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The Good, the Bad and the Ugly of Mortgage Servicing and Implications for Mortgage Modification

posted by Jean Braucher

It looks as if the mortgage cramdown--er, modification--legislation will be sitting around for a while, at least until the stimulus package gets through Congress. So it seems worth talking about its reference to making "payments of such modified loan directly to the holder of the claim" instead of through the Chapter 13 trustee. Although this language was still in the manager’s version of the bill (H.R. 200) as of last week, apparently discussions continue in Washington about whether this is the best policy approach.

A big reason for needing trustees in the picture is to keep track of mortgage payments, because servicers make a lot of errors. There are apparently new servicing companies that are trying to avoid the problems that have been rampant in the industry in the past—dare we hope that some good servicers are coming on line? But no doubt there are still many of the bad (careless) and the ugly (those who are deliberately charging unreasonable or illegal fees during bankruptcy). I'd be interested to hear whether anyone is seeing improvement in this industry since the new focus on its shortcomings.

As a policy matter, the argument for payment of mortgage obligations through the Chapter 13 trustee, rather than directly, is that this approach likely makes it easier for debtors to complete their plans and keep their homes without an expensive fight at the end about whether they are up to date on payments. Putting Chapter 13 trustees in charge of disbursements gives debtors the benefit of their superior record-keeping ability and understanding and their leverage with servicers because of their continuing relationships. While lawyers in areas that have not had a practice of conduit payment of regular mortgage amounts through the trustee often oppose that approach on the assumption that trustee fees will make plans infeasible, the evidence seems to be that conduit payments result in the percentage fee going down. Most trustees already top out on the compensation they are allowed by law. Lower percentage fees in conduit trusteeships may mean that most debtors do not have a problem with feasibility, although unsecured creditors may get paid less. There may be some debtors at the margin who won’t be able to afford a plan if they have to pay trustee fees, but courts could make exceptions in such cases on feasibility grounds (feasibility can cut in different directions depending on the case).

The language in the bill about direct payment raises more questions than it answers. It is at the end of a series of possible modification actions, including writing the loan principal down to value of the collateral, extending the repayment period so that it could be up to 40 years and adjusting the interest rate to the conventional mortgage rate plus a reasonable premium for risk. So it sounds as if providing for direct payment, avoiding the chapter 13 trustee, is not a requirement but an option courts can consider, perhaps to make the payment amounts affordable by eliminating the trustee fee if necessary. But we can expect litigation over this question if the bill’s language stays as is.

Conduit payment of continuing regular mortgage obligations through the Chapter 13 trustee has been on the rise in recent years. Gordon Bermant & Jean Braucher, Making Post-Petition Mortgage Payments Inside Chapter 13 Plans: Facts, Laws, Policy, 80 Am. Bankr L. J. 261 (2006). Arrearages have always been paid through the trustee. The Ninth Circuit’s recent decision in In re Lopez, 550 F.3d 1201 (9th Cir. 2008) (adopting as its own the Bankruptcy Appellate Panel decision, thus holding that a Chapter 13 debtor could make regular mortgage payments directly and not pay trustee fees on them, assuming compliance with confirmation requirements) will not necessarily change that reality even in the 9th Circuit. Chapter 13 trustees could switch their focus to feasibility as a grounds for requiring conduit payments. It wouldn’t take many confirmation challenges investigating the debtor's history of making timely payments or the servicer's record of accurately recording them to induce most debtors' lawyers to propose conduit payments. Furthermore, local rules making conduit payments the default approach, absent a contrary request, can accomplish the same thing, while still allowing some debtors to engage in special pleading for direct payment.

Better yet, a lower percentage fee on mortgage payments, enacted into law, could give trustees sufficient compensation for the services they provide without jeopardizing plan feasibility. The logic of this approach is that the larger size of mortgage payments makes a lower percentage sufficient to cover costs. This approach could be applied to all mortgage payments, modified or not.

Maybe the servicing industry will eventually clean itself up, but even if so, trustee disbursement of all mortgage payments might be good for debtors in general. There is already evidence that wage orders (so that debtors' employers pay the trustee directly) help debtors to complete Chapter 13 plans, and wage orders combined with direct payment to the mortgage claimant avoids the possibility of a slip up in making payments (absent job loss). Two distinguished bankruptcy judges, Judge Small and Judge Wedoff, have long recommended this approach. To make mortgage modification work as a way to save homes, conduit payments (as a general rule, subject to exceptions for feasibility or other special circumstances) would probably be the best policy approach.


