They Left the Bank, But Not the Customers
After The Financial Crisis, Six Bankers Who Have Moved On

Please note that the above link will only be available for a few days to non-subscribers of the Wall Street Journal.

Our firm’s success, in avoiding deficiency judgments, typically comes from negotiating with the lender’s attorneys inside the scope of aggressively defending a foreclosure suit. After gaining some leverage defending a foreclosure suit, where the lenders own attorney advises the lender to take a certain course of action, the lender is much more likely to listen. In other words, the lender’s attorneys have the ear of decision-makers inside the lender’s offices.

By comparison, the lender’s policy makers make policy based on the lender’s balance sheet that particular quarter. This brings up another point, it is likely not important who hands the lender a short sale or loan mod package, outside the scope of foreclosure litigation, the lender’s balance sheet controls the decision-making.

Inside the scope of aggressively defending a foreclosure suit however, settlement agreements negotiated between borrowers and lender’s attorneys specifically spell out, or should spell out the rights and duties of the parties following a short sale. In fact, one of the best reasons to employ a foreclosure defense attorney is to attempt to avoid a deficiency judgment altogether. If you do not defend a foreclosure suit, the lender could go unopposed to get a deficiency judgment. Another reason to employ a foreclosure defense attorney is to put affirmative defenses in place within the foreclosure suit to help avoid the deficiency later if lender attempts to pursue a deficiency judgment following a short sale or foreclosure. Finally, there is a huge value associated with knowing, with some degree of certainty, that you will not be sued or harassed for a deficiency following foreclosure or short sale. It is still amazing to me how few foreclosure suits are ever defended. A foreclosure suit is likely the largest lawsuit the average person will face their entire life, and yet, the vast majority of foreclosure defendants never consult a single attorney, let alone getting a second and third opinion from several attorneys.

Back to short sale approval letters. In looking at the approval letter itself, there are often positives and negatives concerning whether the lender would try to sue you or otherwise pursue other collection efforts concerning a balance owed or a deficiency following a short-sale. Where the lender uses the term “discounted payoff,” when I was in banking, I understood this to mean that the lender was resolving an obligation for less than the face value of the obligation. It is also helpful where the lender agrees to execute a “full satisfaction and release of mortgage”. While the promissory note is the operative document that establishes the debt or obligation itself, the particular wording used in a satisfaction of mortgage could be evidence of a lender’s intent to forgive a deficiency.

Other paragraphs found in short sale approval letters could prove to be problematic for borrowers. Many short sale approval letters contain a statement that “Except as stated above, all provisions of the Note …. shall remain in full force and effect.” This same paragraph is often found in short sale approval letters that state that the short sale is approved as a “discounted payoff”. This statement is clearly inconsistent with the idea of a “discounted payoff”.

We do not currently know of any clear-cut case law that defines the term “discounted payoff”. If an appellate court undertakes to define the term “discounted payoff”, it would likely be sending hundreds of millions, if not billions of dollars one direction or another.

Lenders intentionally create vague short sale approval letters so that they can sell the opportunity to pursue a deficiency balance against XYZ borrower to collection companies. Deficiency balances that remain following a short sale are an opportunity for a collection company to make some money dialing for dollars. Collection company’s purchase these opportunities to pursue a deficiency against you / opportunity to sue on the promissory note itself. Such a sale or collection efforts could occur immediately following a short sale or foreclosure or years later. Such opportunities to pursue deficiency balances are often sold in bulk for pennies on the dollar. If you find yourself being pursued for a deficiency balance following a short sale or foreclosure, you should speak with a competent attorney.

One thing I would like to mention here is that a large portion of the leverage that borrowers possess is their ownership of the property and their ability to deed the property to a person who is willing to pay the lender something for the property in a short sale transaction. Ownership of the property gives standing to defend a foreclosure suit. Following foreclosure or short sale, this leverage is gone. The borrower should utilize such leverage while its available, prior to being defaulted in foreclosure suit.

I would also encourage borrower facing a deficiency balance to refrain from attempting to clean up your credit rating following a short sale or foreclosure. When I was in the lending business, we purchased opportunities to pursue deficiency balances along with other loans and assets. As such, we rarely pursued people with low credit scores – it would have likely been throwing good money after bad.

In short, if you choose to close on the sale of your property in a short sale transaction under a vague short sale approval letter, you will likely face collection efforts ranging from dialing for dollars to a full-blown suit bases on the promissory note. Speak to a lawyer before deciding. For that matter, speak to a lawyer before missing that first payment. There are a few things that borrowers can do prior to missing that first payment that could eliminate or go a long way towards preventing the lender from pursuing a deficiency balance.

Finally, there is some value to you in a vague letter that would appear to let you off the hook. A vague letter cuts both ways. There is also value in being rid of an upside-down property. There are also no guarantees of permanently resolving the deficiency judgment issue inside of the foreclosure suit. However, your success rate will likely go up exponentially where you engage competent legal counsel.

While the idea of state-wide mandatory mediation for primary residence foreclosures is good one, it may be impractical.

First, upon motion or request by a homeowner, judges often require mediation prior to a trial. Therefore, if there are true issues to be discussed, it is likely the judge will order mediation anyway.

Second, judges should have the discretion to handle each individual case as they see fit. For example, often the owners are nowhere to be found and cannot even be reached to schedule a mediation.  In other cases, where the borrower has absolutely no income, no equity or does not care about trying to avoid a deficiency judgment, mediation is an exercise in futility.

Third, it is important to note the timing of when mandatory mediation would occur. As I understand the recommendation, mediation would occur after the foreclosure suit is filed, and after the parties are served, giving the court jurisdiction to order such a mediation.

Finally, and most importantly, by the time the foreclosure suit if filed, many homeowners have already given up and moved out.  The vast majority of foreclosure suits [greater than 90%] are never defended.  Often homeowners don’t truly understand that a foreclosure suit is a real lawsuit. Where the summons gives the homeowner 20-days to respond the complaint, the homeowner should talk to an attorney.  I can’t tell you how many people Castle Law Group has turned away because they failed to respond to the foreclosure complaint within the time allotted and were subsequently defaulted.

What is needed, far more than mandatory mediation, is an educated public. Homeowners need to be informed of their rights.  Avoiding a deficiency judgment, or getting the lender to modify a loan, are legitimate foreclosure defense litigation goals.  Homeowners simply need to be advised to see an attorney when they are served with a foreclosure complaint, or any lawsuit for that matter.