NUTS AND BOLTS OF A FORECLOSURE ACTION

Sponsor: Young Lawyers Division CLE Credit: 1.0

Wednesday, June 17, 2015 2:25 p.m. - 3:25 p.m.

Elkhorn A-D Lexington Convention Center

Lexington, Kentucky

A NOTE CONCERNING THE PROGRAM MATERIALS

The materials included in this Kentucky Bar Association Continuing Legal Education handbook are intended to provide current and accurate information about the subject matter covered. No representation or warranty is made concerning the application of the legal or other principles discussed by the instructors to any specific fact situation, nor is any prediction made concerning how any particular judge or jury will interpret or apply such principles. The proper interpretation or application of the principles discussed is a matter for the considered judgment of the individual legal practitioner. The faculty and staff of this Kentucky Bar Association CLE program disclaim liability therefore. Attorneys using these materials, or information otherwise conveyed during the program, in dealing with a specific legal matter have a duty to research original and current sources of authority.

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TABLE OF CONTENTS The Presenter .................................................................................................................. i Nuts and Bolts of a Foreclosure Action ........................................................................... 1

Foreward ............................................................................................................. 1 Introduction .......................................................................................................... 2 Foreclosure Process ............................................................................................ 3

THE PRESENTER

Bill L. Purtell Lerner Sampson & Rothfuss LPA 120 East Fourth Street, Suite 800

Cincinnati, Ohio 45202 (513) 619-6522

Bill.purtell@lsrlaw.com BILL L. PURTELL is an attorney with Lerner Sampson & Rothfuss LPA in Cincinnati and practices in the areas of foreclosure, real estate and collections. He received his B.A. from Thomas More College and his J.D. from the University of Cincinnati College of Law. Mr. Purtell is a member of the Kentucky, Ohio and Sixth Circuit – Federal Bar Associations. He is also a member of the Legal Aid Society of Cincinnati – Volunteer Lawyers Project, Mortgage Bankers Association and USFN Attorney Network.

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NUTS AND BOLTS OF A FORECLOSURE ACTION Bill L. Purtell

I. FOREWARD

A Kentucky lawyer sought to foreclose a loan for a client who had a mortgage on a parcel split from an old family farm. The Master Commissioner's report stated that the foreclosure would be recommended if the lawyer could prove satisfactory title to the parcel of property split from the master deed. The title to the original farm dated back to 1792, which took the lawyer three months to track down. After sending the information to the Master Commissioner, the lawyer received the following report:

Upon review of the memorandum adjoining your client's motion for judgment, I note that the request is supported by an Abstract of Title. While I compliment the able manner in which you have prepared and presented the application, I must point out that you have only cleared title to the original deed back to 1792. Before judgment can be recommended to the Court, it will be necessary to clear the title back to its origin.

Annoyed, the lawyer filed an objection to the report as follows:

Your report regarding title in Case No. 15-CI-01234 has been received. I note that you wish to have title extended further than the 213 years covered by the present Abstract of Title. I was unaware that any educated person in this Commonwealth would not know that Kentucky seceded from Virginia in 1792, the year of origin identified in our motion for judgment.

For the edification of the Commissioner's office, the title to the land prior to Virginia's statehood was obtained from England, which had acquired it by Right of Conquest from Spain. The land came into the possession of Spain by Right of Discovery made in the year 1492 by a sea captain named Christopher Columbus, who had been granted the privilege of seeking a new route to India by the Spanish monarch, Isabella. The good queen Isabella secured the blessing of the Catholic Church, through its pontiff the Pope. The Pope is the emissary of Jesus Christ, the Son of God. God is credited with being the creator of the world, including, one presumes, Kentucky and Virginia. God, therefore, would be the owner of origin and His origins date back to before the beginning of time, the world as we know it, and the public records available to the plaintiff. I hope you find God's original claim to be satisfactory.

Now, may we have our judgment?

The order of sale was granted.

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II. INTRODUCTION

Foreclosure is…Forbidden?

