the Spanish monarch, Isabella. The good queen Isabella
secured the blessing of the Catholic Church, through its pontiff the
Pope. The Pope is the emissary of Jesus Christ, the Son of God.
God is credited with being the creator of the world, including, one
presumes, Kentucky and Virginia. God, therefore, would be the
owner of origin and His origins date back to before the beginning
of time, the world as we know it, and the public records available
to the plaintiff. I hope you find God's original claim to be
satisfactory.
Now, may we have our judgment?
The order of sale was granted.
1
II.
INTRODUCTION
Foreclosure is…Forbidden?
"Foreclosure of a mortgage is forbidden" – KRS 426.525 (2012).
This seemingly straightforward statement does not actually mean that
foreclosures do not occur in the Commonwealth of Kentucky. It bans the use of
"strict foreclosure," which is a non-judicial method of recovering the mortgaged
property by self-help. 1 These non-judicial methods are actually the more
prevalent type of foreclosure nationwide. 2
An aggrieved creditor in Kentucky may bring an action in equity to enforce the
mortgage and request a sale of the secured property. This is a judicial action that
requests a finding that the covenants of the mortgage have been breached and
asks that the property be sold to pay all lienholders in their order of priority.
As a judicial action, creditors are free to bring as many other claims as they
possess against the defendants, including money damages under a contract or
promissory note, marshalling of liens against other creditors, as well as claims to
reform scriveners errors in the loan documents.
A foreclosure is real litigation which follows all the rules of civil procedure
applicable to other civil actions. The main difference is that the rendering of a
final, appealable order is merely the half-way point of the action. The true goal is
the sale of the property, the disbursal of proceeds to the various creditors, and
the issuance of a foreclosure deed.
The most common type of foreclosure arises from a traditional lender-borrower
relationship. A homeowner seeks a loan from a bank, secured by a mortgage, in
order to purchase or refinance a piece of real estate. However, foreclosures also
exist for mechanics lien holders, condominium associations, and judgment lien
creditors. The foreclosure process is the same, but attention in this presentation
will be given to foreclosure of consensual mortgages.
For more detailed information about Kentucky foreclosure law, please see the
monograph Foreclosure Actions in Kentucky by Gregory D. Pavey and Lea
Pauley Goff (UK/CLE 2005, 1st ed.).
1
See Sebastian v. Floyd, 585 S.W.2d 381 (Ky. 1979), Watkins v. Eads, 2014 WL 2154901 (Ky.
App. May 23, 2014).
2
Twenty-eight of fifty states use a non-judicial method. Source: Mortgage Bankers Association,
http://www.mbaa.org/files/resourcecenter/foreclosureprocess/judicialversusnonjudicialforeclosure.pdf
.
2
III.
FORECLOSURE PROCESS
A.
Loan Documents
1.
Promissory Note.
Most mortgages secure the payment of negotiable instruments
under KRS 355.3-104. The Note is the primary loan document
which determines who is authorized to bring the foreclosure. The
mortgage is simply a secondary document which accrues to the
benefit of the noteholder. 3
2.
Mortgage.
Most residential mortgages are drafted using the Fannie
Mae/Freddie Mac uniform mortgage template, 4 which contains the
standard clauses used in the mortgage industry, including the
rights and remedies upon default. Mortgage Electronic
Registration Systems, Inc. (MERS) is the most common mortgage
holder in the Commonwealth of Kentucky, being nominated as the
holder of record by the borrower on behalf of the lender, its
successors and assigns. 5
3.
Assignments.
While the noteholder has equitable rights to enforce the
mortgage, 6 the better practice is to record an assignment of
mortgage under KRS 382.365. This is generally when MERS will
assign its title interests to the foreclosing noteholder.
B.
Pre-Foreclosure Compliance
To accelerate a loan is to call all the payments due immediately,
eliminating any further monthly payments. The entire balance becomes
payable at once, which allows the foreclosure sale to fully satisfy the
mortgage debt. Acceleration is not automatic, and may be governed by a
host of different rules and requirements, all of which should be met before
filing a foreclosure.
1.
Contractual acceleration.
Kentucky law does not require any specialized notice or warning
before a foreclosure may be filed. Therefore, the terms of the note
3
Stevenson v. Bank of America, 359 S.W.3d 466 (Ky. App. 2011).
