By Alan Steven Wolf of The Wolf Firm Thinking outside the box in fighting emerging threat
By Alan Steven Wolf of The Wolf Firm (Reprinted with permission from USFN Network News - September/October 1996)
Mortgage servicers and their attorneys are all too familiar with an increasingly common form of bankruptcy abuse: Borrower A who is in default suddenly transfers an interest in his property to B. Just prior to foreclosure sale, B files bankruptcy. The lender obtains relief from the stay, but just prior to the delayed sale, B transfers a 10% interest to C and another 10% interest to D. Of course, both C and D file bankruptcy. The lender then obtains relief from stay in both cases with a broader so-called prospective relief order from the court which states that if A, B, C or D files bankruptcy again, there is no automatic stay. Just prior to the continued sale, B encumbers the property with a junior deed of trust, naming XYZ corporation as the beneficiary. B also transfers a 20% interest in the property to E. You guessed it, both XYZ corporation and E file bankruptcy just prior to your foreclosure sale.
So this time the lender gets relief from stay with an even broader court order that says that the stay is terminated as to any entity that claims any interest in the property, not just the entities that currently have an interest in the property. Just prior to the sale, B transfers a 10% interest to F who is an existing debtor in a bankruptcy case filed in another state. The last court order seems to cover the situation, but will the bankruptcy judge in the other state honor the prior order purportedly giving the lender relief from stay in the F bankruptcy? Can you go to sale and then annul the stay and ratify the sale? Do you take the risk and go to sale knowing that you could be hit with damages and sanctions under 11 USC Section 362(h)?
This fact pattern is but one of numerous examples of multiple bankruptcy filing abuse. With strong roots in California, the problem has spread eastward infecting most high volume bankruptcy states. Indeed, one industry group has estimated that over 10% of bankruptcies affecting mortgage lenders are repeat filings and that every such filing causes a six month delay in foreclosure. This translates to over a $2 billion loss each year to the mortgage industry.
While some repeat filings are merely intra-familial filings, intended to delay the foreclosure sale and extend rent free occupancy of the residence, a growing number of repeat filings involve a scheme known as "rent skimming" or "equity skimming."
In a rent skimming scam, title to property is acquired by the perpetrator while a loan is in default. The property is then rented and the game is to delay the foreclosure sale as long as possible while the abuser continues to collect rents. The higher the rents, the longer the delay, and the more properties involved in the scam, the more money collected by the rent skimmer.
Obviously, the automatic stay is used as the vehicle to delay the sale. The fact pattern described above is a favorite way for the rent skimmer to use the stay to avoid foreclosure. The rent skimmer is betting that the risks of going forward with the foreclosure sale in violation of the stay will cause the servicer to delay the sale and merely seek relief from stay.
So far, the rent skimmer's bet has been a good one. Faced with the prospect of damages and sanctions under 11 USC Section 362(h), virtually all lenders stop the foreclosure. Worse yet, most servicers simply treat these cases like any simple motion for relief from stay; they ask their counsel to seek relief from stay under traditional investor fee reimbursement guidelines. In short, servicers take no special or aggressive action.
The servicer's bankruptcy counsel files a simple motion for relief from stay in each of the serial bankruptcy filings, each time the counsel enters the court for an order that is broader in its remedies, until some court is willing to issue a broad enough order so that the foreclosure can continue despite a bankruptcy filing. This often takes months and plays right into the hands of the rent skimmer.
Rent skimming is a very lucrative industry. Most rent skimmers have portfolios of hundreds of properties. Most of these properties rent for well over $500 per month and the average delay is six months. Thus, with merely a 100 properties, a rent skimmer grosses over $55,000 per month. With these numbers, it is easy to see why rent skimmers have become so proficient in delaying the sale. The knee jerk reaction of the industry to merely respond individually to each successive bankruptcy filing is no deterrent to this industry. Indeed it is the very reason the industry exists- the rent skimmer is betting that the servicer will take this predictable action and no other action.
If the industry is serious about stopping multiple bankruptcy filing abuse, especially
as it relates to rent skimming, other action is needed. The industry needs to think
outside the box. Here are some suggestions:
Most servicers are completely unaware of a provision found in most mortgages and deeds of trust that allow the lender to take the rents from property either directly or through the appointment of a state court appointed receiver. In most cases, it does not make economic sense to appoint a receiver over a residential property. The use of a receiver to thwart a residential rent skimming scheme is an exception to that rule. Since the economic basis of the scheme is the collection of rents, the obvious remedy is to take away access to the rents. By taking away the rents, the lender effectively removes any incentive of the rent skimmer to file bankruptcy in order to delay the sale. Moreover, by taking away the rents, the lender stops the cash flow which funds the cancerous spread of the entire scheme.
The key to this approach is to identify the rent skimming scheme
prior to the bankruptcy filing. Once a bankruptcy has been filed, the
bankruptcy court has no power to appoint a receiver (11 USC §105(b)).
A nascent rent skimming scheme can be ascertained pre-bankruptcy by identification of a very specific fact pattern. Anytime there is a transfer or encumbrance of the property and the loan is not paid off or reinstated, it is likely that the Lender is the victim of a rent skimming scheme. It takes a highly astute and organized loan servicing collection department to identify this fact pattern. Servicing department personnel must be trained to check on a property transfer anytime they lose contact with the borrower or anytime the borrower informs them that the property has been encumbered.
