Home ownership is the pinnacle of the American Dream. Our current housing crisis illustrates the societal and institutional failure of protecting individuals trying to obtain this goal. Homeowners facing financial difficulty are frequently unable to negotiate with their mortgage servicers, and often times must file for bankruptcy in a desperate last attempt of maintaining their home. Due to mortgage servicing and the “slicing and dicing” of mortgages, homeowners often have no idea who actually owns and services their mortgage. Recent decisions in Nevada and New York, where federal judges declined to accept mortgage lenders’ proofs of claim, indicate an approaching tipping point. Several judges no longer embrace a lenient view when dealing with mortgage lenders and servicers. One Judge’s comment regarding the ongoing issues with mortgage holders and servicers filing inadequate proofs of claim sums up the issue quite nicely: “Is it too much to ask a consumer mortgage lender to provide the debtor with a clear and unambiguous explanation of the debtor’s default prior to foreclosing on the debtor’s house?”
By Michele L. Murray GSU College of Law J.D. Candidate May 2010
This article examines the statutory framework for mortgage servicers filing a proof of claim, and explains what is required of mortgage servicers attempting to foreclose on a home. The goal of this article is to show that the mortgage servicers that wish to advance their interests must bring sufficient evidence when trying to establish a valid proof of claim in a Chapter 13 Bankruptcy—the note in this case. Next, the article analyzes the potential impact of the majority following recent treatment of mortgage lenders and servicers in bankruptcy proceedings. Finally, this article suggests that note holders change their tactics and provide the required documents when attempting to establish a valid proof of claim, whether it is for proceeding with a foreclosure or for trying to establish they are in fact a party in interest for payment through the Chapter 13 plan.
Filing a Proof of Claim: What is required?
When a debtor files under Chapter 13, there are certain rules in place designed to protect the debtor. The Chapter 13 plan provides an opportunity for the debtor to catch up on arrearages and regain financial control of his life, over time. First, to be a recognized party in the process, the mortgage holder must establish that it is indeed a party in interest in the proceeding. In order for a mortgage holder to establish that it has a recognized interest in the bankruptcy estate, he must following specific rules set forth in the Federal Rules of Bankruptcy Procedure. Federal Rule of Civil Procedure 17(a) states that in order for a party to bring a claim he must have an interest in the action. Similarly, Federal Rule of Bankruptcy Procedure 9001(a) requires a creditor mortgage lender or servicer3 to file a proof of claim. The mortgage holder must file his proof of claim using Official Form 10 or a similar document that substantially conforms to the form. Official Form 10 requires that creditors with claims including “interest or other charges” on top of the principal to attach an itemized statement. The mortgage holder’s proof of claim must include three documents—the note, itemization, and the mortgage. Furthermore, the creditor or an authorized agent of the creditor must execute the claim,7 which means that if a mortgage servicer would like to receive payment through the Chapter 13 plan, he must show that he is authorized to receive the moneys that the plan will generate. The creditor must also provide the following: (1) when the claim is based on a writing, the original or a duplicate shall be filed with the proof of claim,8 and (2) that if a security interest in the property of the debtor is claimed, the proof of claim shall be accompanied by evidence that the security interest has been perfected. Additionally, the proofs of claim must contain the following: (1) undisputed evidence of its chain of custody with regard to the note and mortgage, and (2) a proper confirmatory assignment regarding the transfer of the mortgage.10 When these rules are met with valid support, such claim enjoys prima facie validity under §501(a) Although the rules are explicitly laid out in the Bankruptcy Code, the majority of mortgagees lacked at least one of these required documents when filing proofs of claim.
