Bankruptcy is an option when the foreclosure process has progressed to the point that constructing a workout is no longer feasible or all efforts to find a resolution have failed. In my practice, bankruptcy is often the only remaining option where a default judgment has been entered in the foreclosure case, a sheriff’s sale has been scheduled and the lender stated it is unwilling to pull the sale in order to give the parties more time to modify the mortgage loan. Bankruptcy can be used to halt the sale and either put the loan back on track (where employment conditions have improved) or discharge unsecured obligations that may be getting in the way of a loan modification. At the very least, the automatic stay in bankruptcy buys the debtor some time to reorganize and potentially work something out with the lender.
However, it is important to keep in mind that a bankruptcy petition must be filed in good faith. The classic example of bad faith in the context of foreclosure involves a debtor filing serial Chapter 13 bankruptcy petitions in order to stay in the house rent-free. Under this scenario, the debtor has filed and the mortgage lender responds by filing a motion to lift the automatic stay. The debtor then dismisses the action, only to re-file when the foreclosure again reaches to point of a sheriff sale. The second filing would be presumed to be in bad faith.
Determine under which chapter to file
Presuming the client is acting in good faith, the attorney must determine under which chapter to file in order to achieve the client’s goal of saving the home. If the client got into trouble with bills but now has the wherewithal to pay both the regular mortgage payment and a plan payment to the trustee, a Chapter 13 reorganization may be an option. However, if it is not feasible for the client to put together such a plan and household income is below the median, a Chapter 7 liquidation may clear out sufficient unsecured debts for the lender to rethink a loan modification request. If the latter tack is chosen, it is extremely important to be in close contact with the mortgagee and begin the application process immediately. The lender will require a consent form filled out by the client, giving the attorney the authority to speak directly with the company about the loan.
If a Chapter 7 filing is necessary, the client should be on notice that the lender has the option of filing to lift the automatic stay at any point. In fact, this may happen even if there is a pending application for a loan modification. But a debtor should not allow this dissuade him or her from applying. And it does not mean that the lender has decided not to offer a loan modification package. It just means that the mortgagee is pursuing judgment in order the minimize the time necessary to get the property sold should the debtor decide to surrender the house, should the household income dry up and make a loan modification unfeasible, or should the debtor get a package but fail to make required payments on time during the probationary period.