4
https://www.fanniemae.com/singlefamily/legal-documents.
5
http://www.mersinc.org/.
6
See Stevenson v. Bank of America, 359 S.W.3d 466 (Ky. App. 2011).
3
and mortgage generally dictate any pre-foreclosure compliance.
The standard Fannie Mae/Freddie Mac uniform loan documents
grant a thirty-day period in which the borrower must be notified in
writing of the default on the loan and given a chance to pay the
arrearage in full. However, if some other mortgage template is
used by the lender, there is no requirement to include any
prerequisites to acceleration of the loan once a default occurs.
2.
CFPB regulations.
In 2014, the Consumer Financial Protection Bureau issued a set
of federal regulations which changed much of the industry
practices for acceleration. Under 24 CFR 1024.41(f), the first legal
action for foreclosure (in Kentucky, the complaint for foreclosure),
cannot be filed until the loan is at least 120 days delinquent.
3.
FHA/VA regulations.
The Federal Housing Administration and Veterans Administration
have their own loan programs, for which a set of federal
regulations apply. These rules are usually incorporated by
reference into the loan documents themselves, which then
become binding between the borrower and the lender. This
includes specific rules on when and how a lender may accelerate
a loan after a default occurs. 7
C.
Case Referral
A lender generally refers foreclosure actions to unaffiliated outside
counsel in order to recover the fees/costs of the foreclosure under KRS
411.195. Standard mortgage documents allow for the collection of
reasonable attorney fees. Even if a foreclosure is not filed, there are fees
incurred when counsel opens the file, reviews the loan documents, and
otherwise prepares the case for filing.
1.
Title search.
The final goal of a foreclosure is to deliver clear and marketable
title to the purchaser at sale. Therefore, a foreclosure is only as
good as the title search underpinning it. KRS 426.006 requires the
joinder of all parties who have a claim in the real estate, and title
searches can vary in length; forty plus years, fifteen years, or just
a current owner search. There is no requirement to file the title
search with the Court, or to insure the status of title, so Kentucky
foreclosure deeds come with no guarantee of clear title. 8
7
For example, 24 CFR 203.604.
8
Columbia Life Ins. Co. v. Smith, 271 Ky. 133 (Ky. 1937).
4
2.
FDCPA compliance.
Filing a lawsuit against a consumer is considered debt collection
under the Fair Debt Collection Practices Act. 9 Therefore, the
attorney handling the case must send a letter to the consumer
providing the required disclosures under 15 U.S.C. §1692g. This
requirement is independent of the lender's claims against its
borrower.
D.
Complaint Preparation
1.
Claims for foreclosure.
A standard foreclosure contains two counts: one for liability on the
promissory note, and a second count to foreclose the mortgage
based on the default in the note. Copies of the loan documents
would be attached as exhibits to set forth the terms of the
contract, the parties to be held liable, and the description of the
mortgaged property.
For count one, Civil Rule 9.03 allows a generalized statement to
be made that all conditions precedent to acceleration of the loan
have been performed. This count should also set forth the default
on the loan and the current balance owing.
For count two, a special provision of Kentucky law requires a
statement concerning whether the property may be divided, such
as a farm, without materially impairing the value of the property
and the plaintiff's lien. 10 Most residential properties are indivisible
in this regard, since the bulk of the value resides in the house
sitting upon the property. Count two is also where the other
lienholders of record would be listed.
2.
Necessary parties.
The borrowers on the loan are necessary parties to the personal
liability count. For the foreclosure, KRS 426.006 requires the
joinder of all lienholders who have an interest in the property.
These are the easiest parties to identify and serve.
Spouses in Kentucky have dower rights in the real estate owned
by their spouse. 11 However, these rights only vest at death, are
eliminated in the event of a divorce, and are defeated by purchase
money mortgages or pre-existing mortgages. 12 This is where the
9
Heintz v. Jenkins, 514 U.S. 291 (1995).
10
KRS 426.685(2).
11
KRS 392.020.
5
exceptions tend to overcome the rule, making spouses
unnecessary parties in most foreclosures unless they separately
signed the promissory note or hold title to the property.