A few comments -

First, conduit mortgage payments do, eventually, result in Chapter 13 percentage fees going down substantially - to the 3 to 4 percent range. The problem with a mandated lower fee for mortgage modification conduits is that the percentage won't drop as a trustee's pipeline of cases is filled with conduit mortgage Chapter 13s. If a lower fixed percentage is in the legislation, the fee drops as Chapter 13 trustees are being asked to handle who knows how many cases that won't produce income (for most trustees) until those Chapter 13 Plans are confirmed.

I think the bankruptcy courts and Chapter 13 offices can handle a very large volume of cases - but they may be cash starved at the beginning of a unprecedented huge wave of mortgage modification cases.

Second - the fight on mortgage payments through the Chapter 13 trustee appears to be focussed on who decides. Is it going to be debtors and their attorneys who choose whether to make conduit payments, or will it be the bankruptcy judges? My reading of the initial bill was that it would be the debtors and their attorneys making that decision, not (as it is in most places where most mortgages are conduit) the bankruptcy judges - often based on history, or with a nudge from the Chapter 13 trustee.

If mortgage payments through the Chapter 13 trustee is not 'how it's done' in a particular juridiction, the practice is unlikely to change if the choice is left to debtors (or really debtor's attorneys who prepare the plan.)

Third, the combination of Kagenveama and Lopez has changed Chapter 13 practice in parts of the Ninth Circuit to the point where it looks much like a Chapter 7 with higher, paid-over-time attorney fees. In many high cost of living areas, like LA, over-the-median debtors with negative CMI routinely propose 6 month, zero-percent plans. There are still some cases that look 'normal', where mortgage arrearages need to be paid (and those are always paid through the trustee) but under the proposed bill, it looks like arrearages will disappear.

With California one of the places I would expect the biggest rush to file Chapter 13s to modify underwater mortgages, I have no idea how trustees there are going to have adequate funding to meet the challenge. Taking a 10% fee on what the attorney charged to file the case isn't going to cover the costs of administering a tsunami of new cases.

Fourth - Local rules are really no help if the law makes paying the mortgage directly the choice of the debtor and debtor's attorney - as Lopez says it is, and as the first draft of the mortgage modification bill seems to provide.

Look at the rules for making local rules: "A local rule "may only be upheld if (a) it is consistent with the Bankruptcy Code in that it does not 'abridge, enlarge, or modify any substantive right,' as required by 28 U.S.C. § 2075 and (b) it is 'a matter of procedure not inconsistent with' the Bankruptcy Rules as required by Bankruptcy Rule 9029."" In re McGowan, 226 B.R. 13, 16 (B.A.P. 8th Cir. 1998).

If, as the Ninth Circuit holds in Lopez, the Bankruptcy Code permits a debtor to choose not to make their regular monthly mortgage payment through the Chapter 13 trustee, any local rule that says otherwise would be invalid. Local rules would be similarly ineffectual if, as it appears, a bankruptcy judge's ability to require conduit payment is being specifically written out of the mortgage modification legislation.

Professor Braucher,
There are now 7.8 milion vacant foreclosed homes in U.S., per recent Census Report and soon to be 10 million per knowledgeable predictions.
The mortgage servicing industry is never going to clean itself up without severe prosecutorial action by DOJ. Even so, that will not rewrite all the Pooling and Servicing Agreements that allow, if not overtly encourage servicers to collect and keep all the bogus fees they can, not to mention retaining excess funds from FC sales. It is in their best interest to fabricate defaults and illegal FCs. It is also in the best interest of I-Banks, hedge funds and investors who "speculate"? using complicit servicer malfeasance to short subprime indexes with obscenely lucrative credit default swaps. Regrettably, I have no faith in cramdowns or mods. Unless servicers and their Wall Street accomplices are convicted of their crimes against American homeowners, cramdowns and mods would just be kicking the can down the road.

A possible answer to AMC’s question about the legality of making conduit payments the default rule (under a local rule), even in the Ninth Circuit after Lopez, is that this approach could be based on the feasibility test for confirmation. The Lopez case is clear that confirmation tests still apply. Most of the time, plan completion won’t be feasible without conduit payments (and wage orders). A local rule could be based on that reality, subject to special pleading by debtors who argue that in their cases, the plan isn’t feasible if they have to pay trustee fees on their mortgage payments. I tend to think that in most such cases, the plan isn’t feasible, full stop, but some judges might want to give debtors a chance to make a risky and probably doomed attempt in Chapter 13.
As for the more macro criticism of mortgage cramdown, I get it—it may not do much. Furthermore, I fear that some debtors who have no realistic prospect of saving their homes will struggle and fail under this supposed last chance. The best of the debtor bar, however, would be careful with this new tool and not use it where it will only prolong the agony. So I side with that hope.

