10 posts from August 2019

Ditech, Reverse Mortgages, Consumer Concerns, and Section 363(o)

posted by Pamela Foohey

A couple days ago, Judge Garrity Jr. of the Bankruptcy Court for the Southern District of New York issued a 132 page opinion denying confirmation of Ditech's proposed plan. Ditech, of course, is an originator and servicer of mortgages, including reverse mortgages. Its plan contemplated sales of both its forward and reverse mortgage businesses--free and clear of customers' claims and defenses. As reported at various times since Ditech filed in February 2019, homeowners have claims that Ditech did not credit mortgage payments properly, levied improper fees, failed to recognize tax payment plans, and wrongly foreclosed on homes.

Beyond its sheer length, the opinion is noteworthy for a couple reasons. First, the sales of mortgage businesses in the context of a plan raised the question of whether § 363(o) applied. Section 363(o) deals with consumer credit transactions subject to the Truth in Lending Act and provides that if any "interest" in such a transaction is purchased through a sale, then the buyer must take all the claims and defenses related to the consumer credit transaction. Ditech, of course, wanted to sell free and clear of those claims, through the plan. In holding that § 363(o) does not apply in the plan context, Judge Garrity Jr. provides a detailed analysis of the section's legislative history. This history includes removal of language about application to reorganization plans by an amendment proposed by Senator Phil Gramm (which was approved), and Senator Gramm's continued opposition to the addition of § 363(o) in its entirety because he claimed it would, among other things, encourage people to make up grievances against mortgage originators and servicers. (As many readers likely know, Senator Gramm spearheaded the Gramm-Leach-Bliley Act.)

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My Favorite Contract Metaphors: Skeuomorphs, Sea Squirts, Barnacles and Black Holes

posted by Mitu Gulati

I love contract metaphors. I’m especially fond of metaphors for the phenomenon of antiquated and useless contract provisions that find a way to persist over the decades in boilerplate contracts.  Philip Wood, the legendary English lawyer, uses the metaphor of barnacles on a ship’s hull to describe how more and more of these useless provisions can accumulate over the years, eventually severely impacting the efficiency of the ship. If you like boats and hate barnacles (perhaps because one of your most hated chores in the summers was for you to attempt to scrape barnacles off the hull of your uncle’s fishing boat), this metaphor may work especially well for you (sorry, Uncle Marvin). Another favorite of mine, that does not bring up memories of unpleasant chores, is Doug Baird’s skeuomorph.  To quote Douglas, who in the course of his explaining why we should not be surprised that suboptimal contract terms both emerge and then persist, has some wonderful examples:

To take a[n] . . .  example, maple syrup is often sold in a glass bottle with a small handle that serves no discernable utilitarian purpose. This is a relic of the time when maple syrup came in jugs and the handles were large enough to be useful. This phenomenon—of a product feature persisting when incorporated in a new environment in which it no longer serves a function—is well known and has a name: skeuomorph.

Douglas goes on to explain that these skeuomorphs can bizarrely become desired features of the product in question (and remember he is drawing an analogy to contract drafting). He writes, while continuing with the maple syrup bottle example:

Buyers of maple syrup want to see a small handle on the bottle. It serves no purpose, but it is what consumers have come to expect. Blue jeans are no longer made for working men who carry pocket watches, but buyers of blue jeans want a watch pocket all the same, even though they have no idea of the purpose it serves and have no use for it. Everyone expects Worcestershire Sauce bottles to come wrapped in paper even though the reason for doing this has long disappeared. Tagines took a particular shape for functional reasons when they were made of clay, and they retained this shape when made of aluminum even though there was no longer a functional reason for doing so. Skeuomorphs can be found everywhere on the “desktops” of personal computers

In short, the idea that a clause could be added to a contract and remain there merely because everyone expected it to be there suggests nothing special about either pari passu clauses in particular or contract terms more generally. The same forces are at work as with ordinary product attributes. Crafting legal prose is hard, and few contracts are ever written from scratch. Lawyers almost always start with a template taken from someplace else. For this reason, those who draft contracts are likely to import features from earlier contracting environments, even when they serve no purpose, merely because they are familiar. To give another example involving financial instruments, the first railway bonds were based on real estate mortgages. They still bear some of the attributes of real estate mortgages, and not always for the better.

