Is Deficiency Judgment or Short Sale Note a Consumer Debt in Bankrup...

Chapter 7 bankruptcy debtors are excused from the means test if their debts are primary non-consumer debts. The distinction between what is a consumer debt and what is a non-consumer debt is sometimes unclear. Mortgage debt on the debtor’s primary residence is a consumer debt. I believe a deficiency judgment after foreclosure or a short sale relating to the underlying mortgage note would also be consumer debt.

In some short sale arrangements the mortgage lender asks the homeowner to sign a new promissory note for a deficiency amount as a condition for permitting closing of the owner’s short sale. First mortgage lenders rarely pursue deficiency judgments after a short sale, and I think, and most attorneys would agree, that it would be ill-advised (an understatement) for a homeowner to sign a new promissory note to the lender as a condition of a short sale.
One of my clients signed such promissory note to his first mortgage lender at a short sale closing in the amount of over $175,000. The client wants to file bankruptcy. The clients’ family income is over $125,000 for a family of four. The client cannot pass the means test. The issue is whether the new promissory note is a consumer debt; if it is, my client is exempt from the means test because his non-consumer debt currently exceeds his consumer debt. The client has not purchased a new homestead.
My client has not asked me to research this legal issue so I am not aware of a case on this point. On one hand, the new note relates back to his homestead and the new note would not exist but for his consumer debt of the original homestead mortgage. On the other, the client did not sign the new note to acquire a consumer item. He signed the note to do a short sale in order to avoid a foreclosure and its impact on his credit. In my opinion, the new promissory note is more likely a non-consumer debt. The debt was not incurred to “consumer” , that is, not to purchase a good for personal use or consumption.

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