Discharge Injunction Violation: Can A Lender Refuse To Foreclose, Release Its Lien, Or Accept Surrender Of A Property?

After filing a chapter 7 bankruptcy, the debtors tried to surrender their residence to the mortgage lender. After the bankruptcy the lender refused to accept a surrender, refused to foreclose and refused to release its lien. The debtors brought an adversary proceeding claiming that, among other things, this refusal constituted a violation of the discharge injunction they received in bankruptcy. The bankruptcy court found no violation; the Bankruptcy Appellate Panel agreed; and on appeal the 1st Circuit affirmed - but with some cautionary comments.

All parties agreed that the mortgage loan was substantially underwater. The loan had a balance of ~$186,000, while initially the debtors valued the property at $130,000 and the lender valued it at $86,000. Although a foreclosure proceeding was pending at the time the bankruptcy was filed, the lender voluntarily dismissed the foreclosure without prejudice based on the bankruptcy.

The debtors received a discharge under Section 727 of the Bankruptcy Code, which means that they were discharged from all prepetition debts, including the mortgage loan. Under Section 524(a) of the Bankruptcy Code a discharge "operates as an injunction against the commencement or continuation of an action, the employment of process, or an act, to collect, recover or offset any such debt as a personal liability of the debtor, whether or not discharge of such debt is waived."

After they received their discharge, the lender advised that it would not proceed with foreclosure, and that the debtors remained responsible for taxes, insurance and maintenance of the property. In response, the debtors reminded the lender of the discharge and demanded that it either commence foreclosure or discharge the mortgage. The bank declined, although it advised that it would consider a settlement option or a short sale. After exchanging a few additional letters, the debtors vacated the property, turned off the utilities and notified municipal authorities and the sewer company that the lender was the party responsible for any obligations pertaining to the property.

The debtors then reopened the bankruptcy case and brought claims against the lender based on its violation of the discharge injunction, including a request that it be required to either take possession of the property or deliver unencumbered title. The bankruptcy court did find a violation in connection with a letter that stated that the debtors still had "a financial obligation to...