Loopholes Plague New Law
The bankruptcy reform law implemented last October was supposed to make life easier for mortgage servicers, but attorneys who represent the industry say that debtors are already finding ways to circumvent some of the law's intent.
That means abuse of bankruptcy protection to prevent or delay foreclosure may continue, and attorneys said creditors such as mortgage servicers have a big stake as case law develops regarding the new statute.
Speaking at a California Mortgage Bankers Association Western States Loan Servicing Conference here, Michael Ackerman, an attorney with Zucker, Goldberg & Ackerman in New Jersey, said that debtors' lawyers are urging debtors in bankruptcy court to sue servicers for "proof of claim" issues involving fees such as broker price opinions and inspections that are routinely required during default servicing.
In part, debtors' counsel are motivated by a desire to use the suits to win attorney fees from bankruptcy courts, he said. With fewer consumer bankruptcy filings, debtors' lawyers are looking for ways to compensate for a drop in bankruptcy filing fees, he noted.
Mr. Ackerman said servicers should consider "proactive litigation" in order to have a greater say in the development of case law involving the bankruptcy statute. Being a plaintiff gives lenders more control over the facts of the case being decided and what bankruptcy judge hears the case, he noted.
Historically, being proactive in filing lawsuits is not something the servicing industry does well, he said. But with the new law still in its infancy, he urged servicers to be proactive because cases decided now will set a baseline for future cases.
"Whoever hits the issue first in each district will have an overwhelming influence on the cases that come after," Mr. Ackerman said.
With over 200 bankruptcy judges across the country, Mr. Ackerman noted that there is plenty of potential for disparities in how the courts deal with bankruptcy disputes.
"Just because you get sued doesn't mean you are wrong," he said.
By taking the initiative, lenders can avoid having precedent set on cases where a "nasty set of facts" might appeal to a judge's sympathy even though the law may be on the side of the creditor, he said.
Mr. Ackerman said that servicers should not shy away from litigation in bankruptcy, in part because bankruptcy is inherently a contested issue.
He said that servicing loans affected by bankruptcy is one of the biggest challenges faced by default management teams, largely because bankruptcy cases involve more nuance than standard loan defaults.
Mr. Ackerman also said mortgage servicers need to explain their role to bankruptcy courts and trustees, so that fees for routine default management practices such as broker price opinions don't get derided as junk fees.
"I think we have to do a better job of educating judges about what we do and why we do it," he said.
Ted Manley from the firm of Manley Deas Kochalski, Columbus, Ohio, said that the new bankruptcy law incorporates a lot of disclosure requirements associated with the Truth in Lending Act.
Most of those new disclosure requirements fall upon the debtors own counsel, but he said creditors attorneys and servicers should be aware of them. The law requires disclosure of what financial obligations will survive a bankruptcy discharge, he noted.
Attorneys speaking on the CMBA panel said that lenders should establish formal cash flow procedures for loans affected by a debtor bankruptcy to ensure that their policies are compliant with new bankruptcy rules.
The statute was supposed to clamp down on the use of repeat bankruptcy filings to delay foreclosure, but attorney Thomas Holthus of McCarthey & Holthus, San Diego, said that debtors are finding ways to try to circumvent the limitations on repeat filings.
He noted that the law itself has posed challenges for bankruptcy judges, with some deriding it as "difficult to parse" and "virtually incoherent."
While repeat filings by a single party are presumed to be in bad faith, he said courts are "all over the board" in terms of interpreting whether or not repeat filers, who've typically failed to comply with earlier repayment plans, actually intend to repay debts under a new bankruptcy filing.
Also, the new law's requirement that filers receive credit counseling has thrown a wrinkle into the repeat filing debate. If debtors fail to get credit counseling, courts will likely dismiss the bankruptcy filing or strike it. If they strike the filing, that essentially means the filing is annulled, Mr. Holthus said. And it opens the door to a repeat filing.
Mortgage servicers need to monitor this issue during a bankruptcy, he said.
"I would not advise you to proceed until that case is either dismissed or stricken by the court," he said. (c) 2006 Mortgage Servicing News and SourceMedia, Inc. All Rights Reserved. http://www.mortgageservicingnews.com http://www.sourcemedia.com