Your idea regarding feasibility is nice, but doesn't reflect the reality of the situation in two respects. First, Lopez says it is the debtors choice to pay the monthly mortgage payments through the Plan, or not. Second, any bankruptcy court that is intellectually honest is going to be very reluctant to play the feasibility card to deny confirmation.

Look at the kinds of Chapter 13 plans that are regularly confirmed. Food budgets of $100 a month, plans based on the debtor getting a job after months or years of unemployment, plans funded by contributions from friends or family members. All those get confirmed - because feasibility is the easiest confirmation test to meet. But, the same judges who are willing to give below median debtors a chance to keep their homes (at least for a little longer) are going to deny confirmation because plans are unfeasible without conduit mortgage payments? Maybe, but it will be for agenda driven reasons, not the consistent application of the feasibility requirement.

Your idea that judges will deny confirmation based on feasiblity would be even more unlikely in a post-mortgage modification world. Most bankruptcy courts that force monthly mortgage payments to be conduited through the Chapter 13 trustee do so when there is a certain level of arrearage, 2 months, 4 months, or some dollar amount of arrearage. Under the mortgage modification bill, there will be no arrearages. It looks like everybody starts from even on confirmation, weakening the argument that conduit payments are necessary for feasibility.

The other systemic problem in the Ninth Circuit is the wider effect of the Kagenveama approach. It affects other issues, like what is deductible on the Means Test. Many courts, probably the majority, hold that in Chapter 13 cases (unlike the majority looking at the same issue in Chapter 7) you cannot deduct the expense for monthly payments that the debtor will not actual make in the future because second and third mortgages were stripped, houses, vehicles and 'toys' were surrendered, and/or non-910 vehicle liens were crammed down. Kagenveama is a total endorsement of the backward looking approach, and fiercely divorced from any sort of reality based determinations. Following Kagenveama, bankruptcy courts there are going to be more likely to allow above-median deductions for expenses that won't be paid in the future, meaning a majority of cases are going to have negative CMI, meaning most above-median debtors are going to have no obligation to pay unsecured creditors anything. Nevertheless, for feasibility purposes, they are going to have I and J disposable income far in excess of what would be needed to directly pay the remaining monthly mortgage obligation.

Again, your position would require bankruptcy judges to hold that doing what every homeowner does on their own - making the monthly mortgage payment - makes a Chapter 13 Plan unfeasible, while the same court is going to confirm wish and a prayer plans by debtors with budgets that are so lean they make you want to cry?

This issue is of particular importance now because the two circuit court decisions that are contra Kagenveama, Fredrickson (8th Cir.) and Lanning (10th Cir.) have sought cert. from the Supreme Court. And Kagenveama has at least a punchers chance of being the part of the circuit split that comes out on top before the high court. It has strong plain meaning appeal, and that is the starting point, and often the ending point, of statutory analysis. If Kagenveama does carry the day, then were are all going to have to live in the bizarro world of the Ninth Circuit Chapter 13 practice.

If Ron White were a bankruptcy scholar, he'd have changed his saying to: "You can't fix stupid . . . legislation." BAPCPA is a disaster only Congress can change.

And if Congress passes mortgage modification, while the U.S. Supreme Court upholds Kagenveama based on plain meaning over "they couldn't possibly have meant THAT" as the primary tool of statutory construction, we are going to have - for high income debtors - mortgage modification in what looks an awful lot like a Chapter 7.

Well, I've already said that we need simplification, and I think AMC is adding some detail on that rather large point. More than five years ago, I proposed a single consumer chapter, with a surplus income requirement for those who can afford it, as in bankruptcy in Australia and Canada. That would sure beat what we have now. Current Chapter 13 trustees could be redeployed to deal with the minority of surplus income cases.

Along the way in that last comment by AMC, I think we see issues under current law mixed up with the proposed legislation. The proposed legislation as of now seems to allow direct payment by the debtor to the mortgage claimant on modified mortgages, at least in some circumstances, but perhaps subject to the discretion of the modifying judge to instead provide for payment through the trustee. So there would be lots of litigation to figure out whether in general modifications will be paid through the Chapter 13 trustees. This would be layering on more mess on top of the exisiting mess. (I think there are some points of agreement here.) If Congress is going to pass modification legislation, it would be nice if it would say clearly how this will be administered and, if Chapter 13 trustees will be involved, provide for reasonable fees.

