Second Mortgage Rights and Considerations   The debt owed to them is not going away any time soon  January 25, 2010 Stephen J. Nash Nash & Lodge, PLLP nash@nashandlodge.com As discussed above, there are many myths surrounding second mortgages but what are the options available to the second lender.  To negotiate with a second lender you must understand the others that are available to them.  When dealing with a lender on the first mortgage, it is straight forward - if the lender starts a foreclosure by advertisement, the lender has given up the right to sue for a deficiency and the owner/borrower will not agree to a short sale that the lender agrees to give up their right to a deficiency.  Since the lender isn't giving up a right that won't be wiped out by the foreclosure and the lender knows that it's holding costs go up while the value of the property further declines, the lender has a strong incentive to agree to such a short sale.  Unfortunately, the rights and the position of the subsequent lenders is much less clear and much more complex to sort out out and come to an agreement that is beneficial to the owner/borrower.                                                    Hold Up The Sale   While the lender has no incentive to foreclose or redeem from a prior mortgage foreclosure, they still have a mortgage on the property that has to be released in order for the homeowner to sell in a short sale.  Since the second lender does not have to release the mortgage without full payment, they have leverage over those who want the short sale to go through.  For this reason, the prior mortgage holder will normally agree to allowing a small payment out of the short sale proceeds to go to the second mortgage holder to induce them to release their mortgage.  While the second lender will often take what they can get, they have no obligation to accept anything less than full payment even if it means the short sale is lost.     If they do agree to the short sale, the second lender is very unlikely to satisfy the underlying note unless documentation is produced showing that they have no way of collecting the debt now or in the future.  The key to negotiating with the second mortgage holder is to a thorough understanding of the debtor/creditor laws of the state you are in.  What can the lender go after if they get a judgment?  What is protected?  Can the debtor file bankruptcy to wipe out the debt?  What assets can be protected if the debtor files bankruptcy?  Without knowing the answers to these questions, you cannot begin to negotiate with the second lender.  If the debtor has assets that the lender can go after to collect the debt or if the debtor cannot or does not want to file bankruptcy, the debtor has to realize that the second lender is not going to simply let them out of the terms of the note.       Some people think that if the second lender agrees to the short sale that they have forgiven the debt.  That is not true - you have to get a written statement from the lender that they have satisfied the note.  Some people may think that the lender has lost or given up it's rights to sue on the note because they haven't yet sued.  The fact that they have not yet sued does not mean that they won't in the future.  As long as they continue to have the right to sue, they can simply wait for a better time start the lawsuit (like when people actually have money again).        Sue Today or Sue Tomorrow     The subsequent lender can sue on the note any time after there is a default.  They do not have to foreclose or wait for the first lender to foreclose.  They do not have to wait for a sale of the property and they do not have to agree to a short sale where they agree to give up their right to sue for the deficiency.   If the short sale falls through or if it goes through but the second lender does not agree in writing to satisfy the underlying note, the lender can sue the debtor now or sometime in the future.  The general rule is that creditors sue right away if they think you have assets that may disappear or they will wait until you have assets to go after.  The fact that a second lender has not sued the debtor does not mean that will not do so some time down the road.  It would be perfectly logical for the lender to assume that in this economy that many of their debtors have very little for them to after right now so that they may as well wait until the country begins to recover and then sue the debtors.     We are now seeing some lenders suing on the note before a foreclosure has been commenced.  I am sure their logic is that if their is no equity in the property to pay off their debt, why wait for a foreclosure that they won't benefit from?  While we have not seen a great deal of such lawsuits, more may come into play as more and more of the local and regional banks are pulled into the process due to the fact that they hold a high number of second mortgages.  The local and regional lenders may move quicker than the national lenders because they are not as big and have less bureaucracy.  The impact of a delinquency is much greater for the local or regional lender than for the national lender.  In the case of the local and regional lender you are often negotiating with the same people who made the loan while on a national level you are dealing with a low paid, poorly trained employee in a loss mitigation department.  When it is your own deal that has gone bad, there is more urgency to the situation.         No matter who ultimately attempts to collect on the notes, lawsuits are inevitable.  Today we are not seeing an explosion of such collection lawsuits but that does not mean that they will not occur.  