The Very Latest on the Chapter 13 Mortgage Cramdown Legislation

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

The economic stimulus bill so dominated Congress' agenda of the last two weeks that there was no formal progress on either the Senate or House Chapter 13 Mortgage Cramdown bills since January 27 when the House Judiciary Committee debated amendments and voted in favor of amended H.R. 200. (See my prior Bulletin on that hearing and the approved amendments.) That amended bill has now been "ordered to be reported with an amendment" to the full House, but no House debate on the amended bill has yet been scheduled according to public sources.

No Action But a Lot of Talk

There has been a lot of background maneuvering and public posturing.

The Administration:

At the highest level, on Tuesday, 2/10, Treasury Secretary Timothy Geithner testified before the Senate Budget Committee in highly publicized (and roundly criticized) presentation on the financial rescue plan. He referred in his testimony to the bankruptcy cramdown legislation, saying that it “will be an important part of the president's plan." But he spoke cautiously: “At that same time, we want to do it very, very carefully, because this is a delicate situation, complicated balance. And we want to make sure we're not making the process worse as we go forward.”

Then a day later, on Wednesday, he and Housing and Urban Development Secretary Shaun Donovan met with major creditor and community representatives to discuss a $50 billion proposal which would greatly increase governmental intervention in the mortgage modification process. Already approved bailout funds would be used to buy up millions of at-risk loans directly, at a discounted price, and then refinance them to homeowners at more affordable terms. An advantage is that loans themselves are much easier to value than the mortgage-backed securities which have been virtually impossible to value.

A Proponent:

Shortly after the House Judiciary Committee passed the House version of the bankruptcy bill, its sponsor, Rep. John Conyers, wrote an op-ed column in the Wall Street Journal strongly advocating for the legislation. He directly addressed some of the criticism about it:

To those who claim that my bill will end up harming consumers by increasing the cost of credit, I would respectfully suggest that they are not taking account of the track record of the modern-day bankruptcy code.

For more than three decades, the bankruptcy code has permitted the very kind of court modification we are considering today, for every other form of secured debt, including loans secured by second homes, investment properties, luxury yachts, and jets. For over 20 years, this very kind of modification has been available for home mortgages already -- if the home is a family farm. There is no indication that this has in any way increased the cost of credit for any of these kinds of loans.

As for my legislation, we have narrowed it to apply only to existing mortgages. So it will have no effect on new mortgages and cannot impact their cost.

Finally, to those who argue that this legislation constitutes some form of "moral hazard," which will encourage reckless borrowing in the future, I would simply ask them to come to Detroit, my home town. . . .. Block after block, "for sale" and foreclosure signs feed off of each other, driving down home values, uprooting families, decimating communities, and causing local tax revenue that pays for police and firefighters to plummet. We don't have the luxury of worrying about hypothetical future moral lessons. We need to stop the bleeding today.

The Opposition:

In a competing op-ed article today also in the Wall Street Journal, Todd Zywicki, law professor at George Mason University and long-time vocal opponent of bankruptcy mortgage cramdowns argues that the legislation would increase interest rates and upfront home purchase fees, would "unleash a torrent of bankruptcies," "overwhelming the bankruptcy system," and this "surge in new bankruptcy filings, brought about by a judge's power to modify mortgages, could destabilize the market for all other types of consumer credit." But Prof. Zywicki does not seem to acknowledge that the bill is being changed to apply only to mortgages existing at the time of enactment. And his statement that "[i]n 2005, Congress eliminated the power of bankruptcy judges to modify auto loans" makes one wonder whether he has a good grasp on bankruptcy law. I suggest a reading of his article together with a highly cogent and thoroughly documented refutation of Zywicki's arguments found in the written testimony on January 22 by Adam Levitin, Associate Professor of Law at Georgetown University Law Center, before the House Judiciary Committee hearing on the bankruptcy legislation.