As to conduit payments under existing law, a lot of intellectually honest players in the system have taken the position that they can be ordered as a general rule (that's the majority practice by Chapter 13 trustees around the country, and judges have allowed that to happen), and probably those players won't follow Lopez outside the Ninth Circuit unless the Supreme Court lumbers in (and inevitably makes the mess worse). In the Ninth Circuit, I don't think the feasibility basis for a rule of conduit payments in general is flimsier than a dozen other rulings I've read recently. And I don't blame judges for that; they are playing the hand they have been dealt.

Professor, one small clarification re: "A big reason for needing trustees in the picture is to keep track of mortgage payments, because servicers make a lot of errors."

This statement, to me, implies that some servicers are making *mistakes* or tacking on fees by accident. It is my personal experience, and dare I say the experience of many, many other Mortgage Servicing Fraud victims, that the "errors" that servicers make are in no way accidental or mistaken. They are deliberate attempts to unlawfully and fraudulently create additional profit which they simply are not due under either the terms of the various mortgage contracts OR state/federal regulations.

What some servicers are doing is criminal and the acts should be prosecuted to the fullest extent of the law. Additionally, these servicing "errors" that appear in the course of bankruptcy proceedings are, in many cases, the very same "errors" that forced borrowers into Chapter 13 in the first place. For many MSF victims, Chap 13 is the last ditch effort to save their home after months or years of attempting to correct the accounts so as to avoid having to file a 13 or 7. But when borrowers can't find competent legal representation that they can afford the only thing left for them is bankruptcy. This goes directly to my statement that justice is only for those that can afford it.

Unfortunately, studies focusing on Mortgage Servicing Fraud outside of or prior to bankruptcy proceedings don't seem to be of too much interest. Harvard, Yale, MIT, Wharton, Stanford and others all have the tools at hand to perform some incredible studies on MSF but, to the best of my knowledge, have not and are not doing so. Harvard alone could use both Hale & Door and the Legal Aid clinic. I believe Atty Twomey was working with/through H&D when she brought Maxwell v. Fairbanks. The psych, legal, medical and accounting departments could be performing a joint study that I'm certain would reveal some astounding data with regard to MSF if they so chose.

My apologies. As some may have noticed, one of the effects of MSF is that victims tend to get on a roll and talk about their experience whenever possible. My simple point is that it perturbs me when I see servicers STILL being cut slack for their actions. It is long overdue for the niceties and couching of language with regard to servicer actions to cease. These are not mistakes. These are not errors. They are profit/greed driven business platforms that really need to be prosecuted once and for all.

All it took was for Bill Russell to throw one elbow. Once that happened the muggings on the court ceased...

To me unsecured creditors will benefit from NOT having mortgage arrears in the plan. With Mortgage Arrears, you are giving the mortgage co. interest on top of interest. Eliminating the arrears will (in theory) promote higher percentage plans. I know, I know, we usually eat up the extra in allowable expenses. But when we do that, debtors wont have those $100 per month food budgets.

Leaving mortgage payments outside of a chapter 13 payment or (direct) will again have the effect of lowering the total cost because of the Trustees percentage. A major part of the Trustees income comes about because we have mortgage arrears in the plan. Interest on top of principal & interest. Without mortgage arrears and mortgage payments "Passed through" the Trustee, the Trustee will be disbursing less and less. Coupled with a mandated percentage of disbursement, Chapter 13 Trustees will see less and less of the "pie". It is my understanding though that although the Trustees receive a percentage of disbursements, Trustees themselves are salaried and paid by the government (someone correct me if I am wrong). All of that may be negated by sheer volume if the Amendment is passed.

All of that to say: Debtors are much more successful when they make "conduit" payments and Plan payments are deducted straight from wages. I also like the control over Servicer fees.

I read a recent article that opened my eyes a bit when it comes to Servicer fees. The answer, MIP. MIP pays for the late fees, BPO, Attorneys fees AND 25% of the value of the foreclosed home. So it is to the Servicers benefit to "rack up the fees" because MIP pays for it! All of that gets transposed into a POC when or if the debtor files for Bankruptcy. They are used to getting those fees so when it goes into Bankruptcy they don't want to lose out. If their fees makes the plan unfeasible GREAT, they foreclose (eventually) and they get their fees (maybe not minus the fees they already received) from the debtors Bankruptcy.

Patches, everyone gets their money and THEN some in foreclosure situations - especially if the note has been securitized.

1.) Going with the securitization scenario. Trusts are covered by "note insurance". If a loan becomes non-performing, i.e. "dead", a claim can be put in for the value of that loan. Hence the value of the loan is recovered. If you're at all familiar with any of Judge Schack's cases you may recall him asking for affidavits from note holder/servicer personnel explaining why trusts were purchasing already "dead" or non-performing loans and inserting them INTO the trusts. Unfortunately, I haven't seen any of those affidavits yet. If anyone has copies I would absolutely love to read them.