If you like this topic, I recommend Douglas’ piece “Pari Passu Clauses and the Skeuomorph Problem in Contract Law” (you should of course ignore all the bits of this brilliant piece that are critical of my paper with Bob Scott and Steve Choi on Contractual Black Holes (yes, another metaphor I’m very fond of) that Douglas’ piece was a comment on).

Last but not least is the Sea Squirt, a close cousin of the barnacle.  This one comes from M&A guru, Glenn West who was speaking on a panel at UT in 2018 on M&A Contracting.  The title of his presentation was: “Have Sea Squirts Invaded Your Contract?—Avoiding Mindless Use of So Called ‘Market’ Terms You May or May Not Understand”.  Below I’ve excerpted some priceless language from an August 2017 blog post by Glenn on MAC clauses in M&A agreements.  And yes, Glenn is talking about M&A contracts containing brainless bits of language; the contracts drafted by the most elite among all transactional lawyers.

As an aside, there are a number of excellent recent papers arguing over how brainless M&A contracts are; see here (Anderson & Manns) and here (Coates, Palia & Wu).

From Glenn’s blog post, here goes:

The sea squirt is an animal that begins life with a brain and a tail.  Immediately after it is born, it uses its brain and tail to propel itself through the water until it finds some rockto attach itself.  Once it attaches itself to that rock it consumes its brain, absorbs its tail, and thereafter never moves again; it lives out its remaining life as a brainless water filter.

Many of the standard terms of M&A agreements also began their existence with a brain—the brain of a smart lawyer who perceived an issue that needed to be addressed and drafted a clause to address it.  And then other smart lawyers recognized the value of that newly drafted clause, and adapted and improved it until it became a standard part of most M&A agreements.  But once that clause became attached to the “market” it became divorced from the brain or brains that created it, and soon everyone was using it regardless of whether they truly understood all the reasons that prompted its draftingEven worse, market attachment is so strong that even after a standard clause has been repeatedly interpreted by courts to have a meaning that differs from the meaning ascribed to that clause by those who purport to know but do not actual know its meaning (mindlessly using the now brainless clause), it continues to be used without modification.  Such is the case for many with the ubiquitous Material Adverse Change (“MAC”) or Material Adverse Effect (“MAE”) clause.

My friend at UNC Chapel Hill, John Coyle, has an article coming out soon on “Contract as Swag”.  I’m eager to see how that metaphor will work. I like swag and I want learn how to get more of it.

Private Equity's Abuse of Limited Liability

posted by Adam Levitin

One of the central features of the Stop Wall Street Looting Act that was introduced by Senator Elizabeth Warren and a number of co-sponsors is a targeted rollback of limited liability.

This provision, more than any other, has gotten some commentators’ hackles up, even those who are willing to admit that there are real problems in the private equity industry and welcome some of the other reforms in the bill. (See also here and here, for example.)

The idea that limited liability is a sine qua non of the modern economy is practically Gospel to most business commentators.  These commentators assume that without limited liability, no one will ever assume risks, such that any curtailment of limited liability is a death sentence for the private equity industry.

They're wrong. Limited liability is a substantial, regressive cross-subsidy to capital at the expense of tort creditors, tax authorities, and small businesses. Limited liability is a relic of the underdeveloped financial markets of the Gilded Age and operates as an implicit form of leverage provided by law. But it’s hardly either economically efficient or necessary for modern business activity. It's a fairly recent development in the western world, there are numerous exceptions to it, and a number of notable firms have prospered without it (JPMorgan & Co., Lloyds of London, American Express, and many leading law law firms).

In any event the Stop Wall Street Looting Act rolls back limited liability solely for private equity general partners in a surgical manner such that doesn’t affect limited liability more broadly. All the Stop Wall Street Looting Act will do is reveal which private equity firms have real managerial expertise, and are thus able to thrive without limited liability, and those that don’t and require the legal subsidy to be profitable. Far from undermining the private equity industry, it is a restoration of a central tenet of honest American capitalism: reward should be commensurate with risk.

