Recent Entries

The Tide Towards Tightening Regulations of Educational Loans

By Monette W. Cope, Junior Partner

Legislators and regulators are proposing remedies to rising defaults on educational loans in the so-called “student loan bubble”.

In an attempt to hold educational institutions partly responsible for defaults, a bill was introduced in the Senate which would impose “risk-sharing payments” on certain institutions that participate in direct federal student loan programs.[1]  Those institutions where 25% or more of the fiscal year’s students borrowed under those programs will be subject to the payments if they have high default rates.  The payments would be from five to twenty percent of the total of the institution’s defaulted loans, including interest and collection costs.  The payments would be waived or reduced if the institution has a “student loan management plan” approved by the Secretary of Education.  To be approved, the plan must contain an analysis of the defaults and an action plan to address them.  It must also include individual financial aid counseling and strategies to reduce defaults and delinquencies.  This would at the very least impose an underwriting responsibility on educational institutions that are usually born by financial institutions.

A pair of bills currently pending would amend the Truth in Lending Act to require private lenders obtain a certification from the school of the student’s enrollment, the cost of attendance, and the difference between the cost of attendance and the student’s financial assistance.[2]  A second set would require the institutions provide the Secretary of Education with data on its student loans and post the data online, including the average amount of the loans, and the percentage of students who have loans and obtained their degrees, and the median earning of graduates for each specific degree.[3]

The Dodd-Frank Act created a student loan ombudsman within the Consumer Financial Protection Bureau (CFPB) to oversee complaints about private student loans. According to the most recent report,[4] the complaints mirror those made in the mortgage industry after the housing collapse. They include violations of the Servicemembers Civil Relief Act, payment processing errors, and inability to modify or refinance the loans.   Most of the complaints are about failed attempts to modify loans.  The CFPB opines that more flexible modification options would improve collections and add to borrowers’ spending power, thereby spurring more mortgage and automobile loans. It cites in approval a joint statement by the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation and the Board of Governors of the Federal Reserve System that they “will not criticize financial institutions for engaging in prudent workout arrangements with borrowers who have encountered financial problems, even if the restructured loans result in adverse credit classifications or troubled debt restructurings in accordance with accounting requirements.”[5]  The unstated hope is that without these worries, student loan lenders and servicers will be more likely to modify loans.

Finding many of the same issues in student loan servicing as were found in the mortgage servicing industry, the ombudsman suggests a study to determine if regulations recently imposed by RESPA on mortgage servicers could be applied to student loan servicers.  RESPA Regulations that were cited included regulating the transfer of loan servicers, improving borrowers’ access to accurate payoff statements and loan histories, and requiring servicers designate customer representatives who have the authority to address borrowers’ issues.

Likewise, it proposes to study whether some provisions in the Credit CARD Act of 2009 should be applied to servicers.  Specifically mentioned were the timing of statements and disclosure of the amount the borrower would pay if only the minimum payment is made. The ombudsman found the biggest problem, however, was the application of extra payments and underpayments. Because it will result in the most savings to borrowers, the ombudsman believes extra payments should be applied to the loan with the highest interest rate, not divided evenly or pro-rated with other loans.  When an underpayment is made, the ombudsman found that it was often pro-rated between all loans, resulting in late fees on all of a student’s loans. The better practice is to progressively apply it starting with the lowest loan balance to prevent a default and late fees on at least one of the loans, if possible.

The CFPB stated that action must be taken unless student loan lenders and servicers voluntarily make the suggested changes.  This should serve as a warning and policies should be reviewed.  The tide is moving towards more regulation of the student loan industry.

 

[1]  S.1873 by Sen. Reed, Jack D-RI, currently referred to the Committee on Health, Education, Labor, and Pensions.
[2]  S.133 by Sen. Durbin, Richard D-IL, currently referred to the Committee on Health, Education, Labor, and Pensions and H.R.3612 by Rep. Polis, Jared D-CO-2, currently Referred to House Financial Services.
[3]  S.915 Sen. Wyden, Ron D-OR, currently referred to the Committee on Health, Education, Labor, and Pensions and H.R.1937 by Rep. Hunter, Duncan D. R-CA-50 currently referred to the Subcommittee on Higher Education and Workforce Training.
[4]  October 2013 Annual Report of the CFPB Student Loan Ombudsman
[5]  Citing Banking Agencies Encourage Financial Institutions to Work with Student Loan Borrowers Experiencing Financial Difficulties, available at http://www.fdic.gov/news/news/press/2013/pr13065a.pdf (July 2013).