A Key Non-Partisan Report:

A new report was issued on January 26 by Credit Suisse entitled "Bankruptcy Law Reform – A new tool for foreclosure avoidance," which should have a huge impact on the public discussion of this issue. (Credit Suisse' Fixed Income Research group was also the source of a study on projected foreclosures whose conclusions have been constantly cited by both the press and top governmental decision makers. See my earlier Bulletin on that study: Projected Foreclosure Rates Are Increasing: the Insights in the Credit Suisse Report Beyond the Headlines.) The report starts with an excellent comparison of bankruptcy mortgage cramdown to other modification efforts such as FHA's Hope for Homeowners and the FDIC's Streamlined Modification Plan. Then the majority of the reports reviews in exhaustive detail the costs and benefits of cramdown to debtors and investors, particularly analyzing the impact on various classes of investors, the heart of the mortgage modification conundrum. Its conclusion:

Overall we think the bankruptcy reform will be a net positive in terms of foreclosure reduction, as it may be an effective way to improve both home equity and affordability. It has several attractive features relative to other loss mitigation alternatives, such as comprehensive debt restructuring, less moral hazard, and direct dealing with second liens. Though it is an important new tool in the toolkit, we can’t dismiss unintended consequences such as: (1) many more borrowers filing than who qualify, (2) bankruptcy bar ramping up its marketing machine, and (3) new defaults created by borrowers who believe (falsely or otherwise) bankruptcy will be their salvation.

I urge anybody interested in a non-partisan and competent discussion of this issue to at least flip through this (mostly) very readable report.

The Bottom Line

The ultimate question to address in the foreclosure mess is: who should bear the loss when a mortgage is larger than a home’s value? All the foreclosure prevention and mortgage modification programs wrestle with this, and many being now being considered pass on much of this loss onto taxpayers. The Chapter 13 proposal would not pass virtually any of the direct costs onto taxpayers, and the debate rages about how the costs would be passed onto the public through higher future interest rates and reduced credit availability. Some commentators, such as in an article early this morning by MSNBC's John Schoen consider it "[b]y far the most controversial proposal to break the loan modification logjam." See also this recent Forbes article from the mortgage banker's perspective bylined "Somebody has to take a hit if bankruptcy judges forgive troubled mortgages. It's probably you." Yet bankruptcy cramdown still appears to be on the Administration's list as a necessary part of the solution. Now that the stimulus wrangling appears to be done, Congress can return its attention to the apparently still worsening foreclosure crisis and to the bankruptcy bills.

The New York Times' lead editorial yesterday gives the legislators, and us, some final food for thought:

Unless the stimulus is accompanied by a successful twin effort to stem foreclosures and stabilize the banks, the downward pull of falling home prices and constrained credit will be too great to overcome.
Unfortunately, after a botched rollout this week of their bank bailout plans, administration officials will likely need another few weeks to develop a coherent proposal — and weeks thereafter to vet and implement it.
They need not, and should not, wait to start a foreclosure-prevention effort, but it’s not clear whether Mr. Obama’s team understands the scale of the effort required. Earlier this week, Treasury Secretary Timothy Geithner suggested that some $50 billion from the bank-bailout funds may be used on foreclosure prevention. That is the low end of the estimate that had been floated.
The administration also appears to be waffling in its support for passing new legislation that would allow bankrupt homeowners to have their mortgages modified under court protection. To be powerful, an anti-foreclosure effort must include both carrots, like interest-rate subsidies that would make it easier for lenders and borrowers to agree on modified loan terms, and sticks, including the option for a bankruptcy court judge to impose a settlement on lenders who aren’t doing enough to prevent unnecessary foreclosures.

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

Judge Perris Grants Motion to Dismiss Claim for Breach of Fiduciary Duty on Grounds of Standing and the Business Judgment Rule, With Leave to Amend

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


Batlan v. WT Consulting, Inc.
Adversary Proceeding No. 08-03196-elp
Unpublished letter by Judge Elizabeth Perris
January 26, 2009


The Rulings

In this letter to the parties on whether to grant defendants' motion to dismiss a claim for breach of fiduciary duty alleged by a Chapter 11 liquidating agent, Judge Perris made three rulings: 1) to dismiss the claim for lack of standing by the plaintiff liquidating agent, with leave to amend; 2) to dismiss the claim because of the business judgment rule, also with leave to amend; and 3) anticipating a successful amendment to address the business judgment rule, she made clear that under federal notice pleading standards a complaint for breach of fiduciary duty need not anticipate the business judgment rule defense as long as that rule was not raised in the complaint.


Facts
James Thompson and Scott Walters owned Thompson & Walters Nursery Sales, Inc., an Oregon corporation (T&W #1). They sold its assets to a similarly named Delaware LLC (T&W #2). It subsequently failed, and filed a liquidating Chapter 11.


The Adversary Proceeding
The Chapter 11 liquidating agent filed an adversary proceeding against Mr. Thompson and Mr. Walters to avoid the sale to T&W #2 as a fraudulent conveyance and to recover against them for their alleged breach of fiduciary duty. They responded with a motion to dismiss the adversary complaint. At a prior hearing Judge Perris denied this motion as to the fraudulent conveyance claims. So now the purpose of her letter was to rule on the motion to dismiss as to the claim for breach of fiduciary duty.