If the United States holds an interest in the property, either
through an IRS tax lien or through some other agency, special
rules apply to the complaint. 28 U.S.C. §2401(b) requires the U.S.
to be named and served both through the U.S. Attorney General
in Washington, D.C., as well as through the local District Attorney
for that area of Kentucky. This statute also provides the U.S. with
sixty days to respond to the complaint instead of the usual twenty
days. A copy of the U.S.'s interest in the land must be attached to
the Complaint, beyond mere notice pleading.
Surprisingly, the one party who is unnecessary to a foreclosure is
the current occupant of the property. 13 A holder of a recorded
lease may be necessary, but the common residential tenant with
an unrecorded lease is not necessary to marshal and foreclose
the lender's mortgage. The sunset provision of the federal
Protecting Tenants at Foreclosure Act has occurred; therefore
there are no further protections for tenants under Kentucky law.
3.
Additional relief.
Being a judicial action, a lender may ask the court for further legal
or equitable relief during the pendency of the foreclosure. This
could range from reforming errors in the loan documents, to
resolving competing priority claims between lenders, to requesting
a receiver to manage the property. Most commonly, these
additional counts are used to clear up any defects in the title so
that the court can order a sale which will pass good and clear title
to the property.
E.
Lis Pendens
1.
Notice of action.
KRS 382.440 states that "No action…commenced or filed in any
court of this state, in which the title to... real property…is in any
manner affected or involved…shall in any manner affect the right,
title or interest of any subsequent purchaser, lessee, or
encumbrancer of such real property, or interest for value and
without notice thereof, except from the time there is filed, in the
office of the county clerk…a memorandum stating: (a) The
number of the action, if it is numbered, and the style of such action
or proceeding and the court in which it is commenced, or is
pending; (b) The name of the person whose right, title, interest in,
12
KRS 392.040.
13
McEwan vs. EIA Properties, LLC, 428 S.W.3d 633 (Ky. App. 2014).
6
or claim to, real property is involved or affected; and (c) A
description of the real property in the county thereby affected."
Therefore, the filing of the lis pendens notice is an essential step
in making sure that the foreclosure deed passes a good title that is
unaffected by any post-complaint matters affecting the real estate.
2.
Effect on bona fide strangers.
Lis pendens is not a lien. Instead, it is a notice which alerts all
parties to the pending action. 14 Lis pendens gives notice to all
hypothetical third parties, even bankruptcy trustees under federal
law, 15 allowing the lender to avoid any consequences that would
normally occur with a bona fide party without knowledge under
Kentucky law.
F.
Jurisdiction & Venue
1.
Circuit court.
Circuit court is the court of general jurisdiction in Kentucky. 16
Circuit court has standing over foreclosure actions as the district
court can hear neither actions against real estate, nor actions in
equity, nor actions for more than $5,000. 17 Any one of those three
limitations would move foreclosures into the circuit court.
2.
FDCPA requirement.
15 U.S.C. §1692i requires that foreclosures be filed in the venue
where the property is located, regardless of Kentucky law. This is
a unique situation in which the choice of an independent lawyer,
i.e. a debt collector, limits a party's venue to bring suit on their
claim.
3.
Standing to bring suit.
Both Civil Rule 17.01 and Kentucky case law require that the
plaintiff in a foreclosure be someone who actually holds the Note
and can enforce the mortgage. As stated by the Supreme Court,
"[O]rdinarily the real party in interest is the person who is the
beneficial owner of the cause of action sought to be prosecuted.
Where the cause of action is assignable, and the entire cause has
14
Strong v. First Nationwide Mortg. Corp., 959 S.W.2d 785, 788 (Ky. App. 1998).
15
Palmer (In re Ritchie) v. Wash. Mut. Bank, 416 B.R. 638 (B.A.P. 6th Cir. 2009).
16
Kentucky Constitution §112.
17
See Ky. Const. §113(6) and KRS 24A.120.
7
been assigned, clearly the assignee has become the owner of the
cause and he is the real party in interest." 18
Much litigation has occurred nationwide concerning standing to
bring suit, which mostly points to paperwork gaps with the
foreclosing lender, such as not having the correct assignments of
the mortgage or indorsements on the Note. However, presentation
of the original note by the lender tends to resolve these disputes.
G.
Service of Process
1.
Methods of process.
All methods of process are available in a foreclosure. However, in
order to obtain a personal judgment on the debt, most lenders
attempt service by certified mail or personal service.
