By Travis Menk, Esq.

Brock & Scott, PLLC *

USFN Member (CT, NC, RI, AL, FL, GA, KY, ME, MD, MA, MI, NH, NJ, OH, PA, SC, TN,   VT, VA)

During USFN’s Sept. 10 Briefing, New Loss Mitigation Options and Bankruptcy Impacts, a discussion featuring four Creditors’ attorneys and a servicer internal legal counsel highlighted the new last chance waterfall options recently implemented by the VA, FHA, and the USDA, and each program’s respective impacts on debtors and creditors in bankruptcy. Each of these programs, while created with the intent to assist borrowers with new options in light of the high-interest rate environment, opens the door to a host of potential issues in the realm of bankruptcy. This Briefing gave a basic educational overview of each of the three programs and detailed the considerations and impacts on current bankruptcy processes and forms that will need concentrated attention by debtors, creditors, and trustees alike to eliminate potential challenges throughout the bankruptcy process.

The Veteran’s Affairs Servicing Purchase Program – U.S. Department of Veterans Affairs

Marcy J. Ford, Partner at Trott Law, began the presentation with an overview of the VA’s last chance waterfall option known as VASP. This program provides for a loan modification significantly below market interest rate with a 30-to-40-year term option and may require a three-month trial period. Ford noted that if the debtor is involved in an active Chapter 13 case, VASP will not be considered while the case is pending unless the Chapter 13 was filed during a trial period, in which case court approval is required to finalize the modification. It was noted that in jurisdictions which do not typically require court approval, this court approval would likely still be necessary based on the specific VA requirement in this situation. Ford also noted that if the borrower is in an active Chapter 7 case and applies for loss mitigation, VASP will not be an option until the case is closed. However, it was noted that if the debtor files for bankruptcy during the trial period, VASP finalization goes on hold until the bankruptcy case is closed.  Emphasis was placed on the case having to be closed and that having stay relief or the trustee filing a report of no distribution would be insufficient. Ford also noted that caution should be given about advising debtors to dismiss their cases based on the potential to get VASP eligibility.  A question asked of the panel was how to proceed with VASP as it relates to bankruptcy court mortgage modification/mediation orders, and it was surmised that these bankruptcy court modification/mediation programs could not supersede the rules set by the VA, and, as such, the court would be unable to force VASP as an option during the case.

The FHA Partial Claim + Payment Supplement Program – U.S. Federal Housing Administration

Maria Tsagaris, Partner at MRLP, continued the presentation with an outline of FHA’s last chance waterfall option known as the FHA Partial Claim + Payment Supplement program. Servicers must implement this program by January 1, 2025. Tsagaris detailed that borrowers will be eligible for an amount up to 30% of the outstanding balance of the loan for a combination of a partial claim to bring the account current with the remaining available balance divided over 36 months to act as reduction to the monthly payment amount up to 25% of the payment. The remaining balance after the partial claim piece is given to the creditor to bring the account current is to be held by the servicer as a separate custodial account that cannot be comingled with any other funds. The creditor is permitted to take funds out of the custodial payment supplement account and apply them to the account when the debtor pays the creditor the reduced monthly payment amount. The partial claim plus the payment supplement amounts will become an interest free second lien on the property pursuant to the recorded security instrument, which will come due when the first mortgage is paid or refinanced or upon the sale of the property.

Tsagaris mentioned that for the debtor to be eligible for this program, they had to indicate that they could maintain the payment and had to sign a note, security instrument, and payment supplement agreement. In addition to an annual accounting to both HUD and the borrower, 60 to 90 days prior to the end of the 36-month period, the creditor would need to provide a detailed annual report as to the status of the payment supplement account. It was also noted that at 36 months and 1 day, the program will automatically terminate, and any remaining payment supplement funds had to be refunded to HUD. The program would also terminate in the following scenarios: request of the borrower, modification, foreclosure, short sale, or deed in lieu. 

Tsagaris noted a couple of the mechanics set forward by the program. The program requires 30-day default reports on each of these accounts but failure to make an ongoing payment does not terminate the program. The program also sets forth detailed instructions for the requirements and responsibilities of servicers regarding the transfers of loans that are involved in the program. Finally, Tsagaris also noted that servicers will receive a $1,750 payment supplement incentive for completion of the program. Full details of the program can be found in Mortgagee Letter 2024-02.

Alice Whitten, Internal Legal Counsel for Wells Fargo, when asked, stated that the incentive of $1,750 likely did not cover the cost to fully implement this program, as it has been described as one of the most complex programs to implement at the servicer level. A discussion among the panelists then ensued about whether industry members were getting too concerned about the impacts of these programs given that these were last chance waterfall options only available if all other waterfall options failed. The discussion focused on the fact that if interest rates remain high, precluding other loss mitigation waterfall options from being viable, these three programs and their impacts would likely be seen more often than naught. Given that thought process, the Briefing turned to the bankruptcy impacts of the FHA Partial Claim + Payment Supplement Program. 