"Foreclosure of a mortgage is forbidden" – KRS 426.525 (2012). This seemingly straightforward statement does not actually mean that foreclosures do not occur in the Commonwealth of Kentucky. It bans the use of "strict foreclosure," which is a non-judicial method of recovering the mortgaged property by self-help.1 These non-judicial methods are actually the more prevalent type of foreclosure nationwide.2 An aggrieved creditor in Kentucky may bring an action in equity to enforce the mortgage and request a sale of the secured property. This is a judicial action that requests a finding that the covenants of the mortgage have been breached and asks that the property be sold to pay all lienholders in their order of priority. As a judicial action, creditors are free to bring as many other claims as they possess against the defendants, including money damages under a contract or promissory note, marshalling of liens against other creditors, as well as claims to reform scriveners errors in the loan documents. A foreclosure is real litigation which follows all the rules of civil procedure applicable to other civil actions. The main difference is that the rendering of a final, appealable order is merely the half-way point of the action. The true goal is the sale of the property, the disbursal of proceeds to the various creditors, and the issuance of a foreclosure deed. The most common type of foreclosure arises from a traditional lender-borrower relationship. A homeowner seeks a loan from a bank, secured by a mortgage, in order to purchase or refinance a piece of real estate. However, foreclosures also exist for mechanics lien holders, condominium associations, and judgment lien creditors. The foreclosure process is the same, but attention in this presentation will be given to foreclosure of consensual mortgages. For more detailed information about Kentucky foreclosure law, please see the monograph Foreclosure Actions in Kentucky by Gregory D. Pavey and Lea Pauley Goff (UK/CLE 2005, 1st ed.).

1 See Sebastian v. Floyd, 585 S.W.2d 381 (Ky. 1979), Watkins v. Eads, 2014 WL 2154901 (Ky. App. May 23, 2014). 2 Twenty-eight of fifty states use a non-judicial method. Source: Mortgage Bankers Association, http://www.mbaa.org/files/resourcecenter/foreclosureprocess/judicialversusnon-judicialforeclosure.pdf .

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III. FORECLOSURE PROCESS

A. Loan Documents

1. Promissory Note.

Most mortgages secure the payment of negotiable instruments under KRS 355.3-104. The Note is the primary loan document which determines who is authorized to bring the foreclosure. The mortgage is simply a secondary document which accrues to the benefit of the noteholder.3

2. Mortgage.

Most residential mortgages are drafted using the Fannie Mae/Freddie Mac uniform mortgage template,4 which contains the standard clauses used in the mortgage industry, including the rights and remedies upon default. Mortgage Electronic Registration Systems, Inc. (MERS) is the most common mortgage holder in the Commonwealth of Kentucky, being nominated as the holder of record by the borrower on behalf of the lender, its successors and assigns.5

3. Assignments.

While the noteholder has equitable rights to enforce the mortgage,6 the better practice is to record an assignment of mortgage under KRS 382.365. This is generally when MERS will assign its title interests to the foreclosing noteholder.

B. Pre-Foreclosure Compliance

To accelerate a loan is to call all the payments due immediately, eliminating any further monthly payments. The entire balance becomes payable at once, which allows the foreclosure sale to fully satisfy the mortgage debt. Acceleration is not automatic, and may be governed by a host of different rules and requirements, all of which should be met before filing a foreclosure.

1. Contractual acceleration.

Kentucky law does not require any specialized notice or warning before a foreclosure may be filed. Therefore, the terms of the note

3 Stevenson v. Bank of America, 359 S.W.3d 466 (Ky. App. 2011). 4 https://www.fanniemae.com/singlefamily/legal-documents. 5 http://www.mersinc.org/. 6 See Stevenson v. Bank of America, 359 S.W.3d 466 (Ky. App. 2011).

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and mortgage generally dictate any pre-foreclosure compliance. The standard Fannie Mae/Freddie Mac uniform loan documents grant a thirty-day period in which the borrower must be notified in writing of the default on the loan and given a chance to pay the arrearage in full. However, if some other mortgage template is used by the lender, there is no requirement to include any prerequisites to acceleration of the loan once a default occurs.

