The Essential Terms of the New--And Now Suddenly More Likely to Pass--Chapter 13 Mortgage Cramdown Bill

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys, Andy@BLSforAttorneys.com



This Bankruptcy Bulletin presents the core cramdown provisions of Senate Bill 61, the Helping Families Save Their Homes in Bankruptcy Act of 2009, following up on last Thursday's dramatic announcement of Citigroup's new support for the bill. See my Bulletin of last Friday on this break-through agreement between the Senate Democratic leadership and Citigroup.

(Tomorrow's Bulletin presents other very important and less publicized provisions of the bill, including a major indirect expansion in the Chapter 13 jurisdictional limits for secured and unsecured debt (Section 109(e)), detailed new rules governing post-petition fees of mortgage creditors (Section 1322(c)), as well as the concessions made to Citigroup to gain its support.)

Senate Bill. 61, and its companion bill in the House, H.R. 200, were introduced on the floor of the Senate and House last Tuesday, 1/06/09, but as of this last weekend the text of of the bills had not been received from the Government Printing Office by the Library of Congress, and no summary of the bills had yet been prepared. However the text of S. 61 was printed in the Congressional Record upon its introduction and so is accessible there.


The Core of the Bill: Amendments to Section 1322(b)

Although many parts of the bill are the same or very similar to its versions introduced and debated in the prior Congress (see S. 2136 of the 110th Congress), the current bill takes a different, and very much broader approach in its core cramdown provision. Whereas in the last session mortgage modification was limited to debts "secured by a nontraditional mortgage, or a subprime mortgage, and any lien subordinate to such claim, on the principal residence," now modification is expanded to any "loan secured by a security interest in the debtor’s principal residence that is the subject of a notice that a foreclosure may be commenced." (See the end of this Bulletin for the portion of the bill on the Section 1322(b) amendments.)

And there is no budgetary limitation: in an amended form of last year's bill, a debtor had to show through their monthly budget "insufficient remaining income to retain possession of the residence by curing a default and maintaining payments." That is no longer a condition for mortgage modification (although other budget-related provisions in Chapter 13 arguably accomplish that in practice, at least in many situations).

The most important provision, the cramdown: new subsection 1322(b)(11)(a) permits a Chapter 13 plan to provide "for payments of the amount of the allowed secured claim as determined under section 506(a)(1)." Section 506, entitled "Determination of secured status," includes subsection (a)(1), the well-known provision which provides for the bifurcation of an undersecured claim into secured and unsecured portions--with the secured portion determined by "the extent of the value of such creditor's interest in the estate's interest in such property."

With adjustable rate mortgages, this bill allows the plan to prohibit, reduce, or delay "adjustments to such rate of interest applicable on and after the date of filing of the plan." Note that this seems to preclude "prohibiting, reducing, or delaying" PRE-PETITION interest rate increases--that is, debtors appear stuck with the interest rate as of the date of filing, but subsequent language in the bill--discussed immediately below--seems clearly to allow interest rate adjustments, for all principal residence mortgages regardless whether fixed or adjustable rate.

Post-petition interest may be modified to a new rate, using the same language as last year, determined as follows:

an annual percentage rate calculated at a fixed annual percentage rate, in an amount equal to the then most recently published annual yield on conventional mortgages published by the Board of Governors of the Federal Reserve System, as of the applicable time set forth in the rules of the Board, plus a reasonable premium for risk . . . .

The mortgage repayment period may be modified

to extend the repayment period for a period that is no longer than the longer of 40 years (reduced by the period for which such loan has been outstanding) or the remaining term of such loan, beginning on the date of the order for relief under this chapter

This is substantively similar to last year's bill, but with the significant increase from the prior 30 to now 40 year maximum.

The final change in Section 1322(b)(11) is subsection (D) stating that the plan may provide "for payments of such modified loan directly to the holder of the claim," that is, such payments need not be paid through the Chapter 13 trustee.

There is a very timely discussion of this specific issue by Katherine Porter, associate professor at the University of Iowa law school (and former associate at Stoel Rives LLP in Portland, Oregon in its bankruptcy and creditors' rights group), in an article from just last Friday entitled Cramdown Controversy #1--Who Do I Pay? She asserts that "[t]he pending legislation contains language that would require the payments on mortgages modified in bankruptcy to be made 'directly to the holder of the claim.' " And she concludes: "I think debtors should have the option of making payments on a modified mortgage either directly to the mortgage company or through the trustee, as is currently the practice."

Query: By my reading (see below), Section 1322(b)(11)(D) permits but does not require direct payments to cramdown mortgage creditors. What is Porter seeing that I'm missing?