1) Standing
Defendants argued that the liquidating agent did not have standing to bring a claim for breach of fiduciary duty as to T&W #1, the Oregon corporation. Plaintiff refuted this by relying on a federal court opinion in Delaware holding that "the court should collapse the transactions involved in the asset sale and consider them as integrated transactions that form a 'single integrated plan'." Thus plaintiff would have standing as to all entities involved in that "plan." But Judge Perris noted that the Delaware case involved a much more complex set of transactions unlike the single sale here, that the Delaware case did not involve an Oregon corporation, and that plaintiff had not pled a basis under Oregon law for such "collapsing of transactions" to provide for standing. So she granted the motion to dismiss as to T&W #1, while also granting plaintiff leave to amend if able to cure this shortcoming.

2) Business Judgment Rule
Defendants also argued for dismissal of the claim for breach of fiduciary duty as to T&W #2 "because it does not overcome the business judgment rule." That rule creates a presumption that "directors' decisions are made in good faith and are based upon sound and informed business judgment." Therefore, from the defendants' perspective, the plaintiff needed to plead affirmatively to overcome the business judgment rule or else have the claim dismissed. The rule relates only to directors' decisions, not those of officers. The complaint was unclear whether defendants were directors of T&W #2. So the judge granted the motion to dismiss the claim for breach of fiduciary duty as to T&W #2, while again granting plaintiff leave to amend if he is able "to clarify the basis of the claimed fiduciary duty of defendants Thompson and Walters, in particular whether they were directors of T&W #2."

3) Judge Perris then directly addressed the Business Judgment Rule, anticipating plaintiff's successful repleading that defendants were directors. She noted that the federal pleading standard is notice pleading in contrast to fact pleading in Delaware, the source of most of defendant's supportive case law, thus inferring that she accepted plaintiff's argument that the Delaware case law was inapplicable or at least of limited applicability. She made clear her opinion:

I recognize that the cases regarding whether a plaintiff must plead around the business judgement rule are divided. I am more persuaded by the reasoning in the line of cases that holds that 'a ruling on the applicability of the business judgment rule is peculiarly a question of fact, wholly inappropriate for consideration on a motion to dismiss.' . . . . Under the federal notice pleading standard, a plaintiff is not required to preemptively plead around defenses not alleged in his complaint. In this case, plaintiff did not make any allegations about the business judgment rule in his complaint. [Citations omitted.]

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 the Chapter 13 Mortgage Cramdown Bill Going to Be Enacted, and If So When?

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

The Chapter 13 mortgage cramdown amendment will likely occur, but not as quickly as some had predicted, and almost certainly with a number of changes limiting its scope.

The Cramdown Bill is NOT Going to Be Part of the Economic Stimulus Package

• Why is this important?: That would have expedited its passage & likely improved its chances.
  
• Reason: Tactical decision by Obama and Democratic leadership to reduce Republican resistence to the stimulus.
• Specific goal: Avoid filibuster of stimulus bill in Senate, where it needs 60 votes & so requires at least some Republican support.
• Good decision?: House passed stimulus bill on Tuesday 1/27 without a single Republican vote, even after aggressive lobbying by Obama, including a visit to Capitol Hill and meetings with key Republicans.
• House Democratic leadership comments:

Senator Dick Durbin, sponsor of S. 61, said Obama persuaded him in a White House meeting Friday, 1/23, to remove the bankruptcy bill from the economic recovery package, but that Obama pledged his support for the bankruptcy proposal and would work with Durbin to attach it to other "must pass" legislation.

Speaker Nancy Pelosi: "We have a lot of work to do, and, as has been indicated, we have a deadline and a sense of urgency that we need to get the job-creation part of this [stimulus] done. We will have other legislation, or a free-standing bill, but we will get it [the Chapter 13 cramdown bill] done.”

House Majority Leader Steny Hoyer: "“I think [the bankruptcy bill] would probably hold things up in the Senate. President Obama, as you know, said he is for doing this but would prefer not to do this in the package because this package is so critical to get this done.”