When the fact pattern is properly recognized, the lender's response can be swift and efficient. Generally, the receiver can be appointed ex parte, with little or no notice to the rent skimmer. Due to the fraudulent nature of the scheme, there is seldom any opposition. If a bankruptcy is filed, the receiver can be maintained in possession by the appropriate motion under 11 USC Section 543(d)(3).
Many firms have developed flat fee programs for residential receiverships. While these
programs are more expensive then traditional motions for relief from stay, the appointment
of a receiver generally precludes serial bankruptcy filings and acts as a strong deterrent
to rent skimming.
In the event that the rent skimming scheme is not identified prior to bankruptcy, then
the servicer will generally be involved in a series of bankruptcy filings intended to
delay the sale while rent is being collected. As noted above, the knee jerk reaction has
been simply to file successively for relief from stay hoping eventually to obtain some
type of broad prospective relief order. This passive approach plays right into the hands
of the rent skimmer. Here are some different approaches that ought to be considered:
In highly abusive fact patterns and where there is a sympathetic judge, a lender can consider conducting its foreclosure sale despite the knowledge of the bankruptcy filing. After the sale is conducted, the lender should immediately bring a motion to annul the stay and ratify the sale based on the bad faith facts. Annulment of the stays means that the stay essentially never existed in the eyes of the law, so that the sale is valid, not void. The benefit to this approach is that the foreclosure sale stops the abusive scheme in its tracks. Once title is wrestled from the rent skimmer and the interests of any junior beneficiaries wiped out, the pattern of transfers and bankruptcy filings cease.
Obviously, this approach places the lender at great risk. A sale conducted after
notification of the bankruptcy is a willful violation of the stay subjecting the lender to
a variety of damages including punitive damages under 11 USC Section 362(h). Thus, if the
motion to annul is unsuccessful, the downside risk to the lender is great. The key here is
to know the judge in the newly filed cases. Some judges will gladly grant the order
annulling the stay; others will deny such an order and issue sanctions for the willful
violation of the stay.
A safer approach is to seek true ex parte relief from stay prior to sale. In a true ex parte relief procedure, no notice whatsoever is given to the debtor. Thus, the order granting relief from stay is entered and the sale conducted without the rent skimmer's knowledge and without the rent skimmer's ability to time the delay of the sale through new transfers and filings.
While highly effective, most judges will not allow ex parte relief from stay without notice. Some base their position on a belief that such ex parte relief from stay is only appropriate where there is an immediate danger to the public. Other judges refuse to consider such ex parte requests due to their already heavy case load.
When a judge is willing to consider ex parte relief, an attorney must generally wait in
the judge's courtroom all day waiting for the judge to have time to consider the motion.
The cost of this motion is beyond the typical investor reimbursement guidelines.
The most effective and most costly motion involves one designed to obtain a "universal order." A universal order is one which attempts to effect all of the debtor's property and help all of the debtor's creditors. Generally, these orders annul the stay as to all the debtor's property; dismiss the case with prejudice at a date six months or more in the future; and provide the court jurisdiction in the interim with an express order that any transfer of the property without prior court approval is void.
The universal order strikes at the heart of the rent skimming scheme effectively stripping bankruptcy protection from all the debtor's property and precluding transfers to other entities. The effectiveness of this remedy also acts as a deterrent to further rent skimming abuse.
It should be noted that the order affects all creditors and is very costly. Essentially, the moving party must show that there is a concerted scheme to use the bankruptcy process for an unlawful purpose. Proving this high level of abuse to the court takes detailed evidence.
Although these orders are highly effective, servicers are reluctant to carry the high
cost of this motion, especially where the court order will only help them on one or
several loans. This view is often short sighted. Although the servicer is paying for the
relief from stay granted to the other creditors without any effective means to obtain
reimbursement from those other creditors, these orders have a strong deterrent effect on
rent skimming. Thus, the long term outlook of the servicer is well served by a such an
approach.
Rent skimming is a difficult problem for servicers. It is a highly lucrative business and it will continue to grow unless servicers are willing to think outside the box and take creative, aggressive action.
The best solution is to have a receiver appointed prior to the filing of the
bankruptcy. Once bankruptcy is filed, there are a variety of approaches other than the
traditional motion for relief from stay, including going to sale and then attempting to
annul the stay, seeking true ex parte relief from stay and seeking a universal order.
Servicers are encouraged to investigate and try these new approaches.
For further information please contact:
The Wolf Firm, A Law Corporation, is an "AV" rated law firm which concentrates on providing superior legal services to the mortgage banking industry. The firm's national clientele includes many of the largest mortgage bankers in the country, as well as a variety of savings banks, commercial banks, commercial finance companies, credit unions, and the Resolution Trust Corporation. With a staff of approximately forty individuals, including attorneys, certified paralegals, legal secretaries, administrators, clerical personnel, and a full time computer systems analyst, the firm represents its clients on a wide range of matters including all aspects of both residential and commercial/multifamily mortgage loan origination and servicing, securitization, regulatory compliance, bankruptcy, and litigation related to the foregoing in both federal and state courts throughout California. For more routine matters, such as residential bankruptcies, evictions and receiverships, The Wolf Firm has developed extremely cost-effective and efficient programs using specially trained paralegals and computer technology to assist its attorneys in handling these matters at rates that are the most competitive in the State of California and, through its membership in the USFN, the Firm is able to arrange similar services in virtually every state in the nation.
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