Senate Bill 61's Amendments to Section 1322(b)
For reference, here is the portion of Senate Bill 61 directly pertinent to the new Section 1322(b)(11):

[T]he [Chapter 13] plan may--

(11) notwithstanding paragraph (2) and otherwise applicable nonbankruptcy law, with respect to a claim for a loan secured by a security interest in the debtor’s principal residence that is the subject of a notice that a foreclosure may be commenced, modify the rights of the holder of such claim—

(A) by providing for payment of the amount of the allowed secured claim as determined under section 506(a)(1);

(B) if any applicable rate of interest is adjustable under the terms of such security interest by prohibiting, reducing, or delaying adjustments to such rate of interest applicable on and after the date of filing of the plan;

(C) by modifying the terms and conditions of such loan—
(i) to extend the repayment period for a period that is no longer than the longer of 40 years (reduced by the period for which such loan has been outstanding) or the remaining term of such loan, beginning on the date of the order for relief under this chapter; and
(ii) to provide for the payment of interest accruing after the date of the order for relief under this chapter at an annual percentage rate calculated at a fixed annual percentage rate, in an amount equal to the then most recently published annual yield on conventional mortgages published by the Board of Governors of the Federal Reserve System, as of the applicable time set forth in the rules of the Board, plus a reasonable premium for risk; and

(D) by providing for payments of such modified loan directly to the holder of the claim.

Again, tomorrow's Bulletin will present the other very important and less publicized provisions of Senate Bill 61, including an expansion in the Chapter 13 jurisdictional limits, new rules governing the allowance of post-petition fees by mortgage creditors (Section 1322(c)), as well as the three conditions agreed to with Citigroup (which have not yet been included in an amendment of S.61.


by Andrew Toth-Fejel
Bankruptcy Litigation Support for Attorneys
Andy@BLSforAttorneys.com

PLEASE NOTE that this Bulletin and the entire contents of this website are NOT designed for the general public but rather only for attorneys. The writer is not licensed to practice law in any state. This means that he is not legally permitted to give any legal advice or perform any legal services. Any non-attorney reading this must consult an attorney about ANYTHING contained here. Nothing in this website is intended to be nor should be read as being legal advice to anyone.

© 2009 Bankruptcy Litigation Support for Attorneys

Chapter 13 Mortgage Cramdown Bill Now Expected to Pass Within Weeks, May Be Attached to Stimulus Package: Citigroup Withdraws Opposition

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys, Andy@BLSforAttorneys.com

At a press conference yesterday afternoon Senators Dick Durbin, the Senate's second-ranking Democrat, Christopher Dodd, the Senate Banking Committee Chairman, and Charles Schumer of New York announced that Citigroup had just agreed to a deal to withdraw its long-standing opposition to Durbin's mortgage cramdown bill, in return for some concessions in its contents. Citigroup's CEO Vikram Pandit wrote in a letter to the legislators: "Given today's exception economic environment, we support [the bill's] swift passage." The Senators said they wanted to attach the bill to the major stimulus package, which appears to be President-elect Obama's highest priority after he is inaugurated just a few days from now.

Senator Durbin had just reintroduced the bill in the new Congress on Tuesday, very similar to the bill, S. 2136, the Helping Families Save Their Homes in Bankruptcy Act, which had been defeated in a Senate vote in April 2008 with only 36 Senators voting in favor of it. That bill had been co-sponsored by 13 Senators, one of the earliest being Barack Obama, followed by Joe Biden and Hillary Clinton. Last September the bill was included in several versions of the $700 billion financial bailout package but was excluded from the final version. On Tuesday, Rep. Brad Miller, D-N.C., re-introduced complementary legislation in the House.

Prospects for Passage
According to Senator Schumer, "Citigroup's action has broken the dam. . . . My office has now been called by heads of the -- of most of the major banks in the country, saying they want to hop on board. And I'm now hopeful that we can get the banking industry to be supportive of this provision -- at the very least, [to] not oppose it."

A BusinessWeek.com article posted late on Thursday acknowledged that, even before the Citigroup announcement, the financial services industry was in a position of having to compromise:

[A]s recently as December, industry officials were promising an ugly fight, and saying they might still be able to head off the measure entirely. No longer. Citigroup’s announcement comes even as the same officials acknowledge that a compromise is likely — though perhaps not this compromise. “I think the politics, the substance, the economics, the tax angle all work against the industry on this one,” a financial-services industry official said in an interview Wednesday night, before the Citigroup agreement was public.

A Wall Street Journal website article yesterday assessed the bill's prospects as follows:

While the [Citigroup] agreement makes eventual passage of the measure more likely -- particularly in the new Democratic Congress -- the bill must still pass both chambers.

The cramdown agreement goes further than any compromise discussed with lenders before the current Congress. Now, Democrats have the votes they need to pursue bold pro-consumer measures that were repeatedly defeated last year, particularly in the closely-divided Senate, where Republicans used procedural maneuvers to quash many of Democrats' favorite initiatives, including cramdown.

A less sanguine attitude was expressed by M. Jonathan Hayes of BankruptcyProf Blog who said: "I expect this legislation to pass later this month and then "whoa nelly."

The Concessions to Citigroup
At yesterday's press conference, the Senators revealed the three negotiated changes to the original cramdown bill:
1. Only existing mortgages, specifically those entered into before the date of enactment of the new law, would be eligible for the cramdown, on the theory that this would put less upward pressure on future home mortgages, in order to at least partially undercut the industry's persistent argument that bankruptcy modifications would drive up the cost of future mortgages;
2. Homeowners would be required to certify that they attempted to contact their lender regarding loan modifications at least 10 days before filing for bankruptcy;
3. If a lender is found to have violated the Truth in Lending Act (TILA) in certain minor ways during the bankruptcy, it would be subject to fines but would not have to forgive the loan, bringing it in line with the statute as it is outside bankruptcy; major violations would still be subject to full sanctions under TILA.

