Prebankruptcy Waivers: The Price to Pay for Workouts?

A call came into my office this week from a legal services attorney who asked if her client’s forbearance agreement with a subprime mortgage lender would prevent her from filing bankruptcy.  As part of a workout which gave the client 6 months to catch up on arrears, the one-page agreement included the following:

“The debtor does not intend to file a bankruptcy after the agreement is executed.  In the event a bankruptcy is filed, the debtor agrees to allow the lender to obtain Relief from the Automatic Stay in order to foreclose on the mortgage.”

These kinds of clauses tend to pop up quite a bit in payday loan agreements as well.  Here is an example from one of my files in which the consumer is asked to initial 9 separate clauses, one being: 

“I understand to obtain Early Payday without expection [sic] of my check being good constitutes fraud.  I am not in any form of bankruptcy proceedings or will not until after my check has cleared the bank, declare any form of bankruptcy or talk to an attorney about declaring bankruptcy.”   

Our attorney who took the call about the mortgage workout asked me how he should respond.  Tell her not worry, I said, it’s not enforceable.  I could tell my colleague wanted more of an explanation, which forced me to focus on why I hate these things.  I have long felt that the drafters of these clauses never intend them to be enforceable.  Their purpose is to get unrepresented debtors to think they can’t access the courts for relief, or if they do that relief will be severely limited.  Better yet, debtors might not even seek help from an attorney, fearing that their pursuit of legal remedies would somehow be a fraudulent act.   

One way to test this I’ve thought is to check whether such clauses appear in workout agreements in commercial loan transactions.  If I am correct, why would anyone bother including such clauses in those contracts as they would not have the same impact on these more sophisticated debtors who are surely represented by counsel.  And then there are Code sections 541(c) and 363(l) which make these clauses not very useful. 

This is where readers of Credit Slips can help me.  Do those of you who negotiate these contracts add waiver clauses?  I did quickly review the treatise The Law of Distressed Real Estate, and although there is an extensive discussion on bankruptcy and how lenders must consider a potential bankruptcy when negotiating a workout, there is no talk about including waiver clauses in the contract.  I could not find in the Model Workout Agreement provided, which is 50 pages long with more than 110 numbered clauses, a prebankruptcy waiver clause.  Of course, bankruptcy is listed as an event of default, but that is in every contract.  I’ve also heard though there has been a trend towards greater judicial acceptance of these clauses, at least in regard to stay relief motions in single asset cases.  So tell me, are these waivers found just in consumer contracts? 

A final thought on an even more irksome clause found in forbearance agreements – the blanket release of all claims the debtor has or ever will have.  Unlike the prebankruptcy waivers, these releases are intended to be enforced.  It is one thing for these releases to be included in a settlement in which the consumer is represented and has brought claims against the lender or servicer in a court action, or threatened to file suit, and meaningful relief is provided (such as rewrite of the loan with substantial interest rate and principal reduction).  It is quite another thing for a consumer to give up as part of six-month repayment plan claims not only relating to the servicing of the loan but also those concerning the loan origination.

Several years ago, I participated as co-counsel in an action brought against the servicer Fairbanks Capital (later called Select Portfolio Servicing).  Of the many practices being challenged, we were concerned about reports that these releases were being asserted as defenses in litigation involving abusive loans being serviced by Fairbanks.  As part of the global settlement in that private class action, we included this provision: “A forbearance agreement or other default resolution plan will not require a borrower to waive or release claims against the Company.”  In a separate action against Fairbanks brought by the Federal Trade Commission, an injunction was entered enjoining this practice.  The FTC order provided that Fairbanks was enjoined from enforcing any clause in a forbearance agreement that required the “borrower to acknowledge his/her lack of claims or defenses; waive access to court; or otherwise waive or release any rights or claims.”  It is noteworthy that the FTC’s enforcement authority to pursue court actions such as this is founded in the Federal Trade Commission Act, which is intended to prohibit “unfair or deceptive acts or practices.”  Although parties to an FTC consent agreement do not admit any wrongdoing, for settlement purposes only, courts often use FTC consent agreements as guidance in interpreting state UDAP statutes.

With all the talk these days about loan mods, I certainly hope that there is some focus on this issue and an effort made to get these clauses out of workouts.  Inclusion of boilerplate blanket releases in workout agreements should be seen as an unfair and deceptive trade practice.   

Comments

[Adam Levitin]

Blanket waivers of claims are common enough in corporate forebearance agreements. Their enforceability is another matter, though, especially if the borrower files for bankruptcy shortly thereafter--courts are likely to look up the blanket waivers as a provision extracted in a duress situation and as an important potential asset of the estate.

[Jon Hayes]

Take a look at Cashco Financial Services v. McGee (In re McGee), 359 B.R. 764, (9th Cir BAP, December, 2006)

Issue: When a creditor files a 523(a) complaint which the court finds properly sets forth a prima facie case to which the debtor defaults, must the court thereafter enter a default judgment or may the court require evidence supporting the allegations in the complaint?

Holding: The court may require further evidence to support the allegations.

The clause said, "I'm not going to file bankruptcy." The finance company said, "We relied on that." The court said, "Yeah, right. Why then are you charging 190% interest?"

[Harley Goldstein]

See section IV(B)(3) of "Can Ipso Facto Clauses Resolve the Discharge Debate?: An Economic Approach to Novated Fraud Debt in Bankruptcy" at 1 DePaul Bus. & Comm. L.J. 417, which discusses enforcement of various pre-bankruptcy clauses in a number of contexts. I am also aware of several of these types of clauses in commercial transactions.