Can I Sue a Bankrupt Loan Company?

Yes, you can sue a bankrupt mortgage lender or servicer, but chances are you won't recover much if you win. When a company goes into bankruptcy, all collection efforts, including lawsuits against the company, get put on hold. The company's assets get divided among the people the company owes money to in order of priority determined by law.

Unfortunately, chances are good that you would not be one of the people entitled to priority. So you could only collect leftover money. That might be nothing. A bankruptcy lawyer can provide legal advice about where your case would have priority in the bankruptcy proceeding and whether pursuing it makes sense.

Home Ownership

According to the U.S. Census Bureau, about two-thirds of Americans are homeowners. Many benefits come with owning your own home, which include:

• Relatively stable housing costs
• An investment that increases in worth
• Tax benefits
• A sense of permanence and belonging in your community

When buying a house, most people do not pay cash out of their bank account. They get a home loan from a mortgage lender (typically a bank or a credit union) in exchange for an interest in your property. You are in default if you fail to pay your lender as the loan requires. That gives the bank the right to sell the property and recover what remains due under the loan. This process is foreclosure.

Mortgage Servicing

Mortgage lenders like Wells Fargo and Bank of America often sell the loan to a mortgage servicer. Mortgage lenders have legal limits on how much they can loan, so selling the loan lets the lender start new loans. Lenders can make more money initiating loans than they can servicing them.

Mortgage loan servicers help process loans. Mortgage loan processing includes:

• Accepting mortgage payments from homeowners
• Making payments to investors (typically through escrow accounts)
• Sending payment reminder notices
• Filing foreclosure documents if the loan is in default.

Possible Claims Against Your Mortgage Servicer

Not every loan processing goes smoothly. Your mortgage lender or servicer might get greedy or make mistakes. For example, your mortgage servicer might misrepresent your actual interest rates under the terms of your loan arrangement. They might also overcharge you for property inspection fees.

If this happens, you might have a claim under federal law. The Fair Debt Collection Practices Act (FDCPA) prohibits mortgage lenders and servicers from using abusive, unfair, or deceptive practices in consumer loans. The FDCPA applies to making and processing mortgage loans so that you can sue your lender or servicer in federal court. Many states have similar laws, so you may also be able to sue under state law.

What If Your Lender or Servicer Files for Bankruptcy?

Let's say you did file a valid FDCPA claim against your mortgage lender or servicer. In most cases, your civil case would proceed through the courts until it gets settled or you win a judgment. That process can get put on hold if your lender or servicer submits a bankruptcy filing for debt relief.

Bankruptcy

We provide much more detail about bankruptcy elsewhere, but bankruptcy is a legal proceeding involving someone who cannot pay their debts. The bankruptcy case, not an adversary proceeding, begins with a petition filed by the person who owes money (the debtor) in federal bankruptcy court under the bankruptcy code. When someone files the petition, all collection efforts by debt collectors — including civil lawsuits to collect a debt — get put on hold. This is an automatic stay.

A bankruptcy judge oversees the case. The judge appoints a third party, the U.S. trustee, to determine what the debtor owes and owns. Meanwhile, people owed money by the debtor (creditors) file claims with the bankruptcy court. The trustee submits a bankruptcy plan for the judge's consideration. That plan describes what property of the debtor may get sold to pay off their debts. It may also identify exemptions (property the debtor gets to keep). The plan may address restructuring or refinancing options, depending on the type of bankruptcy case filed ( chapter 7 bankruptcy, etc.).

Once they receive the bankruptcy plan, the judge decides whether to approve it as submitted or if it needs changing. If the judge approves the plan, the trustee sells the property and distributes the proceeds to the creditors.

Priority

Often, the debtor does not own enough property to cover their debts. If that happens, the trustee has to pay off creditors in an order established by law. That order depends on which type of creditor you may be.

There are generally two types of creditors. Secured creditors also have a property interest (security interest) in the debtor's property. For example, if you bought a car with a car loan, your lender has a security interest. It would be a secured creditor. In contrast, unsecured creditors do not have a security interest in the debtor's property. You just owe them money.

Discharge

Secured creditors have priority over unsecured creditors. In other words, the U.S. trustee pays the proceeds of the sale of the debtor's property to secured creditors first. If there is leftover money, the trustee pays what remains to the unsecured creditors. Typically, there is little, if any, money left over to pay them.

Once the remaining property gets distributed to the creditors, the bankruptcy judge discharges the rest of the debts and closes the bankruptcy case with a court order. You can't recover a debt if it got discharged in bankruptcy, which means creditors (particularly unsecured creditors) often get nothing.

You Might Win, But You Could Still Lose

Let's get back to your FDCPA lawsuit. If your mortgage servicer files a bankruptcy petition, your lawsuit — an attempt to collect a debt — gets put on hold when the automatic stay goes into effect. Because you do not own a security interest in your mortgage servicer's property, you are a consumer creditor, an unsecured creditor.

Your mortgage servicer would go through the bankruptcy process. You would file a claim, setting out the basis for your lawsuit and the money you seek to recover. Once the trustee has acquired the servicer's property and sold off its assets, they would distribute the proceeds first to secured and unsecured creditors. If you have a valid legal claim, you might get some money. It will be less than what you are seeking. You would not be able to file a debt collection lawsuit.

A Case Study: Ditech Holdings

One recent mortgage lender and servicer that filed for bankruptcy was Ditech Holdings. Ditech Holdings owned two companies: Ditech Financial (a mortgage lender and servicer) and Reverse Mortgage Solutions (a provider of home equity conversion loans known as reverse mortgages). Ditech collected mortgage payments on about 1.4 million residential real estate loans through its affiliates.

Thousands of homeowners sued Ditech in individual and grouped lawsuits called class actions, claiming that it mishandled their mortgage payments and charged illegal fees in several scams. In February 2019, Ditech and its affiliates filed for bankruptcy in the Southern District of New York for the second time in less than two years. The majority of claims got discharged in bankruptcy; most homeowners received little. Later that year, Ditech sold off its mortgage businesses, Ditech Financial and RMS, as part of the bankruptcy reorganization plan.

A Lawyer May Be Able to Help You Recover

Mortgage lenders and mortgage servicers are generally large businesses with many resources. But, they can get into financial trouble and file for bankruptcy like other companies.

If you believe you have a claim against your lender or servicer, you can pursue it in the bankruptcy proceedings. You may not be able to recover much, if anything, but a bankruptcy attorney can help you decide whether your claim is worth pursuing. Keep in mind that if you delay suing too long, you may not be able to recover anything through legal action once the company's debts get discharged.