Jury Verdict Expands to $298 Million in False Claims Act/FIRREA Case as Court Assesses Treble Damages and Penalties

Jury Verdict Expands to $298 Million in False Claims Act/FIRREA Case as Court Assesses Treble Damages and PenaltiesA federal court in Texas recently entered a massive judgment against a mortgage originator for financial crisis conduct, transforming an already severe $93 million jury verdict into a $298 million punishment, and issuing one of the first judicial opinions regarding how to assess penalties under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (“FIRREA”).

The suit began in 2011 as a whistleblower action, in which the government quickly intervened, alleging the submission of false Federal Housing Administration (“FHA”) insurance claims by Americus Mortgage Corporation (formerly known as Allied Home Mortgage Capital Corporation), one of its affiliates, and its CEO (collectively, “Allied”) between 2001 and 2011. The matter eventually proceeded to a five-week jury trial, where Allied was found liable for multiple violations of the False Claims Act (“FCA”) and FIRREA. The conduct proven at trial involved:

  • Submission of 1,192 FHA insurance claims for loans that were recklessly underwritten and ineligible for FHA insurance;
  • Submission of 103 FHA insurance claims for loans originated in branches without proper HUD registration, using registration numbers of other, registered branches;
  • Submission of nine false annual certifications to HUD relating to compliance with quality control requirements; and
  • Submission of an email from Allied to a HUD employee in 2009 containing 18 falsified quality control reports.

The dramatic increase from the $93 million jury verdict resulted from mandatory trebling of the government’s damages under the FCA as well as the court’s imposition of civil penalties.

In an attempt to lessen the blow of mandatory FCA trebling, Allied argued that “net” damages, rather than “gross” damages are the proper sum to treble. A “net” damages calculation would allow deduction of any payment the government had received back on the claims from the amount of loss prior to trebling. The court rejected this argument and Allied’s supporting case law from the Seventh Circuit, noting that Fifth Circuit precedent expressly prohibits such deductions. With trebling, the United States’ “gross” damages increased from $92,982,775 to $278,948,325 for the claims related to unregistered branches and underwriting failures.

The FCA also mandated penalties of $5,500 to $11,000 per claim for Allied’s conduct, in addition to treble damages. (This amount could have been higher had the conduct occurred more recently, as FCA penalties since 2015 have begun increasing each year with the inflation rate. The current range is $10,957 to $21,916.) Here, the court assessed $10,000 penalties, finding Allied’s conduct worthy of penalties at “the high end of the spectrum” for pre-2015 conduct, because of the many years across which the fraud occurred, the intentionality and severity of the conduct, the large amount of actual damages incurred by the government, and Allied’s failure to come clean when confronted by HUD during a routine audit years prior. The court assessed a penalty for each of the 103 claims submitted by unregistered branches and the 1,192 claims with underwriting failures—for a total of $12,950,000 in FCA penalties.

The court then turned to assessing FIRREA penalties, for which it has broad discretion and a dearth of case law to provide guidance. The statute allows for the assessment of penalties up to $1,100,000 per violation, up to $5,500,000 for a continuing violation, or the amount of the pecuniary gain or loss resulting from the violation. Although FIRREA has been on the books since 1989, there is little authority available for defendants to gauge where their conduct falls on the penalty spectrum when considering whether to settle with the government or take the risk of trial. The court in this matter appears to be only the third court in the country to address the calculation in an opinion, and to date, assessed the most severe FIRREA penalties. See United States v. Luce, No. 11 C 05158, 2016 WL 6892857, at *5 (N.D. Ill. Nov. 23, 2016) ($0 penalty) and United States v. Menendez, No. CV 11-06313 MMM JCGX, 2013 WL 828926, at *10 (C.D. Cal. Mar. 6, 2013) ($40,000 penalty). As a result, the court’s method of assessing FIRREA civil penalties in this case is worth careful study by financial institutions.

The court adopted a “totality of the circumstances” inquiry and considered the following factors:

  1. the good or bad faith of the defendant and the degree of his scienter;
  2. the injury to the public, and whether the defendant’s conduct created a substantial loss or the risk of substantial loss to other persons;
  3. the egregiousness of the violation;
  4. the isolated or repeated nature of the violation; and
  5. the defendant’s financial condition and ability to pay.

