Bankruptcy

Creditors: Fear Not?

By Katie Porter

Just as public ire at the mortgage industry reaches a pinnacle, courts have offered the mortgage companies refuge from their mistreatment of consumers in some recent rulings. While these decisions may be aberrations, they have powerful lessons for consumer debtors and their attorneys that bear some discussion.

A bankruptcy court ruled last week that the United States Trustee (UST) lacked the authority to bring a complaint against Countrywide for abusive mortgage servicing practices. (Hat tip to Amir Efrati at the Wall Street Journal for bringing the ruling to my attention.)The In re Sanchez court concludes that the UST failed to state a claim for sanctions because the UST is not authorized to pursue sanctions. I disagree.

I think 11 USC 307, which says the UST may "raise . . . and be heard on any issue in case or proceeding" under the Bankruptcy Code, is intentionally broad and permits the UST to file a lawsuit against alleged wrongdoers, including one asking the court to use its section 105 equitable powers to sanction. While the court suggests that instead the United States Attorney is the appropriate party to punish violations of the bankruptcy laws (yes, for bankruptcy crimes but I'm not sure about civil redress?), the real lesson of the case is that debtors' attorneys need to bring complaints against the mortgage companies. Waiting for the court to identify problems sua sponte as in In re Parsley  or hoping the US Trustee (or even less plausibly the US Attorney) will bring actions is risky at best and negligent at worst. Homeowners in bankruptcy need to know they aren't overpaying their mortgage company, and their attorneys need to shoulder this burden--at least until Congress or the rules committee or voluntary compliance does something to systemically improve the practices of servicers in bankruptcy cases.

The other victory of note for mortgage servicers was the Third Circuit decision in In re Nosek. The court vacated the judgment against Ameriquest awarding the consumer $250,000 in emotional distress damages and $500,000 in punitive damages because it determined that there was no violation of either the Bankruptcy Code or the debtor's chapter 13 plan. The court said that 1322(b), which permits a debtor to cure a default over the course of a plan (such as by paying the mortgage arrears), did not impose any specific duties on a lender. Thus, although Ameriquest did not distinguish between the ongoing current mortgage obligations and the payments on the pre-petition debt in applying the debtor's payments, the court said that the failure of the debtor's plan to specifically obligate the creditor to apply the payments in accordance with 1322(b) to cure the arrears eliminated the debtor's ability to invoke section 105's enforcement authority. The lesson for debtor's attorneys here is that the chapter 13 plan itself apparently needs to specify how the mortgage company should apply the pre- and post-petition payments. While section 524(i), added as part of BAPCPA and not at issue in this case, may have given a different result, I think the Nosek decision strongly suggests that bankruptcy courts should permit debtors to include 524(i) language in their plans and debtors' attorneys who fail to do so--or at least fail to argue to a court that they can do so--are putting the rights of their clients at risk.

Consumer bankruptcy attorneys have a heavy burden to shoulder after BAPCPA, which imposed additional advertising restrictions, paperwork requirements, and potential liability on them. I think these two decisions add to the duties of debtor's attorneys, exacerbating concerns about the need for and the reality of increasing attorneys' fees for bankruptcy relief.

Full post as published by Credit Slips on October 21, 2008 (boomark / email).