Debtor’s Attorney Making Objection to Invalid Proof of Claim
Although some argue that it is the Trustee’s duty to follow up the mortgagee’s claim filed with the court,13 the Debtor still has an opportunity to determine whether or not the proof of claim meets the requirements set forth in §501. Failure to meet the filing requirements of §501 often goes unchallenged by the Debtor and his attorney, which may result in the mortgage company ignoring the formal requirements of the bankruptcy proceeding. Section 501(a) states that “[a] claim or interest…is deemed allowed, unless a party in interest…objects.” Most commonly the debtor will bring the objection to the mortgagee’s proof of claim that then shifts the burden of proof back to the mortgagee.15 In most Chapter 13 cases, however, the claims are not disputed. The debtor’s attorney fails to object to the claim.16 When the Debtor’s attorney first has the opportunity to review the mortgage holder’s proof of claim; he must look for two things to ensure that he is protecting his client’s interest. First, the Debtor’s attorney must ensure that the bank has the correct documents. Secondly, one must object to a proof of claim if the required documents are not in place as an attempt to “stop the courts from rubber stamping every bank’s claim in bankruptcy court or in state foreclosure court.”18
If the mortgage servicer provides documentation that appears to have missing paperwork, then the Debtor’s side will provide evidence showing that such documentation is invalid. Meeting this burden of proof and placing the burden back on the mortgage services varies amongst different courts, but this should not keep a Debtor’s attorney from providing the appropriate representation his client deserves. If the original documentation is incorrect, then the burden of proof should never have shifted away from the supposed mortgage holder in the first place. In the past, objecting to a mortgage holder’s proof of claim has proven quite intimidating for the Debtor’s attorney not only because of the significant discrepancy between the two parties resources, but also because it requires the ability to correctly litigate complicated issues. The Debtor’s attorney should not be intimidated by any potential litigation because the original proof of claim should never be granted prima facie evidentiary status in the event that the filing does not meet the requirements of Rule 3001(f).
UCC 3-306: Possible Remedy to Lost Note
Even if the mortgagee is unable to produce the original note, there are rules that direct how the claimant is to proceed when such documentation is missing. Article 3 of the Uniform Commercial Code, Section 309 relates specifically to circumstances in which a person can enforce a promissory note without having the original. Those circumstances are not without limits. Section 3-309 states that a “person not in possession of an instrument is entitled to enforce the instrument if: (1) the person seeking to enforce the instrument: (a) was entitled to enforce the instrument when loss of possession occurred; or (b) has directly or indirectly acquired ownership of the instrument from a person who was entitled to enforce the instrument when loss of possession occurred; (2) the loss of possession was not the result of a transfer by the person or the lawful seizure; and (3) the person cannot reasonably obtain possession of the instrument because the instrument was destroyed, its whereabouts cannot be determined, or it is in the wrongful possession of an unknown person that cannot be found or is not amenable to service of process.”
Although there is a system set in place and which most states have adopted, there is still a requirement under UCC 3-309 that the loss of the original is not the claimant’s fault. An example may be seen where the mortgage servicer is attempting to foreclose on a home and is unable to produce the original note. The lender will claim that the note has been lost or destroyed. At this point, the Debtor’s attorney needs to be willing to step in and challenge the lender to put proof where its interest is. It is “not the obligation of the borrower” to provide the appropriate documentation in the bankruptcy and foreclosure proceedings. Mortgage servicers will likely try and use this mechanism as future litigation over the documentation of original notes and proofs of claim increase. The courts should bear in mind the importance set forth in §3-309(a)(2)—the claimant must come to court with clean hands.
The Tipping Point
Over the past two years, the bankruptcy system has seen a new trend characterized by mortgage notes gone missing and inadequate documents filed with the proofs of claim.Where the claims process was once regarded as fair and just in protecting creditors and debtors alike, recent treatment by several federal judges of mortgagee’s claim proves that something has shifted in the judicial system. Perhaps, the current housing crisis has spawned the new attitude toward lenders. Alternatively, this may be the result of subprime lending. Regardless of what phenomenon is to blame, one cannot deny that something has changed in the way judges are looking toward mortgage holders and servicers. The likely culprit is the careless accounting work and record keeping on the part of mortgage servicers who have little to no incentive in providing quality service to its customers. Indeed, mortgage-servicing companies have a host of concerns beyond the individual note, not the least of which includes performing well for investors. These realities leave the homeowners with no safeguards to ensure that their mortgage servicers are keeping their interest in mind.
Several federal judges seem to no longer accept the “dog ate my mortgage”2excuse. Judge Robert D. Drain for the Southern District of New York delivered the most recent “smack down”22 on Oct. 9, 2009, ruling that PHH Mortgage failed to prove its claim to a debtor’s home in White Plains, wiping out PHH’s claim for a $461,263 mortgage debt. Judge Drain is not alone in his distaste for mortgage servicers’ misbehavior, as other judges have begun to scrutinize the lenders’ and servicers’ inability to provide proper documentation for ownership of the note. Even if this decision does not prove to be the future majority approach in dealing with misbehavior in the claims process, “the case is an alert to lenders that dubious proof-of-ownership tactics may no longer be [an] accepted practice.”
