Subprime Lenders in Bankruptcy

New Century Financial Corp. filed for Chapter 11 yesterday in Delaware (case # 07-10416). At least four other lenders have filed bankruptcy in the last three months (Ownit, Mortgage Lender's Network, People's Choice Home Loans, and ResMAE Corp.). As Tara Twomey noted in a recent post, the financial pressures on these companies from bad loans leaves them with fewer dollars to put to their servicing responsibilities.

Now that these companies are in bankruptcy, I see another challenge: How, if at all, should these companies deal with their liability to borrowers that may have claims against them for TILA, state predatory lending violations, FDCPA claims, etc? Courts use a variety of measures--conduct test, relationship test, or state law accrual test--to determine whether pre-petition claims exist. I think consumer borrowers may be bankruptcy claimants under any of these tests. Given the origination practices of some of these lenders, such companies may be wise to ask the court to address this potential liability in their reorganization plans. (I gather that New Century is going to attempt to reorganize and not merely liquidate as it has arranged for $150 million in post-petition financing.) Of course, many consumers may not yet be aware of their lending claims, making it difficult or impossible for them to file individual proofs of claim. A couple of solutions seem possible, depending on a court's inclination: permitting a "class claim" on behalf of all similarly situated consumers or the appointment of a future claim representative. Such claims would be paid in tiny bankruptcy dollars but given my skepticism about the post-petition fate of these lenders, consumers may be well-advised to assert bankruptcy claims to get a seat at the negotiating table and a stake in the reorganization outcome.

Comments

[David Yen]

In other Chapter 11 cases filed by lenders they have tried to launder the loans by holding a sale of the loans free and clear of all claims. Although this was probably contrary to the Code, it was done anyway in several cases. There is a provision in the 2005 amendments that is supposed to prevent this. Despite that, my prediction is that they will try to launder their loans anyway. I do not expect any federal regulators or the US Trustee to try to prevent this. This may be an area where state AGs need to ally themselves with consumer advocates.