Bankruptcy Reform

The recently enacted bankruptcy reform legislation was meant to aid creditors - including mortgage lenders - by making it more difficult for consumers to shed debt through personal bankruptcy filings. But it's unclear if that's the effect the legislation will have on the mortgage servicing industry. In fact, in some key regards, it appears that the legislation will raise more thorny complications for lenders and the attorneys who represent them in the case of personal bankruptcy filings.

As attorney Alan Wolf explained at the Western States Loan Servicing Conference in Las Vegas recently, many in the industry have focused on the good parts of the new legislation, but the new law consists of consumer protection features as well that might throw a loop at servicers. Parts of the law "are subject to various interpretations" that could have a negative effect on servicers.

In part, that's because there is little judicial case history on the new law. Various contradictions or murky issues have yet to be sorted out. And the new law has not addressed all of the contradictions that currently exist between different districts, where different judges have taken different views about the interpretation of existing bankruptcy laws.

One feature of the new law that could vex lenders is a "means test" designed to determine which borrowers can file under Chapter 7, which allows greater opportunity for debt relief, and which have to file under Chapter 13. However, it's not clear to what extent this complex test will affect mortgage servicers, since many homeowners file under Chapter 13 anyway, which is designed to help troubled borrowers hold onto assets such as a home.

Attorneys and judges who addressed a bankruptcy session at the recent conference left MSN with the impression that the new law is not going to be a clear win for the mortgage industry, at least not until various gray areas are sorted out. Before that time arrives, lenders will likely see a lot of inconsistencies in how the law is implemented.

But as Judge Linda B. Riegle of the U.S. Bankruptcy Court for the District of Nevada explained, the new law's intent, at least, is good for servicers.

"The basic premise of the new paradigm is that people should repay their debts if they can," she said.

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