In response to the financial crisis, New York enacted new legislation requiring mandatory settlement conferences in foreclosure actions during which the foreclosing lender and the borrower must negotiate, in good faith, to determine if any foreclosure alternatives are available to the defendant borrower. However, that law conflicts with the prohibition in the Bankruptcy Code against a creditor taking any act that can be construed as trying to collect a discharged debt from a debtor. Thus, if a foreclosure action is commenced against a borrower who previously received a discharge on their mortgage loan debt, the lender is left with a “Catch 22″: comply with the CPLR and risk violating the Discharge Injunction, or vice versa.
CPLR 3408 was enacted in 2009 to address the mortgage crisis in New York, see N.Y. State Senate Introducer’s Mem. in Support, L. 2008, ch. 472, at 9, and was intended to provide “assistance to homeowners currently at risk of losing their homes by providing additional protections and foreclosure prevention opportunities” and provide “the homeowner [an additional] opportunity to reach resolution with the lender early in the foreclosure process … .” Id. at 10. As is relevant here, CPLR 3408 requires the parties engage in settlement discussions before the court to determine if the “parties can reach a mutually agreeable resolution to help the defendant avoid losing his or her home.”
CPLR 3408 states, in relevant part, that
[i]n any residential foreclosure action involving a home loan … in which the defendant is a resident of the property subject to foreclosure, … the court shall hold a mandatory conference … for the purpose of holding settlement discussions pertaining to the relative rights and obligations of the parties under the mortgage loan documents, including, but not limited to determining whether the parties can reach a mutually agreeable resolution to help the defendant avoid losing his or her home.
The statute has also been interpreted to require the foreclosing lender to stay its pursuit of in rem relief while these conferences are held, see 22 NYCRR 202.12-a(7) (“Motions shall be held in abeyance while settlement conferences are being held pursuant to this section.”), and instead, for foreclosing plaintiffs to focus on whether an agreement can be reached to provide a borrower who is living in the property being foreclosed an opportunity to remain in the home.
Bankruptcy Code §524
11 U.S.C. §524(a)(2) of the Bankruptcy Code (11 U.S.C. §101, et seq.) prevents a lender from pursuing a debt against the borrower personally, providing that it
operates as an injunction against the commencement or continuation of an action, the employment of process, or an act, to collect, recover or offset any such debt as a personal liability of the debtor, whether or not discharge of such debt is waived; …
However, there is a carve out to the “Discharge Injunction” above, or “Safe Harbor,” provided by §524(j) of the Bankruptcy Code, which was added to the Code in 2005, that permits a creditor (e.g., a lender) with a secured interest (e.g., a mortgage) in the principal residence of a discharged debtor to engage in acts, in the ordinary course of business, seeking or obtaining periodic payments associated with a valid security interest (e.g., a loan modification agreement); but only in lieu of pursuit of in rem relief (i.e., a foreclosure).
Conflict Between CPLR 3408 And Bankruptcy Code §524
This Safe Harbor should protect lenders when they send communications relating to administration or loss mitigation of mortgage debt, even when personal liability for the mortgage debt has been discharged, prior to the pursuit of in rem relief. The question remains, however, if a lender is still protected once they pursue their in rem rights by commencing a foreclosure action and, particularly, how this protection applies in mandatory CPLR 3408 conferences, where lenders are required to engage in loss mitigation negotiations; or if by engaging in CPLR 3408 conferences, the lender risks a Discharge Injunction violation if it is deemed to be seeking to collect a debt against the borrower as a personal liability.
To read §524(j) as protecting communications during 3408 settlement conferences is consistent with the intent behind 524(j). During the debate in the U.S. House of Representatives on April 14, 2005, Congressman Lee Terry of Nebraska stated the following with respect to proposed §524(j) (§202 of the House Bill):
Mr. Speaker, in pertinent part, section 202 of S. 256, the “Bankruptcy Abuse Prevention and Consumer Protection Act of 2005,” amends section 524 of the Bankruptcy Code by making the discharge injunction inapplicable to certain acts by a creditor having a claim secured by a lien on real property that is the debtor’s principal residence, so long as the creditor satisfies certain criteria. First, the creditor’s act must be in the ordinary course of business between the creditor and debtor. Second, such act is limited to seeking periodic payments associated with a valid security interest in lieu of pursuit of in rem relief to enforce the lien.
