Servicer Shield May Not Protect

JAN 24, 2013 1:59pm ET

WE’RE HEARING...recent settlements between lenders and regulators over alleged foreclosure abuses and the Consumer Financial Protection Bureau’s new servicing rules may do little to lift the cloud of litigation risk hanging over lenders.

Patrick McManemin, a Dallas-based partner with the law firm of Patton Boggs, said the CFPB’s new servicing rule could create more problems than it solves. Requirements related to foreclosure practices could prove especially difficult to manage when lenders are dealing with a large volume of loan defaults.

“I think there is going to be a lot of room for potential litigation exposure as circumstances and events require some of the new rules to be interpreted,” McManemin told me. “We are going to have a period of time when courts are going to be required to interpret some of these rules, and that’s going to be difficult.”

He said there appears to be no “safe harbor” for violations that result from good faith mistakes rather than intentional violations of the CFPB rules. Among the rules that could prove tricky as servicers manage large foreclosure volumes: a requirement that they must consider an application for a modification if it arrives at least 37 days before a scheduled foreclosure sale. Restrictions on “dual tracking” of loan modification efforts and foreclosure procedures may also expose servicers to litigation risk.

The CFPB’s new servicing rules also give investors a say in foreclosure decision making. That’s a new wrinkle for servicers to manage, McManemin said.

“All of a sudden investors have some rights and a seat at table in terms of foreclosures. This adds a potential step in the process required of servicers.”

The requirement that servicers give troubled borrowers “direct, easy, ongoing” access to servicing employees may be a stumbling block.

Moreover, the rule explicitly gives borrowers the right to sue their servicer in certain loss mitigation disputes.

Less worrisome today, McManemin believes, is the threat of more investor suits against lenders alleging misrepresentations in the sale of mortgage pools. That’s because in many cases, the statute of limitations for making such claims relating to loan pools sold at the height of the mortgage crisis is coming to a close. However, many such cases remain in the pipeline, he said.

McManemin said the recent $8.5 billion settlement between ten large servicers and regulators regarding alleged foreclosure abuses does not shield servicers from further litigation. Servicers had hoped for a deal that would grant a broad release from claims and put foreclosure litigation behind them.

“The limited nature of the release in the settlement does not eliminate all of the existing litigation risk,” he said.

Michael Steinlage, a partner with the law firm of Larson King in St. Paul, Minn., agreed that recent settlements between servicers and regulators may do little to alleviate the litigation risk for servicers.

“From past experience in this area in particular, even the best laid plans seem to never quite meet the expectations of the various people who were involved in pushing them.”

Steinlage, who practices primarily in Minnesota, said loan modifications are increasingly a focus of litigation involving mortgage servicers. In Minnesota, servicers are seeing a rise in allegations that loan modifications were promised but never completed. He says servicers often have strong grounds to defend themselves against these charges.

“Ultimately, a loan modification is a modification of an existing contract, and there has to be a signed document. Absent that, most courts don’t find an enforceable modification,” he told me.

Servicers are also under fire for pursuing foreclosure actions simultaneously while efforts to reach a modification are underway, he said. Again, he said credit agreements relating to postponement of foreclosure usually need to be in writing to be accepted by the courts.

MERS-related lawsuits are comparatively rare in Minnesota, he said, because the state has a “fairly unique” statute that specifically authorizes MERS as the nominee with a right to take foreclosure action. Nonetheless, most lenders are foreclosing in their own names to avoid disputes related to MERS’ standing as nominee for the lender.

Steinlage says that investor lawsuits, mostly related to origination activity but sometimes involving companies that also service loans, may increase because certain elements of those cases have survived motions to dismiss. Larson King has represented investors in some of those cases. Steinlage said some investors are now doing due diligence to see if they can pursue recovery of money lost from the purchase of bad mortgages. If they decide to proceed, those investors could seek to consolidate their claims into existing litigation, he said.

The recent $8.5 billion settlement between servicers and regulators reflected frustration with the slow pace of modifications, he said. One issue driving the settlement was the high cost of reviewing thousands of foreclosure files to see if modifications should have been offered.

Despite the billions of dollars that servicers have agreed to pay to settle claims related to foreclosure practices, a simple web search about recent enforcement actions finds that there are still plenty of people who think lenders are getting off easy. As long as there is significant public skepticism about banks’ foreclosure practices, litigation risk is likely to remain elevated.

Ted Cornwell has covered the mortgage markets since 1990. He is a former editor of both Mortgage Servicing News and Mortgage Technology.

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