A Warning Order Attorney may be appointed under Civil Rule
4.05, which allows the foreclosure to continue against the real
estate. However, any claims for personal liability on the note are
extinguished when this method of service is used. 19 The action
becomes solely in rem against the mortgaged property, which
requires the posting of a bond under Civil Rule 4.11 in order to
distribute the proceeds of the foreclosure sale.
2.
Long-arm jurisdiction.
Out of state defendants, generally corporate lienholders, may be
served by the Secretary of State if they have no local agent in
Kentucky. 20 A lienholder in Kentucky generally meets the
minimum standards for constitutional jurisdiction under KRS
454.210(2)(a)(6) because they hold an interest in the real estate
being foreclosed. 21
H.
Lienholder Rights
1.
Tax lien holders.
Tax liens assessed against the foreclosed real estate enjoy a
superior position over a mortgage. 22 As between two super-liens
of equal dignity, the proceeds of sale are shared on a pro rata
basis.
18
Louisville & Nashville R.R. Co. v. Mack Mfg. Corp, 269 S.W.2d 707, 709 (Ky. 1954).
19
KRS 454.165.
20
KRS 454.210(3).
21
See generally Hinners v. Robey, 336 S.W.3d 891 (Ky. 2011).
22
KRS 134.420.
8
2.
Senior liens.
If a defendant possesses a lien senior to the plaintiff's lien, the
senior lien cannot be disturbed without its consent. 23 This is true
even if a default judgment is taken against the senior lien, but the
senior lien objects to the foreclosure sale. 24 Because of this,
senior liens are not strictly a necessary party to a foreclosure, as a
plaintiff may choose to foreclose its own lien subject to this senior
lien without having to name it in the foreclosure.
3.
Junior liens.
Junior liens must be marshalled and released as part of a
foreclosure.
I.
Master Commissioner Referrals
1.
AOC referrals.
Many counties have standing rules which automatically refer all
foreclosures to the Master Commissioner's office. 25 In other
cases, the referral is filed by the court at the time of judgment. For
all cases, Court of Justice form AOC-141.S must be filed along
with the $200 fee required by AP Part IV, Section 1(10).
2.
Civil Rule 53.
A Master Commissioner generally acts a magistrate to the court
as well as the executing officer who sells the property. Therefore,
the actions of the Master will be governed by Civil Rule 53. The
court may refer disputed issues of fact to the Magistrate, who will
conduct hearings, take evidence, and then provide a report to the
court.
J.
Judgment and Order of Sale
1.
Default judgment.
If a party has not answered within the applicable time period, a
motion for default judgment may be filed under Civil Rule 55. This
applies equally to borrowers on the loan, titleholders to the
property, and lienholders on the property. A party who fails to
marshal their interests with the court risks having their interests
wiped away in the foreclosure.
23
KRS 426.690.
24
Mortg. Elec. Registration Systems v. MainSource Bank, 425 S.W.3d 892 (Ky. App. 2014).
25
See Jefferson Circuit Court Local Rule 5.
9
Default judgments are common in foreclosure practice, so special
attention must be given to the appropriate affidavit under the
Servicemembers Civil Relief Act to avoid foreclosing on an activeduty servicemember. 26 The court may also require evidence of
damages, although a properly pled complaint should set forward
the liquidated damages that can be accepted by the court under
Civil Rule 8.04.
2.
Summary judgment.
Given the contractual issues involved, foreclosures tend to be
good candidates for summary judgment under Civil Rule 56. A
standard motion would include an affidavit under Civil Rule 56.05
which sets forth the executed loan documents, the default on the
loan, the acceleration of the loan, and the application of payments.
The burden would then shift to the borrower to present evidence
of payment or any other defense to foreclosure. 27
3.
Judgment and Order of Sale.
While it is possible to separate the personal judgment on the loan
from the execution upon the mortgage, standard practice is to roll
both into one consolidated Judgment and Order of Sale. The
judgment should set forth the sums to be recovered on the loan,
marshal the priority of each lienholder, and set the terms of the
Master Commissioner's sale. There can be a wide variety of sale
terms, but most counties require public notice of the sale,
compliance with all provisions of KRS 426, and a judgment credit
against the bid price if the foreclosing lender is the successful
purchaser at sale.
The order of sale should also set forth the legal description for the
property, declare whether the property will be sold in whole or in
parts, and set forth whether the sale will be subject to any
easements, unpaid taxes, or other items superior to the lender's
mortgage.
