After a bankruptcy discharge, what to do when mortgage holders and secured creditors go too far.

A bankruptcy discharge makes most but not all debts legally noncollectable against the person who is discharged. When despite this a creditor tries to collect the discharged debt, the result can be a lawsuit to hold the creditor in contempt for violating the bankruptcy discharge. But not all creditors are prevented from collecting or enforcing their rights.

A bankruptcy discharge does not prevent collection of debts incurred or which arose after the bankruptcy filing. It does not prevent collection of domestic support obligations (eg alimony or child support), most student loans or most taxes. It does not prevent collection of debts which have been voluntarily “reaffirmed” in the bankruptcy (typically car loans and leases)

Those creditors who hold a mortgage or collateral (eg a car loan or lease) are still allowed to enforce their rights as a lien holder. Thus, pursuing foreclosure of a home or repossession of a motor vehicle is allowed. But in these situations, a mortgage lender or other lien-holder can sometimes step over the line if they take action that goes beyond merely enforcing their rights to property, and has the effort of coercing a payment by the individual on the personal debt that was discharged.

This concept that a debt is discharged against the individual, but not against property which is collateral for the debt is difficult from some to grasp. Think of it this way. When we get a mortgage loan or a car loan, we are really making two promises. One is the “IOU” promise to pay back the debt. The other is backing that promise up by giving the lender legal rights to property, eg the home or car. The IOU is what the discharge takes away, but the lender still has the right to get and sell its collateral if the loan is not paid. After a discharge, that is all a mortgage lender has left.

So how far can a mortgage lender go? A creditor violates the discharge injunction when it: (1) intentionally takes action after a discharge, with knowledge that a discharge has been ordered and where (2) the creditor’s action  operates to coerce or harass the debtor  into paying a discharged obligation.  The First Circuit Court of Appeals defined the “objectively coercive” standard in stating that “even legitimate state-law rights exercised in a coercive manner might impinge upon the important federal interest served by the discharge injunction, which is to ensure that debtors receive a ‘fresh start’ and are not unfairly coerced into repaying discharged prepetition debts.”

The line between what is allowed and what is not is not always clear. Here are some recent examples how this might play out:

1. After the debtors had abandoned a home and a foreclosure had proceeded to the point that they no longer had any rights of ownership, a mortgage servicer violated the discharge by sending a letter, entitled “Validation of Debt”, contained information notifying the debtors of the transfer of the loan, the amounts due under the note, and pertinent information for making future mortgage payments, and later letters with additional information about the assignment,
alternatives to foreclosure, and property insurance. . Included in all but one letter was a generic disclaimer stating that  the communications were not attempts to collect debts from customers in pending bankruptcy cases, or those who had already obtained a discharge under the Code. The Maine bankruptcy court found the lender in contempt because at the time these letters were sent, they served no valid purpose served relating to enforcement of the security interest because the lender already had its collateral.

2. In another case, the lender did not violate the discharge when they refused to pursue a foreclosure to completion or to release their mortgage lien, even though this forced the debtors to incure additional expense for insurance and property maintenance.

3. In that same case, the lender did face contempt penalties for demanding payment on the mortgage loan and telling the borrowers their personal obligation to pay on the mortgage loan was not discharged in bankruptcy.

4. In another case, the creditor filed suit against the debtor’s business, naming them individually as nominal parties against whom no judgment was sought individually. Even though the suit looked to be questionable and possibly meant for harassment, this did not rise to a discharge violation. That the debtors had to take time and effort to provide discovey of facts as witnesses in the litigation, that was not enough.

The point is that mortgage lenders and secured creditors do have certain rights, but sometimes they go too far. When that happens it is time to seek legal advice.



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