The Bill's Language
As of very late Thursday, January 8, The Library of Congress' legislative information service "THOMAS" did not seem to have the new 2009 version of Durbin's bill available on its website, nor could I find it on the Senate's website. I noticed other bloggers were also searching for it. As soon as it becomes available, I will dedicate a Bulletin to its terms, and update its prospects for passage.

In the meantime, I was inclined to provide here a quick review of Durbin's Senate Bill 2136, of LAST year's session, the Helping Families Save Their Homes in Bankruptcy Act, but its two versions--as introduced in October 2007 and then as amended in July 2008--were sufficiently different as to the core amendments to Section 1322 of the Bankruptcy Code that it makes more sense to see what the new bill actually contains, including the new changes just negotiated with Citigroup.

by Andrew Toth-Fejel
Bankruptcy Litigation Support for Attorneys
Andy@BLSforAttorneys.com

PLEASE NOTE that this Bulletin and the entire contents of this website are NOT designed for the general public but rather only for attorneys. The writer is not licensed to practice law in any state. This means that he is not legally permitted to give any legal advice or perform any legal services. Any non-attorney reading this must consult an attorney about ANYTHING contained here. Nothing in this website is intended to be nor should be read as being legal advice to anyone.

© 2009 Bankruptcy Litigation Support for Attorneys

Ch. 7 Case Dismissed Under Sect. 727(a(3) Because Debtor Failed to Keep or Preserve Adequate Business & Financial Records on $800,000 in Bank Deposits

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys, Andy@BLSforAttorneys.com

U.S. Trustee v. Caron (In re Caron)
Bankruptcy Court, District of Oregon
Adversary Proceeding 08-0365-rld; Case No. 07-33796-rld7

December 2, 2008 ((NOTE: this opinion was just uploaded to the Court's website although it is dated a month earlier.)
Unpublished opinion by Judge Randall Dunn


This opinion, although unpublished, presents good guidance on the standards for dismissal under § 727(a)(3).

Recent Ninth Circuit Opinion: Caneva
In his opinion Judge Dunn cites and relies on a very recent Ninth Circuit opinion, Caneva v. Sun Communities Operating Limited Partnership (In re Caneva), __ F.3d __, 2008 WL 4791680 (9th Cir. Nov. 5, 2008), which was the subject of this website's Bankruptcy Bulletin published on the day following its filing, titled Ninth Circuit Affirms Denial of Discharge under Section 727(a)(3) for Chapter 7 Debtor's Failure to Keep Financial Records.

The holding in Caneva was that under § 727(a)(3) the party moving for dismissal has the burden of:

establishing a prima facie case (1) that [debtor] had failed to keep or preserve records and (2) that such failure made it impossible to ascertain his financial condition and material business transactions. The prima facie case shifted to [debtor] the burden to avoid summary judgment by showing that a genuine issue of material fact existed with respect to whether his failure was justified under the circumstances of his case.
. . . .
[T]he statute imposes an affirmative duty on the debtor to keep and preserve recorded information that will allow his creditors to ascertain his financial condition and business transactions. A debtor who has admitted to owning businesses for which he kept no recorded information and to transferring a substantial sum of money without retaining any documentation has not kept or preserved information within the meaning of the statute, and must provide a justification for this failure that goes beyond a conclusory statement in an affidavit that he is entitled to discharge.

Summary of the Opinion
This Oregon Caron opinion largely mirrors Caneva but adds some additional important nuances. In this Chapter 7 case the United States Trustee (“UST”) filed an adversary proceeding to deny debtor’s discharge on various § 727 grounds in addition to subsection (a)(3), including §§ 727(a)(2)(B), (a)(4)(A), and (a)(5), but Judge Dunn did not have to address those because he found the (a)(3) grounds to be sufficient for dismissal. The judge entered a judgment denying "discharge for failing to keep and preserve adequate business and financial records to allow creditors and the chapter 7 trustee to ascertain and evaluate [the debtor] Mr. Caron’s financial condition and material business transactions." Specifically, during the two years before filing the case, debtor deposited a total of more than $800,000 in a number of different bank accounts without any accounting, "commingled indiscriminately," leaving the UST and the court unable to "determine what Mr. Caron’s income and expenses were for 2006 and 2007. The UST having met its burden of proof under section 727(a)(3), Judge Dunn further concluded "that Mr. Caron has not met his burden of proof to justify the lack of adequate business and financial records."

Standard of Proof
This opinion makes clear that while the "party seeking to deny a discharge to the debtor generally bears the burden of proof, "[s]ince the Supreme Court’s decision in Grogan v. Garner, 498 U.S. 279 (1991), the burden of proof standard for denial of discharge actions under § 727 is preponderance of the evidence." So:

ultimately, in spite of whatever weight on the scale favors the debtor’s discharge, a party seeking to deny the debtor a discharge under § 727 likely will prevail if the evidence establishes that it is more likely than not that the objecting party’s case is justified.

Section 727(a)(3)
Section 727(a)(3) denies a discharge to a debtor who “has concealed, destroyed, mutilated, falsified, or failed to keep or preserve any recorded information, including books, documents, records, and papers, from which the debtor’s financial condition or business transactions might be ascertained, unless such act or failure to act was justified under all of the circumstances of the case.”