K.
Master Commissioner Sales
1.
Scheduling the sale.
Many counties incorporate the sale date into the Judgment and
Order of Sale. Should the original sale be cancelled, a new
motion/order scheduling sale can be filed. In larger counties, such
as Jefferson County, sale scheduling is arranged between the
lender's counsel and the Master's office. The minimum time
26
50 U.S.C. App §521.
27
Steelvest, Inc. v. Scansteel Serv. Ctr., 807 S.W.2d 476 (Ky. 1991).
10
between judgment and sale is twenty-one days due to the
newspaper publication requirements of KRS 426.560.
2.
Appraisal of the property.
KRS 426.520(2) requires that the property be appraised by two
disinterested, intelligent housekeepers of the county, with the
Master Commissioner refereeing any disputes. The appraisal
must be filed of record before the sale, which was a recent change
in the law in 2012. This allows parties to calculate whether their
bid will trigger a right of redemption in the property.
3.
Bidding at sale.
Most judgments provide that the foreclosing lender may credit its
judgment against the bid it places at sale. This waives any
requirement to pay a deposit at sale or otherwise tender good
funds in order to bid. The lender would only pay any items senior
to its lien, such as court costs, taxes, and senior liens.
Members of the public will need to be prepared to pay cash on the
date of sale, as set forth in the County's local rules or in the order
of sale. KRS 426.705 allows a prospective bidder to post a bond
for the purchase price, although the Master must approve of the
surety. Many Masters have their own rules on how to obtain an
approved surety, which should be approved before the sale
begins. 28
4.
Assignment of bid.
A successful bidder is allowed to assign the rights to their winning
bid. Many lenders will file a written assignment of bid to transfer
the property to an entity who will hold and market the property for
them after the foreclosure ends. This allows the Master to execute
the foreclosure deed directly to the assignee, while the original
bidder fulfills any terms of the bid, such as crediting its judgment
against the bid. The order confirming the sale should likewise refer
to the assignment of bid.
L.
Confirmation of Sale
1.
Report of sale.
The Master is required to file a report listing the results of the
execution on the order of sale. This report complies with Civil Rule
53, which allows the parties ten days to lodge their objections to
the report. If no objections are raised, the lender may request that
the court confirm the outcome of the sale.
28
For example, see http://www.tmcsales.info/index.html.
11
2.
Order of Confirmation.
A foreclosure sale passes no rights until the sale is reviewed and
confirmed by the court under KRS 426.575. The order confirming
sale therefore authorizes the Master Commissioner to issue the
deed to the purchaser, or any assignee of the purchaser, as well
as distributing the proceeds of the sale as set forth in the original
judgment.
3.
Bond under Civil Rule 4.11.
As mentioned before, a constructively summoned defendant must
be protected against an improper execution against their interests
for up to one year. If the sale occurs before this one-year mark, a
bond must be filed by the purchaser. If a delay occurs between
judgment and sale, so that the sale occurs more than one year
later, no bond will be required.
4.
Post sale motions.
A variety of post-sale motions can be filed to aid in the process of
confirming the sale and distributing proceeds. Unless authorized
by local rule in advance, the Master Commissioner will move the
court to approve the sale fees, advertising fees, and other
expenses. A lender may ask for a supplemental judgment to cover
the advances made on the loan between the time of judgment and
the time of sale, as well as attorney fees incurred.
M.
Deed of Commissioner
1.
Transfer of title.
While there is no timeframe under which the deed must be
recorded, legal title passes to the grantee upon delivery. This
vests the grantee with the right to possess the property, collect
rents, and otherwise dispose of the property.
2.
Release of liens.
Unless specifically ordered by the court in the confirmation of sale,
there is no separate release of the liens named in the foreclosure.
Instead, legal title to these interests merge into the Master's deed
and transfers to the purchaser at sale. 29 Combined with the lis
pendens notice filed at the beginning of the case, this allows the
purchaser to have a title clear of all liens named in the foreclosure,
and those that arose after the lis pendens.
29
KRS 426.574.
12
N.
Right of Redemption
1.
Defendant's redemption.
KRS 426.530 creates a six month right of redemption whenever a
property fails to sell for more than two-thirds of its appraised
value. This allows the defendant to tender the purchase price of
the property to clerk of courts, together with 10 percent per diem
interest on the bid price, along with all taxes and reasonable costs
necessary to bring the property into compliance with local codes.