A Brooklyn judge in late January of this year allowed a suit to proceed against Bank of America and its attorneys who are being accused of facilitating a mortgage “doomed to fail. In a recent Nevada case, U.S. District Judge Kent Dawson held that MERS could not foreclose on a home because it did not provide evidence that it held the note on the residence and didn’t show that it was an agent of the lender.26 The Debtor did not file the objection to the proof of claim. The trustee objected to MERS’s attempt of foreclosing on the property without valid proof that it was a party in interest. The bankruptcy judge denied MERS’s motion for relief from the automatic stay. U.S. District Judge Robert Dawson affirmed the bankruptcy court’s finding, stating that “[s]ince MERS provided no evidence that it was the agent or nominee for the current owner of the beneficial interest in the note, it ha[d] failed to meet its burden of establishing that it is a real party in interest with standing.” Furthermore, “[i]n the context of a motion for relief from stay, the movant, MERS in this case, bears the burden of proving it is a real party in interest.” national distaste is emerging against the banking and mortgage modification practices.30 In September of 2009, Arizona bankruptcy Judge Randolph J. Haines expressed similar sentiment towards banking and mortgage servicing practices when he ordered a high- ranking banking executive to testify. The executive was asked to account for its company’s misbehavior with respect to an individual debtor who had repeatedly asked for modification information and sent several rounds of the same paperwork through Wells Fargo’s mortgage division. Judge Haines commented that “[t]his is certainly not an isolated case,” noting that it is a scenario “[he] and other bankruptcy judges around the country are hearing over and over and over again.”32
Some judges do not agree with the line of reasoning seen in New York and Nevada: if you cannot produce the note, then you are not a party in interest. A more moderate approach was applied in a Massachusetts case. There, the bankruptcy judge pressed Deutsche Bank to prove the validity of its claim as holder of the note and owner of the mortgage (i.e. its standing to enforce the note). Despite recognizing error in the assignment of the mortgage note, due primarily to an ineffective power of attorney, the bankruptcy court ultimately found in the bank’s favor after the required documents were provided to the court.33 Under the Massachusetts’s decision, a proof of claim will be allowed despite original erroneous documents if the claimant is able to provide “clear, unambiguous chain of title of custody of the note and mortgage.”
Ramifications and Institutional Effects
The trend seems clear amongst these three states in dealing with the infant industry of mortgage servicers—there are certain rules that mortgage lenders and servicers must comply with. Although these shenanigans have been overlooked in the past, these recent decisions suggest that such practices will no longer be tolerated. The Federal Rules of Bankruptcy are in place in furtherance of two primary goals: (1) to create a fresh start for the debtor and (2) to ensure that creditors enjoy an equal and fair share of the pie. Although the policy behind the bankruptcy system is straightforward, the rise of the mortgage servicing industry and its sloppy behavior in regards to filing proofs of claim that meet the Federal Rules of Bankruptcy prove that something in our system has frustrated the goals of bankruptcy and home ownership in America. If the treatment seen by Judge Drain and Dawson prove to become the majority approach, then there will be significant consequences, both positive and negative for consumers.
The requirements of the Bankruptcy Code impose new rules on the mortgage servicers, leading to an increased likelihood of abuse. Widespread abuse reveals the vulnerability of homeowners entering bankruptcy, and the “harms of poor mortgage servicing are heightened in bankruptcy, a supposed refuge for families trying to save their homes.” Requiring mortgage lenders and servicers to comply with bankruptcy rules regarding proofs of claim will ensure that the homeowner will not face the unfair burden
of having to pay the true lender that might go unaware of the payments to the wrong servicer.38
Attorneys representing debtors in bankruptcy often face the difficult economic decision of spending countless hours attempting to litigate the proof of claim with an enormous financial company like MERS and EMC, both of which have much larger resources for such litigation. Historically, the likelihood of an attorney filing a complaint against the mortgage servicing company has been far too low. The recent decisions and treatment by judges provides the attorney with more reason to raise an objection to such proofs of claim. Not only could the claim be wiped out altogether as seen in New York, but also the amount of the claim could be reduced due to improper documentation of the claim. Both results indicate a pendulum that has shifted back to the side of the debtors. Where the lending world previously had been allowed to traipse freely through the bankruptcy field, these opinions show that times have changed. If the lenders and servicers want to foreclose or be a part of the claims process, then they must play by the rules. The lenders and banking practices will have no choice but to adjust their current practices.