The court also rejected Allied’s argument that it would be unconstitutional to assess both FCA and FIRREA penalties for the same conduct, finding instead that the false certifications and quality control reports were different conduct than the problematic FHA insurance claims.

Testimony of former executives seemed to damn Allied in the court’s eyes, as one executive admitted that she and other officers knew that Allied was not in compliance with quality control rules and yet signed the certifications nonetheless. The court found that the conduct had continued for years and reflected a “high level of scienter and egregiousness” but that the defendants’ financial situation “weigh[ed] slightly in favor of a less than maximum allowable” penalty. The court assessed separate FIRREA penalties against the Company, its affiliate, and its CEO of $1,100,000 for the false certifications and $1,100,000 for the falsified quality control reports. The FIRREA penalties alone thus totaled $6,600,000.

Although the damages and penalties imposed in this case are shocking, there is a silver lining for financial institutions. The Allied ruling has now provided some guidance as to the ceiling for FIRREA penalties where no such guidance previously existed. Moreover, although the penalties seem harsh, the court actually declined to penalize Allied to the fullest extent requested by the government—which sought imposition of $9,900,000 in FIRREA penalties across the three defendants. Where defendants can demonstrate that conduct is more akin to “an isolated or occasional mistake,” rather than “a prolonged, consistent enterprise of defrauding,” they may successfully lessen the impact of civil penalties under FCA or FIRREA. We will continue to provide you updates as this area of the law develops.

In Alabama: Lenders Must Strictly Comply with Notice Requirements

In Alabama: Lenders Must Strictly Comply with Notice RequirementsThe Alabama Supreme Court recently released an opinion interpreting the pre-foreclosure notice requirements contained in paragraph 22 of the standard mortgage form. In short, strict compliance is required. The Court in Ex Parte Turner, concluded that lenders must specifically advise borrowers of their right to bring a court action to contest the default as required by the mortgage—anything less is insufficient. The notice sent to the borrowers in that case stated: “[y]ou . . .  have the right to assert in foreclosure, the non-existence of a default or any other defense to acceleration and foreclosure.” The notice did not, however, inform the borrowers “. . . of the right to bring a court action to assert the non-existence of a default or any other defense of Borrower to acceleration and sale” as required by paragraph 22 of the standard mortgage form.

The Alabama Court of Civil Appeals found that the lender’s notice substantially complied with the language of the mortgage. The Alabama Supreme Court reversed this decision however on the basis that precedent requires strict compliance, not substantial compliance. This, according to the court, means near verbatim language in pre-foreclosure notices tracking the language in paragraph 22 of the mortgage form. In reaching this conclusion, the court observed that in a non-judicial foreclosure state such as Alabama, language informing borrowers of the right to bring a legal action is important to prevent lulling borrowers into believing that they can wait to advance their defense to foreclosure as a response to a lawsuit that, as a practical matter, may never come.

The decision will have lasting impact on pending and future foreclosures in Alabama. Lenders should work with their vendors to ensure that their current notices of default and notices of acceleration conform in all respects with the language contained in paragraph 22 of the standard mortgage form.

Judicial Estoppel Defense in Bankruptcy Claims Likely to Get More Difficult

Judicial Estoppel Defense in Bankruptcy Claims Likely to Get More DifficultA recent decision from the Court of Appeals for the Eleventh Circuit has impaired a valuable defense for early dismissal or settlement with bankrupt plaintiffs. This decision will affect strategy for mortgage originators, servicers, and other financial services companies that face a high volume of claims from bankrupt consumers.

On September 18, 2017, the Eleventh Circuit issued its en banc decision in Slater v. U.S. Steel Corp. overruling prior circuit precedent on the judicial estoppel defense. Judicial estoppel is an equitable defense that bars a plaintiff’s claim when she takes differing positions in subsequent court cases with an intent to make a mockery of the judicial system. Courts in the Eleventh Circuit have applied the defense when a plaintiff pursues a lawsuit in one court and files for bankruptcy without disclosing the claim as an asset that may be used to pay her creditors. Courts apply the judicial estoppel defense in these circumstances to prevent plaintiffs from obtaining a windfall by concealing an asset from the bankruptcy court while simultaneously asserting the same claim in a different court. Companies facing consumer litigation have successfully employed this defense by reviewing sworn bankruptcy schedules to see if plaintiffs failed to disclose claims asserted in pending lawsuits. As discussed here, following the Eleventh Circuit’s Slater decision, defendants will be less likely to prevail on this defense in the early stages of litigation.

