By Alan Steven Wolf of The Wolf FirmKaren Abernethy (Bank of America- Richmond)
(USFN Report, September/October 1998)
By Alan Steven Wolf of The Wolf FirmEscrow is a tough and demanding aspect of loan administration. Most servicers have specialized staff that focus their entire attention to the minutia of escrow, from RESPA's exacting requirements, to compliance with a plethora of state laws, differing loan documents, and divergent investor guidelines. Sophisticated computer programs analyze the loans, track disbursements and cushions and otherwise struggle to comply with this highly technical and error fraught aspect of servicing.
Servicing loans in bankruptcy offers similar hurdles. Specialized staff ensure that the automatic stay is not violated, review various pleadings, file proofs of claim, account for post and prepetition payments, seek relief from stay, defend against cramdowns, and generally follow the nuances of each bankruptcy court. There is no rest for the weary.
As exacting as these two disciplines are, their complexity is increased by magnitudes when their paths cross. An escrowed loan that becomes subject to a bankruptcy proceeding is an accident looking for a place to happen. How does a servicer properly file a proof of claim involving an escrowed loan? What is the relationship between escrow shortages, deficiencies and surpluses and pre and post petition payments? Must a servicer reanalyze a loan when a bankruptcy is filed? Must a servicer return surplus funds to the borrower when a plan is confirmed? Can a servicer increase the post petition payments to cover a shortage? Can a servicer increase post petition payments to cover increased estimates in taxes and insurance? Two divergent federal laws must somehow be reconciled. Surprisingly little analysis is found in the courts and servicers tend to be all over the board with their approaches, a type of homage to the complexity of the task.
To appropriately apply escrow administration to loans in bankruptcy one must first understand the intricacies of both disciplines. That is a daunting task and well beyond the scope of this article. Nonetheless, some basics will help to guide us. Obviously, an escrow account is an account established or controlled by a servicer to collect sums to pay charges, such as taxes and insurance related to the property subject to the mortgage (See, definition in Reg. X Section 3500.17(b).) The determination of the amount to be collected so that the escrowed items can be paid is a process known "escrow analysis" which is generally performed once a year. (Reg. X Section 3500.17(i)) Escrow analysis is a fun mathematical game to determine what is referred to as the "target balance," the amount that is just enough to pay the necessary disbursements, plus any allowed cushion.
To get to the target balance requires a multistage process. First, an analysis of estimated disbursements by the month and for the entire year is made. Next, calculations need to be completed so that monthly escrow payments are high enough to make sure that all disbursements are made without the need for advances by the servicer, and yet those payments must be low enough so that the escrow account balance falls to zero at the end of at least one of the months. (Reg. X Sections 3500.17(d)(1)(I)(B), 3500.17(d)(2)(I)(B).) Dependent upon the loan documents and state law, a servicer may also be able require a cushion of up to two months of the borrower's escrow payments. (Reg. X Sections 3500.17(d)(1)(i)(C).)
Determining next year’s disbursements is more art than science; essentially it’s an educated guess as to what future disbursements of taxes and insurance will be. More often than not, and through no fault of the servicer, that guess is wrong. If the servicer underestimated the amount necessary to make all disbursements, then there will be an escrow shortage. If the estimate is way off, and the servicer must make a corporate advance (as opposed to merely dipping into the escrow cushion), there is a deficiency. On the other hand, if the servicer overestimated the disbursements, there will be an escrow surplus. The shortage, deficiency or surplus is determined at the time of the next escrow analysis. If there is a shortage or deficiency, servicers generally require that they be repaid over twelve equal monthly installments. (Reg. X Section 3500.17(f)(4)(ii) and Section 3500.17(f)(4)(i)). Where the loan is current and there is a surplus equal to or greater than $50, the servicer must refund the surplus to the borrower within thirty calendar days from the date of escrow analysis. Where the loan is current and the surplus is less than $50, the servicer may refund the surplus to the borrower or credit the surplus against the following year’s escrow payment. (Reg. X Section 3500.17(f)(2)(I)) If the loan is in default, the servicer may retain the surplus in the escrow account according to the terms of the mortgage loan documents. (Reg. X Section 3500.17(f)(2)(i)).
It is important to note that escrow analysis has nothing to do with default; in doing an escrow analysis it is assumed that all prior payments have been made. Also, the funds held by the servicer in the escrow account have a unique status; they are owned by the borrower and yet they are due the servicer as additional security. If the loan is paid off, any remaining escrowed funds are returned to the borrower. On the other hand, to reinstatement the loan, the servicer must be paid all sums due, which of course include any escrowed amounts.
Bankruptcy provides strange twists to escrow administration. The most frequent twist relates to a confirmed chapter 13 plan. In a chapter 13 plan, the debtor takes a snapshot of the arrearages that existed at the time of the bankruptcy filing (the "prepetition arrearages") and agrees to pay those arrearages over the life of the plan (generally 36-60 months) while maintaining regular monthly payments. The overall concept is that at the end of the plan, the debtor will be current.
There are two big errors servicers sometimes make in regard to escrowed loans subject to bankruptcy. One error is to set up payments in such a way that the debtor, after having made all of the payments under the plan, is not current at the end of the plan. If the debtor has overpaid, it may result in sanctions against the servicer. If the debtor has underpaid, it may result in the inability to collect the deficiency.
Unless carefully watched, where an escrowed loan is in bankruptcy, it is easy to make mistakes that would result in the loan not being current at the end of the plan term. For example, if the servicer shows that the prepetition arrearages are all of the payments, including impound amounts due prior to the bankruptcy and then ups the post petition payments to cover the unpaid impounds, that would result in double recovery and overpayment at the end of the plan term.
