An Attorney s Options for Handling Clients in Trouble with Real Estate Aka: Forbearance to Bankruptcy and Everything in Between Erica Crohn Minchella ~ Attorney at Law 7538 St. Louis Ave Skokie, IL 60076 847-677-6772 Erica Crohn Minchella has practiced law in Illinois for more than 30 years concentrating in bankruptcy for the first 18 years and real estate transactions throughout her career. Currently, a major focus of her practice is foreclosure defense and short sales. She approaches the representation of her clients from the perspective of attempting to put them on firm financial footing, assuring that they are fully advised of their rights, obligations and the concerns they should have about future aspects of their transaction. Minchella is the President of the Association of Foreclosure Defense Attorneys in the Chicago metropolitan area. She is regularly asked to speak to lawyers on issues of Foreclosure Defense and advising clients who are facing financial challenges. She has been asked to speak for the Illinois State Bar Association, Illinois Institute of Continuing Legal Education, Real Estate Institute, Illinois Real Estate Lawyers Association, Chicago Bar Association, Lake County Bar Association and Chicago Title Seminar Series. DISCLAIMER: The following materials and accompanying Access MCLE, LLC audio program are for instructional purposes only. Nothing herein constitutes, is intended to constitute, or should be relied on as, legal advice. The author expressly disclaims any responsibility for any direct or consequential damages related in any way to anything contained in the materials or program, which are provided on an as-is basis and should be independently verified by experienced counsel before being applied to actual matter. By proceeding further you expressly accept and agree to Author s absolute and unqualified disclaimer of liability. 1 P a g e
Table of Contents Erica Crohn Minchella ~ Attorney at Law... 1 The Prospective Client... 3 Ask Your Client the Right Questions... 3 Forbearance... 4 The Loan Modification... 4 Principal Reduction... 5 Deed in Lieu... 5 The Short Sale... 5 Foreclosure Defense... 6 Negotiated Settlement with Subordinate Lien Holders... 6 Chapter 13 Lien Stripping... 7 Chapter 7... 7 Delinquency with a Homeowner s Association... 7 Chapter 11... 8 Considering the Tax Implications... 8 For Clients Purchasing a REO... 9 2 P a g e
The Prospective Client 1) When interviewing a client, how does the attorney know what they need? They come in with an idea of what they want, but it is the attorney who must determine what will work for them even if it wasn t what they thought they wanted. 2) Attorneys should be the focal point for the decision-making process. a) HUD counselors will only discuss modifications b) Real Estate Brokers will only discuss short sales. c) Lenders will only provide information that is in their best interest d) An attorney should be able to analyze for all of the alternatives Ask Your Client the Right Questions 1) What is the value of the house? 2) When was the loan taken out (1999 loans were documented very differently and better than loans made in 2006) 3) What is the structure of the debt? i) Interest rate ii) Term iii) Number of liens iv) Other liens against the property 4) What is the amount of the debt? 5) How far underwater are they? Does it make sense to keep the property if there is no value? 6) What is the attachment to the home? i) Kids in school? ii) Someone in the home disabled or dying? iii) Attachment to neighborhood? 7) Is the attachment valid i.e. does it make sense in the real world? 8) What time frames would help the homeowner solve their problems? 3 P a g e
i) Kids graduating ii) Party dying iii) Collect cash iv) Desire to relocate 9) Who is the lender? Lenders vary in their cooperation by huge degrees. Knowing who the lender is will help you determine what strategies might or might not work. Bank of America, for instance, has improved many of its programs for loss mitigation. Some smaller servicers don t have a clue or the staff to resolve a problem if they did have a clue. Forbearance Back in the old days, when a borrower went delinquent on their mortgage, the lender would occasionally agree to a forbearance agreement where the borrower would be allowed to catch up on missed mortgage payments without threat of foreclosure, over a structured, set period of time. a) This only works if the mortgage makes sense, in terms of the balance owed, the interest rate, only a few missed payments, a single event that caused the default that will not occur again, a steady cash flow that will allow for the payment. b) Generally, it is only an option for older loans. However, it is an option especially if the homeowner comes to you early enough. c) A viable strategy may be to deal with loans where the payments are not delinquent but taxes have fallen into arrears. The Loan Modification A loan should only be modified if it is worth keeping the house. Otherwise, you are subjecting the client to a loan that will never get paid down, will never give the homeowners equity, and will leave the client open to future failure or the need to negotiate a short sale. A loan modification where the house remains underwater is really nothing more than renting from the bank. 4 P a g e
Principal Reduction There are lenders who are giving principal reduction - referred to as hitting the lottery. There is no way to know why or when a lender will agree to a principal reduction. They are more common in cases where the lender is subject to the AGs settlement, but there are simply no guarantees. It is generally a better deal for both the lender as well as the homeowner, as the re-default rate for homeowners who obtain principal reduction is substantially lower than those who do not. (There is, of course, some logic to this. Who wants to keep paying for a property in which they will never see any equity? Contrarily, if a homeowner feels that every payment makes a difference in the equity they create; their motivation to stay current is higher.) Deed in Lieu The attorney should only use this when a foreclosure is imminent, the lender has rejected every short sale option the homeowner has proposed, and the owner has no interest in keeping the property. It is only slightly better for the credit report than a foreclosure, which is why the attorney should hesitate to use it. But it is still better than a completed foreclosure. It can only be used if there are no subordinate creditors because only a completed foreclosure process will foreclose out subordinate liens (e.g. won t work for Condo where there is association debt.) Check your jurisdiction as to whether a deed in lieu will absolve your client of any liability for the deficiency. The Short Sale The attorney should use this when trying to preserve the owner s credit and get a release of the liability. Other than for that, only the Broker and lawyer are compensated so there really is no other benefit to the owner. Not all lenders or second lien holders will release liability. This is a negotiated process. 5 P a g e