In Slater, the Eleventh Circuit reaffirmed that courts may apply judicial estoppel when a two-part test is met: The plaintiff (1) took a position under oath in the bankruptcy proceeding that was inconsistent with the plaintiff’s pursuit of the lawsuit and (2) intended to make a mockery of the judicial system. The contested legal issue in Slater was what evidence is necessary to find that a plaintiff who did not disclose a lawsuit in bankruptcy intended to make a mockery of the judicial system? Prior Eleventh Circuit decisions endorsed a rule that the mere fact of the plaintiff’s nondisclosure is sufficient to show such intent, even if the plaintiff corrected her bankruptcy disclosures after the omission was called to her attention and the bankruptcy court allowed a correction (see Barger v. City of Cartersville, 348 F.3d 1289 (11th Cir. 2003); Burnes v. Pemco Aeroplex, Inc., 291 F.3d 1282 (11th Cir. 2002)). In Slater, the court granted en banc review to reconsider this precedent and overruled the Barger and Burnes decisions. Courts in the Eleventh Circuit may no longer infer a plaintiff’s intent to misuse the judicial system without considering the individual plaintiff and the circumstances surrounding the nondisclosure of a cause of action in the plaintiff’s bankruptcy schedules. Among other things, courts may consider factors such as the plaintiff’s level of sophistication, her explanation for the omission, whether she subsequently corrected the disclosures, and any bankruptcy court motions or orders concerning the nondisclosure.

According to the en banc panel, overruling prior precedent on judicial estoppel brings the Eleventh Circuit in line with the law in the Sixth, Seventh, and Ninth Circuits. On the other hand, the Fifth and Tenth Circuits have recognized that knowingly omitting a cause of action from bankruptcy schedules is enough to support the “intent to make a mockery of the judicial system” prong of the judicial estoppel defense.

Thus, in the Eleventh Circuit, obtaining summary judgment or dismissal based on judicial estoppel with respect to bankruptcy disclosures is likely going to be more difficult. Merely relying on plaintiffs’ sworn bankruptcy schedules is no longer sufficient to prove the intent element of the judicial estoppel defense.  Courts are now required to undertake a more rigorous inquiry of the plaintiff’s intent. Plaintiffs will be able to present self-serving factual arguments regarding the circumstances surrounding nondisclosure of a cause of action in bankruptcy.

Fortunately for defendants, Chief Judge Carnes wrote a concurrence clarifying that the judicial estoppel defense is not eradicated. Notwithstanding the Eleventh Circuit’s new requirement to consider the “surrounding circumstances”, courts are “not required to accept the testimony of the plaintiff that her misstatements . . . were not made with intent to mislead, even if that testimony is uncontradicted.” If a bankrupt plaintiff denies any intent to mislead the court or creditors by not disclosing a cause of action, the court has the “authority and responsibility to find the facts and not blindly accept [such] testimony.”

SEC Wants the Truth and Nothing but the Truth in Advertising

SEC Wants the Truth and Nothing but the Truth in AdvertisingTell the truth, the whole truth, and nothing but the truth: that’s the message to registered investment advisors from the Office of Compliance Inspections and Examinations (OCIE) in a recent risk alert about the SEC’s Advertising Rule (Rule 206(4)-1).

The rule prohibits advisors from making untrue statements of material fact and from otherwise including misleading material in advertisements. The rule covers a broad array of communications, including communications that offer “(1) any analysis, report, or publication concerning securities, or which is to be used making any determination as to when to buy or sell any security, or which security to buy or sell, or (2) any graph, chart, formula, or other device to be used in making any determination as to when to buy or sell any security.”

Lessons from the OCIE Risk Alert:

  • Don’t present misleading performance results. 
    Setting forth performance results without deducting advisory fees or failing to acknowledge limitations in benchmark comparisons is a no-no.
  • Don’t cherry-pick profitable stock selections. 
    Advertisers who include only profitable stock selections in their marketing materials are reminded that the Advertising Rule imposes conditions on such one-sided presentations.
  • If you include past specific investment recommendations, you should include them all. 
    An illustration of particular investment strategy may be misleading if it does not include all recommendations.
  • Tell prospective clients the truth about fees and expenses. 
    It’s not ok to advertise performance results, even in one-on-one presentations, unless you show performance results after deducting advisory fees and other expenses.