Very importantly:

Unlike many of the other discharge denial provisions of § 727, § 727(a)(3) does NOT require that the party seeking to deny the debtor a discharge establish that the failure to keep or maintain adequate financial records was “knowing” or “fraudulent.” “What constitutes adequate books, documents, and records must be decided on a case-by-case basis, depending on the Debtors’ business operations and sophistication."

Finally,

§ 727(a)(3) is not appropriately used as a trap to deny a discharge to consumer debtors or business operators who through inadvertence, lack of competence, or both, maintain less than pristine business records. However, the Bankruptcy Code does not condone a complete default in maintaining and preserving records from which basic information regarding a debtor’s business and financial affairs can be obtained.

Burden of Proof, Initially with Proponent, then Shifts to Debtor

The plaintiff in a § 727(a)(3) action bears the initial burden of proof to establish “(1) that the debtor failed to maintain and preserve adequate records, and (2) that such failure makes it impossible to ascertain the debtor’s financial condition and material business transactions.” [Citation excluded.] Once plaintiff makes such a prima facie case, the burden shifts to the debtor defendant to justify the
inadequacy or nonexistence of the records.

Debtor's Justifications
After the UST met its burden of proof, debtor, through his counsel Michael Day, made the following arguments to justify the insufficient records:

1) Lack of access to one set of financial records: The opinion appears to be sympathetic to the realities that. as to one set of the debtor's businesses, the business records were maintained by a partner's wife on her computer, and that when the partner and his wife and the computer disappeared a number of months before the bankruptcy was filed, he had no access to those records. So although Judge Dunn was troubled by the lack of records maintained by debtor after the partner's disappearance, he said he "might be inclined to find that adequate justification for Mr. Caron’s lack of records for the Royal Air Cargo business was provided from the uncontradicted evidence of the absconding of his business partner . . . and his record-keeping wife," but the debtor's other other major business and financial activities "cry out for further justification."

2) Debtor is "not an accountant": While acknowledging that a § 727(a)(3) analysis "is fact dependent in each case and focuses in large part on the relative business sophistication of the debtor whose discharge is challenged," Judge Dunn was adamant about the limits of this excuse:

One does not have to be an accountant to be able to prepare and maintain a ledger, showing 1) when and how much money was received from a particular customer, 2) how the funds were handled or invested, 3) when and how much money was repaid to each customer, and 4) how much compensation Mr. Caron received for his services.

He found "the virtually complete lack of such records to be astonishing and ultimately not credible."

3) In his closing argument Mr. Day raised the argument that the debtor's lack of record-keeping could be "cultural." Although noting that no evidence was presented at trial on this argument, Judge Dunn could not resist addressing it, with a flash of his wry humor, by saying:

I am unaware generally of any culture that conducts commerce without some means of recording business transactions. The practice of keeping records of business transactions goes back at least to pre-cuneiform script on clay tablets in ancient Sumer. See the entry on “Sumer” in Wikipedia.

He found "that Mr. Caron’s cultural background as a Kazakh emigrant to the United States does not justify his failure to keep and preserve adequate financial and business records in this case."

by Andrew Toth-Fejel
Bankruptcy Litigation Support for Attorneys
Andy@BLSforAttorneys.com

PLEASE NOTE that this Bulletin and the entire contents of this website are NOT designed for the general public but rather only for attorneys. The writer is not licensed to practice law in any state. This means that he is not legally permitted to give any legal advice or perform any legal services. Any non-attorney reading this must consult an attorney about ANYTHING contained here. Nothing in this website is intended to be nor should be read as being legal advice to anyone.

© 2009 Bankruptcy Litigation Support for Attorneys

Mortgage Modification Programs Have Been Ineffective. Why?

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys, Andy@BLSforAttorneys.com

Influential financial leaders, including Federal Reserve Chairman Ben Bernanke and FDIC Chair Sheila Bair, have recently made strong statements about the ineffectiveness of the mortgage modification programs. For months Bair has been particularly relentless in her efforts to focus the attention of the Treasury Department and other agencies besides her own on dealing more aggressively with "the root cause of the financial crisis -- too many unaffordable mortgages creating too many delinquencies and foreclosures." (From her Statement on 11/18/08 before the U.S. House of Representatives Committee on Financial Services.)

Bernanke joined in with his usual measured but, considering the source, emphatic comments:

Despite good-faith efforts by both the private and public sectors, the foreclosure rate remains too high, with adverse consequences for both those directly involved and for the broader economy. More needs to be done. . . . . To be effective, loan modifications should aim to put borrowers into mortgages that they can afford over the longer term. . . . . [P]rincipal write-downs may need to be part of the toolkit that servicers use to achieve sustainable mortgage modifications.

(From his speech on December 4, 2008 at the Federal Reserve System Conference on Housing and Mortgage Markets.)

Initial Results of Mortgage Modification Programs

Hope for Homeowners

This major federal program was a component of the very high-profile Housing and Economic Recovery Act signed into law on July 30, 2008 and implemented on October 1, 2008. Please see my earlier Bulletin about it. The Act created a new voluntary program within the Federal Housing Administration (FHA) to back up to $300 billion in FHA-insured mortgages to distressed homeowners.

