The story goes that a farmer bought a mule from a salesman who told him that if he were polite to the mule, it would do whatever he wanted. After months of being nice – but with no success in getting the mule to work, the farmer asked the salesman for help. The salesman came over, hit the mule on the head with a 2x4 and explained that you did have to be nice – “but first you had to get the mule’s attention.”
It is clear by now that all of the efforts to fix the mortgage disaster in the United States have been greatly hampered by the problems with bad mortgage servicing practices. The poor record keeping, erroneous charges, inability to maintain continuity with borrowers in discussing loan modifications, and the like have contributed greatly to the difficulties seen in the numerous programs that have attempted to help borrowers retain their homes.
These problems have even greater effect when the borrower is in bankruptcy and has the fewest resources to maintain their payments and discover and challenge mistaken claims by the lender and the servicer. On the other hand, bankruptcy also, in the words of Cliff White, the director of the Executive Office of the United States Trustee, “provided an early warning sign of problems in mortgage servicing.” (Quoted in a column by Gretchen Morgenstern in the New York Times on Mary 14, 2011.) Bankruptcy cases always involve a judge (unlike the majority of states with nonjudicial foreclosure proceedings), as well as a Chapter 7 or 13 trustee and the United States Trustee office, in addition to the debtor’s lawyer. As a result, there are more parties with an eye to overseeing the validity of the proceedings than occur outside bankruptcy. In consequence, the first rumblings heralding the growing storm of mortgage servicing problems were heard in individual bankruptcy cases where courts noted, with evident amazement, examples of extraordinary bungling of records, evidence, and pleadings.
Again, according to Mr. White, the U.S. Trustee office initially dealt with these as isolated problems but as the examples piled up, the office began taking a more aggressive approach to seek discovery and determine whether problems were isolated incidents or the results of corporate policies. He noted that the all of the major servicers, including Bank of America, Citigroup, G.M.A.C. JPMorgan Chase, and Wells Fargo, had actively opposed the U.S. Trustee’s offices investigative efforts, contesting the office’s statutory authority to pursue such matters, and resisting efforts to go beyond individual cases to obtaining discovery on systemic issues.
Mr. White further challenged the servicer’s contentions that problems were isolated incidents, noting that, in their investigations in less than 20 districts, they had found hundreds of facial deficiencies, including many instances where the deficiency claims were improper or inflated. These sorts of problems undoubtedly were one of the consequences of the practices of “robo-signing” foreclosure documents that were uncovered last fall. As noted in the ABI’s June 30, 2011 Bankruptcy Brief, one consequence is that the number of serious mortgage delinquencies now outnumber the foreclosure proceedings actually going forward by more than 50 to 1 as the courts and the servicers struggle to correct the problems.
Meanwhile, the bankruptcy courts continue to need to deal with the problems in front of them – and to determine what tools they have to sanction past bad behavior and coerce or compel better behavior for the future. A number of cases, such as In re Parsley, 384 B.R. 139 (Bankr. S.D. Tex. 2008) and DeAngelis v. Countrywide Home Loans, Inc. (In re Hill), 437 B.R. 503 (W.D. Penn. 2010) have discussed their remedial toolbox in the face of what would appear to be grossly negligent conduct but which might or might not fall over the edge into actual fraud or bad faith. In each case, the court significantly limited its potential sanctions in view of its conclusion that its inherent authority did not extend to sanctioning merely negligent conduct. Indeed, each of the current remedial approaches – contempt, Rule 9011 sanctions, sanctions for vexatious litigation under 28 U.S.C. 1927, or the court’s “inherent powers” – have their limitations in dealing with conduct that is not clearly fraudulent or in bad faith, no matter how inept and harmful to the debtor and the system. In addition, the ongoing questions about the U.S. Trustee’s authority to act in this area and its rights to generalized discovery have continued to encourage additional litigation and limited its ability to police these issues.
According, Senators Leahy (D-VT), Whitehouse (D-RI) and Blumenthal (D-CT) introduced S. 1054, the “Fighting Fraud in Bankruptcy Act of 2011,” on May 24, 2011. Both Whitehouse and Blumenthal were former Attorneys General for their states before being elected to the Senate and Leahy, although first elected to the Senate in 1974 and serving ever since then, was States’ Attorney in Vermont for eight years before being elected. That background likely convinced them of the need to strengthen and clarify the role of the U.S. Trustee’s office and the courts in reviewing and remedying these problems. As a result, the bill appears intended to be the 2x4 that will be used to gain the attention of the mortgage industry mule.
The bill would add a new Section 113, labeled “Remedies for negligent, reckless, or fraudulent assertion of claim.” Section 113(a)(3) states a definition of “relief” that includes, in addition to any other power the court possesses, the power to enter an order or judgment in any case or cases in which a person has “asserted a claim” in violation of subsection (b) (A) that imposes a civil penalty of up to $5,000 per claim; (B) actual damages to the debtor or the trustee, and (C) “other prospective or retrospective relief, including but not limited to declaratory, relief, injunctive relief, or an auditing requirement.” Subsection (b), in term, provides that a court may, on its own motion or that of the United States trustee (or bankruptcy administrator) “enter relief” (as defined above) against a person that has through “negligence, recklessness, or fraud, improperly asserted a claim” in any case in Chapter 7 or 13. The “relief” may be entered to the extent necessary to rectify the “negligent, reckless, or fraudulent assertion of a claim,” or to prevent such assertions.