Investment advisors should review the full scope of their advertising and marketing materials and consider whether those materials are consistent with the Advertising Rule. Remember, the SEC wants you to tell the truth, the whole truth, and nothing but the truth in your advertising and marketing materials.

How to Protect Yourself from Financial Disaster in the Wake of a Natural Disaster

How to Protect Yourself from Financial Disaster in the Wake of a Natural DisasterIn light of Hurricane Harvey and all the damage that it caused, as well as the potential damage that may be inflicted by Hurricane Irma, the Consumer Financial Protection Bureau (CFPB) has provided advice on measures to take to secure your financial situation. Of course, as with any natural disaster, your most urgent needs should be addressed first and foremost. However, after that there should be great consideration given to the financial obligations that you may incur. Further, the CFPB provided some warnings related to scams that unfortunately tend to pop up at times of disaster. This will provide an overview of some of the ways to ensure that your financial situation stays intact following a natural disaster.

Once you begin to think about your financial obligations, particularly if you have had damage to your home or any other property following a natural disaster, the CFPB has provided five steps you can take to keep your financial obligations in check:

1. Contact your insurance company. If you have had damage to any of your property and you have insurance coverage, then reaching out to your insurance company or broker is crucial to start the claims process. Unfortunately, many of those affected by Hurricane Harvey did not have flood insurance. It is necessary to obtain a copy of your policy to review what types of coverage you have or request a copy of your policy from your insurance company. Further, take plenty of pictures and/or video of all of the damaged property in order to preserve the damage at the outset.

2. Register for assistance. You can always register for assistance with the Federal Emergency Management Agency (FEMA) or online with the Disaster Assistance Improvement Program (DAIP).

3. Contact your mortgage servicer. Many people may not know who their mortgage servicer is. If you do not, you can always contact the Mortgage Electronic Registration System (MERS) to find out the company that services your mortgage. Once you contact your mortgage lender and explain your situation, it will not completely eliminate your responsibility to pay the mortgage, however, your lender may be able to provide forbearance or an extension in which to make those payments.

4. Contact your credit card companies and other lenders. The key to this step is contacting those companies before your next payments are due to explain why your income has been interrupted and that you may not be able to pay your loans and/or credit cards on time.

5. Contact your utility companies. If you are unable to remain living in your home, ask your utility companies to suspend services for the time being. Keep in mind that if you are planning to move back into your home at some point, you may want to keep air flowing in order to prevent mildew and mold from growing or spreading.

CFPB also has provided good information on scams to be aware of. To avoid being a victim of a scam following a natural disaster, it is imperative to ask questions to make sure that the goods or services offered are legitimate.

Five things that should cause alarm:

  1. People who want you to pay upfront fees for any type of services, including obtaining loans.
  2. Contractors selling repairs door to door. Again, when a contractor asks to receive upfront payments or offers huge discounts, that should be a red flag. My practice is always to contact the Better Business Bureau to find out if the contractor is legitimate.
  3. Any person posing as a government employee, insurance adjuster, law enforcement official or a bank employee. Even if those people are in uniforms and have badges, never give out any of your personal information until you confirm whether that person is legitimate. For instance, government employees will never ask for payment or financial information from you.
  4. Be cautious of fake charities, particularly any that ask for donations over the phone. If you want to contribute following a natural disaster, it is always good to do your research and/or contact your local Red Cross or United Way for the best way to contribute.
  5. Be wary of any “limited time offers.” If someone is trying to pressure you to make a decision quickly or to sign anything without having time to read over it thoroughly, it should raise a red flag. Contact an attorney to help you review any type of documents or contracts. Many cities provide free legal services during times such as these. You can reach out to your local bar association to find out if these types of services are available in your area.

Finally, the CFPB has provided a checklist that you can review in order to make sure that your financial records are secure. You can also contact the CFPB directly by calling (855) 411-2372.

Further, since Hurricane Harvey made landfall, several mortgage backers are offering forbearance to borrowers in the Houston area. Freddie Mac, Fannie Mae and the Federal Housing Administration have all offered forbearance for at least 90 days to borrowers in areas affected by the hurricane.  These entities have also announced that they can extend some cases for up to a year depending on severity. That means borrowers do not have to make their monthly payments and no penalty fees will be charged. However, note that interest will still accrue during that time. While these three entities are the ones mentioned in this article, I would assume other mortgage providers may follow suit. Therefore, I would suggest that anyone affected by Hurricane Harvey reach out to their provider to find out if a similar offer is being extended and how to take advantage of it.

