Forecasting the Legal Landscape

Editor's note: This story originally appeared in the January edition of DS News. 

COVID-19 was the centerpiece of legal actions affecting the default servicing industry in 2020 and will likely be for at least the first several months of 2021. The pandemic resulted in a lengthy backlog of cases expected to extend well into the year and perhaps even into 2022.

The pandemic and resulting economic crisis resulted in financial hardships for borrowers and foreclosure moratoria at the federal, state, and local levels, many of which extended at least briefly into the new year and may continue much longer than that.

At the beginning of December, the Federal Housing Finance Agency (FHFA) extended the moratoriums on single-family foreclosures and real estate owned (REO) evictions from December 31, 2020, until at least January 31, 2021.

The foreclosure moratorium applies to only Fannie Mae- and Freddie Mac-backed, single-family mortgages. The REO eviction moratorium applies to properties that have been acquired by Fannie or Freddie through foreclosure or deed-in-lieu of foreclosure transactions.

"Extending Fannie Mae and Freddie Mac's foreclosure and eviction moratoriums through January 2021 keeps borrowers safe during the pandemic," said FHFA Director Mark Calabria, in a prepared statement. "This extension gives peace of mind to the more than 28 million homeowners with an Enterprise-backed mortgage."

FHFA projected additional expenses of $1.1 to $1.7 billion due to the existing COVID-19 foreclosure moratorium and its extension. These expenses are in addition to the $6 billion in costs incurred before the announcement.

In a previous statement, Fannie Mae said it "has taken a number of actions to help homeowners and renters facing financial hardship due to COVID-19." In addition to suspending foreclosures on homeowners, Fannie Mae extended eviction protections to multifamily renters when the property owner received a forbearance. Fannie Mae also reminded homeowners that they are never required to repay missed payments all at once and shared tips to help homeowners avoid foreclosure fraud or scams. The GSE also announced a new COVID-19 payment deferral option to help homeowners ready to resume their monthly mortgage payments following a COVID-19 forbearance.

Moratoria Extensions Expected in Early 2021 

Default servicing professionals expect the January 31 extension to be only the first step in extending some of the moratoria related actions taken in 2020, saying the extension is a stopgap to put any future decisions in the new Administration's hands.

"There will be many difficult challenges coming out of COVID for the new Administration," said Roy Diaz, managing shareholder of Diaz, Anselmo, Lindberg P.A., and Chair of the Legal League 100, a professional association of U.S. financial services law firms.

Diaz and several others expect the moratoria to be extended to at least March, marking a year since the first of them started. Even when the moratoria lifts, any progress for default servicing litigation will depend on various factors, not the least of which will be the pandemic's progress. Many government health experts don't expect the vaccines to affect the virus's direction until at least the second quarter, and probably not until mid-year.

In addition to how to handle the moratoria, forebearances, etc., going forward, the Administration and new Congress need to determine what relief, if any, they will try to provide for landlords of non-commercial properties. A majority of those landlords have their own mortgages on properties and count on rental income to pay the debt service, taxes, etc., on the property and provide additional income for themselves, Diaz said. As of this print deadline, moratoria for rental evictions remained December 31, 2020.

"Further extensions and delays will depend on the policy positions taken by the new administration and the composition of the Senate, which would set the tone of what bills can get through to the President," said Tony Van Ness. Van Ness, who is Managing Attorney at Van Ness Law Firm, echoed many others' thoughts in law firms working in the default servicing business. "Although the FHFA has congressional oversight, in my opinion, they will issue extensions or mandates as they seem fit. Congress plays a role in the fact that the Heroes Act had provisions addressing foreclosure forbearance whereby several months would be automatically provided. If this bill passes next year, it could trigger mass forbearance holds outside of any moratorium."

Some states and municipalities have moratoria that include properties not covered by the FHFA rules. Other states, like Florida, started moving forward with legal actions against payments in default.