2. CFPB regulations.

In 2014, the Consumer Financial Protection Bureau issued a set of federal regulations which changed much of the industry practices for acceleration. Under 24 CFR 1024.41(f), the first legal action for foreclosure (in Kentucky, the complaint for foreclosure), cannot be filed until the loan is at least 120 days delinquent.

3. FHA/VA regulations.

The Federal Housing Administration and Veterans Administration have their own loan programs, for which a set of federal regulations apply. These rules are usually incorporated by reference into the loan documents themselves, which then become binding between the borrower and the lender. This includes specific rules on when and how a lender may accelerate a loan after a default occurs.7

C. Case Referral

A lender generally refers foreclosure actions to unaffiliated outside counsel in order to recover the fees/costs of the foreclosure under KRS 411.195. Standard mortgage documents allow for the collection of reasonable attorney fees. Even if a foreclosure is not filed, there are fees incurred when counsel opens the file, reviews the loan documents, and otherwise prepares the case for filing.

1. Title search.

The final goal of a foreclosure is to deliver clear and marketable title to the purchaser at sale. Therefore, a foreclosure is only as good as the title search underpinning it. KRS 426.006 requires the joinder of all parties who have a claim in the real estate, and title searches can vary in length; forty plus years, fifteen years, or just a current owner search. There is no requirement to file the title search with the Court, or to insure the status of title, so Kentucky foreclosure deeds come with no guarantee of clear title.8

7 For example, 24 CFR 203.604. 8 Columbia Life Ins. Co. v. Smith, 271 Ky. 133 (Ky. 1937).

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2. FDCPA compliance.

Filing a lawsuit against a consumer is considered debt collection under the Fair Debt Collection Practices Act.9 Therefore, the attorney handling the case must send a letter to the consumer providing the required disclosures under 15 U.S.C. §1692g. This requirement is independent of the lender's claims against its borrower.

D. Complaint Preparation

1. Claims for foreclosure.

A standard foreclosure contains two counts: one for liability on the promissory note, and a second count to foreclose the mortgage based on the default in the note. Copies of the loan documents would be attached as exhibits to set forth the terms of the contract, the parties to be held liable, and the description of the mortgaged property.

For count one, Civil Rule 9.03 allows a generalized statement to be made that all conditions precedent to acceleration of the loan have been performed. This count should also set forth the default on the loan and the current balance owing. For count two, a special provision of Kentucky law requires a statement concerning whether the property may be divided, such as a farm, without materially impairing the value of the property and the plaintiff's lien.10 Most residential properties are indivisible in this regard, since the bulk of the value resides in the house sitting upon the property. Count two is also where the other lienholders of record would be listed.

2. Necessary parties.

The borrowers on the loan are necessary parties to the personal liability count. For the foreclosure, KRS 426.006 requires the joinder of all lienholders who have an interest in the property. These are the easiest parties to identify and serve. Spouses in Kentucky have dower rights in the real estate owned by their spouse.11 However, these rights only vest at death, are eliminated in the event of a divorce, and are defeated by purchase money mortgages or pre-existing mortgages.12 This is where the

9 Heintz v. Jenkins, 514 U.S. 291 (1995). 10 KRS 426.685(2). 11 KRS 392.020.

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exceptions tend to overcome the rule, making spouses unnecessary parties in most foreclosures unless they separately signed the promissory note or hold title to the property. If the United States holds an interest in the property, either through an IRS tax lien or through some other agency, special rules apply to the complaint. 28 U.S.C. §2401(b) requires the U.S. to be named and served both through the U.S. Attorney General in Washington, D.C., as well as through the local District Attorney for that area of Kentucky. This statute also provides the U.S. with sixty days to respond to the complaint instead of the usual twenty days. A copy of the U.S.'s interest in the land must be attached to the Complaint, beyond mere notice pleading.