Big Win for Servicers and Lenders of Fannie and Freddie Owned Loans against Nevada HOA Foreclosures

Big Win for Servicers and Lenders of Fannie and Freddie Owned Loans against Nevada HOA ForeclosuresToday, the U.S. Court of Appeals for the Ninth Circuit issued a significant decision in favor of lenders and mortgage servicers fighting off claims that their mortgage liens were extinguished by Nevada homeowners associations’ foreclosures from 2010 to 2014. In Berezovsky v. Moniz, the court held that the Federal Foreclosure Bar found in the Housing and Economic Recovery Act of 2008 preempted state law so as to bar an HOA’s foreclosure under Nevada Revised Statute 116.3116 from eliminating a security interest when a Government Sponsored Enterprise (such as Fannie Mae or Freddie Mac) owned the underlying mortgage loan. The court specifically rejected arguments that the Federal Foreclosure Bar did not apply in the Nevada HOA foreclosure context and that the Federal Housing Finance Agency (which has served as the conservator for Fannie Mae and Freddie Mac since 2008) had implicitly consented to the HOA’s foreclosures causing the elimination of the Freddie Mac security interest in question. The court also held that the fact that Freddie Mac’s ownership of the underlying mortgage loan was not apparent from the recorded chain of assignments of the deed of trust was inconsequential, as Nevada law does not require disclosure of the owner of a promissory note secured by a deed of trust.

The Berezovsky decision represents a resounding win for lenders and servicers of Freddie Mac and Fannie Mae loans. As a published decision, Berezovsky is binding precedent in federal court in the Ninth Circuit and should dictate judgments in favor of the lenders and servicers of Freddie Mac and Fannie Mae loans in all open litigation, provided that the lenders and servicers adequately prove the GSE’s ownership of the underlying mortgage loan at the time of the HOA’s foreclosure sale. Berezovsky should also serve as highly persuasive precedent on a question of federal law for the Nevada Supreme Court, as it considers the same questions about the application of the Federal Foreclosure Bar.

CFPB Arbitration Rule Hits a Roadblock

CFPB Arbitration Rule Hits a RoadblockThe Consumer Financial Protection Bureau (CFPB) issued a final rule on pre-dispute arbitration agreements on July 10, 2017. The final rule was published in the Federal Register on July 19, 2017, and as such, it is due to become effective on September 18, 2017 (60 days from the date the rule is published). The final rule prohibits consumer financial services providers from including terms in arbitration agreements that limit a consumer’s ability to join or initiate a class action lawsuit.

The final rule sparked both praise and opposition from various groups around the country. While several groups quickly began publishing articles and writing letters, one group that has the power to stop the new regulation in its tracks decided to step in—Congress.

The House of Representatives elected to utilize the newly dusted-off Congressional Review Act (CRA) in an attempt to invalidate the recently adopted rule. The CRA allows Congress to disapprove of any regulations issued by executive agencies within 60 legislative days of publication in the Federal Register. Importantly, a “resolution of disapproval” under the CRA requires only a simple-majority vote, with no chance of amendment or filibuster. If the House, Senate, and president disapprove of the regulation, the regulation is effectively “killed” and cannot be reissued by the agency.

In this case, it took the House of Representatives only 15 of the allotted 60 days to vote in favor of striking down the CFPB’s final rule. The 231-190 vote, which took place on July 25, 2017, almost uniformly followed party lines. Meanwhile, Senate Banking Committee Chairman Mike Crapo (R-Idaho) has already introduced the Senate version of the resolution of disapproval. However, the date for the Senate vote has not yet been finalized.

With the Senate now in recess until September 5, we will have to wait to see what happens next. If Republicans can gather enough votes for a simple majority to vote for disapproval, then the resolution will only need President Trump’s blessing. Given the fact that the Trump administration has been adamant about its position on regulation, it is highly unlikely that we would see a veto from the president. Thus, the fate of the CFPB’s final rule will likely rest in the hands of a simple majority of the U.S. Senate once sessions resume on September 5, 2017. Under the language of the CRA, the Senate will have 60 legislative days from the date that the rule was published, July 19, 2017, to vote on the resolution for disapproval.