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Alix v. McKinsey Update

posted by Stephen Lubben

Judge Furman has dismissed the federal RICO charges, and the case may be headed to state court. Our chances of actually finding out if McKinsey flouted rule 2014 (and § 327) are looking increasingly dim:

OPINION AND ORDER re: 88 JOINT MOTION to Dismiss by all defendants. filed by McKinsey Holdings, Inc., Kevin Carmody, Alison Proshan, McKinsey Recovery & Transformation Services U.S., LLC, Jon Garcia, Seth Goldstrom, Robert Sternfels, McKinsey & Company Inc. United States, Dominic Barton, McKinsey & Co., Inc. If Alix's allegations in this case are true (as the Court has assumed they are for purposes of this motion), they are certainly troubling. Moreover, Alix and AlixPartners may well have good reason to be upset about Defendants' alleged misconduct and may indeed have genuinely public-spirited reasons for seeking to deter it going forward. But that is not enough to state a claim for relief, much less a claim under the civil RICO statute, which provides a remedy only to those whose injuries directly resulted from a defendant's scheme. Defendants' motion to dismiss is accordingly GRANTED as to Alix's federal claims and those claims the First, Second, Third, and Fourth Causes of Action are dismissed with prejudice. The Court defers ruling on Defendants' motion to dismiss Alix's state-law claims until it confirms, following the parties' supplemental briefing in accordance with the schedule set forth above, that it has diversity jurisdiction over those claims. The Clerk of Court is directed to terminate the Individual Defendants Dominic Barton, Kevin Carmody, Jon Garcia, Seth Goldstrom, Alison Proshan, Robert Sternfels, and Jared D. Yerian as parties and to terminate ECF No. 88. SO ORDERED., (Jon Garcia, Seth Goldstrom, Alison Proshan, Robert Sternfels, Jared D. Yerian, Dominic Barton and Kevin Carmody terminated.) (Signed by Judge Jesse M. Furman on 8/19/19) (yv) (Entered: 08/19/2019)

Trump Wants to Buy Greenland for the U.S. – But Who Is the Relevant Seller?

posted by Mitu Gulati

(This post draws from my prior work with Joseph Blocher and the many conversations we have had about this topic over the years; he bears no responsibility for errors and sarcasm)

According to a flurry of news reports from the WSJ, CNN, Bloomberg, the NYT and many more, our eminent chief executive has an interest in the possibility of buying Greenland.  Most reactions to this news of DJT’s latest whim have boiled down to incredulity, while also generating a fair amount of mirth (see here, here and here).  What has interested us the most, though, are the articles that have concluded that the U.S. cannot buy Greenland. Bloomberg’s Quick Take ran the title – “Can Trump Actually Buy Greenland – The Short Answer is No”. 

But is that really the case? The relevant international law seems to present no explicit barrier to nations buying and selling territory (here). Indeed, much of today’s United States was acquired through the purchase of territory.  The barrier that most commentators see as insurmountable is not legal, but rather the lack of a willing seller.  Maybe so.  But a handful of quotes from government officials and politicians in Denmark and a few from politicians in Greenland (see here and here) is not necessarily enough to conclude that this trade could never work.

Before jumping to the foregoing conclusion, one needs to first ask how such a sale would work.

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Coyle on Studying the History of a Contract Provision

posted by Mitu Gulati

The way many of us teach interpretation in Contract Law, there is little role for history (admittedly, this is just based on casual observation). The meaning of a clause is a function of the words that make up that clause.  The parties to the transaction are assumed to have drafted it to document the key aspects of their transaction, to balance risks and rewards blah blah.  If a dispute arises, we might have an argument as to whether a strict textualist reading of the words accurately represent what the parties really meant by them or whether we need to also examine the context of the relationship. What we do not ever do, however, is to delve into the history of the clause from before these parties contemplated using it – that is, of what prior drafters of the original versions of this clause might have meant in using it.

The foregoing makes sense in a world in which the contracts for each deal are drafted from scratch. But does anyone draft contracts from scratch?  What if we live in a world where 99.9% of contracts are made up of provisions cut and paste from prior deals; provisions that are assumed to cover all the key contingencies, but not necessarily understood (or even read)? In this latter world, where there are lots of provisions that the parties to the transaction never fully focused on (let alone understood), might there be an argument – in cases where there are interpretive disputes -- for the use of a contract provision’s history? Might that history not sometimes be more relevant than the non-understandings of the parties as to what they did or did not understand they were contracting for? (Among the few pieces that wrestle with this question are these two gems: Lee Buchheit's Contract Paleontology here and Mark Weidemaier's Indiana Jones: Contract Originalist here)

I’m not sure what the answer to the foregoing question is. But it intrigues me.  And it connects to a wonderfully fresh new body of research in Contract Law where a number of scholars have been studying the production process for modern contracts.  The list of papers and scholars here is too long to do justice to and I’ll just end up making mistakes if I try to do a list.  But what unites this group of contract scholars is that for them it isn’t enough to assume that contracts show up fully formed at the time of a deal, purely the product of the brilliant minds of the deal makers who anticipate nearly every possible contingency at the start.  Instead, understanding what provisions show up in a contract, and in what formulation, requires understanding the contract production process. (Barak Richman's delightful "Contracts Meet Henry Ford" (here) is, to my mind, foundational).