Progress on the Bills (S. 61, H.R. 200 & H.R.225)

Senate: No legislative action since it was introduced on 1/06/09 and referred to the Judiciary Committee. But there was the dramatic news conference on 1/08 by the Senate leadership about getting Citigroup's support in return for concessions. See my recent Bulletin: Chapter 13 Mortgage Cramdown Bill Now Expected to Pass Within Weeks, May Be Attached to Stimulus Package: Citigroup Withdraws Opposition

House: After a 1/22 hearing by the Judiciary Committee on both H.R. 200 and H.R. 225, on 1/27 H.R. 200 was voted out of committee to the full House by a vote of 21 to 15, after some amendments were rejected, some adopted. Could not find if a date has been set for a vote by the full House.

The Amendments to H.R. 200:

• Rejected: several Republican amendments to limit the scope of the bill, such as to subprime mortgages only.
• Adopted: 1) A Republican-introduced amendment to exclude debtors who committed mortgage fraud; 2) FHA,VA & Dept. of Agriculture guaranteed or insured mortgages are EXEMPTED from cramdown; 3) any post-petition increases in home value would be shared with the mortgage lenders (decreasing with from 80% to 20% from the 1st to the 4th year of the plan) if the home is sold before the Chapter 13 discharge; and 4) a requirement that the debtor attempts to contact the mortgage holder or servicer at least 15 days before filing the Chapter 13 case, unless a foreclosure is scheduled within 30 days after filing, or for cases filed before the law's effective date the debtor attempts the contact before filing the plan or modified plan. Here is the bill with most of these changes, dated the evening of 1/26 (just BEFORE the hearing).

Please see my earlier Bulletins on the rest of the terms of the original bill, with the amendments informally agreed with Citigroup: The Essential Terms of the New--And Now Suddenly More Likely to Pass--Chapter 13 Mortgage Cramdown Bill and Crucial But Less Publicized Terms of the 2009 Chapter 13 Mortgage Cramdown Bill.


The Biggest Challenge for Enactment: Defeating Potential Filibuster

• 60 votes are needed to break a Senate filibuster. Democrats have 56 Senators, plus two independents who caucus with them, plus potentially the yet-unresolved Minnesota seat.
• Note: The sponsoring Senator of S. 61 along with its 7 cosponsoring Senators, and the sponsoring Representative of H.R. 200 along with its 16 co-sponsoring Representatives, and the sponsoring Representative of H.R. 225 along with its 39 co-sponsors--every one of them--are ALL Democrats.
• Besides winning over at least a few Republicans, it also needs full Democratic support: Last year 10 Democrats did NOT back a similar but narrower bill. All 10 of these are still in the Senate.
• The economic and political world has changed tremendously since then, but has it changed enough?

The Bottom Line

According to the Washington Post article cited below: "Banking executives privately acknowledge that some type of legislation is likely to pass and are arguing that its scope should be limited."

Worthwhile Articles, Papers

Written testimony by Adam Levitin, Associate Professor of Law at Georgetown University Law Center, before the House Judiciary Committee hearing on H.R. 200 and H.R. 225, on January 22, 2009. By far THE very best argument I have seen anywhere in support of Chapter 13 mortgage cramdowns; very thorough, with a wealth of supportive research and accessible references, systematically explains the fallacies in the arguments against Chapter 13 cramdowns, excellently written, a masterful paper well worth the time for anybody interested in the many public policy issues involved.

Written testimony by Christopher Mayer, Senior Vice-Dean of Columbia Business School, at the same hearing as above. Strongly opposes the bills and presents three very intriguing alternative plans to combat the mortgage disaster. In my opinion Prof. Levitin's much more detailed paper squarely, and generally successfully, addresses each of Vice-Dean Mayer's concerns about the bills, but the programs he advocates do grapple with some of the key problems with voluntary modifications, and in some form may well be helpful, in conjunction with the Chapter 13 amendments, His programs focus on the lack of financial incentives for mortgage servicers to negotiate modification, the huge problem of second and third lien holders, and spurring the depressed housing market through lower mortgage interest rates.

An excellent blog story on this House Judiciary Committee hearing on 1/22 at which these two above testified, on the Bankruptcy Prof Blog.

One of the better mainstream press articles on the House Judiciary Committee Hearing of last Tues., 1/27, from the Washington Post: Key House Panel Backs Measure Allowing Judges to Modify Mortgages.

And for the math-inclined, a Los Angeles bankruptcy attorney's amazing less-than-1-page "H.R.200 in Algebraic Form"!

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

BAPCPA Significantly Contributed to the Mortgage Crisis, According to Federal Reserve Bank of New York Staff Report

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

BAPCPA (the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005) substantially "contributed to the surge in subprime foreclosures by shifting risk from credit card lenders to mortgage lenders." That is the conclusion of a Federal Reserve Bank of New York Staff Report called Seismic Effects of the Bankruptcy Reform presented in November (and revised in early March 2009).

