A recent California appellate court case was a win for a foreclosed homeowner, but it also demonstrates how important it is to get good legal advice during bankruptcy. According to Forbes blogger Shah Gilani, the case highlights both the empty promises many troubled homeowners hear when they try to negotiate loan modifications and the “despicable tactics” some banks use to force foreclosures.

In this case, U.S. Bank is essentially accused of tricking a homeowner who had declared bankruptcy into giving up her bankruptcy protection so they could foreclose on her.

Bank offers a loan modification in exchange for the borrower waiving her bankruptcy rights; Modification offer would have doubled her monthly payments

The case involved the wrongful foreclosure of an LA woman’s home. She ran into trouble when the interest rate on her adjustable rate mortgage (ARM) shot up two years after she took out the loan. In March 2008, she received a foreclosure notice from U.S. Bank. She filed for Chapter 7 bankruptcy, which she later converted to Chapter 13.

As soon as she filed, the automatic bankruptcy stay went into effect, which stops all creditors from pursuing any collection activities or contacting the debtor directly until the bankruptcy proceedings are over.

Chapter 13 bankruptcy offers homeowners protections against immediate foreclosure, and many debtors are able to save their homes by reorganizing their mortgage payments and arrearages as part of the Chapter 13 repayment plan. U.S. Bank apparently had no plans to let that happen.

U.S. Bank filed a motion in bankruptcy court to lift the automatic stay so it could move forward with the foreclosure. Its loan servicer then sent a letter to the woman’s bankruptcy lawyer asking for permission to contact her directly in order to “explore Loss Mitigation possibilities.”

The bankruptcy attorney agreed to allow direct discussions. When the homeowner called, the servicer said they couldn’t help her unless the automatic bankruptcy stay was lifted.

The homeowner, hoping to save her home, did not oppose the motion to lift the bankruptcy stay and ultimately decided to withdraw her Chapter 13 bankruptcy.

On December 4, 2008, the stay was lifted. On December 9, U.S. Bank secretly moved forward with the foreclosure, putting the woman’s home up for auction scheduled for January 9, 2009.

Meanwhile, the woman sent in the required documents for the loan modification and was told a negotiator would contact her by January 13 — four days after the home was scheduled to be sold.

One day before the auction, the servicer presented a unilateral offer to the homeowner. They’d modify the loan, all right — raise the mortgage balance by more than $100,000 and double her monthly payments. She declined and lost her home.

She also sued. On January 27, the California Court of Appeal ruled that the bank had failed to meet its obligation to negotiate in good faith.

A promise to negotiate is “not based on a promise to make a unilateral offer but on a promise to negotiate in an attempt to reach a mutually agreeable loan modification,” the Court wrote. According to Gilani, charges of bankruptcy fraud may follow.

Source: Forbes Advisor Intelligence blog, “Judge Rules Against Bank In Mortgage Modification Suit,” Shah Gilani, February 10 2011