One cannot forget the negative implications that such a law will impose on new homeowners and other individuals who obtain lending from those other than the banking industry. First, if the practice of disallowing proofs of claim due to inadequate documentation becomes the norm, new homeowners will likely bear the cost that such decisions will impose on the lending institution as a whole. Although the costs will likely affect future homeowners, the lending must heed Judge Drain’s admonition issued in his recent ruling in New York. Although neither solution is perfect, the bankruptcy system is being undermined at the expense of institutional integrity and judicial economy. Granted, the courts may become clogged with litigation over mortgagee’s proofs of claim. Nevertheless, the debtor will finally be able to assert its authority in the bankruptcy proceeding where its voice has been muted for quite some time. While the prudent practitioner cannot ignore these possibilities, the current state of affairs in bankruptcy and mortgage servicing abuse leaves only one choice for lenders, either shape up or get out.
We should be surprised at the mortgage companies’ surprise. Although the bankruptcy court and debtors attorneys have, by in large, allowed such lackadaisical filing practices from mortgage servicers, we should no longer acquiesce. The decisions in New York, Nevada, and Arizona are putting teeth back into the bankruptcy rules, which have been treated by mortgage servicers as mere aspirations rather than mandatory federal rules. Instead of expressing shock and dismay over the changing opinions of bankruptcy judges, mortgage servicers have no one to blame but themselves for the recent events. They chose to ignore the requirements of the bankruptcy proceeding, and as a result are having to scramble to make up for past erroneous filing and organizing techniques. The rules are clear and should be easy for conscientious lenders to follow. A party must be able to substantiate its proof of claim.
Special thanks to RentPost guest author, Michele Murray
2 Fed. R. Bankr. P. 1322(b)(5) and 1322(c)(1) provide homeowners with this opportunity to catch up on pre-petition arrearage amounts. 3 See Tara Towney, Deciphering Mortgage Proofs of Claim, 27-9, ABIJ 1, 52 (where Towney notes that “[i]n consumer bankruptcies, servicers often file the proof of claim on behalf of the holder”). Additionally, the holder of the mortgage loan should be the creditor and the servicer listed as the authorized agent of the creditor mortgage lender pursuant to Rule 3001(6).
4 Although there are certain requirements set in place, a few courts have found that Fed. R. Civ. P. 17 and the Bankruptcy Code each have “liberal standing provision, designed to allow a party to appear as long as it has a direct stake in the litigation under the particular circumstances,” In re Rosemarie Conde-Dedonato, 391 B.R. 247, 250 (citing Greer v. O’Dell, 305 F. 3d 1297, 1302 (11th. Cir. 2002). 5 Fed. R. Bankr. P. 3001(a).
6 See David Gray Carlson, Proofs of Claim in Bankruptcy: Their Relevance to Secured Creditors, 4. J. Bankr. L. & Prac. 555 (1999)(author provides a precise explanation for why there are particular filing requirements for secured creditors with filing proofs of claim). 7 Fed. R. Bankr. P. 3001(a), 3001(b).
8 Fed. R. Bankr. P. 3001(c). 9 Fed. R. Bankr. P. 3001(d). 10 Jeana K. Reinbold, “Confirming” a Mortgagee’s Chain of Title: The Case of Gifty Samuels,” 28-7 ABIJ 18, (emphasizing that the filing of the proof of claim is a prerequisite to its allowance under §502 of the code). 11 Fed. R. Bankr. P. 3001(f). 12 Infra Note 16. Findings based on a recent study where 1700 Chapter 13 proceedings were the sample.
Chapter 13 Trustee’s Obligations to Review Claims, 28-7 ABIJ 38 (“The growing popularity of debt-buying, claims trading, and servicer transfers has increased the scrutiny brought to claims and prompted chapter 13 trustees to enhance their claims review process”).
14 Fed. R. Bankr. Proc. §501(a); Note also that this includes the Debtor or any other general creditor who has an interest in the proceeding. 15 Another manner of looking at this scenario is that if the filing requirements were not met, the burden of proof remains with the mortgagee creditor (assuming that an objection to its proof of claim is raised). 16 See Katherine Porter, Misbehavior and Mistake in Bankruptcy Mortgage Claims, 87 Tex. L. Rev. 121, 134 (in this study Porter looks at a sample of 1700 chapter 13 bankruptcy proceedings and the overall finding is that the claims process is not providing protection for debtors because the mortgagee’s are ignoring the rules). 17 See David Shaev, “Mortgage Claim Thrown out in New York Chapter 13 Bankruptcy Case,” Nov. 21, 2009, available at http://www.shaevlaw.com/mortgage-claim-new-york-chapter-13- bankruptcy-case-phh/.