Since lenders don't really make decisions in isolation, we can only assume that they will set some arbitrary internal guidelines as to when they will sue debtors and if one person is sued, it is likely that many thousands or millions in a like situation are going to be sued in the near future.  Given the present economic problems, it would not be surprising if many lenders hold off on such lawsuits until the country starts to recover.  Why sue now when people are out of work, hours have been cut back, businesses failing and nobody has any money?  But when the country recovers and people are employed and businesses are prospering again why wouldn't they sue then?                     Some people think that the second lenders will never sue for political reasons.  The fact that the lenders may chose not to sue for political or other reasons is different than saying that they cannot sue.  While the borrower can chose to take this risk, the borrower must be made aware of the risk and make a knowledgeable  decision.  As for myself, I would not bet against the lenders bringing such lawsuits regardless of the politics.  The lenders have continually made clear that they value money over politics and we have already seen some of the large lenders begin to bring collection actions against debtors on second notes.  Politics may dictate that they sell the notes to third parties or their insurers to bring the lawsuits but one way or another they are going to try to recover what they can.            Collect on the Debt or Sell the Debt?    We are seeing signs of second lenders either selling the note to a third party who then tries to collect or to initiate a lawsuit themselves.   We have seen a number of cases where Citibank has sold the note to a third party who then attempts to collect on the debt.  In a couple of cases that our office was involved in, the settlements negotiated with the third party was significantly better than we had offered Citibank 6 months earlier.  It is not hard to imagine that lenders will begin bundling their seconds to sell for pennies on the dollar to third parties who will then try to collect the debt.  This could be helpful to the debtors in that the third parties might be easier to negotiate with but there could be many problems that arise because the third party is relying on the information given to them by the lender that very well could be wrong.  The bureaucracy to cut through to attempt to sort out the real facts could be a horrible undertaking.   Creditor/Debtor Rights    Ultimately,  negotiating with subsequent lender is all about creditor/lender rights.  If the lender sues and gets a judgment what can the lender collect?  If the creditor files bankruptcy what will the creditor loss and what will the creditor be able to keep?  This is a detailed and complex body of the law that cannot be easily summarize in this type of article.  Each state has a different set of laws relating to collections of judgments and bankruptcy.  Assets that are protected from a judgment may not be protected in  a bankruptcy or vice versa.  The debtor may elect state or federal protections when filing bankruptcy.     There are many state and federal laws that prevent debtors from transferring assets to avoid paying judgments or to avoid losing them in bankruptcy or to favor one creditor over the other (i.e.,  read any of the numerous newspaper articles that have been written about Denny Hecker's problems).     In order for a debtor to be realistic about what kind of a deal can be negotiated with the lender they have to know their options.  Can they file bankruptcy and wipe out the debt?  If they do, what assets will they lose and what assets can they protect?  If the creditor sues the debtor what assets can the lender go after and what is protected?  If a debtor has income and has assets they are unlikely to get through this process without losing something, even if they go through bankruptcy.  The debtor and the creditor have to weigh the advantages and the negatives of each option to try to find a balance that they can each live with.   Conclusion   Dealing with lenders whose liens are after the first mortgage is a complex negotiation.  Their options are different than that of the first and the financial condition of the borrower is much more important than it is to the first lender.  Since each state has different creditor/debtor laws, it is essential that you understand the laws as they affect your client or you have no way of knowing whether a proposal from the lender is beneficial or not.  If the debtor has assets that are vulnerable to a lawsuit or cannot survive bankruptcy, the debtor has to be realistic about what deal can be achieved.  The lender is not going to forgive debt that they think they can collect through a lawsuit.  By the same token, the debtor should not be using assets that the lender cannot go after with a judgment or that can survive a bankruptcy to pay off the debt to the subsequent lender.     Each lender and debtor situation is different and can dramatically change the rights and considerations of each.  To successfully negotiate with subsequent lenders forces you to understand the many factors that come to bear so that you can successfully negotiate the borrower through a difficult and scary process.         NOTICE The foregoing is not intended to constitute legal advice for any specific circumstance, but is intended to reflect broadly applicable principles, under Minnesota law, relevant to a typical situation. Each set of facts and each contract are, or can be unique; the unique facts and specific language of the contract may require a different legal analysis and may result in a different outcome. Before proceeding in reliance upon this or any other general description of law, consult with an attorney competent in the field of practice relevant to your situation. Copyright 2010 Nash & Lodge, PLLP