February 1, 2011
WRITTEN TESTIMONY OF HON. ROBERT D. DRAIN
United States Bankruptcy Court for the Southern District of New York
"Foreclosure Mediation Programs: Can Bankruptcy Courts Limit Homeowner and Investor Losses?"
Hearing of the United States Senate Committee on the Judiciary
February 1, 2011
Senator Whitehouse, Senator Grassley, and other Members of the Committee, thank you for inviting me to testify on the Loss Mitigation Program implemented on January 1, 2009 by the United States Bankruptcy Court for the Southern District of New York.
I am one of 10 bankruptcy judges in our court and currently sit in White Plains, New York, just north of Manhattan. As my attached biography shows, I became a bankruptcy judge in 2002, having practiced bankruptcy law since 1984, including as a partner for over 10 years in a respected New York law firm. I dealt exclusively with large corporate bankruptcies and reorganizations, the types of cases for which the Bankruptcy Court for the Southern District of New York is well known: Johns-Manville, Maxwell/MacMillan, Enron, WorldCom, Adelphia Communications, Chrysler, GM, Lehman Brothers.
Like our colleagues around the country, we also preside, however, over thousands of consumer bankruptcy cases, where the fate of the home is of central importance, particularly in chapter 13 and individual chapter 11 cases, to which Congress in the 2005 amendments to the Bankruptcy Code rightly chose to steer individual debtors with regular income.
When confronted in late 2008 with the mortgage foreclosure crisis (and, based not only on statistics but also my own experience presiding over individuals' bankruptcy cases, it was and remains a crisis) my colleagues and I saw a problem that cried out for a formal mediation structure. I believe that our experience in private practice representing large lenders and dealing with them in court led us to see the mortgage crisis and implement our approach to it as much from the lenders' perspective as from the homeowners'. In fact, it was creditors' lawyers -- representing mortgage lenders and servicers -- who first asked the court to consider a home mortgage mediation program.
The problem was, and is, basic. Increased defaults and the drop in home prices rendered the "autopilot" servicing model applied to the vast majority of home mortgage loans inadequate. In other words, a model premised on collecting payments in the ordinary course for all but a tiny percentage of mortgages, and foreclosing on the few defaulted ones in the context of a rising market, all too often simply did not work any more. In the present market, to maximize their recovery lenders actually would have to decide between adding to their stock of foreclosed homes or, alternatively, engaging in a workout with their borrower; either course could be preferable in the right circumstances.
And yet, this process simply was not happening with loan after loan after loan. Instead, loan servicers were leaving enormous amounts of money on the table -- you could see it; their lawyers could see it -- simply because they continued to press the foreclosure button rather than respond to their borrowers' calls to renegotiate defaulted loans. Moreover, whether because of fears about breaching the automatic stay, constraints in their governing documents or perceptions about the risk of liability to their beneficiaries if they negotiated with their borrowers, servicers wanted a court order setting a framework for such negotiations. Finally, the lenders wanted structure imposed on the negotiations to make sure that the homeowners would not simply waste the lenders' time.
Of course, these lender goals almost completely overlapped with the borrowers'. Nothing, I believe, not even the fact of being in default, has been more frustrating to homeowners than loan servicers' refusal or inability to address their defaulted loans directly, banker to borrower, on a busininesslike basis. I believe people will testify to this at today's hearing. From my experience, such testimony does not describe merely isolated instances of lender deafness but a widespread and even, in our court at least until the Loss Mitigation Program became established, a pervasive problem.
To develop the mediation guidelines that eventually became the Loss Mitigation Program, we opened the discussion to consumer lawyers, eventually expanding the group of creditor and debtor lawyers with whom we consulted, and then put the proposal out for public comment. For any court considering such a program, I strongly recommend this approach, as it recognizes local concerns and context. We reached out to the creditor and consumer bar again after the program had been operating for about a year and a half, and, although we have modified it somewhat in the light of their comments, remarkable consensus continues in its support.
The Loss Mitigation Program, as embodied in two General Orders of the court, as well as model forms of commonly used documents, may be found on the court's public website at www.nysb.uscourts.gov under the "Forms" tab.
In summary, it 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 (this we found necessary to obviate disputes over whether information was provided, since a frequent homeowner complaint is that the lenders often ask for the same information after it has already been sent); 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 (we are trying to improve our statistics), 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 program facilitates consideration of a homeowner's eligibility for the government-sponsored HAMP program, but it is not limited to HAMP modifications. Indeed, although the program most often results in some form of loan modification, it is expressly not limited to that outcome. The parties may consider, for example, negotiating a "graceful exit" in which the homeowner has a specified time to leave the house (perhaps coinciding with the end of the school year), parameters for a short sale, or a deed in lieu of foreclosure (which may benefit homeowners by cutting off their responsibility for taxes and upkeep while reducing the lender's wait to obtain the property, foreclosure in New York being a long process).
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.
The court's supervision is critical but limited. Our role is to ensure that the parties deal with each other in good faith. We may not impose an outcome on the parties, either directly or by, for example, refusing to relieve them of the Loss Mitigation procedures until they reach agreement. We are there to enforce the deadlines imposed by the Loss Mitigation order and to resolve complaints that a party is acting arbitrarily, capriciously or otherwise to the detriment of good faith negotiations. For example, the court might appropriately ask a lender representative if the lender has considered whether the debtor is offering to pay more, on a present value basis, than the value of the house in foreclosure, but it would not be appropriate for the court to insist that the lender reconsider a valuation that was not obviously in bad faith. At times we may make a suggestion about how to bridge an impasse, but only on a basis to which the parties are prepared to agree.
About one half of the Loss Mitigations 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 that it is turned over in a way beneficial to both sides.
We often hear that the Loss Mitigation mediations that did not result in an agreement also had a good effect: the homeowners saw, after actually engaging with their lender, the dollars and cents reasons why they could not keep their house. At a time when many homeowners cannot even get their letters and phone calls returned (often by banks that homeowners are acutely aware have themselves been rescued by the federal government), this is no small achievement.
Obviously, before we implemented the Loss Mitigation Program, we assured ourselves of our legal authority to do so. The program is consistent with Congress and the federal courts' general encouragement of mediation, as well as with section 105(d) of the Bankruptcy Code, Bankruptcy Rules 7016 and 9014, and courts' inherent power to manage their own docket. The legal basis for our Loss Mitigation Program has never been challenged, although I am aware of such a challenge to a similar program in the Bankruptcy Court for the District of Rhode Island that has recently been denied by that court.
One reason for legislation in this area would be to make the courts' authority absolutely clear (although I trust that the Rhode Island challenge, if it is pursued on appeal, eventually will work its way through the system). There is another reason as well, however. By passing legislation expressly recognizing the benefits of home mortgage mediation programs, Congress would endorse a solution to one of the most vexing problems of the financial crisis by encouraging bankers to return to being bankers.
Since I am not testifying today on behalf of any group, I can tell you that my personal view of legislation is that less is best. Even if you share that view, however, and perhaps especially if you share it, enabling homeowners and lenders to negotiate the resolution of their loans is a good idea.
Thank you again for inviting me to testify on this important topic. I am happy to try to answer any questions that you have about it.