Section 202 is intended to reassure these secured creditors that if consumer debtors want to continue making voluntary payments so they can keep their principal residences, then secured creditors may take appropriate steps to facilitate such payment arrangements, such as continuing to send monthly billing statements or payment coupons. Moreover, despite the express reference in this provision to liens on real property, §202 should not, by negative inference or implication, be construed as limiting any rights that may have developed through existing case law, or otherwise, that permit secured creditors to send, or consumer debtors to request and receive, monthly billing statements or payment coupons for claims secured by real or personal property.
151 CONG. REC. H2074 (daily ed. April 14, 2005) (statement of Rep. Lee Terry) (citing In re Ramirez, 280 B.R. 252 (C.D. Cal. 2002); Henry v. Assocs. Home Equity Servs. (In re Henry), 266 B.R. 457 (Bankr. C.D. Cal. 2001)).
It appears from the foregoing that Congressional intent was to make the Safe Harbor available to facilitate arrangements between secured creditors and debtors for the making of voluntary periodic payments by debtors so they could keep their principal residences. This intent is wholly consistent with CPLR 3408, which is also intended to facilitate negotiations relating to modification agreements so debtors can keep their principal residences. Communications and information regularly exchanged in 3408 conferences run the risk of being construed as attempts to collect personally against a discharged debtor, particularly because these negotiations often include modification of loan amounts in excess of the value of the secured property. Thus, there is some risk that the creditor’s loss mitigation efforts will be viewed as wrongfully seeking to enforce a discharged debt, even though participation in 3408 conferences is mandatory and is in lieu of the proceeding with a foreclosing lender’s action to enforce the lien.
The reasonable solution for this apparent conflict is for bankruptcy courts faced with a sanctions motions based on post-foreclosure filing loss mitigation solicitations to apply 524(j)’s Safe Harbor, even after a foreclosure action is filed, provided the solicitations are in furtherance of borrowers retaining their home, and not a disguised effort to collect the personal discharged debt.1 This Safe Harbor should extend at least until a lender is “released” from CPLR 3408 conferences, and is relieved of the CPLR’s mandatory loss mitigation obligations (though many courts consider this obligation ongoing through the entirety of the foreclosure action). Such an application is supported by the legislative history creating the Safe Harbor which states, in pertinent part, that it is intended to “reassure these secured creditors that if consumer debtors want to continue making voluntary payments so they can keep their principal residences, then secured creditors may take appropriate steps to facilitate such payment arrangements … .”
At least one New York bankruptcy court, however, has reopened a closed bankruptcy for the purpose of permitting the debtor to file a motion for sanctions based on, inter alia, information provided to him by his foreclosing lender during 3408 settlement conferences. A finding against the lender on this issue could have a chilling effect on loan modification negotiations for any discharged debtor that later is the defendant in a mortgage foreclosure; a lender will need to weigh the importance of providing information to and requesting sufficient information from the debtor defendant to fully analyze foreclosure prevention alternatives due to concern that communications, even with disclaimers, could be construed as an attempt to collect discharged debt in violation of the Discharge Injunction. This could prejudice debtor defendants from enjoying the full benefit intended by CPLR 3408 while placing lenders in the precarious position of trying to comply with New York state statutory requirements to provide information and engage in mandatory negotiations while having to toe an unclear line with respect to how a communication could later be construed by a reviewing bankruptcy court.
Adding to this unenviable position, foreclosing plaintiffs risk a “bad faith” finding for failing to comply with their duties under CPLR 3408 if a state court determines they did not properly engage in the totality of the negotiation process during and even after “release” from mandatory 3408 settlement conferences. This is hardly the environment that fosters meaningful settlement negotiations and the tension that could be created by a ruling narrowly applying the Safe Harbor provided by 524(j) could hinder the very purpose both CPLR 3408 and 524(j) were intended to serve.
Lenders are left with a dilemma—comply with CPLR 3408 and risk a Discharge Injunction violation, or refuse to engage in loss mitigation in a New York foreclosure action, and risk sanctions for “bad faith.” The simple solution, and that which complies with Congressional intent, is to apply the §524(j) Safe Harbor to communications during CPLR 3408 conferences.
1. Though “short sales” where the lender agrees to permit the borrower to sell the home and accept less than the full amount owed in satisfaction of the lien are often discussed in 3408 conference, these negotiations would not fall under the category of “periodic payments”. Thus, communications relating to a short sale are more at risk of being construed as a violation of the discharge injunction, even if the Safe Harbor applies.