2.) If title insurance is involved, a claim may be put in against THAT.

3.) If pmi is involved, a claim may be put in against THAT

4.) The property is foreclosed upon. If purchased by a third party at auction it is purchased for whatever value the auctioneer can get above any "reserve" price. If the servicer OR the note holder purchase the property at auction it is usually done at whatever $ figure is alleged to be owed by the borrower. The scenario I told you about back in October for instance. Property was FCd for $78k and change. 30 days prior to FC it had appraised out at $240k. Auction was held 4 hours north of the property location. Most likely purchased by bank due to the fact that the buy in for that particular property was $10 where every other one that day was only $5k. Property is now on the market for $179k. That $100k profit (assumption) will go in the bank/servicer's pocket and the former borrower will see $0.

This is just one of the many reasons that I bang my head against the wall when the "everyone loses in foreclosure" meme starts up. BS!! Servicers/note holder are potentially profiting as much as 4x the value of a note. And no one seems to care about this.

And I haven't even addressed the states where notes and mortgages can be bifurcated and separate foreclosure actions can be brought by the note holder OR the mortgage holder. Servicers also get to play with the "float" as well which may also be a possibility for soooo many monthly payments being processed late despite being received on time. Ok, so the float isn't profit - it's just an interest free loan for 21-22 days each month.

Oh, wait... Servicers usually get to keep the INTEREST that accrues on float as well... Sorry.

Ahhhhhh! I know! I get the same headaches from those kooks! Makes it twice as complicated to unravel in BK. Messed up! Bunch of "Barn Os". In and out of the water, ya?

Article by someone at US Trustee's office took a stab at trying to figure out whehter direct payment of the mortgage affected successful completion. '


The conclusion: "The comparison in Table 2 does not support the conclusion that moving the ongoing mortgage payments through the trustee operation increases the rate of successful terminations. When we subdivide the group of 58 into smaller groups based on administrative differences between them, the result does not change markedly: The proportion of successful terminations remains approximately 30 percent. "

Footnote 5 of that paper cites two circuit court cases that held, long before the recent Ninth Circuit case, that it was the debtor's option to pay directly, if he or she wanted to. Foster v. Heitkamp, 670 F.2d 478 (5th Cir. 1982) (chapter 13 permits a debtor to act as a disbursing agent in making current mortgage payments); In re Aberegg, 961 F.2d 1307, 1310 (7th Cir. 1992) ("It would serve little purpose to require the debtors to disburse their mortgage payments through the trustee...");

Wouldn't guess that the UST would have ever been on the other end of some unexplained and unwarranted servicing charges in BK. I see a big benefit. My view is from the bottom up.

Two points on the success rate of Chapter 13s in conduit versus non-conduit situations.

I don't think there is a big difference in successful completion percentage. Among Chapter 13 trustees who do make the regular monthly payments, it is almost an article of faith that conduit payments have all kinds of benefits, but I think there is a lot of wishful thinking there. More conduit cases fail early, and there is less flexibility when the debtors hit a rough patch and can't make their full monthly payments - the Chapter 13 trustee is defaulting on the mortgage and should move to dismiss the case more quickly than in a non-conduit situation.

I would suggest that cases that are funded by payroll deductions (as opposed to those that are paid directly by the debtors) have a greater effect on the 'successful completion rate' than whether or not regular monthly mortgage payments are paid through the Plan.

One the other hand, the real answer depends what you mean by 'successful completion' of a Chapter 13. Chapter 13 trustees who make the monthly mortgage payment almost always do some kind of motion to declare the mortgage current at the end of the plan period. In the current situation, where mortgages aren't starting over from scratch upon confirmation, this is a huge benefit. And while debtors' attorneys can do the same thing, their clients' records are vastly inferior to what the trustee will bring to court to show that the mortgage company's accounting was screwed up somehow, or that the right to additional fees have been waived because of a failure to do a timely escrow analysis.

However, there is a negative effect that needs to be considered in defining "success" in the Chapter 13 context. Where monthly mortgage payments are made by the trustee - often along with mandatory car payoffs - Chapter 13 seems to foster a culture of dependency, and lots of repeat filers.

People who have only had to make one payment (or never even see the money, in a payroll deduction situation) can lose the ability to budget, or to exercise "urge control" after they complete their Chapter 13 plans. Many seem to end up going out and making bad financial decisions, and filing Chapter 13 again and again. I don't think that a couple debtor education classes is going to change that dynamic (if it exists).

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