Bankruptcy Questions Answered

Can You be Sued for Non-payment of your Mortgage if You Do Not Reaffirm?

I recently received an email from a blog reader asking about his obligations to his mortgage company when he does not reaffirm:

I have read your blog and you are very through so I write you with hopes that you might answer this question for me. I file Chapter 7  in 08, and did not reaffirm my loan. I am still living in the house and did make some payments. However, i have not for the last 8 months. It is my understanding that I must sign a document to reaffirm and that continuing payment in itself is not a reaffirmation…or?  Well it gets a little more complicated.  My house is valued at $410,000 and the bank has offered me a deal that is going to be hard to refuse. They have agreed to let me do a short re-fi in the amount of 180k.  If I agree to that is that in itself a reaffirmation?

Here is my response: in most cases, when you take out a mortgage loan, you are signing two different types of agreements.  The first type is a promissory note whereby you personally agree to make the payments.  The second type of obligation creates a property lien, meaning that you, as the owner of the property, pledges that property as collateral for the loan.

When you file a Chapter 7 and receive your discharge, your personal obligations are extinguished.  However, a Chapter 7 discharge does not eliminate the mortgage company's lien against your property.  If you "reaffirm" your mortgage, you are actually reaffirming the promissory note and your personal obligations to pay.

For years, many bankruptcy attorneys advised their clients to avoid signing reaffirmation agreements for mortgages, car loans or any other secured debt.  The reasoning – even without a personal "guarantee" lenders are protected by the property lien.  If the lender is willing to accept payments (the so-called "stay and pay" option), the now discharged debtor keeps his property, keeps making payment, but does not have personal liability on the note.

If the debtor misses payments, the lender would still have the right to foreclose or repossess based on the property lien.  The debtor would not have personal liability for any foreclosure or repossession deficiency because his personal liability was extinguished in the bankruptcy.

There is a downside to this "stay and pay" strategy.  First, the debtor does not get any credit report benefit for making payments.  Because the debtor's personal obligations have been extinguished, the lender no longer reports either a positive or a negative payment history.   A positive payment history from a mortgage company can be a good way to restore credit after bankruptcy, and if you do not reaffirm, you will not get this benefit.

Second, there is the "uncertainty factor" if you do not reaffirm.  Most mortgage or vehicle finance installment notes contain a default provision that includes bankruptcy as a default trigger.  In theory, at least, once your bankruptcy is closed (and the automatic stay of bankruptcy terminated), your lender could declare your loan in default and take action under State law to recover the collateral.  In my experience, lenders would much rather have monthly payments than your collateral but this risk does exist.

Finally, many of my readers have asked me if there is such a thing as "constructive reaffirmation" meaning that by making payments, are you in effect re-obligating yourself?  Are you creating a contractual obligation by your actions?

I think that the answer to this depends on State law but I would suspect that a mortgage or vehicle lender would have a hard time making this argument.  In many States (such as in Georgia) a financial obligation related to real estate must be written and they must have specific terms.  As a matter of general contract law, a contract usually will not be enforceable if its terms are not specified.   I would argue therefore that a debtor's actions of simply making payments and the lenders actions of accepting such payments should not be enough to create personal liability on the part of the debtor.  I would be interested to know if any of the attorneys who read this blog have a different opinion or if anyone is aware of any case law that says otherwise.

At a minimum, if a lender tries to make the argument that you have somehow re-obligated yourself personally by your act of making payments, I would insist that the lender provide you with case law or other support for its position, and you should consult with a lawyer before agreeing to any payment or taking any action (like signing a new, valid contract) that could create personal liability.

My reader states that his lender has proposed a refinance for $180,000.   He did not say, but I presume that his prior (discharged) mortgage was much higher than this and that his current payments under the "stay and pay" are based on this higher balance.  If he enters into a mortgage contract for $180,000, that contract will function like any other mortgage – and include both personal liability under a promissory note as well as a property lien.   It is not a reaffirmation because the bankruptcy is over – instead, the proposed $180,000 loan deal is equivalent to a new mortgage.  This proposed deal could result in lower payments plus positive credit history, but it will also create personal liability that currently does not exist.  I would certainly advise my reader to discuss his options with an attorney so that he will fully understand the implications of his decision.

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Does Your Landlord have any Obligations to Mitigate Damages if You Breach Your Lease?

Not surprisingly, I get calls from small business owners who are contemplating personal bankruptcy when their businesses fail.  There are many issues that arise in these types of cases but I would like to focus on one problem that, more than any other, can force the business owner into bankruptcy.

Generally when the owner of a small business leases retail space, the landlord will demand a personal guarantee.  This means, of course, that in the event of a default, the business (which may be a corporation or LLC) faces liability and the business owner personally faces liability.

Given this reality, every small business owner should seek counsel to discussion asset protection options before starting his business, but that is a topic for another day.

If the business fails you might be surprised to learn that the landlord does not necessarily have to take any steps to "mitigate damages" by releasing the retail space.  Instead, the landlord can demand payment for the full value of the lease from the business owner personally.  If the business owner has a house with $100,000 of equity, that equity is therefore at risk, and given that Georgia's bankruptcy exemption statute is stingy ($10,000 for an individual or $20,000 for a married couple filing jointly), bankruptcy may not offer much protection.

I ran across two helpful resources that go into more detail about the landlord's obligations or lack thereof.  The first is a blog post from Atlanta lawyer David Pardue in his Georgia Real Estate Litigation blog.  In his post, David discusses a recent Georgia Court of Appeals case called Sirdah v. North Springs Assocs., LLLP, which was decided by the Court of Appeals in June, 2010.  In the Sirdah case, the Court restated its previous holding that a landlord is under no duty to mitigate damages unless (1) the landlord accepts the tenant's surrender, or (2) the tenant successfully terminates the lease.  In the Sirdah case, the tenant returned his keys to the landlord and argued that by accepting the keys, the landlord accepted the tenant's surrender.  The Court said that accepting the keys did not constitute an acceptance of the surrender.

Another helpful resource is a more extensive article written by attorney Stephanie Everett of the Bloom Law Firm in Atlanta.  In this paper, Stephanie examines the various scenarios that could arise when a tenant breaches a lease and the resulting consequences.  Although Stephanie's article is written for the benefit of landlords, tenants will find the information very helpful as well.

As the law in this area could change, you should not rely on these resources in the absence of counsel.  If you are a small business owner and you are coming to the realization that your business may not survive, you would be wise to consult with a lawyer to discuss your options both in business and in terms of bankruptcy.  I have seen far too many business owners who simply left and discovered after the fact that their bankruptcy options were limited, or too painful.

Posted in 1, Business, David Pardue, General consumer bankruptcy info, Georgia Bankruptcy, Protected property issues, Sirdah v. North Springs Associates, a, accepted, accepts, and, appeals, assocs, breach of lease, breaches, called, case, consequences  , damages, duty, faces, landlord, lease, lease  , leases, liability, liability given, llc, mitigate, mitigation of damages, north, owner, personally, resulting, retail, retail lease and personal liability, sirdah, small, space, springs, successfully, tenant, terminates, the, v | Comments Off