 

Hanging Paragraph of §1325: What Is Not Included?

By Keri P. Ebeck, Attorney

If a debtor purchases a new vehicle and thirty days later files a Chapter 13 bankruptcy, should the debtor get the benefit of the substantial depreciation of the vehicle’s value? No, the addition of the Hanging Paragraph of §1325 was designed to prevent this type of perceived abuse by debtors.

The Hanging Paragraph of §1325 provides that:

For purposes of paragraph (5), section 506 shall not apply to a claim described in that paragraph if the creditor has a purchase money security interest securing the debt that is the subject of the claim, the debt was incurred within the 910-days preceding the date of the filing of the petition, and the collateral for that debt consists of a motor vehicle  (as defined in section 30102 of title 49) acquired for the personal use of the debtor, or if collateral for that debt consists of any other thing of value, if the debt was incurred during the 1-year period preceding that filing. §1325(a)(*)

The question stemming from this section of the Bankruptcy Code that is not clear and have Courts grappling with how to handle is: what is included or what is not included in the “purchase money security interest”?  For purposes of this article, it will focus on the popular, negative equity of a vehicle purchase and GAP insurance.

Negative equity exists when a debtor purchases a new vehicle and the dealer agrees to finance the negative equity of the trade-in vehicle as part of the new loan. The problem exists when the debtor turns around and files a Chapter 13 bankruptcy. Should the negative equity of the trade-in vehicle be classified as part of the purchase money security interest? There is no definition of “purchase money security interest” in the Bankruptcy Code; therefore the Courts are in agreement that it requires a look to state law to determine the meaning of the term.  Some states actually include in the state law definition of “cash sales price” that negative equity is included, such as New York, Georgia and California.[1]  For those states that do not explicitly define what is included in the sale, the Courts must review the states’ Uniformed Commercial Code, state law statutes,  and its legislative intent to determine if negative equity is part of the purchase money security interest.  “A purchase-money security interest exists if the collateral is the item purchased and it secures its own price.”[2]  The Court in In Re Mancini, concluded that “the payoff concerns a different vehicle and, usually, a different lender. Nothing in the UCC or its comments leads me to believe that the payment of an antecedent debt, such as negative equity, should be included as part of the creditor’s purchase money security interest.”[3]  In review of most cases, unless the States specifically have included or amended their state law statutes or UCC to include negative equity in the definition of a purchase money security interest, it is not included. “A majority of reported decisions conclude that a loan to payoff “negative equity” is not included in a purchase money security interest in a new car for purposes of the hanging sentence.[4]

The Courts have also looked to the addition available to debtors at the time of the vehicle purchase of GAP Insurance. GAP Insurance is defined as insurance to cover the difference between the vehicle’s value and the amount owed to the creditor.  Like its counter part, negative equity, the Courts once again look to the State specific UCC and statutes to determine if it is included. As GAP insurance was not part of the purchase price as it was “neither mandatory, a component of the loan agreement, nor a value-enhancing add-on”[5] , it is determined in most jurisdictions as not being a part of the purchase money security interest. The Court in In Re Mancini concluded, “Gap insurance is not part of the ‘price’ of the collateral, nor is it part of the value ‘given to enable the debtor to acquire rights in or use of the collateral.’” [6]  Therefore, it is clear that most Courts are making the determination that if it is not specifically authorized under State law, both negative equity and GAP Insurance are not included in the purchase money security interest.