Van Ness added: "This is a tough time for all Americans, but just like the virus itself, there is not a specific timetable, and all you can do is prepare for the worst, hope for the best."

Even if not forced to by moratoria, servicers will work hard to work out payment plans with mortgage holders, even if it means extending the length of the loans, agreeing to a payment of less than the total amount owed, lowering interest rates, or some combination, according to Diaz. "Servicers will always prefer a performing loan to having to take back ownership of a property."

However, Diaz acknowledged that there will still be a significant percentage of the loans that will go into default and will eventually need to go through the foreclosure process.

Massive Court Backlogs 

That process will be significantly delayed. Once the moratoria lifts, default servicing companies and law firms supporting them will need to work through the backlog of foreclosures and related cases. How to handle these will be determined in part by whether they involve properties in judicial or in non-judicial states.

In the 22 judicial foreclosure states, the lender must file a lawsuit in court to foreclose. In a non-judicial foreclosure state, the lender can foreclose without going through the court system.

The pandemic delayed foreclosure sales for both types of states, so both have significant backlogs to work through.

Some courts were already backed up before COVID became an issue in early March, said Stephen Hladik, partner at Hladik, Onorato & Federman, and Vice Chair of Legal League 100.

According to the midyear report from ATTOM Data Solutions, a handful of states already had foreclosure resolution times of over 1,000 days halfway through 2020–times that are much longer now: Hawaii, 1,558 days; Louisiana, 1,341 days; New York, 1,242 days; New Jersey, 1,202 days; and Indiana, 1,033 days).

Though not at the 1,000+plus level, the backlogs were large in several other states and municipalities. In Philadelphia, for example, there was a large volume of cases already in the pipeline from 2017-2019. When COVID hit, those cases and everything else was put on hold, Hladek said. Once the moratoria end, new cases will increase the backlog as property owners look to enforce collections of rents or mortgage payments.

According to Diaz, depending on how quickly the government starts letting new cases start going to the courts, it could severely constrain law firms. "Firms could receive a large influx of volume very quickly; most won't be able to handle that right away due to staffing and training issues."

Diaz added that most firms have business models based on handling different workflows of cases at different times, not large chunks at a single time, as they could see in 2021.

COVID-19 has also constrained the courts' capacity as the courts, and supporting offices were closed down for a while, delaying some cases that will take precedence over forbearance, foreclosure, and related cases on the judicial calendar.

With local and state tax dollars down due to the pandemic, the courts' resources will also be down, further constricting the flow of cases of all types.

"There will be months of catch up," Diaz said.

Some states have other issues that can backlog cases even further.

Though there wasn't the same backlog in Florida as in Pennsylvania, in the past, a hurricane has resulted in a backlog of six months, said Tony Van Ness, founder of the Van Ness Law Firm, PLC.

In Florida, evictions can proceed on a statewide basis with one note. The CDC had issued an order aimed at residential (landlord/tenant) evictions that enables them to file an affidavit and halt the eviction given they meet the criteria, Van Ness said. "Although this should not apply to REO properties which are not rentals, some courts allow the holdover tenant to claim under this Order. There is also the federal Protecting Tenants at Foreclosure Act that if they meet certain criteria (valid lease in effect, arms-length transaction), they can stall an eviction."

Technology could help break up some of the logjams, according to Hladik and Diaz. At the end of 2020, courts were just starting to conduct some virtual sheriff's sales, which can bring in additional interest from non-local investors than traditional sheriff's sales.

However, Hladik cautioned that any such sales have to have strict cybersecurity measures in place.

In addition to online meetings, some firms have upgraded their internal technology to provide more streamlined processing of workflows, more detailed and accurate reporting, and more efficient handling of files, Diaz said.

Default Servicing Business Slows 

It's not just the mortgage holders and tenants that have been hurt by the pandemic. Default servicing professions feel the impact too.

"There has been an unprecedented drop of default servicing work across the country," Hladik said. "It's been a challenge to determine how to maintain processes, procedures, and safeguards with a much lower volume of work."