BAPCPA significantly increased foreclosures in two ways. First, the means test shifted some bankruptcy filers from Chapter 7 to Chapter 13, overall shifting debtors' post-petition cash flow from mortgage payments to unsecured creditors. Second, the prohibition against cramdowns on vehicles financed less than 910 days before bankruptcy filing made vehicle loans more secure and thus limited funds available for mortgage payments.

Plausibility of the Hypothesis
The authors start with the observation that "the surge in subprime foreclosures that has rocked financial markets came right after the bankruptcy reform in 2005." While acknowledging many other factors in the foreclosure fiasco, they argue that it made perfect sense that "the first overhaul of U.S. personal bankruptcy law in over a quarter century, [one which] made filing bankruptcy much less protective and much more expensive" would have the effect of protecting some classes of creditors while harming others.

The Circumstantial Statistics
The Report presents statistics showing that BAPCPA reduced overall bankruptcy rates, which "under either Chapter [7 or 13] remain lower than one would predict given economic and housing market conditions," and that the ratio of Chapter 7's to 13's has fallen, reflecting a lower relative demand for filing Chapter 7.

Very importantly, BAPCPA "appears to have reversed the historical relationship between
bankruptcy filings, on the one hand, and the relative performance of mortgages and credit loans, on the other." "Relative mortgage performance used to improve when filings increased, consistent with the argument that filers were better positioned to make the mortgage once their credit card and other unsecured debt was discharged, but not so since [BAPCPA]." Indeed, in the years since the amendment, large credit card lenders have had substantial profits while mortgage lenders and those holding mortgage-backed securities have had huge losses and many business failure. (See Harvard Law School Fellow Michael Simkovic's paper, The Effect of 2005 Bankruptcy Reforms on Credit Card Industry Profits and Prices.) Indeed, the former have been buying up the latter, such as Bank of America's purchase of Countrywide and JP Morgan Chase's takeover of Washington Mutual.

From Circumstantial Evidence to Proof of BAPCPA's Effect
Acknowledging that the above statistics could be just coincidental, not necessarily reflecting changes caused by BAPCPA's amendments, the Report creatively found a way to determine causation and even to begin quantifying BAPCPA's adverse effect. The authors used differences in states' property exemption statutes as a means to show that BAPCPA was more likely to induce bankruptcy filers to file Chapter 7 in high home exemption states than in low exemption states. "Intuitively, home owners in low exemption states were less likely to demand Ch. 7, so limiting access is less likely to matter there."

Using mathematical modeling and statistical analysis the Report found the impact of BAPCPA to be significant: "smaller, but of the same order" as that of changes in house value. It roughly predicted an additional 32,000 more subprime foreclosures per quarter nationally as a result of BAPCPA.

Disclaimer
The Report contained this disclaimer, noteworthy because the involvement of the Federal Reserve:

"This paper presents preliminary findings and is being distributed to economists and other interested readers solely to stimulate discussion and elicit comments. The views expressed in the paper are those of the authors and are not necessarily reflective of views at the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors."

Another Finger Pointing at BAPCPA
As a pertinent aside, in early November I reported on this website about another totally different adverse effect of BAPCPA in my Bulletin titled: At the Extreme of BAPCPA's Unintended Consequences: Did Arcane Provisions of BAPCPA Contribute to the Bear Stearns, Lehman Bros. & AIG Collapses? This Bulletin was based on an article reported in The Financial Times of London, and its primary thesis is summarized in this excerpt from the Bulletin:

By newly exempting credit default swaps and mortgage repurchase agreements from the automatic stay, instruments which Bear Sterns and Lehman Brothers used extensively, creditors of these institutions--such as hedge funds and other financial institutions--no longer had the disincentive that the institutions could file bankruptcy and freeze their transactions and their collateral if they were pushed too hard. These creditors, instead of being normally cautious about settling trades and about forcing these institutions to put up more collateral, became aggressive along these very same lines, which greatly accelerated the credit and liquidity squeeze that led to these institutions' demise.

