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

Crucial But Less Publicized Terms of the 2009 Chapter 13 Mortgage Cramdown Bill

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


This Bankruptcy Bulletin presents the provisions of Senate Bill 61, the Helping Families Save Their Homes in Bankruptcy Act of 2009, BEYOND the core cramdown language covered in yesterday's Bulletin. These both follow up on last Thursday's dramatic announcement of Citigroup's new support for this Chapter 13 mortgage cramdown bill, which itself was reported on in my Bulletin of last Friday. This bill would take effect on the date of enactment, applicable to bankruptcy cases filed on or after that date.

(Senate Bill. 61, and its companion bill in the House, H.R. 200, were introduced on the floor of the Senate and House a week ago today, on 1/06/09, but as of yesterday evening (1/12/09) 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.)

Major Increase in Jurisdictional Debt Limits in Chapter 13 Cases with Debts on Principal Residences
Senate Bill 61's amendment of Section 109(e) would significantly broaden Chapter 13 availability to debtors with relatively high debt (such as business and former business owners), whose "current value of [their principal] residence is less than the secured debt limit." That secured debt limit is currently $1,010,650. So, as long as a debtor's principal residence is worth less than that, the secured and unsecured debts "secured by" that residence are EXCLUDED from the "noncontingent, liquidated" secured and unsecured debt limitations (currently $1,010,650 for secured debt and $336,900 for unsecured). Even if PRE-PETITION that principal residence was lost by foreclosure or by surrendered to the creditor, any debts that remain would also be excluded from the debt limitations, again as long as the current value of that former principal residence is less than the secured debt limit. This provision would mitigate against the more and more common tendency of debtors being forced into Chapter 11 largely by the value of their residences. And because this residential mortgage cramdown option is NOT being extended to Chapter 11, this expansion of the jurisdictional limits would be critical for many potential debtors.

Pre-Petition Credit Counseling Not Required in Chapter 13's With Pending Foreclosure on Principal Residence
The bill would exclude from the Section 109(h)(1) BAPCPA's pre-petition credit counseling requirement any Chapter 13 debtor "who submits to the court a certification that the debtor has received notice that the of a claim secured by the debtor’s principal residence may commence a foreclosure on the debtor’s principal residence."

Consumer Protection Laws, Particularly Truth in Lending
The bill, as in last year's version, contains an addition to Section 502(b), which is a list of types of creditor claims which are either not allowed or else are allowed only to some designated extent. As introduced last week before the new agreement with Citigroup, the bill would allow a creditor's claim "except to the extent that---

(10) the claim is subject to any remedy for damages or rescission due to failure to comply with any applicable requirement under the Truth in Lending Act, or any other provision of applicable State or Federal consumer protection law that was in force when the noncompliance took place, notwithstanding the prior entry of a foreclosure judgment.

This provision was in effect agreed to be amended in the agreement with Citigroup. This agreement has to my knowledge not yet been incorporated into any publicly available amendment to the bill introduced last week. The only readily available source about that agreement is the letter from Citigroup's CEO to Congressional leaders of last Thursday announcing conditional support for the bill. It stated: "[P]rovisions in the bill allowing a bankruptcy judge to void a mortgage entirely for violation of consumer protection laws will be limited solely to those violations of the Truth in Lending Act (TILA) that give rise to right of resission under TILA." Media sources have interpreted this condition to mean, for example in a Wall Street Journal article:

a mortgage debt could be forgiven entirely only if the lender was found to have committed a major violation of the Truth in Lending Act. Under the bill's original language, the entire mortgage debt could be wiped away based on a violation of any number of state and federal consumer lending laws.

Post-Petition Fees of Mortgage Creditors
A section of the bill titled "Combating Excessive Fees," amends Section 1322(c) of the Bankruptcy Code--which refers to the contents of Chapter 13 plans and their treatment of claims secured by debtors' principal residences--by providing rules for adding a post-petition "fee, cost or charge" by "the holder of the claim for such a debt." This section is as extensive as any in the bill. It provides for WAIVER by the creditor of ANY post-petition fees that do not comply with the new noticing procedure, such waiver enforced explicitly through the automatic stay of Section 362(a) during the case and through the discharge injunction of Section 524(a)(2) after the discharge. Such waiver is "for all purposes," presumably meaning not just for purposes of the Chapter 13 case.

The creditor is required to file with the bankruptcy court notice of any additional "fee, cost, or charge" within one year after it is incurred or "60 days before the closing of the case," whichever is earlier, and is required to do so "annually or, in order to permit filing consistent with clause (ii) [regarding filing 60 days before case closing], at such more frequent periodicity as the court determines necessary." Those fees must be 1) "lawful under applicable nonbankruptcy law," 2) reasonable, and 3) "provided for in the applicable security agreement," and 4) "secured by property the value of which is greater than the amount of such claim, including such fee, cost, or charge."

Plan Confirmation
The bill adds the following two additional subsections to Section 1325(a), which is the list of the conditions upon which "the court shall confirm a plan":

(10) notwithstanding subclause (I) of paragraph (5)(B)(i) [about holders of secured claims retaining their liens until the payment of the debt or the discharge, whichever is EARLIER], the plan provides that the holder of a claim whose rights are modified pursuant to section 1322(b)(11) retain the lien until the LATER of—
(A) the payment of such holder’s allowed secured claim; or
(B) discharge under section 1328; and
(11) the plan modifies a claim in accordance with section 1322(b)(11), and the court finds that such modification is in good faith. [Capitalization added.]

This new subsection (10) provides for the holder of a claim secured by debtor's primary residence to retain their lien the later instead of the earlier of the two events: the secured debt payoff and the discharge. I do not understand why a mortgage whose secured portion is paid off during the course of a Chapter 13 case gets to keep their lien until discharge, when any other secured creditor loses their lien upon payoff it occurs before discharge.

And the "good faith" phrase in subsection (11) seems somewhat redundant since Section 1325(a)(e) already requires that a "plan has been proposed in good faith. . . ." Presumably the point is to emphasize that the modification itself must be in good faith.

Immediate Effective Date, Applicability to Ongoing Chapter 13's
As stated above, this bill would take effect on the date of enactment. Given that Congressional leaders are signaling that they intend to add this bill to the major economic stimulus package, which the new Obama Administration very much wants to enact by mid-February, debtors' attorneys particularly need to be counseling virtually every client who owns a home NOW about this potential new law, and specifically needs to be considering the potential huge benefits of delaying filing until after its enactment. If this bill is not made part of the stimulus package--and it is not at all assured to be--its passage, especially in its present form, is less likely, and would not likely be accomplished as quickly.

The bill states that "[t]he amendments made by this Act shall apply with respect to cases commenced under title 11 of the United States Code before, on, or after the date of the enactment of this Act." Unless changed, the "before" in that provision appears to allow post-petition and post-confirmation plan modifications in cases pending at the time of enactment.

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

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