It is perhaps too early to tell whether this research will catch on and revolutionize contract law. I hope it does, but I’m biased.

One of my favorite papers in this new body of contract scholarship showed up recently on ssrn. It is John Coyle’s “A History of the Choice-of-Law Clause” (here). I have rarely found a piece of legal scholarship so compelling.  The paper is not only a model of clarity in terms of the writing, but it is brave. It is completely unapologetic in not only taking on an entirely new mode of research (a painstaking documentation of the historical evolution of the most important terms in any and every contract), but in coming up with a cool and innovative research technique for unpacking that history (this project would have been impossible to do without that innovation).

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The Fifth Circuit Finds a Way to Make It Even Harder to Discharge Student Loans in Bankruptcy

posted by Bob Lawless

On Tuesday, the United States Court of Appeals for the Fifth Circuit released an opinion that, if anything, makes it even more difficult to discharge student loans in bankruptcy. Writing for a three-judge panel in a case called In re Thomas, Judge Edith Jones reaffirmed the court's commitment to the existing case law and added yet another judicial gloss to the words of the statute. The opinion was a missed opportunity to return to a reasonable standard that allows debtors to discharge student debt in appropriate cases while still protecting the public fisc.

The debtor was over 60 years old, part of the trend of older filers in bankruptcy court. She had taken out $7,000 in student loans for two semesters of community college. Within a year after leaving community college, the debtor developed diabetic neuropathy, which left her unable to work at any job that required standing for any period of time. The debtor had to leave a retail job, a restaurant job, and a job at UPS. She lost a previous job at a call center after it was acquired by another company who then fired her within three months for wearing headphone and listening to music during her lunch break, a determination that probably not so coincidentally meant the debt was ineligible for unemployment insurance.

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How NOT to Regulate ISAs

posted by Adam Levitin

Income-sharing agreements or ISAs are becoming an increasingly popular way to finance higher education. The key problem that ISAs face as a product is uncertainty about their regulatory status. Are ISAs “credit” for various statutory purposes? Or are they something else? Into the regulatory void comes a bipartisan bill, introduced by Senators Mark Warner, Marco Rubio, and Chris Coons, that would set forth a regulatory framework for ISAs. The problem is that the regulatory framework proposed is shamefully bad: it would give a green light to discriminatory financing terms and tie the CFPB’s hands from further regulating ISAs.

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Playing with Fire: The CFPB's Proposed Repeal of the "GSE Patch"

posted by Adam Levitin
CFPB recently put out an advance notice of proposed rulemaking to amend the Qualified Mortgage (QM) Rule by letting the "GSE Patch" expire.  What the Bureau is proposing is potentially very dangerous.  While I haven’t liked some of the Bureau's other proposed rules (including under the Cordray Directorship), none of them were an all-out ideological gamble with the economy. This one, in contrast, is really playing with fire.  

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Biden's Involvement in the Detroit Bankruptcy?

posted by Adam Levitin

In the Democratic Primary debate last night, former Vice-President Joe Biden claimed to have been deeply involved in the Detroit bankruptcy: 

Q (Tapper): What do you say to progressives who worry that your proposals are not ambitious enough to energize the progressive wing of your party, which you will need to beat Donald Trump?

A (Biden): ... Number three, number three, I also was asked, as the mayor of Detroit can tell you, by the president of the United States to help Detroit get out of bankruptcy and get back on its feet. I spent better part of two years out here working to make sure that it did exactly that.

What on earth is Joe Biden talking about? I followed the Detroit bankruptcy case fairly closely and never once heard of any involvement from Biden. A google search for "Biden Detroit bankruptcy" shows an involvement consisting of all of one lunch with the Mayor of Detroit.  Maybe Biden was deeply involved behind the scenes, but I doubt it, as the federal government simply didn’t do anything to help out Detroit. Perhaps he was referring to the GM/Chrysler bankruptcies? If so, there was important federal involvement as a lender, but Joe Biden was not an important player in those cases either as far as I know.

If others know more, it would be interesting to hear, but as far as I can tell, Biden is claiming credit for things that he had no involvement in.  

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