But according to a December 19, 2008 press release by the National Association of Consumer Bankruptcy Attorneys (NACBA), in spite of projections that about 400,000 homeowners would be helped, "there have been only 312 applications to date -- and no mortgage modifications whatsoever have taken place."

And if NACBA seems a one-sided source--it is unabashedly promoting amending the Bankruptcy Code to permit mortgage modifications in Chapter 13 plans--here is Ben Bernanke's assessment from the same speech quoted above, again in his understated language:

Another, more recent program, dubbed Hope for Homeowners (H4H), allows lenders to refinance a delinquent borrower into a new, FHA-insured fixed-rate mortgage if the lender writes down the mortgage balance to create some home equity for the borrower and pays an up-front insurance premium. In exchange for being put "above water" on the mortgage, the borrower is required to share any subsequent appreciation of the home with the government. Although the basic structure of the H4H program is appealing, some lenders have expressed concerns about its complexity and cost, including the requirement in many cases to undertake substantial principal write-downs. As a result, participation has thus far been low.

Hope Now

Here's NACBA's assessment:

This voluntary effort by the industry, promoted by the Administration, has produced more public relations than real results. Homeowners have great difficulties getting answers because the services do not have adequate staff to deal with requests. When some accommodation is reached, servicers virtually never reduce loan principal and often enter into repayment agreements that do not even reduce loan payments. Studies have shown that most of the workouts negotiated through Hope Now provide at best temporary short-term relief from foreclosure, and in a large percentage of cases, the homeowner cannot keep up with payments because the agreement does not adequately modify the loan. As of September 2008, Hope Now worked out loan modifications resulting in lower monthly payments for 266,087 homeowners; loan modifications with the same or HIGHER monthly payments for 226,667 families; and 780,000 short term repayment plans.

FDIC/IndyMac Federal Bank

After the Federal Deposit Insurance Corporation took over this huge mortgage company in July of last year, it implemented a modification program that has been emulated in other private and public efforts. Its goal is "to systematically modify troubled mortgages," "to achieve affordable and sustainable mortgage payments for borrowers and increase the value of distressed mortgages by rehabilitating them into performing loans."

According to the independent mortgage website HousingWire.com:

It’s not clear, however, if that implied modification rate — 12.5 percent of eligible severe delinquencies, and 8.7 percent of total delinquencies — is significantly better or worse than what the former Alt-A lender was seeing before its servicing platform was assumed by the FDIC.
. . . .
Some policy experts that have spoken with HousingWire privately have suggested that if the FDIC’s modification approach at IndyMac is truly and honestly successful, and widely implemented, it will clearly incent performing borrowers to default in an effort to secure below-market interest rates on their own mortgage debt. “Bair and the FDIC are walking a fine line here,” said one economist, who asked not to be named because his view were his own and not those of his employer. “Her program needs to succeed, but not so much so that everyone decides they too ought to get a 3 percent mortgage.”

And again the critical word from NACBA:

This effort covers 65,000 borrowers who are more than two months delinquent on their mortgage, but doesn't reduce the outstanding debt in any meaningful way and therefore has not attracted much interest. So far, 7,200 homeowners have modified their loans under this program. And, after a two-month moratorium on foreclosures pending the modification program, IndyMac foreclosures in November skyrocketed 242 percent from October, according to Mark Hanson of the Field Check Group.

Why Mortgage Modification Programs Are Ineffective

1) Many commentators have focused on the now-familiar complaint that with securitized mortgages, which include a disproportionate amount of the troubled loans, the multiplicity of owners make negotiating modifications virtually impossible. The owners often cannot agree or cannot even be found, and simply do not respond to modification pleas.

In Ben Bernanke's cautious words:

[D]espite the substantial costs imposed by foreclosure [on mortgage holders], anecdotal evidence suggests that some foreclosures are continuing to occur even in cases in which the narrow economic interests of the lender would appear to be better served through modification of the mortgage. This apparent market failure owes in part to the widespread practice of securitizing mortgages, which typically results in their being put into the hands of third-party servicers rather than those of a single owner or lender.

In more direct terms, by New York Times' business columnist Joe Nocera:

You see, all of these programs deal only with “whole loans” — that is loans on the books of the institutions, unencumbered by securitizations. So far, the attitude of all involved when it comes to securitized mortgages is to throw up their hands and say — “it’s too hard to deal with!” And it may well be: mortgages that were sold to Wall Street and wound up in mortgage-backed securities have been sliced and diced and sold and resold to investors with varying risk tolerances. They are serviced by people who owe a fiduciary duty to all these investors, no matter what their place on the risk continuum.
. . . .
The situations borders on the absurd. Investors will not allow mortgage modifications that would hurt them more than some other investors — thereby insuring that everyone gets hurt even more as foreclosures continue.

2) Modifications are stymied because the key players, mortgage servicers, risk investor lawsuits if they modify mortgages.

In NACBA's words:

The servicer has obligations to the investors who have purchased the mortgage-backed securities through pooling and servicing contracts, and the interests of these investors conflict. Servicers are hesitant to modify the loans because they are concerned that it will impact different tranches of the security differently, and thereby raise the risk of investor lawsuits when one or more tranche loses potential income. At least one servicer has already been sued. Under the current system, the legally safest course for the servicer clearly is foreclosure.