Oregon Regulates Home Equity Conversion Mortgage Originators and Servicers in New Law

Oregon Regulates Home Equity Conversion Mortgage Originators and Servicers in New LawOregon’s legislature continues to add state level regulations to the Home Equity Conversion Mortgage (“HECM,” more commonly known as a reverse mortgage) marketplace. In 2015, the state imposed a series of content and presentation requirements on any “advertisement, solicitation, or communication” HECM lenders used to induce potential borrowers to apply for a HECM loan. When the clock strikes midnight on January 1, 2018, Oregon House Bill 2562 will usher in further requirements and HECM lenders need to be ready for them.

Contents of Tax and Insurance Disclosure

Oregon Revised Statute 86A.196 already required advertisements for a HECM to notify potential borrowers that they would continue to be liable for taxes and insurance and that failure to pay these sums would bring the loan immediately due. Under the new law, the ads must also disclose the potential consequences of a tax or insurance delinquency: tax liens or even foreclosure.

No Longer Just Originators

Additionally, the revised statute imposes new disclosure requirements related to taxes and insurance on HECM servicers. Come January 1, 2018, lenders—a term the statute does not define—must send an annual notice to every person with whom it has a HECM contract. The notice must contain the same information regarding taxes and insurance, including the consequences of delinquency, that originators must include in their advertisements. The statute also specifies what mailing address to use as well as when the notice should be sent.

Not All Entities Affected

The law does spare some lenders this burden. All lenders defined as a financial institution under Oregon’s Bank Act or as a licensee under Oregon’s Consumer Finance Act are exempted from compliance with either the origination or servicing requirements, while lenders holding a contract with loans that include a reserve account for taxes are excluded from the annual notice requirement.

Takeaway

While affected originators will need to review their ad copy to ensure the new disclosures are included, covered servicers will need to act soon to examine their processes and procedures and tracking systems to ensure that their Oregon portfolio receives the new required annual notice, where required.

CFPB Issues Pay-by-Phone Guidance with Far-Reaching Implications

CFPB Issues Pay-by-Phone Guidance with Far-Reaching ImplicationsOn July 31, the Consumer Financial Protection Bureau (CFPB) issued a public bulletin intended to provide guidance to covered persons and service providers who take payments from consumers using pay-by-phone services and charge the consumer a fee for such a service. The purpose of the bulletin was to highlight and re-emphasize the potential for violations of the Dodd-Frank Act’s prohibition on engaging in unfair, deceptive, or abusive acts or practices (UDAAP) and violations of the Fair Debt Collection Practices Act (FDCPA) when assessing phone pay fees. Given these risks, the CFPB warns that it “will closely review conduct related to phone pay fees for potential violations of Federal consumer financial laws.” While not the first time the CFPB has issued guidance on this topic, this is, perhaps, the most direct and obvious warning to financial services providers.

Bulletin 2017-01: Phone Pay Fees

In the bulletin, the CFPB specifically identified as unfair the practice of not specifically disclosing the amount of various transaction fees associated with different payment methods on written materials, and then failing to disclose all of the consumer’s payment method options, and the fees associated with each available payment method, when the consumer contacts the entity by telephone. The CFPB also identified a number of practices that could be deceptive. For example, the CFPB explained that it could be deceptive for an entity to misrepresent the availability of no-fee options or to misrepresent the purpose of a payment option that will result in a fee. The CFPB also explained that it could be a deceptive act or practice to fail to disclose that a fee will be charged when using a pay-by-phone service, or the amount of any such fees that will be assessed.

In the same bulletin, the CFPB noted that the collection of phone pay fees could constitute a violation of the FDCPA. The FDCPA bars a debt collector from using “unfair or unconscionable means to collect or attempt to collect any debt,” including “[t]he collection of any amount (including any interest, fee, charge, or expense incidental to the principal obligation) unless such amount is expressly authorized by the agreement creating the debt or permitted by law” (14 U.S.C. § 1692f). Some courts have found that the collection of a “convenience charge” as a fee for expedited processing of a phone payment could be a “fee” that is not “expressly authorized by the agreement creating the debt or permitted by law,” thus creating the basis for a private cause of action under the FDCPA (see Wittman v. CB1, Inc., No. CV 14-105, 2016 WL 3093427, at *2-*3 (D. Mont. June 1, 2016)). However, at least one court has held that a $5 transaction fee charged by a debt collector to consumers seeking to pay by credit card did not violate the statute, when the consumer had to affirmatively choose to agree to the fee instead of paying by an alternative means  (see Flores v. Collective Consultants of Cal., No.  SA CV 14-0771, 2015 WL 4254032, at *9-*10 (C.D. Cal. Mar. 20, 2015)).

