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CLIENT ADVISORY - January 1, 2008
Loan Modification Agreements After Bankruptcy: Are They Enforceable?
by Geoffrey J. Peters, Esq.
When real estate is involved in a Chapter 7 bankruptcy case, the bankruptcy code provides the debtor with two options. The debtor's two options are to either reaffirm the note and mortgage or surrender the real estate.
In order to reaffirm an obligation, the debtor must sign a reaffirmation agreement pursuant to 11 U.S.C. § 524. This agreement allows a debt to survive the bankruptcy discharge. The agreement must contain certain statutory language and must be filed with the court. In most jurisdictions, the reaffirmation agreement can be for the entire amount of the debt or a reduced portion of the debt. If a reaffirmation agreement is entered into and filed with the court, the creditor, upon the debtor's discharge, may resume collection activity. This may include contacting the debtor regarding delinquent payments, entering into loan modification agreements, forbearance agreements, or any other agreement under state or federal law.
However, if a debtor fails to enter into a reaffirmation agreement during the bankruptcy case and later requests a loan modification, the rules are not as clear. There are a number of bankruptcy decisions addressing whether a loan modification agreement is valid, absent the filing of a reaffirmation agreement. In the case In re: Heirholzer, 170 B.R. 938 (N. District Ohio, 1994), the debtor filed a Chapter 7 and was discharged from the liability on his mortgage note to the bank. In exchange for not foreclosing on the property, the debtor signed a new post petition note with the bank. Upon defaulting on the note, the debtor reopened his bankruptcy case alleging that the bank attempted to avoid the reaffirmation agreement process by entering into a post petition agreement as opposed to reaffirming through the bankruptcy court. The bankruptcy court held that the post petition note was completely separate from the discharged note since the new contract was supported by sufficient consideration. The consideration was the bank's agreement not to foreclose on the property.
However, the majority of bankruptcy decisions disagree with Heirholzer. The cases hold that a post petition agreement that involves any part of a discharged debt would be an attempt to circumvent the reaffirmation agreement process. These courts rely on the language in 11 U.S.C. § 524, the statute that provides for reaffirmation agreements, which reads, in pertinent part: "An agreement between a holder of a claim and the debtor, the consideration for which, in whole or in part, is based on a debt that is dischargeable…". These bankruptcy courts take the position that if any part of the pre-petition note that is not supported by equity in the real estate is included in a post petition obligation, the post petition obligation is void.
The safest way to proceed with real estate involved in a bankruptcy case is to enter into a reaffirmation agreement. However, if a creditor insists on having debtors sign a new agreement, the amount of the note should be for the value of the real estate. This ensures that the note is not based in whole or in part on any part of the debt that the debtor has discharged. After a bankruptcy discharge, the creditor has the ability to sell the real estate. Thus, if the note is based upon the value of the real estate, the note is not based in whole or in part of any of the discharged debt. Further, the post petition note must be executed after the bankruptcy estate abandons the collateral and relief from stay has been granted.
We would not recommend creditors to enter into new agreements with debtors. Even if the new agreement is based upon the value of the real estate, we cannot guarantee that the court will rule that the post petition agreement is valid.
Our recommendation is for a creditor to enter into a reaffirmation agreement with a debtor in the bankruptcy case. If unsuccessful, a creditor should proceed with its state court remedies in liquidating the real estate. If a debtor requests a loan modification agreement, a creditor may agree to a payment arrangement with debtor regarding future payments. However, if a debtor defaults on the agreement, we would recommend that the creditor proceed with liquidation of its real estate without attempting to collect the amounts due under the loan modification agreement. This procedure would preclude debtor from arguing that creditor attempted to circumvent the reaffirmation agreement process.
If you have any questions on this information, please contact Mr. Geoffrey J. Peters, Esq. or any of our real estate default group attorneys.
Geoffrey is a partner in the Bankruptcy department of the Columbus office of Weltman, Weinberg & Reis Co., L.P.A. He can be reached at (614) 857-4324 or via e-mail at gpeters@weltman.com.
Client Advisory is published by Weltman, Weinberg & Reis Co., L.P.A., an organization providing comprehensive creditor representation. The information contained in this advisory is a summary of legal information and is not intended to constitute legal advice on specific matters or create an attorney-client relationship. Contact any of our offices or visit our website at realestatedefaultgroup.com for more information, company facts and attorney profiles. (c)2007