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

Disability Insurance Benefits Are Included in "Current Monthly Income" Under the Means Test for Determining Presumption of Abuse

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



Blausey v. US Trustee
Ninth Circuit Court of Appeals Case No. 07-15955
January 23, 2009

The Holding

The Ninth Circuit held that disability insurance benefit payments ARE included in Chapter 7 debtors' current monthly income ("CMI") under the means test in determining whether there is a presumption of abuse. This was an issue of first impression among the circuit courts, including the broader question of whether CMI is defined by reference to the Internal Revenue Code. In a split opinion, this three-judge panel upheld the bankruptcy court's dismissal of debtors' Chapter 7 case under § 707(b)(2), holding that, although the Internal Revenue Code explicitly excludes from "gross income" "amounts received through accident or health insurance . . . for personal injuries or sickness," the plain language of the Bankruptcy Code mandates that disability payments be included in CMI.

Statutory Context

As summarized nicely by the court:

Section 707(b)(2) provides a means test by which bankruptcy courts determine whether a case is presumed to be an abuse of Chapter 7. If the case is presumed abusive, it will be dismissed unless the debtor shows “special circumstances” rebutting the presumption. 11 U.S.C. § 707(b)(2)(B)(I). If the presumption does not arise, the bankruptcy court may still find abuse under § 707(b)(3) based on the totality of the circumstances.

The focus here was on whether there was presumptive abuse as determined by the means test, specifically whether or not the "current monthly income" (CMI) component of the means test includes the disability payments. If these disability payments are included in CMI in this case, that led to a presumption of abuse; without those payments being included, the calculations under § 707(b)(2) would have led to no presumption of abuse.

Since the Ninth Circuit panel determined that the disability payments were included in CMI and thus that a presumption of abuse existed, it did not need to address the totality of circumstances issue under § 707(b)(3).

The Code provides a two-part definition of CMI, under § 101(10A)(A) and (B). The term:

(A) means the average monthly income from all sources that the debtor receives . . . without regard to whether such income is taxable income . . . ; and

B) includes any amount paid by any entity other than the debtor . . . on a regular basis for the household expenses of the debtor or the debtor’s dependents . . . , but excludes benefits received under the Social Security Act, payments to victims of war crimes or crimes against humanity on account of their status as victims of such crimes, and payments to victims of international terrorism . . . or domestic terrorism . . . on account of their status as victims of such terrorism.

The Rationale

• The Internal Revenue Code's definition of gross income is not applicable because the Bankruptcy Code's definition of CMI at § 101(10A)(A) explicitly states that its meaning is "without regard to whether such income is taxable income," which "reflects Congress’ judgment that the Internal Revenue Code’s method of determining taxable income does not apply to the Bankruptcy Code’s calculation of CMI."
• "[W]here Congress wishes to define a term in the Bankruptcy code by reference to the Internal Revenue Code, it clearly knows how to do so."
• "[T]he statute makes several specific exclusions from CMI but does not specifically exclude private disability insurance benefits. This indicates that Congress meant for the benefits to be included in CMI."
• Standard definitions of income which base it on being derived from labor are not persuasive because "the purpose of the disability insurance plan is to replace the income that Mrs. Blausey lost due to her disability.".
• According to the legislative history, the purpose of the means test is promoted by the inclusion of disability benefits in the CMI, that purpose being to "help the courts determine who can and who cannot repay their debts and, perhaps most importantly, how much they can afford to pay."

The bottom line: "Congress’s determination that a certain type of income should not be taxed does not reflect a determination that the income is not available to repay debts."

The Dissent and the Jurisdictional Issue

The dissenting judge indicated that he "admire[d] and agree[d] with the court's thoughtful treatment of the merits of this case." So the panel was unanimous on the substantive issue discussed above. The dissent simply believed that the Ninth Circuit did not have jurisdiction to hear the appeal. Indeed of the 14 pages of discussion in the opinion and dissent, only five pages addressed the merits of the case. In any event the holding on the merits will stand for a long time, since the case will not be appealed to the Supreme Court on these jurisdictional grounds because the U.S. Trustee had raised the jurisdictional issue but then won on the merits and so has no reason to 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

Mortgage Modification Programs Are Failing Because Mortgage Servicers Are Not Paid to Have Them Succeed

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

Following up on the Bankruptcy Bulletin on this website of January 7 entitled Mortgage Modification Programs Have Been Ineffective. Why?, in that Bulletin I referred to "one of the most important and least recognized reasons for so few modifications" being that "the incentive structure for mortgage servicers in most cases greatly favors foreclosures over modifications." This Bulletin explores this incentive structure and how it is stymieing mortgage modifications.