Surprisingly, the one party who is unnecessary to a foreclosure is the current occupant of the property.13 A holder of a recorded lease may be necessary, but the common residential tenant with an unrecorded lease is not necessary to marshal and foreclose the lender's mortgage. The sunset provision of the federal Protecting Tenants at Foreclosure Act has occurred; therefore there are no further protections for tenants under Kentucky law.

3. Additional relief.

Being a judicial action, a lender may ask the court for further legal or equitable relief during the pendency of the foreclosure. This could range from reforming errors in the loan documents, to resolving competing priority claims between lenders, to requesting a receiver to manage the property. Most commonly, these additional counts are used to clear up any defects in the title so that the court can order a sale which will pass good and clear title to the property.

E. Lis Pendens

1. Notice of action.

KRS 382.440 states that "No action…commenced or filed in any court of this state, in which the title to... real property…is in any manner affected or involved…shall in any manner affect the right, title or interest of any subsequent purchaser, lessee, or encumbrancer of such real property, or interest for value and without notice thereof, except from the time there is filed, in the office of the county clerk…a memorandum stating: (a) The number of the action, if it is numbered, and the style of such action or proceeding and the court in which it is commenced, or is pending; (b) The name of the person whose right, title, interest in,

12 KRS 392.040. 13 McEwan vs. EIA Properties, LLC, 428 S.W.3d 633 (Ky. App. 2014).

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or claim to, real property is involved or affected; and (c) A description of the real property in the county thereby affected."

Therefore, the filing of the lis pendens notice is an essential step in making sure that the foreclosure deed passes a good title that is unaffected by any post-complaint matters affecting the real estate.

2. Effect on bona fide strangers.

Lis pendens is not a lien. Instead, it is a notice which alerts all parties to the pending action.14 Lis pendens gives notice to all hypothetical third parties, even bankruptcy trustees under federal law,15 allowing the lender to avoid any consequences that would normally occur with a bona fide party without knowledge under Kentucky law.

F. Jurisdiction & Venue

1. Circuit court.

Circuit court is the court of general jurisdiction in Kentucky.16 Circuit court has standing over foreclosure actions as the district court can hear neither actions against real estate, nor actions in equity, nor actions for more than $5,000.17 Any one of those three limitations would move foreclosures into the circuit court.

2. FDCPA requirement.

15 U.S.C. §1692i requires that foreclosures be filed in the venue where the property is located, regardless of Kentucky law. This is a unique situation in which the choice of an independent lawyer, i.e. a debt collector, limits a party's venue to bring suit on their claim.

3. Standing to bring suit.

Both Civil Rule 17.01 and Kentucky case law require that the plaintiff in a foreclosure be someone who actually holds the Note and can enforce the mortgage. As stated by the Supreme Court, "[O]rdinarily the real party in interest is the person who is the beneficial owner of the cause of action sought to be prosecuted. Where the cause of action is assignable, and the entire cause has

14 Strong v. First Nationwide Mortg. Corp., 959 S.W.2d 785, 788 (Ky. App. 1998). 15 Palmer (In re Ritchie) v. Wash. Mut. Bank, 416 B.R. 638 (B.A.P. 6th Cir. 2009). 16 Kentucky Constitution §112. 17 See Ky. Const. §113(6) and KRS 24A.120.

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been assigned, clearly the assignee has become the owner of the cause and he is the real party in interest."18

Much litigation has occurred nationwide concerning standing to bring suit, which mostly points to paperwork gaps with the foreclosing lender, such as not having the correct assignments of the mortgage or indorsements on the Note. However, presentation of the original note by the lender tends to resolve these disputes.

G. Service of Process

1. Methods of process.

All methods of process are available in a foreclosure. However, in order to obtain a personal judgment on the debt, most lenders attempt service by certified mail or personal service.

A Warning Order Attorney may be appointed under Civil Rule 4.05, which allows the foreclosure to continue against the real estate. However, any claims for personal liability on the note are extinguished when this method of service is used.19 The action becomes solely in rem against the mortgaged property, which requires the posting of a bond under Civil Rule 4.11 in order to distribute the proceeds of the foreclosure sale.