The bill would further amend 28 U.S.C. § 586(a) by adding a new subsection 9 that allows the U.S. Trustee “when it deems appropriate” to “monitor and investigate the conduct of other parties in interest with respect to claims,” to take any action that it deems necessary to prevent or remedy any “negligent, reckless or fraudulent assertion of a claim,” by exercising any of its powers under title 28 or title 11 including actions under Section 113 or filing, pursuing, or commenting upon any civil action or proceeding arising under title 11, or arising in or related to a title 11 case. Finally, the bill also adds a new section (g) to 28 U.S.C. § 586 giving the U.S. Trustee the authority to set up audit procedures for claims filed against individuals in Chapters 7 and 13 cases. The number, scope, and nature of such audits is left to the U.S. Trustee’s office’s discretion. A report of the audit is to be filed with the court and is to “clearly and conspicuously identify” any claim that is “not valid,” “not owed in the amount claimed,” or “not supported by adequate documentation.” As to any such deficient claim, the U.S. Trustee shall, “if appropriate, report the filing to the U.S. Attorney for action under title 18 (the criminal title), and, “if advisable,” take other appropriate action such as objecting to the claim, or taking action under Section 113.
Finally, Section 502(b) would be amended to make failure to provide requested documents for an audit grounds for disallowance of a claim, and Section 362(d) would be amended to bar any relief thereunder (i.e., lifting the stay to allow a foreclosure) against a servicemember unless a sworn certification is filed that the creditor has complied with the provisions of the Servicemembers Civil Relief Act have been met. (That act limits interest rates and bar foreclosures while the servicemember is on active duty.) The bill’s provisions are made applicable to all pending cases upon its passage, except for the auditing language, which goes into effect 18 months later.
It is easy to see how the bills’ provisions match up with the problems encountered by the U.S. Trustee’s office to date in attempting to deal with the mortgage servicer claims problems. The bill allows relief for merely negligent conduct, provides for specific civil penalties, and broadly authorizes the U.S. Trustee, to investigate, audit, and seek injunctive and declaratory relief with respect to problematic claims and conduct. It further makes clear that such relief must be sought on a broad, systemic basis, and not merely case-by-case. Passage of the bill should certainly go far to eliminating the challenges the U.S. Trustee has been facing to date.
There are a number of points one can make about the bill. First, the structure of the bill is a bit odd; one normallys forbid certain conduct (filing invalid claims through negligent, fradulent, or reckless conduct), sets sanctions for such behavior (actual damages, up to $5,000 penalties, and declaratory and injunction relief) and state who can enforce the measures. The bill instead puts some of its most important substantive aspects into its definitional section, which makes it a bit difficult to parse, but the meaning eventually becomes apparent.
Second, the bill limits the parties that can seek the new “relief” to only the court and the U.S. Trustee (and bankruptcy administrators). That is probably a very good idea, particularly in light of the very broad language used in the bill and the unfettered discretion given to the U.S. Trustee. A provision that allowed a penalty of up to $5,000 and broad class-action type powers in every instance where there was merely “negligence” in the filing of a claim could create a bonanza mentality in the minds of at least some debtor’s counsel and their clients. Courts do not typically sanction debtors who are merely negligent in omitting a claim or incorrectly disputing its validity; no more should creditors necessarily be for the same level of sloppiness. On the other hand, in light of the broad supervisory powers that the independent U.S. Trustee’s office holds, it should not necessarily be hamstrung by stricter standards such as “gross negligence,” or “willful misconduct,” or “pattern and practice,” in activating its investigative authority.
Having said that, though, one cannot help but be struck by the breadth of the powers given to the U.S. Trustee’s office, and the lack of any limitations on its discretion to act in an area where it will be in a far more adversarial position than in most of its other duties under Section 586. For instance, the U.S. Trustee would be given authority, whenever it deems appropriate, to “monitor and investigate the conduct of other parties in interest with respect to claims.” It is unclear what that is intended to cover in addition to the separate authority to deal with the“negligent, reckless, or fraudulent assertion of a claim.” The latter appears to be directed at a demonstrated problem; the former is a startlingly broad grant of new and undefined authority. It is particularly striking in that, apart from the mortgage field, there does not appear to have been any major problems with other types of claims. (The only other area in recent cases relates to the documentation of credit card balances, and this bill may well conflict with other Code and Rule provisions dealing with the prima facie validity of claims even absent full documentation.)
Other questions about the auditing provisions include why it is limited to only Chapters 7 and 13, and whether it is meant to apply to a sample of claims, or to all claims. The decision on how many claims to audit is within the U.S. Trustee’s discretion but there is no suggestion as to whether this is meant to be a limited, random sample or whether the U.S. Trustee is expecte to review all such claims if possible. Again, to the extent that this power is applied broadly – and noting that a claim may be disallowed if the creditor does not make available “necessary” papers to the auditor (with no definition of what is “necessary”) – this could create a whole new cottage industry of litigation over discovery and over claims allowance issues.
In short, the bill does attempt to deal with a very real problem but as often occurs with legislation, may have hidden problems. In attempting to create broad, generic solutions, it may impinge on areas where there was no real issue to begin with. Moreover, litigation is not always the most useful tool to create general solutions to widespread problems. One of the concerns courts have had with attempts of individual litigants to control their lenders through plan terms has been the lack of uniformity created thereby. One objection lenders raise to the current litigation is that one entity may find itself subject to detailed new rules that do not apply to others merely because it was the one that caught. Certainly, the bill intends to give the U.S. Trustee authority to seek more global relief which may alleviate some of those uniformity concerns, but it is likely that the best solutions may need to go further than what the Trustee can accomplish. That is particularly true in that the servicing problems equally exist outside bankruptcy and the petition may only be the final result of those problems. Thus, in the end, it may be that the settlements being worked on by the Comptroller of the Currency, the U.S. Department of Justice, and the state Attorneys General that are directed at creating proactive requirements for mortgage servicers in their customer dealings may be the most effective way to remedy the problems once and for all – now that they have the mule’s attention.