Bernanke echos this same concern: "The problem is exacerbated because some modifications may benefit some tranches of the securities more than others, raising the risk of investor lawsuits."

3) Simultaneously acquired second mortgages stymie voluntary modifications.

NACBA put it well:

Perhaps the most intractable problem is the fact that a third to a half of all 2006 subprime borrowers took out piggyback second mortgages on their homes at the same time they took out their first mortgages. In these cases, the holders of the first mortgages have no incentive to provide modifications that would free up borrower resources to make payments on the second mortgages. At the same time, the holders of the second mortgages have no incentive to support effective modifications by waiving their rights, which would likely cause them to face a 100 percent loss. The holders of the second mortgages are better off waiting to see if a borrower can make a few payments before foreclosure.

4) Mortgage holders and servicers have not been structurally designed or trained to modify, but rather to collect and foreclose, and these structures can only be re-engineered to a limited degree in an extremely short period. As a result, even when the intentions are good, these organizations have been overwhelmed by the volume of modifications needed.

Again, from Ben Bernanke: "the sheer volume of delinquent loans has overwhelmed the capacity of many servicers, including portfolio lenders, to undertake effective modifications."

5) Finally, the incentive structure for mortgage servicers in most cases greatly favors foreclosures over modifications. This is perhaps one of the most important and least recognized reasons for so few modifications. (See my upcoming Bulletin of January 26, 2008 on this crucial problem.)

An insightful article bylined "Servicers Profit While Investors Face Losses" states:

An environment of increasing delinquencies provides servicers with incentives to pursue their own self interests at the expense of investors and borrowers. Existing compensation structures, lack of oversight, informational asymmetry and consolidation of the mortgage servicing industry ensure servicers can act in their own interests with limited impunity.

(from RGE Monitor, named one of the world's best economics websites by BusinessWeek, The Economist, Forbes and the Wall Street Journal.)

by Andrew Toth-Fejel
Bankruptcy Litigation Support for Attorneys
Andy@BLSforAttorneys.com

PLEASE NOTE that this Bulletin and the entire contents of this website are NOT designed for the general public but rather only for attorneys. The writer is not licensed to practice law in any state. This means that he is not legally permitted to give any legal advice or perform any legal services. Any non-attorney reading this must consult an attorney about ANYTHING contained here. Nothing in this website is intended to be nor should be read as being legal advice to anyone.

© 2009 Bankruptcy Litigation Support for Attorneys

Is a Self-Settled Trust with a Spendthrift Clause Property of the Chapter 7 Estate? The Ninth Circuit BAP Balances the Countervailing Principles

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys, Andy@BLSforAttorneys.com

Cutter v. Seror (In re Cutter)

Ninth Circuit BAP Nos. CC-07-1436-MoDK, CC-08-1024-MoDK, CC-08-1025-MoDK
Filed September 4, 2008
Amended December 3, 2008

This opinion involves "a failed asset protection scheme" which the BAP published "to call attention to a fundamental fallacy inherent in that scheme," "a self-settled trust that identifies only unnamed “surviving” descendants of the trustor as beneficiaries (whose interests vest only after the trustor’s death), but leaves in the trustor/trustee the power to deplete the trust of all of its assets for his own benefit." As is no doubt clear from this statement of the case by the Court, it ruled in favor of the trustee and against the debtor that certain trust assets could be reached by debtor's creditors and thus were property of his bankruptcy estate. The details of this opinion are valuable guidance for any attorney who creates or tries to preserve asset protection mechanisms, or works to defeat them.

(This opinion, although originally "filed" by the Bankruptcy Appellate Panel in September and amended in early December, only became available on the BAP website for the first time, in its amended form a week or so ago, after a timely petition for rehearing resulted in an amended opinion "correct a factual error and to adjust the legal analysis accordingly." Judge Randall Dunn participated in this Panel but did not author the opinion.)

Critical Facts about the Trust
Although the Court took many pages to lay out the detailed facts regarding the various parcel of real estate at issue and the transactions involving them, and the terms of the trust established by the debtor, the critical facts are as follows: Debtor Cutter created an irrevocable trust in 1989 with himself as trustee and the "primary beneficiaries" his "surviving issue . . . and the lineal descendants of non-surviving issue." Debtor was not named a beneficiary but as trustee the Trust Agreement provided him "sole discretion" to make distributions from the trust "to provide for the health, the education, or the support or maintenance in the customary manner of living of the trustor" while he was alive. The Trust Agreement contained a standard spendthrift clause.

The Property at Issue
The Debtor contributed four items of real property to the trust (the "Trust Properties") between 1992 and 2002 through various means including by quitclaim deed directly by him and by grant deed to the trust by a brother but paid for by debtor. In addition a fifth parcel, the "Thurston Circle Property," was transferred in 2003 by grant deed by debtor's son's godfather to "Edward W. Cutter, a Single Man" and a dispute existed as to whether this referred to debtor, Edward William Cutter II, or to his son, Edward William Cutter III.

