Can I Sue a Bankrupt Loan Company?
Yes, you may be able to sue a bankrupt mortgage lender or servicer, but chances are you won't recover much, if anything, even if you were to win. When a company goes into bankruptcy, all collection efforts, including lawsuits against the company, are put on hold. The company's assets are then 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 would only be able to collect money if there was anything left over afterward. That may be nothing. A bankruptcy attorney would be able to provide you with legal advice about where your case would have priority in the bankruptcy proceeding and whether pursuing it makes sense in your circumstances.
According to the U.S. Census Bureau, approximately two-thirds of Americans are homeowners. There are numerous benefits that come along 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
Most people, when they buy a house, do not pay cash out of their bank account. They obtain a home loan from a mortgage lender (typically a bank or a credit union) in exchange for an interest in your property. If you fail to make payments to your lender as required by the loan, you are in default. That gives the bank the right to sell the property and recover what remains due under the loan. This process is called foreclosure.
Mortgage lenders, such as Wells Fargo and Bank of America, often sell the loan to a third party called a mortgage servicer. There are a couple of reasons why. Mortgage lenders have legal limits on how much they can loan, so selling the loan lets the lender initiate new loans. Lenders may make also be able to make more money initiating loans than they can servicing them.
Mortgage loan servicers help with the processing of a loan. 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 simply make mistakes. For example, your mortgage servicer might misrepresent what your actual interest rates are under the terms of your loan arrangement. They might also overcharge you for property inspection fees.
If this happens, you might have the basis of 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 connection with consumer loans. The FDCPA applies to the making and processing of mortgage loans, so you may be able to sue your lender or servicer in federal court if you have a valid legal claim. Many states have similar laws, so you may also be able to sue under state law.
What If Your Lender or Services Files for Bankruptcy?
Let's say you did file a valid FDCPA claim against your mortgage lender or servicer. In most instances, your lawsuit would proceed through the courts until it was either settled or you won a judgment. That process can be put on hold, however, if your lender or servicer files for bankruptcy.
We provide much more detail about bankruptcy elsewhere, but bankruptcy is basically a legal proceeding involving someone who cannot pay their debts. The bankruptcy case begins with a petition filed by the person who owes money (the debtor) in federal bankruptcy court under the bankruptcy code. When the petition is filed, all collection efforts — including lawsuits to collect a debt — are put on hold. This is called an automatic stay.
A bankruptcy judge is responsible for overseeing the case. The judge appoints a third party, the U.S. Trustee, to determine what is owed and what is owned by the debtor. Meanwhile, people who are 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 be 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.
Once they receive the bankruptcy plan, the judge determines whether to approve the plan as submitted or whether it needs to be modified in certain ways. If it approves the plan, the trustee sells the property and distributes the proceeds to the debtor's creditors.
In many cases, 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 are those who in addition to being owed money by the debtor, have a property interest (security interest) in the debtor's property. For example, if you bought a car and got a car loan, your lender likely has a security interest in the car. They would be a secured creditor. In contrast, unsecured creditors are those who do not have a security interest in the debtor's property. They are just owed money.
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. And then, if there is money left over, 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 is distributed to the creditors, the bankruptcy judge discharges the rest of the debtor's debts and closes the bankruptcy case. You cannot recover a debt if it has been discharged in bankruptcy, which means creditors (particularly unsecured creditors) often get nothing.
You Might Win, But You Could Still Lose
Let's now get back to your FDCPA lawsuit. If your mortgage servicer files a bankruptcy petition, your lawsuit — which represents an attempt to collect a debt — is 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 would be a consumer creditor, an unsecured creditor.
Your mortgage servicer would go through the bankruptcy process. You would file a claim, which would set out the basis for your lawsuit as well as the amount of 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 creditors, and then to unsecured creditors. If you have a valid legal claim, you might receive some money. If you do, it will probably be substantially less than what you are seeking.
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 (RMS) (a provider of home equity conversion loans known as reverse mortgages). Ditech collected mortgage-loan payments on about 1.4 million residential real estate loans through its affiliates.
Thousands of homeowners sued Ditech in both individual and in grouped lawsuits called class actions, claiming that it mishandled their mortgage payments and charged illegal fees in a number of scams. In February 2019, Ditech and its affiliates filed for bankruptcy for the second time in less than two years in the Southern District of New York. The vast majority of claims were discharged in bankruptcy; most homeowners received little. Later that year, Ditech sold off its mortgage business 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 substantial resources. However, they can get into financial trouble and file for bankruptcy just like many other companies.
If you believe you have a claim against your lender or servicer, you may be able to pursue it in the bankruptcy proceedings. You may not be able to recover much, if anything, but a bankruptcy attorney may be able to help you assess whether your claim is worth pursuing. Keep in mind that if you delay suing too long, you may not be able to recover anything once the company's debts are discharged.
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