2. Long-arm jurisdiction.

Out of state defendants, generally corporate lienholders, may be served by the Secretary of State if they have no local agent in Kentucky.20 A lienholder in Kentucky generally meets the minimum standards for constitutional jurisdiction under KRS 454.210(2)(a)(6) because they hold an interest in the real estate being foreclosed.21

H. Lienholder Rights

1. Tax lien holders.

Tax liens assessed against the foreclosed real estate enjoy a superior position over a mortgage.22 As between two super-liens of equal dignity, the proceeds of sale are shared on a pro rata basis.

18 Louisville & Nashville R.R. Co. v. Mack Mfg. Corp, 269 S.W.2d 707, 709 (Ky. 1954). 19 KRS 454.165. 20 KRS 454.210(3). 21 See generally Hinners v. Robey, 336 S.W.3d 891 (Ky. 2011). 22 KRS 134.420.

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2. Senior liens.

If a defendant possesses a lien senior to the plaintiff's lien, the senior lien cannot be disturbed without its consent.23 This is true even if a default judgment is taken against the senior lien, but the senior lien objects to the foreclosure sale.24 Because of this, senior liens are not strictly a necessary party to a foreclosure, as a plaintiff may choose to foreclose its own lien subject to this senior lien without having to name it in the foreclosure.

3. Junior liens.

Junior liens must be marshalled and released as part of a foreclosure.

I. Master Commissioner Referrals

1. AOC referrals.

Many counties have standing rules which automatically refer all foreclosures to the Master Commissioner's office.25 In other cases, the referral is filed by the court at the time of judgment. For all cases, Court of Justice form AOC-141.S must be filed along with the $200 fee required by AP Part IV, Section 1(10).

2. Civil Rule 53.

A Master Commissioner generally acts a magistrate to the court as well as the executing officer who sells the property. Therefore, the actions of the Master will be governed by Civil Rule 53. The court may refer disputed issues of fact to the Magistrate, who will conduct hearings, take evidence, and then provide a report to the court.

J. Judgment and Order of Sale

1. Default judgment.

If a party has not answered within the applicable time period, a motion for default judgment may be filed under Civil Rule 55. This applies equally to borrowers on the loan, titleholders to the property, and lienholders on the property. A party who fails to marshal their interests with the court risks having their interests wiped away in the foreclosure.

23 KRS 426.690. 24 Mortg. Elec. Registration Systems v. MainSource Bank, 425 S.W.3d 892 (Ky. App. 2014). 25 See Jefferson Circuit Court Local Rule 5.

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Default judgments are common in foreclosure practice, so special attention must be given to the appropriate affidavit under the Servicemembers Civil Relief Act to avoid foreclosing on an active-duty servicemember.26 The court may also require evidence of damages, although a properly pled complaint should set forward the liquidated damages that can be accepted by the court under Civil Rule 8.04.

2. Summary judgment.

Given the contractual issues involved, foreclosures tend to be good candidates for summary judgment under Civil Rule 56. A standard motion would include an affidavit under Civil Rule 56.05 which sets forth the executed loan documents, the default on the loan, the acceleration of the loan, and the application of payments. The burden would then shift to the borrower to present evidence of payment or any other defense to foreclosure. 27

3. Judgment and Order of Sale.

While it is possible to separate the personal judgment on the loan from the execution upon the mortgage, standard practice is to roll both into one consolidated Judgment and Order of Sale. The judgment should set forth the sums to be recovered on the loan, marshal the priority of each lienholder, and set the terms of the Master Commissioner's sale. There can be a wide variety of sale terms, but most counties require public notice of the sale, compliance with all provisions of KRS 426, and a judgment credit against the bid price if the foreclosing lender is the successful purchaser at sale.

The order of sale should also set forth the legal description for the property, declare whether the property will be sold in whole or in parts, and set forth whether the sale will be subject to any easements, unpaid taxes, or other items superior to the lender's mortgage.

