REQUIRED READING: Several pieces of servicing-related legislation were introduced in the first month of the 112th U.S. Congress. Among the bills brought to the floor in the Senate was the Limiting Investor and Homeowner Loss in Foreclosure Act of 2010 (S.222), which would amend the Bankruptcy Code and grant courts nationwide the authority to order servicers and borrowers, at the petition of either party, to negotiate loss mitigation settlements. The mediations would be mandatory, but actual workouts would have to be consensual and approved by the court, according to legal experts familiar with the bill.
Introduced by Sen. Sheldon Whitehouse, D-R.I., S.222 is partly inspired by mediation programs in Rhode Island and New York that are administered through the bankruptcy courts. Foreclosure mediation has spread throughout the nation in recent years, with variations of the settlement-conference theme having popped up in Connecticut, Florida and Nevada, among other states.
"The Rhode Island program is modest, but I believe that it has the potential to help many thousands of homeowners, and help is definitely needed," Whitehouse said during a Feb. 1 Senate Judiciary Committee hearing. The Senate bill has the support of the American Association of Mortgage Investors, Whitehouse explained.
Although servicers have grown accustomed to programs that bring borrowers and bank representatives to the bargaining table, S.222 has raised the eyebrows of those who view bankruptcy court as an inappropriate setting for such negotiations. During the Feb. 1 committee hearing, several lawmakers and expert witnesses testified that passage of S.222 could have severe unintended consequences, such as making bankruptcy the first course of action, rather than a last resort, for borrowers seeking loan modifications.
Sen. Chuck Grassley, R-Iowa, pondered whether the legislation would breed increased judicial activism, leading to a situation in which the courts could coerce servicers into offering generous modifications. Multiple proposals by Democratic lawmakers and consumer groups to enact bankruptcy cramdown legislation have been shot down and appear unlikely to be revived. Some believe that mandating mediation will be the natural progression for advocates of bringing loss mitigation under the purview of bankruptcy courts – a typically consumer-friendly environment.
Just one week before the Senate committee hearing, the loss mitigation program implemented by the U.S. Bankruptcy Court for the District of Rhode Island overcame objections raised by two mortgage servicers.
Counsel for PHH Mortgage Corp. and Ocwen Loan Servicing challenged the program on the grounds that it was not contemplated in the Bankruptcy Code. In their arguments, the attorneys contended that the court, by instituting the program, overstepped its authority. Judge Arthur N. Votolato, who helped conceive the program in late 2009, overruled the objections. In a Jan. 28 court order, Votolato wrote that the court's loss mitigation effort "is intended to start a dialogue, giving the parties nothing more than the opportunity to discuss their respective positions."
Whitehouse hailed the ruling as a major victory for Rhode Island homeowners. His introduction of S.222 has opened up debate at the national level, but the legislation's fate remains to be seen. Nevertheless, there are signs that bankruptcy judges may not wait for federal legislation.
"It's coming," says Joseph M. Dolben, associate and bankruptcy manager for East Providence, R.I.-based Nicholas Barrett & Associates. He sat on the local rules committee that helped draft the Rhode Island program. While the program can benefit borrowers, it slows down the process for servicers, Dolben says.
"Just like the Bankruptcy Code itself, I would say there's a lot of potential for abuse of the system," he says. "Someone who really has no ability to afford a modification in any amount can request this mediation, if it's not properly objected to. You can look at three to four months, at least, of basically needless stall.
‘Of course, the servicer has to pay the attorney to deal with that," he adds.
Early this year, judges in Colorado asked trustees and attorneys for both debtors and creditors to form a working group. Its mission: to examine the potential for mediation programs in the state's bankruptcy courts.
"The reason our courts are looking at it is they are very concerned that, in Chapter 13 confirmation hearings, debtors are saying they can't do a final plan, because they're in the middle of a HAMP modification or they've applied for HAMP and haven't gotten a response back," explains Deanna Westfall, managing bankruptcy attorney for Denver-based Castle Stawiarski. The Colorado courts have identified as a possible template the loss mitigation program managed by the U.S. Bankruptcy Court for the Southern District of New York, she says.