The Bankruptcy Court's Rulings
Debtor filed a Chapter 7 case in July 2005. The trustee filed an adversary proceeding with many claims but the only one at issue in this appeal is for quiet title. On a motion for summary judgment by the trustee to quiet title in the trustee for both the Trust Properties and the Thurston Circle Property, the bankruptcy court granted the trustee partial summary judgment in holding that the Trust Properties belonged to the Chapter 7 estate, and denied summary judgment as to the Thurston Circle Property because of genuine issues of material fact about the intended grantee of that property.


The BAP's Holding and Rationale re the "Trust Properties"

Section 541 of the Code and Trusts
Since Debtor held title to the Trust Properties as trustee of the Trust, "under section 541(d), the corpus of the Trust would not be property of Debtor’s estate, unless he held an equitable interest in the Trust and its assets, or unless he could exercise powers over the corpus of the Trust for his own benefit." The BAP held that debtor did hold an equitable interest in the Trust as a beneficiary because he "possessed the right, at his sole discretion, to make distributions in order to provide for his health, education, or 'support and maintenance in [his] customary standard of living.' ”

Appropriate to Apply California Law on Self-Settled Spendthrift Trusts
The BAP observed that

California law invalidating efforts of a settlor from using a trust to shield property from his or her creditors applies “even where the settlor is not a nominal beneficiary, as where a settlor attempts to create a spendthrift trust for the benefit of his or her minor children, to be managed by the settlor and revocable at his or her pleasure.” (Citation excluded.)

And citing a Ninth Circuit opinion, the

critical inquiry in determining whether a spendthrift trust is valid under California law is whether the trust’s beneficiaries exercise excessive control over the trust.
. . . .
[Thus] under California law, a settlor of a spendthrift trust cannot also act as beneficiary of that trust (i.e., California law prohibits ‘self-settled’ trusts).

Since under the Trust Agreement the Debtor in his role as Trustee of his self-settled trust "could potentially use all of the Trust’s principal and income to maintain his standard of living," thus he exercised "excessive control" making the spendthrift trust invalid, and making the trust assets a part of his bankruptcy estate.

Section 541 Sufficient in Itself to Make Trust Assets Property of Chapter 7 Estate
Although generally "if only a portion of a spendthrift trust’s corpus is contributed by a beneficiary-debtor, only that portion becomes property of the beneficiary-debtor’s estate," "[i]f, . . . the trust agreement allows the debtor-beneficiary to exercise control over and reach trust property contributed by others, the estate is entitled to the maximum amount that the trust could pay or distribute to the debtor-beneficiary." Thus, since debtor had complete discretion regarding all of the trust assets, his "beneficial interest in all of the Trust corpus became property of the estate and Debtor’s power to use Trust assets for his benefit became property of the estate."

The BAP's Decision about the "Thurston Circle Property"

The trustee appealed the bankruptcy court's denial of summary judgment on this one parcel of property, but the BAP declined to hear the matter, based on Rule 54, Federal Rules of Civil Procedure.

Rule 54(a) and (b) are as follows:

Rule 54. Judgments; Costs
(a) Definition; Form.
“Judgment” as used in these rules includes a decree and any order from which an appeal lies. A judgment should not include recitals of pleadings, a master's report, or a record of prior proceedings.(b) Judgment on Multiple Claims or Involving Multiple Parties.
(b) Judgment on Multiple Claims or Involving Multiple Parties.
When an action presents more than one claim for relief — whether as a claim, counterclaim, crossclaim, or third-party claim — or when multiple parties are involved, the court may direct entry of a final judgment as to one or more, but fewer than all, claims or parties only if the court expressly determines that there is no just reason for delay. Otherwise, any order or other decision, however designated, that adjudicates fewer than all the claims or the rights and liabilities of fewer than all the parties does not end the action as to any of the claims or parties and may be revised at any time before the entry of a judgment adjudicating all the claims and all the parties' rights and liabilities.

The bankruptcy court had entered a partial summary judgment on the "Trust Properties" citing Rule 54, but that judgment specifically stated: "Other issues in this adversary proceeding remain pending and will be separately adjudicated.” Thus the bankruptcy court's Rule 54(b) determination did not reach the issues reached in trustee's appeal on the "Thurston Circle Property." The BAP stated that although it had discretion "to entertain interlocutory appeals from judgments that are not final," it chose not to because of the disputed factual issues about ownership of that property. Instead the BAP declined to accept jurisdiction and dismissed that portion of the appeal.

by Andrew Toth-Fejel
Bankruptcy Litigation Support for Attorneys
Andy@BLSforAttorneys.com

PLEASE NOTE that this Bulletin and the entire contents of this website are NOT designed for the general public but rather only for attorneys. The writer is not licensed to practice law in any state. This means that he is not legally permitted to give any legal advice or perform any legal services. Any non-attorney reading this must consult an attorney about ANYTHING contained here. Nothing in this website is intended to be nor should be read as being legal advice to anyone.

