Limiting Investor and Homeowner Loss in Foreclosure Act of 2010

In 2009, the bankruptcy courts for the Districts of Rhode Island and New York began loss-mitigation programs, whereby the court may order a homeowner and loan servicer to try in good faith to negotiate a settlement that would be preferable to foreclosure for all parties. [1] Under these programs, the servicer is required to provide a negotiator with the authority to modify and/or settle. There is no requirement that the parties reach a settlement, and all settlements under the loss-mitigation programs are consensual.

In the loss-mitigation program’s first 14 months in Rhode Island, 728 homeowner requests for the program have yielded 123 loan modifications. In addition to the modifications, other settlements have included short sales and deeds in lieu of foreclosure. [2] In New York, of the more than 2,000 requests for loss mitigation, about one half that have concluded have resulted in some form of an agreement—usually a loan modification reducing the interest rate and stretching out payments—that has meant that the home remains occupied or turned over in a way that is beneficial to both sides. [3] These bankruptcy courts believe that their loss-mitigation programs are consistent with Congress and the federal courts’ general encouragement of mediation, as well as with § 105(d) of the Bankruptcy Code, Bankruptcy Rules 7016 and 9014, and courts’ inherent power to manage their own docket. [4] Under § 105(d), “[t]he court, on its own motion or on the request of a party in interest…shall hold such status conferences as are necessary to further the expeditious and economical resolution of the case.” [5] Similarly, in Vermont, Chief Bankruptcy Judge Colleen Brown has adapted her court procedures for those who enter bankruptcy while involved in Vermont’s foreclosure-mediation program. [6]

Ocwen Loan Servicing and Deutsche Bank recently challenged the legal authority of the Rhode Island Bankruptcy Court to run their mediation program. [7] While that court ruled against Deutsche Bank, with the threat of future appeals and ongoing litigation, on January 27, 2011, Sen. Sheldon Whitehouse (D-R.I.) introduced S.222, the “Limiting Investor and Homeowner Loss in Foreclosure Act of 2010,” to provide legislative support for these loss-mitigation programs. [8]

The act would clarify the bankruptcy courts’ authority to implement loss-mitigation programs, and make a conforming amendment to § 362(e) that would extend the automatic stay with respect to the home to permit the parties to complete the loss-mitigation program. The bill was read twice and referred to the Senate Committee on the Judiciary, and subsequently co-sponsored by Sen. Richard Blumenthal (D-Conn.) on February 17, 2011, Sen. Patrick Leahy (D-Vt.) on March 3, 2011, Sen. Al Franken (D-Mn.) on April 4, 2011, and Sen. Bernard Sanders (D-Vt.) on May 10, 2011. On March 31, 2011, the Senate Judiciary Committee voted 10-8 to approve the bill. It now heads to the Senate floor. Following the introduction of this bill, on February 1, 2011, the Senate Judiciary Committee held a hearing entitled “Foreclosure Mediation Programs: Can Bankruptcy Courts Limit Homeowner and Investor Losses?”

Testimony by proponents of the bankruptcy loss-mitigation programs was lead by Hon. Robert D. Drain, who specifically testified on the Loss Mitigation Program implemented on January 1, 2009, by the Bankruptcy Court for the Southern District of New York. He stated that:

The Loss Mitigation Program…applies in cases under chapters 7, 11, 12 and 13 of the Bankruptcy Code to loans secured by an individual debtor’s primary residence. It may be invoked, on notice and with an opportunity to object, by either the homeowner or the lender. If there is no objection, the court enters an order establishing deadlines for the exchange of contact information for representatives with authority to negotiate; requests for and exchange of relevant information, such as the debtor’s income and expenses, tax returns and appraisals of the house; the filing of affidavits listing the information that has been exchanged;…a conference between the parties; a conference, if necessary, with the court; and an outside date to conclude the mediation. While the parties are negotiating, all litigation between them is put on hold, although either party can request that negotiations be terminated and litigation resume.

Lender objections to the invocation of loss mitigation (and requests to terminate negotiations) are granted if, taking into account the homeowner’s financial circumstances and the value of the house, it is not reasonable to expect the parties, negotiating in their own self-interest to reach an agreement. As best we can tell…there have been over 2,000 requests for loss mitigation, only 90 of which drew an objection. We have entered 75 orders granting such objections. As lenders became more familiar with the program and it became clear that we would not tolerate its invocation as a delaying tactic, objections to loss mitigation have almost ceased…

The Loss Mitigation Program has two primary benefits. It ensures, first, that there is a responsible lender representative with whom to discuss the loan. I cannot emphasize this enough: without the structure imposed by the program, most of the time this would not happen. Second, the program’s structure, under the ultimate supervision of the court, ensures that the parties deal with each other in good faith.