The New York program started operations in January 2009 – some 11 months before the Rhode Island court system began ordering mediations. In little more than two years, the New York court has processed over 2,000 requests for loss mitigation, of which only 90 have drawn objections from creditors, according to Judge Robert Drain, who testified at the Senate committee hearing. He estimated that half of the mediations have resulted in a workout agreement.
"As lenders become 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," Drain told the committee. He testified that the program was set up in response to an overlapping borrower and servicer desire for a framework for negotiations. Prior to the program's implementation, servicers were leaving money on the table, and borrowers were unable to get clear answers about the status of loan modification requests, he said.
In prepared testimony, Drain said that most of the New York program's corollary benefits relate to its bankruptcy context. Court approval of a loan workout helps protect servicers against investor claims that a loan was mismanaged, as well as from allegations that documents are not in order – "not a negligible concern today," he said. Bankruptcy proceedings can also resolve workout impediments relating to junior-lien holders, he added.
The impact of S.222 on junior-lien negotiations would be minor, given the authority that bankruptcy courts already have in regard to stripping underwater subordinates, says Marcy Ford, executive vice president and partner at Trott & Trott. To her, what's most disconcerting about S.222 is that mandatory mediation "probably leads to a significant amount of undue pressure on lenders to do something or face the wrath of the court," she says.
Pending loan modifications can disrupt confirmation hearings, but debtor requests for modifications more often occur in response to servicers' motions for relief from the automatic stay, Ford explains. At the Senate committee hearing, Andrew Grossman, a visiting legal fellow at The Heritage Foundation, a conservative think tank, called the premise of mandatory mediation in bankruptcy "questionable."
"As experience with HAMP has shown, the low-hanging fruit is gone," he said. "Most modifications that are obviously win-win have been done or could be done without the intervention by a bankruptcy court."
Bankruptcy judges could very well be unsympathetic to servicers' arguments that no further loss mitigation options are available, attorneys say. The fear, in turn, is that loans could be held hostage in the bankruptcy process. Servicers "have to have a pretty compelling reason to not want to participate," Dolben observes of Rhode Island's mediations.
"I think that in a large number of cases, [forced mediation] will be unfair to creditors," Ford says, adding that she does not believe judges in her state would necessarily use S.222, if passed, to mandate cramdowns on first-lien mortgages, which would still be prohibited. "Every case is different, but in many cases, the debtors have already gone through the loss mitigation process and they have not been approved for specific reasons."
Ford sees the potential for mediation-in-bankruptcy to have a coercive effect on servicers. If passed in its drafted form, S.222 would give judges leeway in how they implement mediation programs. Judges could, for example, mandate the physical presence of servicers at mediations – a costly requirement. Such a scenario might prompt servicers to reduce principal or make a similarly generous offer in order to avoid a drawn-out and extremely expensive process.
"It still wouldn't allow cramdowns on first liens on the debtor's principal residence, but if [S.222] passes, it would give borrowers and judges significant leverage in terms of dealing with mortgage companies and potentially forcing them to the table," Ford says.
Bankruptcy judges – among the earliest critics of servicers' loss mitigation efforts – might be eager to have such leverage, Dolben notes. "Certainly, judges in bankruptcy court – who are, probably on the whole, debtor-friendly – I think would relish in forcing banks to modify loans, if they could," says Dolben.
Westfall says she doesn't believe mediation belongs in bankrupcy court, "because it really doesn't alter or affect the rights that we're talking about in the bankruptcy court." Sometimes, she says, a HAMP modification can prove to be less beneficial to borrowers than is a typical bankruptcy proceeding. Statistics show that modifying debt through Chapter 13 – which enables borrowers to pay their past-due amount over a five-year period – can be favorable to HAMP terms, which require extending a loan over 40 years.
"For people who come off medical [leave] and are now back to where they were before, bankruptcy without HAMP might actually be a better answer," she says.
Still, Westfall concedes that the appeal to judges of mediation in bankruptcy is clear.
"It's very transparent, and that's a benefit," she says. "And frankly, that's the part that makes our courts excited."