The Role of Mortgage Servicers
As succinctly stated in an article by Katherine Porter, associate professor at the University of Iowa law school (and former associate at Stoel Rives LLP in Portland, Oregon):

The communication problems in today's securitized mortgage market are very different than during past real estate downturns, such as the Midwest farm crisis of the 1980s or the wave of foreclosures in the 1930s. Why? Because of the widespread use of mortgage servicers, third-party agents who collect payments from borrowers and remit them to the mortgage note holders (usually investors, often via a trust). Mortgage servicers are responsible for enforcing defaults, including pursuing foreclosures, and for engaging in loss mitigation. Gone are the days of sitting down with the bank that originated your loan and negotiating a new deal. . . . . I am concerned that policymakers, including legislators, judges, and regulators still do not understand the barrier that loan servicing presents to voluntary or consensual loan modification.

How Servicers Are Paid
An excellent article on the nefarious role of mortgage servicers, The 800 Pound Gorrilla in the Room: Servicers Profit While Investors Face Losses, outlines their general fee arrangement:

When loans are performing servicers generate most of their income through flat servicing fees based on the unpaid principal balance of the loans. When loans become delinquent, the lack of cash flow causes fees to be deferred until a cash-generating resolution occurs, but the opportunity to increase the fees grows more than enough to compensate for the delay. Such sources of ancillary revenue include penalty fees for late payments, “foreclosure fees and costs, insufficient funds charges, property inspection fees, broker price opinions or appraisals, corporate advances, post-petition fees and suspense funds.” . . . . These fees all flow to the servicer, not the investor.[Citations excluded.]

(See also Katie Porter's two excellent postings last May in Credit Slips on a Senate Judiciary Committee's subcommittee hearing on mortgage servicing at which she testified, where she refers to the testimony of Countrywide's executive for loan administration on how servicers generate income.)

Resulting Conflict of Interest Between Servicers and Investors
Since the servicer's fees are paid before investors, the above "Servicers Profit While Investors Face Losses" article also argues:

Increased fee rates on defaulted loans along with the certainty of receiving them encourages the servicer to lengthen the duration of default status, further reducing the value of the mortgage pool to the investor. Additionally, in a market of declining home equity, investors face greater likelihood of a loss of principal when servicers aggressively charge ancillary fees.

[Citations excluded.]

The Accepted Benefits of Mortgage Modifications With Principal Reduction
In a detailed but highly understandable speech by Fed Chair Ben Bernanke in March 2008 titled Reducing Preventable Mortgage Foreclosures, he strongly acknowledged (albeit in his necessarily understated tone) the great need for mortgage servicers and investors to modify mortgages through principle reductions, not just fiddling with the interest rate or term of the mortgage:

Loan modifications, which involve any permanent change to the terms of the mortgage contract, may be preferred when the borrower cannot cope with the higher payments associated with a repayment plan. In such cases, the monthly payment is reduced through a lower interest rate, an extension of the maturity of the loan, or a write-down of the principal balance.
. . . .
To date, permanent modifications that have occurred have typically involved a reduction in the interest rate, while reductions of principal balance have been quite rare. The preference by servicers for interest rate reductions could reflect familiarity with that technique, based on past episodes when most borrowers' problems could be solved that way. But the current housing difficulties differ from those in the past, largely because of the pervasiveness of negative equity positions. With low or negative equity, as I have mentioned, a stressed borrower has less ability (because there is no home equity to tap) and less financial incentive to try to remain in the home. In this environment, principal reductions that restore some equity for the homeowner may be a relatively more effective means of avoiding delinquency and foreclosure.

The Lack of Principal Reductions in the Voluntary Modification Programs
Notwithstanding the clear need for principal reductions, an empirical study of voluntary mortgage modification programs by Valparaiso University Law School professor Alan White, updated through November 2008, found that principal loan balances were reduced in less than 10 percent of modifications. Even monthly payments were reduced in only about 35% of the modifications. Indeed, more than half of the modifications actually increased the total amount of mortgage debt by capitalizing the unpaid contractual interest and fees onto the tail end of the mortgage, and 45% even increased the monthly payments. As a NACBA (the National Association of Consumer Bankruptcy Attorneys) press release last month quoted Professor White:

While banks have written down more than half a trillion in mortgages and mortgage-related securities, homeowners have gotten little or no relief. A broad range of economists from Nouriel Roubini to Ben Bernanke to Martin Feldstein have recognized the need to deleverage the American homeowner. The excess mortgage debt is depressing home prices and consumer spending, and acting as a drag on the broader economy. Empirical evidence from mortgage servicer reports to investors shows that for the most part, the necessary deleveraging of homeowners is not happening.