Equally problematic is causing prepetition debt to be paid post petition. Obviously, it is in a servicer’s best interest to cause as much as possible of the debt to be post petition debt; post petition debt must be paid immediately whereas prepetition debt is paid over a long term (36-60 months), and in post October 22, 1994 loans, without interest. But shifting pre petition debt to post petition payments, without good cause, and whether intentional or not, can result in sanctions from the court.
Dividing prepetition arrearages from post petition payments is surprisingly complicated when applied to taxes and insurance. This has to do with the difference between when the charge is due and when it is paid. A simple payment example puts these concepts into better focus. Assume that you are a junior lienholder in a bankruptcy matter, that the debtor has failed to make ten payments of $100 to the senior lienholder and that seven of those ten payments were due prepetition. If the junior lienholder advances the $1,000 to the senior lienholder after the bankruptcy filing, does that make the $1,000 all post petition debt? There is no answer, but the better view is that the junior steps into the shoes of the senior, i.e., to the extent the advance was for prepetition debt ($700), the junior would amend the proof of claim to show this additional prepetition amount. To the extent the payment was for post petition debt ($300), it would be immediately due the senior. Similarly, advancing for taxes and insurance post petition does not necessarily make that debt post petition debt; it is not when the advance is made but rather when the funds were due the taxing agency that ought to be relevant.
To keep pre and post petition sums separate, a servicer needs to reanalyze the loan when the bankruptcy is filed. If, under this escrow analysis, there is any shortage and/or deficiency in the prior year, it should be made a part of the prepetition arrearages instead of added to the new impound amount to be paid over the next twelve post petition months. Thus, the prepetition arrearages on an escrowed loan are comprised of the prepetition payments (including impounds), plus any shortage and/or deficiency under the new escrow analysis. If upon escrow analysis there is a surplus and there are prepetition arrearages (i.e., the loan is in default), the servicer should show a credit for the surplus in the prepetition arrearages. However, some servicers take a strict reading of RESPA and find that since the loan is technically in default, no credit should be given for surplus in the prepetition arrearages. If there is no default, then any surplus over $50 must be returned to the borrower. Finally, if the new analysis requires an increase in the impounds to cover estimated taxes and insurance, the impounds may be increased.
The failure to do an escrow analysis at the time of the bankruptcy filing results in some problems. As noted above, if there is a shortage/deficiency in an escrow analysis done prior to the bankruptcy filing, that shortage/deficiency is paid over twelve months by adding it to the impound. If a bankruptcy is filed at some time during that twelve month period, then essentially, the debtor is being forced to pay for prepetition debt (the prepetition shortage/deficiency), post petition (since they are made part of the impound). The only way to avoid this result is to reanalyze the loan at bankruptcy filing.
While this approach is relatively safe, it is economically harmful to servers. Where a loan is in default, the servicer must advance corporate funds to maintain the taxes and insurance, yet due to the bankruptcy, it cannot foreclose nor will it be paid on these funds for some time. Is there a better way?
Some servicers have taken a creative and highly aggressive approach, which both assures that there is no disparity at the end of the plan and avoids the corporate advance problem; they change the loan from an escrow account to a non-escrow account. As a non-escrow account, the servicer accounts both pre and post petition for actual disbursements.
By switching to a non-escrowed account, a servicer can essentially convert what would have been prepetition debt to post petition debt. Here is how it works. Assume that in our example above, instead of the $1,000 being due in payments, the $1,000 is due for taxes. Assume further that the impound requires $100 per month, and that for ten months, all of the impound amount is earmarked for the taxes of $1,000. Finally, assume that no payments have been made and that at sometime in the seventh month, a bankruptcy petition is filed.
Under an escrow analysis, $700 is part of the prepetition arrearages and $300 is part of the post petition payments. However, if a servicer were to switch to a non-escrow loan, the entire $1,000 tax payment would be a post petition debt and immediately due. It is truly a post petition debt because the entire sum is due the taxing authority post petition. This distinguishes the tax example from our payment example above because in the payment example, the entire sum was not due post petition, the servicer merely paid post petition a debt that was partially due prepetition.
There are numerous problems with switching from an escrow loan to a non-escrow loan. For example, what do you do with the impound cushion? How do you notify the borrower of this conversion? How do you obtain the approval of your insurers (such as HUD and VA) to terminate the escrow account? Nonetheless, if carefully crafted, it may make business sense. The Freddie Mac Service Guide cleverly alludes to the possibility of taking this approach.
Whether you play it safe or aggressive, you need to be consistent in your approach. Also, a servicer should never account is such a fashion that precludes the debtor being current at the end of the plan term and unless you have some cogent argument, do not convert prepetition arrearages to post petition debt.
For further information, please contact Karen Abernethy at 804/782-5452 or Alan Steven Wolf at 949/720-9200.
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.
Copyright- All rights reserved
The Wolf Firm
A Professional Law Corporation
18 Corporate Plaza Drive
Newport Beach, California 92660
(949) 720-9200 Phone
(949) 720-9250 Fax
E-Mail us at Alan_Wolf@wolffirm.com
| Home | What's New | Firm Profile | Firm Resume | Firm Publications |
| Library | Bookstore | Missing Assignment Database | Mortgage Banking Training |
| Employment | Guestbook | Industry News | Industry Calendar | Search |
| Forms | Photo Albums | Miscellaneous | Disclaimer | Contact us! |
Last Revised On
© 1996-2001 The Wolf Firm. All rights reserved.
