Texas sues ‘debt-relief’ firm; investors claim victory over Countrywide; housing signals mixed; credit card regs kick in

August 22nd, 2009 by Mike Hinshaw

What a week: we may not be witnessing a sea change or even a “perfect storm”–but the cross currents are fierce, interconnected and powerfully intriguing.

In Texas, Attorney General Greg Abbott is w-a-a-y up in the middle of the locked-down Debt Relief USA, in a Chapter 7-related filing that matters a great deal to more than 2,500 former customers who have been left hanging on the line. In a seemingly unrelated but possibly pivotal case, a federal judge in Manhattan has bounced back to state court an investors’ suit against subprime-lending giant Countrywide Financial, which is being closely followed not only by pension funds and insurance big wigs but also by–well, practically the entire lending industry.

Meanwhile, the first changes of Team Obama’s credit-card reforms have taken effect, within days of recognition that the foreclosure debacle has extended its tentacles from the subprime plebes into the prime-rate neighborhoods. In other quarters, sales of existing homes priced less than $100,000 are leading something of a housing rally, even as owners of luxury homes are turning to auctioneers for help in shedding their properties.

Debt Relief USA is the Addision, Texas-based outfit that promised its customers an alternative to bankruptcy protection and then turned around and stiffed them by closing down–and filing for bankruptcy protection for itself. Since our preceding discussion of Debt Relief USA (also known as No Debt USA), the company, according to its Web page, had its Chapter 7 status conference July 29. At least part of the meeting included “the best way to handle claims of consumers and other creditors involving the case.” However, because “the questions about how to handle the property fo [sic] the estate and what notice to give to consumers are still up in the air, the Chapter 7 Trustee decided to adjourn the meeting and re-convene it on August 26, 2009 at 1:00 p.m.”

About three weeks after the meeting, on August 18, Attorney General Abbot filed suit “to recover $4.6 million from Debt Relief USA to pay restitution to former clients who claim they were financially hurt by the Addison-based company’s debt negotiation practices.

“Abbott’s office contends Debt Relief USA, which filed for Chapter 11 bankruptcy relief in June, took money from consumers who were in debt and promised to negotiate better terms with their creditors. As a result, more than 2,500 financially distressed consumers did not received the debt relief promised, Abbott said.”

That account is from the Dallas Business Journal, which goes on to say that “Abbott’s office said it successfully had the company’s bankruptcy case changed from Chapter 11 to Chapter 7 status, which allows the liquidation of assets for the purpose of paying off creditors’ claims.”

What one can infer from that is that Abbott sees no value in Debt Relief USA’s continuing as an ongoing concern. Although Chapter 7 can offer an individual a splendid shot at a second chance, that’s not so for a business that wants to keep doing business. One also presumes the AG has verified the company has enough assets to make liquidation worthwhile. And from reading the petition filed with the court, one can quickly see what the AG’s office thinks about not only this company in particular but maybe also the industry in general. It’s worth reading, especially if you’re considering hiring such a company. Let’s hope the AG can recover at least some of the money for the people who put their faith in this company.

A day after Abbott filed suit against Debt Relief USA, The New York Times posted that a group of holders of mortgage-based securities had won a battle in its fight against Countrywide Financial, which last year had settled with 11 states’ attorneys general over its predatory lending practices.

Shortly before the settlement, described by The Times here as “the largest program ever to modify home loans,” Countrywide was acquired by Bank of America, which is now defending the suit against the investor group. We first described the possibility of such litigation in this post in March when we discussed a paper by Adam J. Levitin, entitled “Resolving the Foreclosure Crisis: Modification of Mortgages in Bankruptcy.”

As Levitin explains, “. . . under the Trust Indenture Act of 1939, to alter the [homeowner's] contract requires at least a majority of the MBS [mortgage backed security] holders, and if the alteration affects the MBS investors’ cashflow, 100% consent is needed.”

In other words, U.S. trust law holds that these “securitized mortgages” can’t be modified via a new agreement between the loan servicer and the homeowner. Sounds crazy that someone–or several–can enter a business deal downstream of the homeowner and somehow cause the homeowner to be unable to renegotiate, but that’s exactly what the investor group is suing about. Their argument is that Countrywide’s original contract with them includes provisions that Countrywide would buy back any loans it subsequently modified.

As The Times explains it: “The lawsuit was filed in December after Bank of America struck a predatory lending settlement with attorneys general in 11 states. In that deal, the bank agreed to modify thousands of mortgages written by Countrywide, providing $8.4 billion in loan aid to an estimated 400,000 Countrywide borrowers.

“Under the terms of the settlement, Countrywide said it would cut principal balances on some loans and reduce interest rates on others. Rates could decline to 2.5 percent, depending upon a borrower’s ability to pay, and remain at that level for five years.

“But it turned out that Bank of America owned only a small portion of the mortgages it had agreed to modify. Investors who owned the largest share of the loans had not agreed to the settlement and would bear the brunt of the reduced payments.”

So Bank of America, on the hot seat after acquiring Countrywide, argued back “that the matter belonged in federal court and that any contractual obligations to repurchase modified loans were trumped by the Helping Families Save Their Homes Act of 2009. Under that law, servicing companies that agree to modify loans receive some protection from liability arising from the loan changes.”

But Judge Richard J. Holwell of Federal District Court in New York disagreed with the bank over jurisdiction and remanded the case back to state court. The Times and one of the plaintiffs called Holwell’s decision a victory for the investor group: ““ ‘I view this as an opening salvo and a demonstration that investors do have contractual rights, even when it is politically unpopular,’ said William A. Frey, one of the investors who brought the lawsuit. ‘This is ultimately going to be one of many legal battles over who should pay the hundreds of billions of dollars in losses on mortgages.’ ”

However, among the many interested–and invested–observers following the case are some who believe this was not a victory for the investors because the judge did not rule on the merits of the case, but simply told both parties they’ll have to prove up in state court. An August 20 press release from the Center for Responsible Lending says, “Nothing in the court’s decision casts any doubt on mortgage servicers’ legal ability to modify distressed loans. Instead, Judge Holwell’s decision merely determines that this pending case should be decided by a New York state court, not in federal court as Countrywide had requested. Judge Holwell made this decision without ruling on any of Countrywide’s defenses to the lawsuit.

“Loan modifications are essential to turning around the current financial crisis, and the number of modifications continues to be dwarfed by the number of foreclosures. We hope that servicers, who are already using ‘investor refusal’ as a scapegoat for denying modifications, will not use the purely procedural decision in this case as a further excuse to refuse to modify loans.”

Next in “The week that was, Part 2“: debt-relief details from Texas lawsuit; changes concerning credit cards; Part 3: housing sales versus housing starts and auctions; obsolete regulation of credit derivatives.

Related resources for personal bankruptcy:
Chapter 7
Chapter 13