Foreclosure Defense (The author is from a judicial foreclosure state and can only speak from that experience. A strategy in a non-judicial state will be different based on the manner in which the lender can obtain title upon default) If the foreclosure is filed while the attorney is waiting for another solution, the attorney must review the loan documentation. Sometimes, the best solution for a homeowner is to just hang on as long as possible. It allows them to put aside funds or live on the limited funds they have for as long as possible. Sometimes they just need to get kids through a school year. Sometimes, the loan documentation is a mess and you have legitimate defenses, not just to buy time, but because the lender is not entitled to maintain a mortgage against the property. A common dilemma If the mortgage is not legitimate, aren t you still left with the debt? How do you get rid of the debt? You can t go bankrupt on it if you have a house with no lien on it If the lender obtains a judgment for the debt owed on the Note, they can get a lien against the house. Deficiency Judgments - Some lenders are now seeking deficiency judgments. Because of this the attorney should try to use short sales, DILs, and consent foreclosures as much as possible to prevent liability unless the client requires bankruptcy for other reasons. Negotiated Settlement with Subordinate Lien Holders Some second lien holders are now suing on the Note, realizing that it is unlikely that they will see any equity in the properties that they have liens against. Citi, and Harris have all done this to many clients. The attorney should attempt to settle these by offering a lump sum payment. One strategy is to remind the creditor that if the client files a chapter 13, their lien can be stripped out. The attorney can try to get the client to come up with funds equating to the creditor s amount and get in a chapter 13 over time, as a lump sum reduced based on the present value of money. Cases have been settled on the fact that there simply wasn t any other money to get, other than the amount originally offered. As an attorney, you can allow the case to go to judgment 6 P a g e
and then make the same offer originally made before judgment, advising the creditor that you are willing to put your client through a citation to discover assets. Chapter 13 Lien Stripping This is the only law that allows a mortgage only a subordinate mortgage to be stripped down to the equivalent of the current value in the property or minimally 10% of the balance of the debt. The Debtor then has to pay a percentage of that value, based on the manner in which their plan is proposed (e.g. they would pay amount of the value of the property against which the lien remains if no value remains, then they would pay 10%) This only works if the debt doesn t exceed the ceiling for secured and unsecured debts Chapter 7 Chapter 7 discharges debt and can create a problem if the Debtor wants to do a modification. If the Debtor reaffirms the debt, then they have agreed to continue on with the same mortgage and cannot discharge it if they cannot obtain a modification. Chase, for instance, will generally not discuss a modification with a bankruptcy pending although there should be no reason for them not to. Under HAMP it is improper for them to ask for a reaffirmation in order to modify. Discharging other debt may make the mortgage payment affordable. Delinquency with a Homeowner s Association Having a homeowner that is delinquent with their mortgage creates other issues when they are also delinquent with the homeowner s association. As an attorney, you should almost always advise clients to remain current with dues. If the dues are not current you can t sell, do a DIL or a consent foreclosure. If the dues are not current, the homeowner can lose possession and could wind up with a personal judgment. 7 P a g e
If the homeowner is trying to sell and there is a special assessment, the attorney may need to negotiate who will be responsible for the payment of the SA as part of the purchase price of the property. Chapter 11 An attorney should use Chapter 11 for single asset investors or other real estate investors. Generally the plan is to allow the orderly liquidation of the real estate, instead of the forced liquidation the bank is requiring. Or, alternatively, if there is a property worth saving and it would just take some time to cure payments, a chapter 11 will allow for that. A Chapter 11 is a great defense to a motion for the appointment of a Receiver. i) The Chapter 11 Debtor is the Debtor in Possession, which is the equivalent of being the Trustee ii) Unless the Debtor in Possession is engage in criminal or fraudulent activity, there is no basis for appointing a Trustee, so the Debtor remains in the position of the Trustee i.e. the Receiver. iii) There are generally only two other defenses to appointment of a Receiver (a) Refinancing is imminent i.e. days away (b) It is not likely that the Plaintiff can prevail on the case. Chapter 11s can also be used for a debtor whose debts or assets are too high and they don t qualify for a Chapter 13. Considering the Tax Implications There is no forgiveness of debt tax obligation on personal residence through 12/31/2013 provided that funds were used for purchase or repair of property. There is no forgiveness of debt tax obligation if insolvent at the time of the debt forgiveness insolvency can mean different things to different investors consult the tax professional. 8 P a g e
Any other forgiveness of debt can cause a tax obligation. i) It is better to have a tax obligation on 1/3 of the debt forgiven than to have the entire deficiency still owing. ii) On the other hand the deficiency would be dischargeable in Bankruptcy, the taxes wouldn t be dischargeable for 3 years after filing of return acknowledging obligation. For Clients Purchasing a REO An attorney must check the docket or the court file to determine: 1) Does the defendant appear to have been properly served? 2) Did the defendant submit to jurisdiction and defend? 3) If not, is there a chance a Defendant will return later to claim an interest in the property? Review title closely: 1) Check real estate tax bills to assure no lingering past bills that aren t showing up (did a previous tax purchaser keep paying bills going forward so it doesn t appear that the taxes are in default?) 2) Was the deed by foreclosure or was it a Deed in Lieu? If a DIL, you must do your own due diligence, as there can be claims against the property about which the lender had no idea e.g. condo assessments. 3) Is the property a Single Family Home or Condo? Is there a Homeowners Association that could make a claim for arrears or special assessments? 4) Is the lender making unreasonable demands given the condition of the property? (Read: tell the client to walk away ) 5) As an attorney you should insist the client gets an inflation endorsement to their title insurance policy and if they are going to do any repairs, a construction endorsement. 9 P a g e