Our bank received a Chapter 7 bankruptcy notice for a customer who has a home equity line of credit (HELOC) with our bank. Can we decrease the available amount on the line, without terminating it, so that the customer may no longer access the funds? If so, what notification, if any, do we need to provide to the customer? Also, would we need to send an adverse action notice to the borrower, or does the bankruptcy prevent us from doing so?

Yes, we believe that your bank may reduce a HELOC’s line of credit after receiving a Chapter 7 bankruptcy notice, subject to the notice requirements discussed below.

Regulation Z generally prohibits creditors from reducing or freezing a HELOC’s credit limit unless an exception applies. One exception permits the reduction or freezing of a line of credit based on a reasonable belief that the borrower “will be unable to fulfill the repayment obligations under the plan because of a material change in the consumer’s financial circumstances.” While a Chapter 7 bankruptcy filing might not necessarily indicate that a borrower will be “unable” to fulfill their repayment obligations, the Regulation Z Official Interpretations clearly state that creditors “may prohibit further advances or reduce the credit limit under this section if a consumer files for or is placed in bankruptcy.” Consequently, we believe that your bank may choose to reduce the HELOC due to the borrower’s Chapter 7 bankruptcy filing.

As to the notice requirements, Regulation Z requires lenders to provide written notice to the borrower when reducing or freezing a HELOC credit limit within three business days after taking the action. Also, the notice “shall contain specific reasons for the action. If the creditor requires the consumer to request reinstatement of credit privileges, the notice also shall state that fact.”

Additionally, your bank may need to provide an adverse action notice under either Regulation B or the Fair Credit Reporting Act (FCRA), or both. Under both Regulation B and the FCRA, an adverse action includes unfavorable or adverse changes to an account, which would include a reduction in the credit available under a HELOC. Also, we do not believe that sending an adverse action notice would be prohibited by the “automatic stay” imposed as part of your customer’s bankruptcy filing.

Notably, Regulation B exempts from the definition of an “adverse action” any actions “taken in connection with inactivity, default, or delinquency as to that account,” as well as a “change in the terms of an account expressly agreed to by an applicant.” If your HELOC agreement provides that a bankruptcy filing is an event of default, or that the customer agrees to a reduction in the HELOC in the event of a bankruptcy filing, we believe your bank may take the position that the HELOC reduction was not an adverse action requiring notice under Regulation B.

Under the FCRA, however, your bank must provide an adverse action notice if the decision to reduce the HELOC was based on information in a credit report. If your bank pulled a credit report for the borrower after receiving the Chapter 7 bankruptcy notice, we recommend providing an FCRA adverse action notice — even if your bank is not required to provide a Regulation B adverse action notice for the reasons discussed above.

For resources related to our guidance, please see:

Regulation Z, 12 CFR 1026.40(f)(3) (“No creditor may, by contract or otherwise: . . . (3) Change any term, except that a creditor may: . . . (vi) Prohibit additional extensions of credit or reduce the credit limit applicable to an agreement during any period in which: . . . (B) The creditor reasonably believes that the consumer will be unable to fulfill the repayment obligations under the plan because of a material change in the consumer’s financial circumstances; . . .”)

Official Interpretations, Regulation Z, Paragraph 40(f)(3)(vi), Comment 7 (“Material change in financial circumstances. Two conditions must be met for § 1026.40(f)(3)(vi)(B) to apply. First, there must be a ‘material change’ in the consumer’s financial circumstances, such as a significant decrease in the consumer’s income. Second, as a result of this change, the creditor must have a reasonable belief that the consumer will be unable to fulfill the payment obligations of the plan. A creditor may, but does not have to, rely on specific evidence (such as the failure to pay other debts) in concluding that the second part of the test has been met. A creditor may prohibit further advances or reduce the credit limit under this section if a consumer files for or is placed in bankruptcy.”)

Regulation Z, 12 CFR 1026.9(c)(1)(iii) (“Notice to restrict credit. For home-equity plans subject to the requirements of § 1026.40, if the creditor prohibits additional extensions of credit or reduces the credit limit pursuant to § 1026.40(f)(3)(i) or (f)(3)(vi), the creditor shall mail or deliver written notice of the action to each consumer who will be affected. The notice must be provided not later than three business days after the action is taken and shall contain specific reasons for the action. If the creditor requires the consumer to request reinstatement of credit privileges, the notice also shall state that fact.”)

Regulation B, 12 CFR 1002.2(c)(1)(ii) (The definition of “adverse action” includes “(ii) A termination of an account or an unfavorable change in the terms of an account that does not affect all or substantially all of a class of the creditor’s accounts; . . .”)

Regulation B, 12 CFR 1002.2(c)(2)(ii) (“Adverse action” does not include “(ii) Any action or forbearance relating to an account taken in connection with inactivity, default, or delinquency as to that account; . . .”)

Regulation B, 12 CFR 1002.2(c)(2)(i) (“Adverse action” does not include (“(i) A change in the terms of an account expressly agreed to by an applicant; . . .”)

FRB Philadelphia, Consumer Compliance Outlook, HELOC Plans: Compliance and Fair Lending Risks When Property Values Change (3Q 2013) (“If a creditor suspends a HELOC or reduces the credit limit, and the action does not affect all or substantially all of a creditor’s HELOC accounts, the creditor has taken adverse action. However, the regulation also states that adverse action does not include ‘a change in the terms of an account expressly agreed to by an applicant.’ Thus, an adverse action notice would not be required if the HELOC agreement specified that the creditor could suspend the HELOC or reduce its credit limit in the event the value of the property significantly declined.”)

FCRA, 15 USC 1681a(k)(1)(B)(iv) (“The term ‘adverse action’ . . . means . . . an action taken or determination that is (I) made in connection with an application that was made by, or a transaction that was initiated by, any consumer . . . ; and (II) adverse to the interests of the consumer.”)

FCRA, 15 USC 1681m(a) (“If any person takes any adverse action with respect to any consumer that is based in whole or in part on any information contained in a consumer report, the person shall (1) provide oral, written, or electronic disclosure . . . .”)

Bankruptcy Code, 11 USC 362(a)(6) (A petition filing for bankruptcy “operates as a stay, applicable to all entities, of . . . (6) any act to collect, assess, or recover a claim against the debtor that arose before the commencement of the case under this title; . . .”)