K. Master Commissioner Sales

1. Scheduling the sale.

Many counties incorporate the sale date into the Judgment and Order of Sale. Should the original sale be cancelled, a new motion/order scheduling sale can be filed. In larger counties, such as Jefferson County, sale scheduling is arranged between the lender's counsel and the Master's office. The minimum time

26 50 U.S.C. App §521. 27 Steelvest, Inc. v. Scansteel Serv. Ctr., 807 S.W.2d 476 (Ky. 1991).

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between judgment and sale is twenty-one days due to the newspaper publication requirements of KRS 426.560.

2. Appraisal of the property.

KRS 426.520(2) requires that the property be appraised by two disinterested, intelligent housekeepers of the county, with the Master Commissioner refereeing any disputes. The appraisal must be filed of record before the sale, which was a recent change in the law in 2012. This allows parties to calculate whether their bid will trigger a right of redemption in the property.

3. Bidding at sale.

Most judgments provide that the foreclosing lender may credit its judgment against the bid it places at sale. This waives any requirement to pay a deposit at sale or otherwise tender good funds in order to bid. The lender would only pay any items senior to its lien, such as court costs, taxes, and senior liens.

Members of the public will need to be prepared to pay cash on the date of sale, as set forth in the County's local rules or in the order of sale. KRS 426.705 allows a prospective bidder to post a bond for the purchase price, although the Master must approve of the surety. Many Masters have their own rules on how to obtain an approved surety, which should be approved before the sale begins.28

4. Assignment of bid.

A successful bidder is allowed to assign the rights to their winning bid. Many lenders will file a written assignment of bid to transfer the property to an entity who will hold and market the property for them after the foreclosure ends. This allows the Master to execute the foreclosure deed directly to the assignee, while the original bidder fulfills any terms of the bid, such as crediting its judgment against the bid. The order confirming the sale should likewise refer to the assignment of bid.

L. Confirmation of Sale

1. Report of sale.

The Master is required to file a report listing the results of the execution on the order of sale. This report complies with Civil Rule 53, which allows the parties ten days to lodge their objections to the report. If no objections are raised, the lender may request that the court confirm the outcome of the sale.

28 For example, see http://www.tmcsales.info/index.html.

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2. Order of Confirmation.

A foreclosure sale passes no rights until the sale is reviewed and confirmed by the court under KRS 426.575. The order confirming sale therefore authorizes the Master Commissioner to issue the deed to the purchaser, or any assignee of the purchaser, as well as distributing the proceeds of the sale as set forth in the original judgment.

3. Bond under Civil Rule 4.11.

As mentioned before, a constructively summoned defendant must be protected against an improper execution against their interests for up to one year. If the sale occurs before this one-year mark, a bond must be filed by the purchaser. If a delay occurs between judgment and sale, so that the sale occurs more than one year later, no bond will be required.

4. Post sale motions.

A variety of post-sale motions can be filed to aid in the process of confirming the sale and distributing proceeds. Unless authorized by local rule in advance, the Master Commissioner will move the court to approve the sale fees, advertising fees, and other expenses. A lender may ask for a supplemental judgment to cover the advances made on the loan between the time of judgment and the time of sale, as well as attorney fees incurred.

M. Deed of Commissioner

1. Transfer of title.

While there is no timeframe under which the deed must be recorded, legal title passes to the grantee upon delivery. This vests the grantee with the right to possess the property, collect rents, and otherwise dispose of the property.

2. Release of liens.

Unless specifically ordered by the court in the confirmation of sale, there is no separate release of the liens named in the foreclosure. Instead, legal title to these interests merge into the Master's deed and transfers to the purchaser at sale.29 Combined with the lis pendens notice filed at the beginning of the case, this allows the purchaser to have a title clear of all liens named in the foreclosure, and those that arose after the lis pendens.

29 KRS 426.574.

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N. Right of Redemption

1. Defendant's redemption.

KRS 426.530 creates a six month right of redemption whenever a property fails to sell for more than two-thirds of its appraised value. This allows the defendant to tender the purchase price of the property to clerk of courts, together with 10 percent per diem interest on the bid price, along with all taxes and reasonable costs necessary to bring the property into compliance with local codes. This is a new amendment from 2014, as the prior version allowed for a one year right that did not require the payment of taxes or property preservation costs incurred by the purchaser.