The CFPB did not expressly endorse either court’s position in the bulletin. However, it did note that its supervision arm had “found that one or more mortgage servicers that met the definition of ‘debt collector’ under the FDCPA violated the Act when they charged fees for taking mortgage payments over the phone to borrowers whose mortgage instruments did not expressly authorize collecting such fees and who reside in states where applicable law does not expressly permit collecting such fees.”

After outlining the various ways in which entities may violate applicable consumer financial laws, the CFPB then explains ways in which entities may minimize the associated risks. One thing is clear—the CFPB expects that entities will “review their practices on charging phone pay fees for potential risks of committing UDAAPs or violating the FDCPA.” The CFPB’s suggestions include, among other things, reviewing “underlying debt agreements to determine whether such fees are authorized by the contract,” reviewing policies, procedures, call scripts, and training materials, reviewing written disclosures to ensure adequate information is conveyed to consumers, and reviewing “service providers as to their pertinent practices.”

Takeaways

The first thing that becomes abundantly clear when reading the CFPB’s bulletin is that the issues they highlight are applicable to nearly all types of consumer financial products and services. Anyone who collects payments over the phone and charges a fee for that service likely is impacted by the CFPB’s views. Consistent with prior guidance on service providers, this bulletin also goes one step further and suggests that entities need to be mindful of the practices employed by service providers collecting payments on their behalf.

Additionally, it is important to keep in mind that this is not the first time the CFPB has issued guidance on phone pay fees. In the Fall 2014 issue of the CFPB’s Supervisory Highlights report, the CFPB highlighted potential FDCPA risks associated with these practices. Since that time, the CFPB has announced two public enforcement actions that included issues associated with pay-by-phone fees and claims of unfair and deceptive acts or practices. By releasing a guidance bulletin directly on these issues, the CFPB likely is signaling that it continues to uncover practices that may violate UDAAP restrictions or the FDCPA. For entities that do not react to the CFPB’s repeated attempts at putting the industry on notice, it is likely that the chances of leniency on the part of the CFPB are fading.

As the CFPB continues to take action against pay-by-phone practices it deems to constitute UDAAP or a violation of the FDCPA, it is hard not to wonder what the long-term implications might be. Much of the UDAAP risks noted by the CFPB likely can be minimized through disclosures and robust policies, procedures, scripting and training. However, if it is a violation to charge a pay-by-phone fee to a consumer who is protected by the FDCPA, minimizing the associated risks becomes extremely challenging. Will entities start adding clauses into debt agreements that specifically authorize pay-by-phone fees?  Will some entities choose to stop offering expedited payment options to all consumers? These questions will be answered over time, but the implications spurred by the CFPB’s guidance could be far-reaching and substantial.

The Effects of a Creditor’s Non-Participation in Bankruptcy Proceedings

The Effects of a Creditor’s Non-Participation in Bankruptcy ProceedingsIt’s essential for secured creditors, particularly those who deal with consumer debts, to have policies in place that address the effects of a borrower’s bankruptcy. A Texas bankruptcy court underscored this need by ruling that a secured creditor’s claim could be modified, lessening its total recovery from the bankruptcy estate, where the creditor did not participate in the borrower’s bankruptcy proceedings despite being notified.

In a recent Chapter 13 case, the court granted a discharge where the debtors’ plan modified and paid off a mortgage, over the creditor’s objection that it could not be bound by the confirmed plan because it had not participated in the plan confirmation process. Finding that the creditor had received constitutionally sufficient notice of its claim treatment, the court held that the creditor was bound to the terms of the confirmed plan and therefore barred by the res judicata doctrine from relitigating its claim value.

The Facts

The debtors owed approximately $23,000 on their first mortgage to secured creditor Montanaro Investments. As part of their plan of reorganization, the debtors proposed paying Montanaro’s claim pro-rata, making monthly payments on the claim at 5.25 percent interest over a period of 54 months. Montanaro received multiple bankruptcy notices, but did not file a proof of claim or otherwise participate in the confirmation process. The debtor’s plan was confirmed without objection, and a copy of the confirmation order was mailed to Montanaro.

