Between Scylla and Charybdis: Communicating with Debtors During and After Bankruptcy

Odysseus faced an impossible choice. Should he face Scylla with her six heads, three rows of shark-like teeth, and long necks who lived in a cavern above the sea, ready to devour anyone who came close to her mountainous retreat?[1] Or should he face Charybdis, a whirlpool monster who devoured everything that came into its watery path?[2] He asked Circe, “Could I not somehow steer clear of the deadly Charybdis, yet ward off Scylla when she attacks my crew?”[3] Circe responded, “You must hug Scylla’s rock and with all speed drive your ship through, since it is far better to lose six of your company than your whole crew.”[4] In other words, there was no avoiding the two evils: Odysseus had to choose the lesser of the two and deal with the consequences.

Like Odysseus, mortgage companies face their own Scylla and Charybdis. On the one hand, the Code prohibits acts to collect debts, such as mortgage debts, that have been discharged in bankruptcy.[5] This is their Scylla. On the other hand, mortgage companies are often bound by statute or contract to keep borrowers informed about their mortgages, such as monthly payments, balances and other important aspects of their loans.[6] This is their Charybdis. In an effort to “hug the Scylla rock” and “drive as fast” as they can, mortgage companies have developed a “bankruptcy disclaimer” that appears on most correspondence sent to bankrupt mortgagors. These disclaimers often tell borrowers that the letter is “for informational purposes only ” and “does not constitute an attempt to collect a debt or to impose personal liability for such obligation.”[7] But this method causes nothing but harm to mortgage companies.

In determining whether correspondence violates the automatic stay or discharge injunction, a court must consider “what type of communication was sent to the debtor and whether the communication had a purpose other than collection of the debt outside the scheme contemplated by the Bankruptcy Code.”[8] “Prohibited communications include those where direct or circumstantial evidence shows the creditor’s actions were geared toward collection of a prepetition debt, were accompanied by coercion or harassment, or otherwise put pressure on the debtor to pay.”[9] Indeed, “a creditor must ensure that it does not coerce a debtor to pay the debt; it must ensure that its correspondence does not have a coercive or harassing effect on the debt.”[10]

The seminal case regarding communicating with debtors is In re Draper.[11] In this case, the court held that correspondence “is clearly geared toward collection of the debt,” and therefore in violation of the Code, if the correspondence sets forth past-due amounts, asks the borrower to remit the past-due amount, and provides a payment coupon.[12] The use of a disclaimer does not help insulate a mortgage company.[13] Specifically, the test of whether communications violate the Code is succinctly stated as follows: Are the communications “designed to place pressure on the Debtor to pay,” and is the only “credible reason” to send the communications “to try to collect payments from debtors”?[14] If so, the actions violate the Code, and any disclaimer is without effect.[15]

The rationale of Draper has been adopted by courts throughout the country. For example, a violation of the Code exists when the information in the correspondence “is not needed or requested by the debtor.”[16] Other courts have agreed.[17] Monthly mortgage statements can be particularly misleading to borrowers in bankruptcy, especially when the debtor is paying pre-petition arrearage and/or ongoing mortgage payments through the Trustee, because the statements may cause the debtor to make “an additional and unwarranted payment.”[18]

The Draper rationale holds true in the chapter 7 context as well. If a debtor states in his Statement of Intention that he intends to surrender the property, courts have unanimously held that a debtor no longer needs “to know the status of the mortgage payments.”[19] Indeed, the “only purpose for sending the monthly statements after that point [is] to induce [a debtor] to make payments on a prepetition debt,” which is now discharged.[20] More recently, courts have held that boilerplate disclaimers on statements do not insulate a mortgage company from liability from violating the discharge injunction in chapter 7 cases.[21]

In essence, courts must examine the tone of the correspondence. The tone of the correspondence cannot be “strikingly different from the bankruptcy disclaimer” printed on the document.[22] Thus, if the tone of the document suggests that it is intended to place pressure on a debtor to pay the debt, then the mortgage company is attempting to collect the debt, despite what any disclaimer might read.[23]

Odysseus lost six men as his ship hugged Scylla’s mountainous home.[24] But unlike Odysseus, who had no choice but to lose some of his crew, mortgage companies have an opportunity to hug Scylla’s rock without taking any casualties. How? The answer is simple: Do not send correspondence to borrowers who have been discharged in bankruptcy or who have otherwise stated their intention to surrender the property.[25]

Yet the implementation of this solution is somewhat problematic. The undercurrent of the problem rests with their computer systems. Correspondence is almost always routinely generated by the various software programs. These programs make no distinction among a borrower, a discharged borrower and a borrower currently in bankruptcy. In fact, often the same notices, letters and statements are sent to all borrowers. The only difference is that a bankruptcy disclaimer is included on the correspondence sent to accounts flagged as being in bankruptcy; otherwise, there are no remarkable differences in the correspondence sent to nonbankrupt borrowers and bankrupt ones.

For borrowers currently in bankruptcy, the software needs to be updated to correspond with only those borrowers who have expressed an interest in retaining the property. That correspondence, however, does not need to demand pre-petition arrears, as the statements did in Draper.[26] Likewise, correspondence can be sent to borrowers post-discharge, but only if the debtor has either reaffirmed the debt or has indicated an intention to retain and pay.[27] Otherwise, the programs need to block all correspondence unless there is a separate statutory requirement.[28] Updating their software to comport with the requirements of the Code would allow mortgage companies to chart the same course as Odysseus, but without suffering any likely harm.