Written By: Alan S. Wolf Published in Summer USFN Report 2007
When a bankruptcy case is filed by a major lender, it obviously reflects poorly on our industry. The headlines about the demise of the subprime sector more than prove this point. Moreover, the filing creates tremendous havoc throughout the industry. For example, the lender’s employees become understandably frantic because their jobs are in serious jeopardy, prospective borrowers generally lose their pipeline loans and eagerly search for other financing options, investors and master servicers scramble to move the servicing to more secure financial partners, and attorneys and general creditors often freeze their services pending some guarantee of payment. It’s a mess.
However, despite all of these problems, perhaps the biggest challenge caused by a major lender filing bankruptcy has to do with the automatic stay. Everyone knows that when a debtor files bankruptcy, an automatic stay is automatically created that protects the debtor from any act that can be construed as an act against the interests of the debtor. Thus, when a borrower files bankruptcy, the automatic stay precludes any foreclosure sale until the servicer first obtains relief from stay.
That same statutory result holds true when a lender files bankruptcy; immediately upon the bankruptcy filing, an automatic stay is created that protects the lender. Of course, if the lender happens to hold title to property (e.g., if the lender acquired title through an REO), it’s easy to see that the lender’s bankruptcy stay would preclude any foreclosure action against the property by any remaining lienholder. Less obvious, but equally true, is the fact that if the bankrupt lender holds a junior lien on a property, every senior lienholder on that property is stayed from proceeding with foreclosure until relief from stay is first obtained.
This is because if the senior lienholder had gone to foreclosure sale, it would have wiped out the debtor-held junior lien, an obvious violation of the stay. (See, e.g., In re March, 988 F.2d 498 (4th Cir. 1993)). Because the automatic stay is construed so broadly, some attorneys believe that if the bankrupt junior lienholder is merely servicing the loan for someone else (as opposed to being the holder of that note), the stay still applies, precluding the senior lien from foreclosing.
The application of the automatic stay to junior liens held by a mortgage lender that has filed bankruptcy has a tremendous impact on our industry. In any one case, the bankrupt lender may hold hundreds of thousands of junior liens and as to each of those properties secured by the debtor’s junior lien, the senior servicer must first seek relief from stay prior to foreclosing.
The need for relief from stay in so many cases has caused a nightmare not only for senior mortgage holders but also for the courts. Bankruptcy courts simply don’t have the staffing necessary to process so many new relief-from-stay motions. To avoid the administrative nightmare that would surely result from thousands of relief-from-stay motions clogging up their calendars, judges in some of the big mortgage lender bankruptcy cases have developed special orders that allow for a “simplified” method for obtaining relief from stay.
The old Empire Funding and Conseco Chapter 11 proceedings are examples of cases where the bankruptcy judges ordered a simplified procedure. Generally, the simplified methods involve providing debtor’s counsel, and other interested parties, with copies of certain documents, and if there is no objection within a set number of days, the stay is automatically terminated without need to file anything with the court.
The New Century Chapter 11 case filed on April 2, 2007, in the Delaware bankruptcy court involves literally hundreds of thousands of junior liens held and/or serviced by New Century. In recognition that the court could not possibly handle the thousands of relief-from-stay motions that would soon be filed, on June 7, 2007 the bankruptcy judge in the New Century case issued an order providing for a “simplified” method for obtaining relief from stay in that case.
The New Century order provides a similar procedure to that developed in the Empire Funding and Conseco cases — notice is given to debtor’s counsel and various other parties of the desire to have the stay terminated, and if no action is taken in 30 days, the stay automatically terminates without need for any court involvement. However, the New Century procedures differ from the Empire Funding and Conseco procedures in one significant way: the senior mortgage lender must pay to New Century $1,000 for each request (notice) made under the simplified procedure! Where does that come from? Why is the debtor entitled to payment when a senior lienholder seeks relief from stay?
It’s not quite as bad as it could be because each request can include multiple properties, and only the first 10 requests require the $1,000 payment — after that the lender can make as many free requests as it wants (i.e., the maximum the lender needs to pay is $10,000). Also, a mortgage lender does not have to follow this procedure and can always bring the normal court-filed motion for relief from stay. Nonetheless, this order presents a very bad precedent. We certainly don’t want to have to start paying debtors to obtain relief from stay.
Mortgage servicers should carefully assess whether they can go to sale where New Century has some sort of interest in a junior lien, and servicers need to decide which method of seeking relief from stay they will employ. It seems that the mortgage industry would be better served by not following the $1,000 per request method. There’s no reason to charge the $1,000, and we don’t want to encourage the spread of orders such as this. Also, the order only covers situations where New Century holds the loan. Thus, where New Century is merely servicing the loan, and the decision is made that the stay is invoked by that servicing interest, the order does not apply, and the normal relief from stay procedures would need to be followed.