Most of the program’s corollary benefits relate to its bankruptcy context. In a bankruptcy case, the lender can see how the homeowner is resolving his or her entire financial predicament, often freeing up income to pay the mortgage; in addition, the Bankruptcy Code enables a debtor to resolve wholly underwater junior mortgages and judgment liens that have been placed on the home and otherwise clear title; and the bankruptcy case provides a forum for dealing with tax liens and claims. Moreover, lenders with document problems—not a negligible concern today—can settle those issues on notice to interested parties and with the approval of a bankruptcy court order, and an order approving even a simple loan modification provides comfort to a loan servicer or trustee about possible claims by trust beneficiaries that the loan was mismanaged. [9]

Another loss-mitigation program proponent was John Rao of the National Consumer Law Center who testified:

All of these programs…have several features in common. They are designed to bridge the communication gap between loan servicers and homeowners, a gap that has often been cited as the major obstacle to effective loss mitigation. The programs require active participation by a representative of the servicer with full authority to consider all loss mitigation options. They regulate production of documents and facilitate some form of meeting between the homeowner and servicer, either in person or by phone. The courts play a role in supervising and, when necessary, intervening to move the process along. The programs do not require servicers or lenders to implement a particular loss mitigation option. In the bankruptcy context, these programs importantly do not compel a modification of the mortgage creditor’s claim and therefore are not in violation of section 1322(b)(2) of the Bankruptcy Code. Instead, they set a standard for transparency and accountability in the foreclosure process that is often lacking without this intervention…

Bankruptcy courts can play an important role in avoiding unnecessary foreclosures and facilitating mortgage modifications through implementation of loss mitigation programs. In many respects, bankruptcy courts are ideally suited to facilitate mortgage modifications through implementation of mediation programs such as those in Rhode Island and New York. These reasons include:

1. Breaking through servicer roadblocks…

2. Getting a timely answer…

3. Providing basic due process…

4.Providing protection from foreclosure…Because the foreclosure units within a servicer operation (and the law firms that handle the foreclosures) often do not communicate with the loss mitigation units handling modification requests, this “dual-track” system has resulted in a number of homeowners being foreclosed while their applications have been pending, only to be told after a sale that they were eligible for a modification. The automatic stay under section 362 of the Bankruptcy Code protects the homeowner at least until the settlement negotiations can be concluded. If a stay relief motion is filed by the creditor, the loss mitigation programs provide that any continuances will be made in accordance with Bankruptcy Code section 362(e).

5. Avoiding “Robo-Signer” abuses by servicers…If there are concerns that a loan modification may be entered into by a servicer who does not have authority to act on behalf of the true owner of the mortgage, or if the homeowner contends that the unpaid amount of the debt listed in the loan modification agreement includes fees and charges not permitted by the mortgage documents or state law, these matters can be resolved by the bankruptcy court as part of the claims allowance process under sections 501 and 502 of the Bankruptcy Code.

6. Ensuring proper review of modification agreement…. In a loss-mitigation program, any loan modification or other settlement reached by the [parties] will be submitted to the court for approval. The debtor’s counsel, chapter 13 trustee, and the court thus have an opportunity to consider whether the debtor was properly evaluated for other programs, and whether the agreement is in the debtor’s best interest.

7. Dealing with second mortgages…Loan modifications facilitated in a bankruptcy court loss-mitigation program resolve this problem because all the liens on the property can be provided for in the debtor’s chapter 13 plan based on a uniform set of laws and valuation standards.

8. Dealing with the homeowner’s entire debt load…many homeowners are burdened with debt other than their home mortgages.… Loan modifications made during a bankruptcy proceeding address this problem because all of the family’s financial problems are dealt with under the supervision of a court approved Chapter 13 plan or discharged in a Chapter 7 case. In this way, homeowners are far more likely to avoid default on a mortgage modification. [10]

Currently, a committee of the state attorneys general and officials of the U.S. Department of Justice are also engaged in negotiations with the major banks and mortgage servicers over wide-ranging proposed changes to their allegedly faulty foreclosure practices which may address the very issues that form the basis of S.222. Expect a detailed report on those discussions and the proposals being discussed, as well as a review of the testimony of those opposed to S.222 in an upcoming newsletter.