© 2009 Bankruptcy Litigation Support for Attorneys

Projected Foreclosure Rates Are Increasing: the Insights in the Credit Suisse Report Beyond the Headlines

By Andrew Toth-Fejel, Bankruptcy Litigation Support for Attorneys, Andy@BLSforAttorneys.com

Last month a much-cited Credit Suisse report greatly increased its forecast of the number of U.S. residential mortgages anticipated to go into foreclosure, from its prior report last April. The report's headline was that 8.1 million mortgages are now anticipated to be in foreclosure within the next four years. But none of the stories about this report seemed to go beyond the first few sentences of the report's summary. (See this CNN-Money story, one in the Washington Post, and even one from a NACBA--National Association of Consumer Bankruptcy Attorneys--press release) Here are some valuable insights from inside this report.

Potential for Even More Foreclosures
Beyond the 8.1 million foreclosure headline, the report made clear that a more severe recession would push the number of foreclosures higher to a projected 10.2 million. Just factoring the "consensus increase in the unemployment rate to 8%" alone pushes the projection to 9.0 million. But on the other hand even a moderately successful loan modification program could bring the
foreclosures down to as "low" as 6.3 million.

However this last number assumes a modification rate of 50% of mortgages facing foreclosure along with a re-default rate of 40% of those modified mortgages. Given the tremendous ineffectiveness of mortgage modification programs so far (see my future Bulletin of 1/07/09 on this), these may be a very optimistic assumptions.

Rationale for Increase in Anticipated Foreclosures
The last Credit Suisse report on anticipated foreclosures in April 2008 forecast 6.5 million foreclosures in the next four years, so the increase to 8.1 million is substantial. The update is based on changes in mortgage delinquency rates, with home values continuing to decline putting more homeowners into negative equity positions.

The home price decline up to September 2008 has resulted in about 48% of subprime borrowers "underwater”, i.e., those with outstanding mortgage balances (including both first and second liens) that were higher than current property values. Among all non-agency loans, 41% were under water by September, with the highest percentage seen in option ARM loans (66%) and the lowest in prime jumbo loans (25%). Further, . . . we expect that 72% of subprime loans and 62% of all non-agency loans will have negative equity within two years. This is important because the propensity to default is highly correlated with the degree of negative equity. . . . . On average, the likelihood of rolling into default for borrowers deeply underwater, as measured by current loan-to-value (LTV) ratio higher than 110%, is two (for subprime loans) to four times (for other non-agency loans) that for borrowers whose current LTV is still less than 80%.

In summary, "despite some initial signs that subprime foreclosures were near a plateau, the combination of severe weakening in the economy, continued decline in home prices, steady increase in delinquencies, particularly in the prime mortgage space, ensure that foreclosure numbers, absent more dramatic intervention, will march steadily higher."

Effect of Changes in the Labor Market
In this study, the increases in foreclosures were correlated to increases in the unemployment rate based on the assumptions that the home ownership rate is about 67%, so for every 100 newly unemployed, 67 will be homeowners, and a very high percentage of those have mortgages on their homes (those who own free and clear are largely either retired or self-employed, not in the conventional labor force). With some having cushions in the form of savings and/or a second income earner, the study assumed 60% of those who become unemployed will lose their homes. This yields a "40% response ratio of foreclosure to new unemployment."

Using this 40% ratio, and assuming "a steady rise in the unemployment rate, peaking at 8% at the end of 2009, then falling to 7% by the end of 2010 as the economy starts recovering" brings the total foreclosures to 9.0 million; while a "deep recession scenario follows the base case through 2009 but keeps increasing after that, peaking at 10% by the end of 2010" brings the total foreclosures to 10.0 million foreclosures during the four-year period.

The report also noted that not only do foreclosures go up directly with increases in the unemployment rate, foreclosures also increase among the formerly unemployed who find employment but with lower income, and among the underemployed, those going from full-time to part-time employment. Given the large number of homeowners who are overleveraged, even modest reductions in income among the employed will lead to foreclosures for many beyond those resulting from outright unemployment.

Effect of Loan Modification Programs
This study acknowledged the "aggressive effort, from both the government and the private sector, to expand loan modification efforts significantly," but stated that "there are many flaws with these programs and they won’t be sufficient to stem the rising tide of foreclosures." The study cited the limitations in eligibility to owner-occupied homes and for owner-occupiers who do not have second homes or any investment property. And "since most . . . programs only allow principal forbearance, borrowers deeply underwater may choose not to accept mod[ification]s if they will be obligated to pay the forbearance amount upon sale of the home."

Nevertheless the study presented two loan modification scenarios, a "best scenario, in which 70% of expected foreclosures are assumed to be modified with a re-default rate of 20%, total future foreclosure would decline [from 9.0] to 4.0 million, a 56% deduction. In comparison, the most conservative scenario, in which only 30% of foreclosures are modified and re-default at 60%, the total foreclosures would decline to 8.0 million."

Again, please return to this website to see my future Bulletin of 1/07/09 on the performance thus far of the current loan modification programs to see whether these are realistic assumptions.

by Andrew Toth-Fejel
Bankruptcy Litigation Support for Attorneys
Andy@BLSforAttorneys.com

PLEASE NOTE that this Bulletin and the entire contents of this website are NOT designed for the general public but rather only for attorneys. The writer is not licensed to practice law in any state. This means that he is not legally permitted to give any legal advice or perform any legal services. Any non-attorney reading this must consult an attorney about ANYTHING contained here. Nothing in this website is intended to be nor should be read as being legal advice to anyone.

© 2009 Bankruptcy Litigation Support for Attorneys