The right of redemption is a personal right that can be sold, encumbered, or executed upon under KRS 426.540. Because the right of redemption is personal to the debtor, an in rem judgment cannot be used to execute upon the right of redemption. If the lender bids its total debt, thereby satisfying its judgment, there can be no further execution against the right of redemption. Best practice would be to buy the right of redemption from the defendant, or to wait out the six month period before marketing the property.

The right of redemption does not stop the foreclosure or prevent an eviction of the defendant from the property. Instead, the Master's deed will reflect the defendant's right of redemption.

2. United States of America.

Under federal law, the U.S. has a one-year right of redemption on any property for which it holds an interest. That period is shortened to 120 days if the U.S.' interests compose solely a federal tax lien. This right exists regardless of the amount bid at sale.

O. Bankruptcy Considerations

1. The automatic stay.

Upon the filing of a bankruptcy, a stay is imposed by law.30 Actual knowledge of the bankruptcy is not required, and actions filed in violation of the stay are considered void. In the context of a foreclosure, a bankruptcy is generally filed to stop a judgment or a sale from occurring.

30 11 U.S.C. §362(a).

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2. Chapter 7 vs. Chapter 13.

A Chapter 7 bankruptcy seeks to discharge all debts and pay all creditors from available assets. The bankruptcy trustee generally will abandon the real estate from the bankruptcy if a valid mortgage eats up all the equity in the property. The debtor then receives a discharge of debt, converting any pending or potential foreclosure into an in rem action on the mortgage.

In contrast, a Chapter 13 bankruptcy creates a repayment plan that lasts up to five years. The goal of the bankruptcy court and the trustee is to ascertain the debts due at the time of filing, the stream of income available to the debtor, and the debtor's plan of repayment. This puts an extended hold on any foreclosure action given the multi-year potential of the bankruptcy plan. Long term debt, such as a mortgage, survives the bankruptcy plan and personal liability is not discharged.31

P. Loss Mitigation Alternatives

1. Contractual reinstatement.

Kentucky law does not require the deceleration of a properly accelerated loan. Instead, the provisions in a standard mortgage allow the borrower to pay the arrearage on the account and cancel the foreclosure at any point up to judgment. Although the mortgage contract cuts off the right to reinstate at judgment, it is universally accepted that lenders will accept a full tender of reinstatement funds any time before a sale occurs. A full tender of reinstatement funds includes the payment of the fees and costs of the foreclosure, as well as any loan advances made under the mortgage.

2. Loan modification.

A popular option, made more common by federal programs such as HAMP, is to modify the loan. The arrearage is capitalized into a new principal balance, which cures the default on the loan. The term of the loan can remain the same, or it can be re-amortized over a longer period of time. Generally, the interest rate on the loan is reduced to make the larger principal balance more affordable. To be reviewed for a loan modification, a complete package of financials disclosures is required.32

31 11 U.S.C. §1328(a)(1). 32 24 CFR 1024.41.

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3. Short sale.

Many lenders will allow the borrower to sell the property and extinguish the mortgage, even if the sales price is below the balance due on the loan. This generally requires an arms-length sale to a disinterested third party after a period of time in which the property is marketed to the public. The lender will then issue a tax statement for any debt forgiven in the short sale, which has various tax consequences for the borrower. Congress has previously exempted this forgiven debt from income tax, but this provision is reviewed annually. Lenders will not take a borrower's tax planning into account when structuring a short sale.

4. Deed-in-lieu.

A final option is for the borrower to voluntarily transfer title to the lender via a deed. Since this deed is outside the scope of the foreclosure, it is not protected by lis pendens nor the marshalling of liens. Therefore, title to the property must be clear before a lender will agree to accept a deed-in-lieu. Non-merger clauses are put in the deed so that the lender can foreclose its mortgage if subsequent title search reveals a cloud on title.

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NOTES

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