Patrick Hruby, Senior Associate at Brock & Scott, PLLC, highlighted these impacts and many of the best practices that creditors, creditor’s attorneys, and trustees have been working together on to facilitate integration of this program into bankruptcy. Hruby presented a proposed 410A with disclosures regarding the debtor being in the program, the effects of the program on the ongoing payment, and the expiration date of the program for the debtor. He also noted suggested revisions to Part 3 of the 410A of the proof of claim for missed payments and corresponding unreceived monthly principal reductions. He also suggested revisions to Part 4 to account for the reduced ongoing payment amount due to the monthly principal reduction. Hruby also noted that for jurisdictions utilizing GAP Payments or administrative arrears, the payment supplement portion is going to want to be shown in Part 3. Hruby also noted that post bankruptcy entrance into the FHA Partial Claim + Payment Supplement Program would necessitate an amended proof of claim and a payment change notice. Also, payment change notices will need to be carefully drafted to note the full payment amount and the amount due from the borrower due to the payment supplement.  

The payment change notice information issue brought to the forefront that communication needs to be as clear as possible on all documents in bankruptcy with respect to this program in order to avoid any unintended consequences and potential inquiries from the trustees and U.S. Trustees/Bankruptcy Administrators. At the end of the 36-month payment supplement period or if the program is terminated, it was noted that a payment change notice will have to be filed to show the elimination of the monthly payment supplement. On the topic of program termination, it was noted that if the debtor modifies the loan, the program will be terminated. As a result, it was noted that creditor’s counsel will need to look closely at the plan for modifications or cramdowns that would terminate the program and object appropriately. Consequently, debtor’s attorneys should also be aware if their debtor client is in one of these programs and to shape the debtor’s plan accordingly so as not to inadvertently terminate the program. Finally, it was also noted that the handling of annualized payments in Chapter 12 cases would present some interesting and unique situations with respect to default reporting and payment supplement distribution.

Lance Olsen, Partner at McCarthy Holthus, LLP, continued the discussion of the impacts of this program in bankruptcy focusing on payoff statements, motions for relief, and consent orders. As an initial note, Olsen mentioned that relief would, in theory, be needed to record the second mortgage even though he had not seen a ton of referrals for relief to record other standard partial claim mortgages, unlike creditor’s attorneys in other parts of the country. Olsen continued by noting that under the program, if the creditor is asked for a payoff involving a loan in the partial claim + payments supplement program, the creditor will have to give a payoff for both the original loan and the second position lien partial claim + payment supplement balance. A discussion among the panelists explored whether these two payoffs should be done in two separate payoff quote letters or combined into one letter with the two separate payoffs included.  In addition, Olsen noted that creditors with motions for relief and in consent orders need to make sure to be very detailed and clear with additional disclosures and information in those motions and consent orders including, but not necessarily limited to, the total amounts owed, the reduced payment amounts owed, and the payment supplement amounts owed to the creditor as a result of the debtor failing to make the reduced payments to the creditor.

The Payment Supplement Account Program – U.S. Department of Agriculture

Ford finished up the Briefing by giving details on USDA’s last waterfall option, the USDA Payment Supplement Account Program. Ford stated that while this program is similar to FHA’s Partial Claim + Payment Supplement program, the programs differ in that this program utilizes an advance from the servicer and not a partial claim. As such, a second lien is not placed on the property and an additional note and mortgage are not signed. This program became effective July 24, 2024, with a goal to achieve an ongoing payment reduction of 25% for up to three years and would require three trial payments. Ford noted that no bankruptcy guidance has been presented by the USDA and so, as a result, it does not appear that an active bankruptcy would interfere with the implementation of this program.

The Briefing generated a significant number of audience questions. One question related to the timing of the recording of the partial claim. It was noted that the FHA instructions required the partial claim to be recorded in five days, which the bankruptcy practitioners noted would be difficult given motion timeframes in bankruptcy court, and, as a result, the motions may need to be filed as soon as the partial claim + payment supplement option is offered to attempt to comply with this requirement. Another question raised was whether any of the participants had faced any issues with a Trustee in a Chapter 7 bankruptcy saying the partial claim cannot be executed or recorded by the debtor, as the property is not part of the bankruptcy estate. Hruby indicated that he had courts in Ohio which have refused to approve partial claims, as they felt it interfered with the reaffirmation process, but none of the other panelists indicated they had any similar issues.

Each of these three programs are complex, with numerous details and nuances that will present challenges for debtors, creditors, courts, trustees, and counsels to navigate within the tides and winds of the bankruptcy process. Each bankruptcy practitioner and creditor should familiarize themselves with these programs and the impacts on bankruptcy in order to best insulate themselves from potential problems that could result if details are not thoroughly thought through.

Watch a recording of this Briefing and be sure to register for USFN’s next complimentary Briefing – Show Me, Insurability & The Road Ahead for REO Properties – on Oct. 15 at https://www.usfnevents.org/briefings.html.

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USFNews - Oct. 2, 2024

* Denotes firm is a 2023 USFN Award of Excellence recipient