This is a new amendment from 2014, as the prior version allowed
for a one year right that did not require the payment of taxes or
property preservation costs incurred by the purchaser.
The right of redemption is a personal right that can be sold,
encumbered, or executed upon under KRS 426.540. Because the
right of redemption is personal to the debtor, an in rem judgment
cannot be used to execute upon the right of redemption. If the
lender bids its total debt, thereby satisfying its judgment, there can
be no further execution against the right of redemption. Best
practice would be to buy the right of redemption from the
defendant, or to wait out the six month period before marketing
the property.
The right of redemption does not stop the foreclosure or prevent
an eviction of the defendant from the property. Instead, the
Master's deed will reflect the defendant's right of redemption.
2.
United States of America.
Under federal law, the U.S. has a one-year right of redemption on
any property for which it holds an interest. That period is
shortened to 120 days if the U.S.' interests compose solely a
federal tax lien. This right exists regardless of the amount bid at
sale.
O.
Bankruptcy Considerations
1.
The automatic stay.
Upon the filing of a bankruptcy, a stay is imposed by law. 30 Actual
knowledge of the bankruptcy is not required, and actions filed in
violation of the stay are considered void. In the context of a
foreclosure, a bankruptcy is generally filed to stop a judgment or a
sale from occurring.
30
11 U.S.C. §362(a).
13
2.
Chapter 7 vs. Chapter 13.
A Chapter 7 bankruptcy seeks to discharge all debts and pay all
creditors from available assets. The bankruptcy trustee generally
will abandon the real estate from the bankruptcy if a valid
mortgage eats up all the equity in the property. The debtor then
receives a discharge of debt, converting any pending or potential
foreclosure into an in rem action on the mortgage.
In contrast, a Chapter 13 bankruptcy creates a repayment plan
that lasts up to five years. The goal of the bankruptcy court and
the trustee is to ascertain the debts due at the time of filing, the
stream of income available to the debtor, and the debtor's plan of
repayment. This puts an extended hold on any foreclosure action
given the multi-year potential of the bankruptcy plan. Long term
debt, such as a mortgage, survives the bankruptcy plan and
personal liability is not discharged. 31
P.
Loss Mitigation Alternatives
1.
Contractual reinstatement.
Kentucky law does not require the deceleration of a properly
accelerated loan. Instead, the provisions in a standard mortgage
allow the borrower to pay the arrearage on the account and cancel
the foreclosure at any point up to judgment. Although the
mortgage contract cuts off the right to reinstate at judgment, it is
universally accepted that lenders will accept a full tender of
reinstatement funds any time before a sale occurs. A full tender of
reinstatement funds includes the payment of the fees and costs of
the foreclosure, as well as any loan advances made under the
mortgage.
2.
Loan modification.
A popular option, made more common by federal programs such
as HAMP, is to modify the loan. The arrearage is capitalized into a
new principal balance, which cures the default on the loan. The
term of the loan can remain the same, or it can be re-amortized
over a longer period of time. Generally, the interest rate on the
loan is reduced to make the larger principal balance more
affordable. To be reviewed for a loan modification, a complete
package of financials disclosures is required. 32
31
11 U.S.C. §1328(a)(1).
32
24 CFR 1024.41.
14
3.
Short sale.
Many lenders will allow the borrower to sell the property and
extinguish the mortgage, even if the sales price is below the
balance due on the loan. This generally requires an arms-length
sale to a disinterested third party after a period of time in which
the property is marketed to the public. The lender will then issue a
tax statement for any debt forgiven in the short sale, which has
various tax consequences for the borrower. Congress has
previously exempted this forgiven debt from income tax, but this
provision is reviewed annually. Lenders will not take a borrower's
tax planning into account when structuring a short sale.
4.
Deed-in-lieu.
A final option is for the borrower to voluntarily transfer title to the
lender via a deed. Since this deed is outside the scope of the
foreclosure, it is not protected by lis pendens nor the marshalling
of liens. Therefore, title to the property must be clear before a
lender will agree to accept a deed-in-lieu. Non-merger clauses are
put in the deed so that the lender can foreclose its mortgage if
subsequent title search reveals a cloud on title.
15
16
NOTES
17
18