Restructuring

Contributed by Blaire Cahn
We have previously written about the efforts by courts nationwide to crack down on mortgage lenders with inadequate documentation practices.  The recent case of In re Accredited Home Lender Holding Co., No. 09-11516, 2011 WL 304588 (Bankr. D. Del. Jan. 28, 2011), decided by the United States Bankruptcy Court for the District of Delaware, cautions that lenders who file for bankruptcy protection must nevertheless still answer to their borrowers for their questionable lending practices.
In January 2005, Eugene C. Smalls obtained a mortgage from Accredited Home Lender Holding, Inc., a lender focused on the subprime mortgage market.  Four years later, Accredited Home and four of its affiliates sought bankruptcy protection, and Smalls filed a general unsecured claim against the debtors for $850,000 alleging fraud, wrongful foreclosure, and violations of state and federal laws in connection with the mortgage.  The debtors filed an omnibus objection to the claim asserting that the debtors had no liability to Smalls under applicable law.
In his response to the objection, Smalls listed the debtors’ parade of horribles in recounting his experiences with them.  Smalls stated that the debtors improperly initiated foreclosure proceedings against him before he was three months in arrears (thus violating HUD regulations), failed to produce original loan documents, failed to apply correctly the payments he mailed them, coerced him into signing a forbearance agreement (which the debtors never countersigned), charged him attorneys’ fees that were not allowable under state law (and exceeded the attorneys’ actual fees), illegally listed his home as being in foreclosure (causing him emotional distress), coerced him into refinancing at a higher rate (and charged him a prepayment penalty when he did), and provided inaccurate reporting to his credit agencies.
Although the court sided with debtors with respect to some of the arguments that Smalls made – finding, for example, that there was no private cause of action for violating HUD regulations and that the debtors’ failure to countersign the forbearance agreement did not preclude its enforcement – the court’s decision was not a “slam dunk,” by any means, for the debtors.  In fact, the court agreed with Smalls that the forbearance agreement could not be enforced against him because he had signed it under duress – when he signed the forbearance agreement, Smalls did not have legal representation and was being treated for post traumatic stress syndrome.  He was also facing the loss of his home, though he believed he was current on his mortgage.  Finding the forbearance agreement was not enforceable to bar the claims asserted by Smalls, the court next examined the breach of contract claims he asserted.
Smalls alleged various breaches of the mortgage agreement by the debtors.  He asserted that the debtors failed to provide him with 30 days to cure deficient payments as required by the mortgage agreement.  He testified that the first notice he received was dated June 8, 2006 and that payment of delinquent amounts were demanded on the same date.  While the debtors argued that they sent Smalls notice of their intent to foreclose in April 2006, the court relied on the testimony by Smalls that he did not receive any such notice and noted that the debtors failed to present evidence to the contrary. 
Further, Smalls contended that he sent a number of payments to the debtors, which the debtors either failed to credit against amounts owed or applied to principal and that he was not in default when the debtors threatened to foreclose in the spring of 2006.  The debtors argued that the terms of the mortgage agreement permitted them to return any payments that would not bring the loan current, including partial payments.  While the debtors did return certain of the payments, no notice was provided to Smalls prior to June 8, 2006 that the payments were not being applied to amounts owed or that partial payments would not be accepted.  The Court determined that the debtors’ actions amounted to a breach of the mortgage agreement.  The Court also found that Smalls was not delinquent in June 2006 and, as a result, ruled that the debtors were not entitled to collect attorneys’ fees from Mr. Smalls in connection with the alleged default.
Smalls also took issue with the pre-payment penalty charged by the debtors in connection with a refinancing of the mortgage in August 2007.  Although the debtors argued that Smalls refinanced the mortgage of his own accord and signed the note authorizing the penalty, the court determined that the imposition of the penalty was unconscionable in light of the debtors’ continued threats of foreclosure even after Smalls executed the forbearance agreement.  The court also determined that because the debtors forced Smalls to refinance, his claim could include the additional interest paid in connection with the refinancing.      
Finally, the court awarded Smalls a claim for damages for emotional distress and invasion of privacy as well as out-of-pocket expenses incurred in defending the foreclosure action.
Though the court allowed the claim for $116,052.04, a fraction of what Smalls originally sought, the court’s willingness to consider all of the evidence presented by Smalls (including a physician’s letter documenting the emotional distress suffered by Smalls) is a testament to the continued efforts by bankruptcy courts to achieve equitable results on a case-by-case basis regardless of whether the lender with the questionable mortgage practices is the debtor or the creditor in a bankruptcy case.