What happens once the Court determines that the negative equity or GAP insurance is not included? Is the entire claim subject to the cramdown or is it only a certain amount? The Courts have adopted two rules on the above issue. The first is known as the “transformation rule”: “if an item of collateral protections to secure not only its own purchase price but also that of other items, the security interest that existed before the ‘add on’ procedures is transformed into non-purchase-money status.”[7]  Therefore, the lien would now be subject to cramdown outside of the purview of the Hanging Paragraph of §1325.  The second rule is known as “dual status”, which by definition states that the existence of the nonpurchase money interest does not defeat or destroy the entire claims’ status under the 910 rule. “A purchase- money security interest in a quantity of goods can remain such ‘to the extent’ it secures the price of the item, even through it may also secure the payment of other articles.”[8]  Most jurisdictions have adopted the “dual status” rule as it is more in line of how the Hanging Paragraph of §1325 was designed to protect creditors against cramdown of their claims. The Court in In Re Johnson concluded that “applying the dual purpose rule is more consistent with congressional intent…”[9]  The Court went on to state that “simply, application of the transformation rule is too severe.”[10]  The all or nothing of the transformation rule leaves little protection for creditors, while the dual status rule implements what Congress had intended with §1325.

While creditors may allow consumers/debtors to finance more than the actual collateral, whether or not it creates a purchase money security interest and how it will be treated in the bankruptcy is really a determination for the Court. Creditors should be aware of such issues, but it should not deter them from lending or exercising their rights in a bankruptcy.

 

[1] In Re Johnson, 380 B.R. 236
[2] Pristas v. Landaus of Plymouth, Inc., 742 F.2d. 797 (1984)
[3] In Re Mancini, MDPA Case No. 07-02236
[4] In Re Hayes, 376 B.R. 655
[5] In Re Honcoop, 377 B.R. 719
[6] In Re Mancini, MDPA Case No. 07-02236
[7] Pristas v. Landaus of Plymouth, Inc., 742 F.2d. 797 (1984)
[8] Id.
[9] In Re Johnson, 380 B.R. 236
[10] Id.

Bankruptcy Update

By Alan C. Hochheiser, Partner

I recently had the opportunity to attend a presentation by the Deputy Director of the Consumer Financial Protection Bureau (CFPB) while attending a conference. I went into the presentation with an open mind, hoping that the Deputy Director would extend a part of an olive branch to those involved in the bankruptcy and collections arena. For the first 5 minutes of the half hour presentation, I was pleasantly surprised. The agency seemed open to input from the creditor side and saw the necessity of working together to address the concerns in the industry. The remaining twenty-five minutes were like the extreme weather we all experienced over the last few months – cold, dark and scary.

The goal of the CFPB has always been transparency. The message that the Deputy Director sent loud and clear, was that they will do everything possible to protect the consumer. The impression of the hundreds at the presentation is that this would occur without great input from the credit industry and without taking into account the effect on consumer lending and collection.

Over the last several months, the CFPB has continued to remain very active. The Bureau has proposed rules as it pertains to the Fair Debt Collection Practices Act (FDCPA). Although the FDCPA was enacted by and can only be changed by Congress, the CFPB believes it has the authority to make adjustments and enforce its version of the law.  The comment period to these proposed rules has recently ended and there were numerous comments submitted. The question that we are all waiting to be answered is whether the CFPB will take into account the concerns of the financial services industry.

The CFPB also initiated its new Mortgage Rules. These rules, which at times contradict current bankruptcy law, did receive a current exemption as to certain provisions in bankruptcy, but those could be changed at any time.  Bankruptcy law and rules are approved by Congress and blessed by the Supreme Court of the United States, are now being reviewed by the CFPB. The CFPB is once again trying to change the playing field.

Are Your Periodic Statements Ready?

By Stephen R. Franks, Attorney

As summer winds down and we head into fall, important changes are looming in the mortgage servicing industry.  On January 10, 2014 new rules will go into effect for residential mortgage loans.  These rules were enacted on January 17, 2013 by the Consumer Financial Protection Bureau (CFPB). The new rules cover nine major topics, one of which relates to periodic statements.

Proposed Section 1026.41 establishes that periodic statements will be required for residential mortgage loans.  The CFPB stated that the purpose of the new rule is for servicers to design the statements to be easy for consumers to read; however, they still wanted to give flexibility to the servicer to customize the statement. 

The statement should be designed to provide the consumer with an easy-to-read format and to highlight key information.  Related concepts and figures are to be grouped together and set off from other groups of information.  Servicers do have the flexibility to use regional terminology, so long as it is commonly understood. 

