Creditor Assessed Punitive Damages for Violating Bankruptcy Discharge Injunction
Most individual debtors in Chapter 7 receive a discharge of their unsecured debts unless the debts are reaffirmed with the bankruptcy court’s approval. The discharge includes the unsecured portion of any mortgage loan (i.e., the deficiency). The Bankruptcy Code automatically enjoins actions to collect a discharged debt, and creditors who violate the injunction by attempting to collect a discharged debt may be held in contempt of court.
In a recent decision, the Maryland Bankruptcy Court applied these rules to find the holder of a second mortgage in contempt of court for attempting to require the debtor to reaffirm her debt to the creditor as a condition of allowing the debtor to retain her home after foreclosure.
Under the alleged facts, the debtor owned a home subject to two mortgages: a first mortgage in the initial amount of $284,000 and a second mortgage in the initial amount of $49,650. It was undisputed that the house was worth less than the amount due under the first mortgage, and thus, the second mortgage was underwater. Prior to bankruptcy, the second mortgage loan was sold to a loan purchaser for $2,881. The debt buyer then issued a Notice of Intent to Foreclose, which led to the debtor’s Chapter 7 bankruptcy filing. The debtor received a discharge. Thereafter, the second lien mortgagee (creditor) foreclosed on its lien and purchased the property at the foreclosure sale subject to the first lien. It obtained an order evicting the debtor from the house. The debtor asked the creditor for a proposal that would permit her to stay in the residence. The creditor proposed an agreement that would have required the debtor to pay $81,600 over a 30-year term, including a one-time arrears payment of $3,000. The debtor rejected the offer, reopened her bankruptcy case and, represented by a firm on a pro bono basis, filed a lawsuit against the creditor for violating the discharge injunction. The creditor attempted to mitigate by deeding the house back to the debtor. The court held that the discharge injunction had been violated and awarded punitive damages against the creditor in the amount of $25,000 plus compensatory damages and attorney’s fees.
Although mortgage liens are unaffected by a bankruptcy discharge in Chapter 7 and a mortgagee has the right to foreclose after bankruptcy if the loan is in default, the bankruptcy court found that the discharge injunction had been violated, because the creditor went too far by conditioning retention of the house on reaffirmation of a discharged debt. Mortgagees who want to work with borrowers after bankruptcy should proceed with caution so as not to violate the discharge injunction where the house is worth less than the mortgage balance.