As work has slowed, the industry has consolidated, with some leaving the business entirely, Hladik said. "It's a challenge to retain intellectual capital."

"Unlike the Great Recession of 2008-2010, the current crisis isn't the fault of anyone. The consumer didn't do anything to cause this," said Caren Castle, Senior Attorney with The Wolf Firm. So the focus of government action and the default servicing industry has been to help consumers save their homes.

"You've seen sympathetic courts," Castle added. "Some of these people have never missed a payment before."

Though unemployment figures improved in the second half of 2020, Castle pointed out that many–including many in the default servicing industry–were still underemployed, not having the volume of work, commissions, hours, overtime, etc., that they once had.

There will be a continuing strain on consumers and the default servicing industry, Castle said. Even when the COVID vaccines start making their way into the general public sometime in the late winter/early spring, it will be some time before the unemployed and underemployed return to their previous work status.

"There's no appetite to throw everyone out on the street," Castle said.

According to Castle, local, state, and federal officials will be looking for various solutions, some of them borne out of the 2008-10 recession. "We have many more tools now. We focus on customer service rather than collections. There are so many variables. There will be a massive amount of loan modifications."

Chad Neel, Chief Executive Business Officer with McCarthy Holthus LLP, pointed out that the forbearance agreements that put missed payments at the end of mortgages, loan modification offers, and other programs are new or more well-defined since the Great Recession. They will help debtors and servicers alike work through resolutions.

There will undoubtedly be foreclosures as well, Castle and others added. But prices for single-family homes have increased throughout the last year, so many homeowners of single-family properties will benefit from an increase in equity that will enable them to sell their homes, satisfy debts and move into a more affordable home.

In addition to modifications and foreclosures, Castle said she expects a significant increase in bankruptcies, with some default servicing firms shifting much of their business from collection to bankruptcy work.

Many firms handle both foreclosure and bankruptcy work, so as the type of work shifts, they will shift resources accordingly, Diaz and others said.

True Lender Doctrine 

Though COVID-related moratoria, rules, and regulations dominated the default servicing legal landscape in 2020 and will continue to well into 2021, there were other legal developments as well.

In July, the Comptroller's office proposed a rule designed to address the true lender doctrine, intended to determine the true lender in a credit transaction–a bank or a non-bank partner.

Some non-bank partners market loans, identify borrowers, collect applications, and handle other loan-related issues while the bank underwrites the loan. The proposed rule says that the national bank is the lender if it is named in the loan agreement or funds it. Under the proposed rule, the "true lender" determination doesn't change if the bank transfers the loan.

Neel added that there are numerous state laws proposed to delay foreclosures, with resolutions the preferred outcome.

Another pending state law that could have some impact, according to Neel, is California SB 1079, which would, until January 1, 2026, would require the notice of sale to contain a specified notice to a tenant regarding the tenant's potential right to purchase a property containing from one to four single-family residences pursuant to a process the bill would prescribe. In connection with these properties, the bill would require a trustee to maintain an internet website and a telephone number to provide specified information on the properties free of charge and available 24 hours a day, seven days a week.

Existing law, concerning the exercise of a power of sale under a mortgage or deed of trust, requires the sale to be held in the county where the property or some part of it is situated and to be made at auction, to the highest bidder, as specified. Existing law generally requires that if the property consists of several lots or parcels, they are to be sold separately unless the deed of trust or mortgage provides otherwise.

Until January 1, 2026, this bill would prohibit a trustee from bundling properties for sale instead of requiring each property to be bid on separately unless the deed of trust or mortgage provides otherwise. According to Neel, this provision would help prevent large property owners from coming in at the last minute to buy several properties at once.

Other state legislation impacting the default servicing industry in California and elsewhere could emerge later in 2021, but most legislation and the state and federal levels will likely build off the pandemic-related rules adopted last year. They will depend mainly on the progress in fighting the virus and any rebound in the economy and employment.

Find the January 2021 issue in full, here.