The Economic Disincentives for Servicers to Modify Mortgages
In the speech quoted above, Fed Reserve Chair Bernanke also acknowledged the disincentives for servicers to engage in modifications (which he here also calls "workouts"):

Unfortunately, even though workouts may often be the best economic alternative, mortgage securitization and the constraints faced by servicers may make such workouts less likely. . . .. Thus, servicers may not pursue workout options that are in the collective interests of investors and borrowers. Some progress has been made (for example, through clarification of accounting rules) in reducing the disincentive for servicers to undertake economically sensible workouts. However, the barriers to, and disincentives for, workouts by servicers remain serious problems that need to be part of current discussions about how to reduce preventable foreclosures.

Bernanke reemphasized this theme in a speech just a few weeks ago:

[D]espite the substantial costs imposed by foreclosure, 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. The rules under which servicers operate do not always provide them with clear guidance or the appropriate incentives to undertake economically sensible modifications.

As more pointed stated by the author of the article above bylined "Servicers Profit While Investors Face Losses" (with extensive footnotes excluded):

Ancillary fees, which are profit centers for servicers, result in significant losses to investors. The servicer is ensured collection of the fees and costs as they are received prior to the investor getting any proceeds. Any deficiencies are covered from the securitized pool. Increased fee rates on defaulted loans along with the certainty of receiving them encourages the servicer to lengthen the duration of default status, further reducing the value of the mortgage pool to the investor. Additionally, in a market of declining home equity, investors face greater likelihood of a loss of principal when servicers aggressively charge ancillary fees.
. . . .
Not only do servicers have incentives to use strategies which are detrimental to investors, but the means to act with limited impunity. Lack of investor, borrower and regulatory oversight and informational asymmetry between the investor and servicer ensures servicers will act on their self interests. Additionally, the consolidation of the mortgage service industry leaves investors with few alternatives to their current servicers.

The Solution?
This is a problem that has been recognized and directly addressed in the past with proposed legislation that has gone nowhere. For example, HR 5679 last year, The Foreclosure Prevention and Sound Mortgage Servicing Act of 2008, would have required mortgagees and servicers to participate in "reasonable loss mitigation activities," a carefully defined term, before being able to start the foreclosure process. The bill also sought to address homeowners' challenges in communicating with the servicer about modification by commonsensically requiring servicers to provide a toll-free telephone number with which homeowners could reach a person at the servicer, within the U.S., with the necessary information and authority to deal with loss mitigation, and thus presumably with modifications. This bill never passed out of committee.

The multi-billion dollar question now is whether the Chapter 13 mortgage modification bill currently charging through Congress is about to be part of the attempted solution to this so-far intractable problem.

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

Judge Brown Affirms Chapter 13 Trustee's Ability and Obligation to File Modified Plan After Increase in Debtors' Income

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


In re Midgley
Bankruptcy Court for the District of Oregon Case No. 05-30162
January 6, 2009
Unpublished opinion of Judge Trish Brown

Although unpublished, this opinion provides an excellent overview of the trustee's and debtor's duties regarding plan modifications in the context of debtors' income increases. Perhaps one of the reasons this opinion was not published is that it applies the pre-BAPCPA Bankruptcy Code and so will not be relevant for long, but there are still many pre-BAPCPA Chapter 13 cases pending. Indeed since they are all at least three years old, there is more likelihood that there have been changes in income in the interim, making this opinion still highly worthwhile. Also, although the case involved an increase in debtor income, some aspects of Judge Brown's opinion also apply to reductions in income.

The Eye-Catching Facts
In this Chapter 13 case filed in January 2005, debtors' gross annual income was disclosed to be $114,408, and the plan was confirmed with payments of $455 per month for 36 months. In fact the debtors' gross income for 2005 was $150,781 and for 2006 was $154,301, so as Judge Brown pointed out, "in the first two years of the plan the Debtors' income was $76,366 more than shown on Schedule I." The Order Confirming Plan contained the standard language requiring debtors "to report immediately" gross income changes of more than 10%, and to "provide copies of all tax returns to the trustee each year immediately upon filing." The debtors did not timely provide the trustee with tax returns for those two years or inform the trustee by any other means that their income had increased. Instead only after the trustee made multiple requests for copies of the tax returns, he received both the 2005 and 2006 returns in March 2008 (close to the time the case was originally scheduled to be completed). The trustee filed a modified plan in June 2008 not changing the monthly plan payment but stating that "debtors shall pay not less than $19,500.00 to the Trustee for distribution through the plan after all obligations under the first 36 months have been satisfied.”

[Remainder of this Bulletin is being edited.]

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