Eleven months after confirmation, the debtors filed a proof of claim on Montanaro’s behalf, listing the $23,000 claim secured by the debtors’ home, paid at the 5.25 percent interest rate given in the plan. No party objected to the late-filed claim, and so the court allowed it as filed.

The debtors completed their plan payments and moved for a Chapter 13 discharge. Only then did Montanaro contact the debtors to advise that they owed a balance of more than $30,000 on the mortgage, due in part because the contract rate of interest (14 percent) was higher than the interest rate provided in the plan (5.25 percent). The debtors moved to deem the mortgage fully paid by the plan, pointing out that they filed a proof of claim on Montanaro’s behalf, which was fully paid by the trustee through the confirmed plan. Montanaro countered that it could not be bound by the confirmed plan because such treatment essentially voided its lien, an action only permitted if the creditor had participated in the bankruptcy proceedings.

Did the Chapter 13 Plan Attempt to Void Montanaro’s Lien?

Montanaro contended that the debtors’ plan attempted to void its lien, an action that is only permitted if the secured creditor participates in the reorganization proceedings. The debtors argued that the plan did not void Montanaro’s lien, but rather provided for payment of the claim until discharge pursuant to the debtor-filed proof of claim.

The court sided with the debtors, focusing on the threshold question of whether the plan voided Montanaro’s lien at all, as opposed to examining whether creditor participation is required to void liens. The court found that the debtor’s plan did not deprive Montanaro of any recovery, as would be consistent with voiding a lien, but rather sought to pay Montanaro its full claim value as stated in its proof of claim. The court also highlighted language in the confirmed plan that explicitly preserved Montanaro’s lien until the debtors’ discharge. As a result, the court held that the debtors’ plan did not void Montanaro’s lien, rendering arguments about Montanaro’s participation moot.

Does a Confirmation Order Bar Relitigating Claim Value?

The court next turned to the question of whether the debtors’ plan bound Montanaro such that res judicata barred the creditor from relitigating claim valuation issues. Montanaro argued that the debtor-filed proof of claim contravened the Bankruptcy Code by reducing the interest rate on a mortgage, and as a result, the plan failed to account for the entirety of its claim.

Section 1322(b)(2) of the Bankruptcy Code generally forbids modifying interest rates on claims secured by the debtor’s principal residence. Once a plan is confirmed, however, the confirmed plan provisions bind the debtor and each creditor, even if those provisions improperly modify an interest rate under section 1322(b) or otherwise contradict the Bankruptcy Code (see 11 U.S.C. § 1327(a)).

Relying on the Fifth Circuit’s res judicata test, the court found that Montanaro was barred from relitigating its claim value because (1) Montanaro and the debtors had been parties throughout the confirmation process and discharge proceedings; (2) the court had jurisdiction to issue the confirmation order; (3) the confirmation order was a final adjudication on the merits; and (4) both suits involved the same cause of action.

Although not required for the res judicata analysis, the court also found that Montanaro received constitutionally sufficient notice of the debtor’s bankruptcy, the plan, and confirmation order to be bound by the plan’s terms, even though it had not participated in the confirmation process.

Montanaro was ordered to release its lien on the debtor’s home upon entry of the debtor’s discharge.

The Takeaway

  • File timely proofs of claim: Creditors should aim to file their own proofs of claim, rather than relying on the debtor or trustee to file for them, to ensure the claim includes the proper interest rate, arrearage, and total claim amount. Notably, the upcoming amendments to the Federal Rules of Bankruptcy Procedure, effective December 1, 2017, require secured creditors to file a proof of claim for their claim to be allowed. Amended Rule 3002(a) also clarifies that failure to file a proof of claim does not, by itself, void the secured creditor’s lien.
  • Address claim valuation issues before plan confirmation: Creditors should establish procedures to timely process and respond to bankruptcy notices, particularly regarding confirmation hearings. If claim valuation issues arise, they should be addressed prior to the plan’s confirmation.

For additional discussion regarding upcoming changes to the Federal Rules of Bankruptcy Procedure, please see Christopher Hawkins’s May 2017 blog post on the new rules.

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