The statement must include the principal balance and current interest rate. It must also include an explanation of the amount due, and provide the monthly payment amount, along with the allocation of the payment amongst principal, interest, and escrow.

The statement should be a snapshot of how past payments have been applied to the principal balance, interest, escrow, fees, charges, and any partial payments.  The statement should also include transaction activity that shows any activity since the last payment.  Late fees must be described with the date, the amount and the fact that it was imposed.

Statements must be more than just available to the borrower.  They must be either physically mailed to the borrower or made available online.  If the statement is available online, the servicer must send an email to the consumer stating it is ready.  Joint obligors do not need separate statements. Only one statement needs to be sent. 

The statement must be sent each billing cycle, and it must be sent within a reasonably prompt time after the close of the grace period of the previous billing cycle.  The CFPB recommends four days after the previous month’s grace period has ended to send out the new statement.  Disclosures must be made clearly and conspicuously in writing on the statements.  The CFPB has crafted a recommended form statement for use that is available on its website.

Of particular interest is the fact that the servicer is required to post a message on the front of the statement if a partial payment is being held in suspense.  Additionally, statements must contain contact information for the consumer to obtain information from the servicer and also contact information for the State housing finance authority.

The above rule applies to creditors, assignees and servicers.  However, there is an exemption for small servicers that only service 5,000 or fewer mortgage loans and service only mortgage loans they originated. 

Stephen is an attorney in Bankruptcy located in the Brooklyn Heights, Ohio office who can be reached at 216.739.5645 and sfranks@weltman.com.

Eastern District of Michigan New Model Plan Update for Chapter 13 Cases

By Cheryl D. Cook, Attorney

As you may be aware, the Eastern District of Michigan adopted a new Model Chapter 13 Plan that became effective January 1, 2013.  A copy of that model plan can be found at the Eastern District Bankruptcy Court website:  http://www.mieb.uscourts.gov/sites/default/files/forms/Chapter_13_Model_Plan.pdf

The new model plan contains a prominent notice advising creditors:

YOUR RIGHTS MAY BE AFFECTED.  THIS PLAN MAY BE CONFIRMED AND BECOME BINDING WITHOUT FURTHER NOTICE OR HEARING UNLESS A TIMELY WRITTEN OBJECTION IS FILED.  READ THIS DOCUMENT CAREFULLY AND SEEK THE ADVICE OF AN ATTORNEY. 

In light of the U.S. Supreme Court decision in United Student Aid Funds, Inc. v Espinosa, 559 U. S. ___, 130 S.Ct. 1367, ___ L.Ed.2d. ___ (2010), this notice is intended to give creditors ample warning of the effect of the failure to timely object to plan treatment. 

Within the time specified by the Court, creditors should carefully review the provisions of the plan (or forward it to their attorneys for review) to determine whether an objection is required.  In the Eastern District of Michigan, the Court will actually schedule a specified deadline for objections.  Failure to timely file an objection is likely to result in a waiver of that objection, so it is critical that creditors perform this review right away. 

Under the section labeled “Additional Terms, Conditions and Provisions,” the model plan specifies the order of payment of claims by class, and it contains a provision specifying that Class 5.1 and Class 6.1 creditors will receive equal monthly payments to the extent that funds are available at the date of each disbursement. 

In addition, according to discussions at a recent bankruptcy conference, Trustees administering this plan interpret the recent Rule 3002.1, read in conjunction with the new model plan, to require a timely proof of claim from secured creditors, as well as unsecured creditors. 

In the past, secured creditors may have delayed filing a proof of claim in reliance on their perfected lien, and Trustees would pay those claims according to the debtor’s plan.  The Trustees in the Eastern District of Michigan seem to be looking at Rule 3002.1 as imposing an affirmative requirement that such secured claim holders must file a formal proof of claim by the claims bar date, based on the new requirements for filing supplements to the proof of claim.[1]  

Cheryl is an attorney in Bankruptcy located in the Detroit office who can be reached at 248-989-3089 and chcook@weltman.com.

[1]Fed. R. Bankr. P. 3002.1 requires creditors holding claims that are secured by a security interest in the debtor’s principal residence, and which are provided for under §1322(b)(5) of the debtor’s Chapter 13 Plan to file payment change notices and post-petition fee/expense/charge notices.