When a Mortgage Company Goes Into Bankruptcy

1
When a Mortgage Company Goes Into Bankruptcy

• Robert Franke and Allan Wisk
• Strasburger Price, LLP

2
4,000 homes
? More than 4,000 homes owned and managed by the
firm and its RIMCO subsidiary could be put on the
market, depressing property values in Detroit and
Highland Park. ? Mortgage and land contract
holders worry about losing homes because taxes
and property insurance premiums werent forwarded
and not all monthly payments were credited, court
records show.
Mortgage firms collapse leaves thousands in
limbo and jeopardizes property values.
3
I cant find anyone to fix my furnace, and I just
spent 4,000 of my own money having the roof
fixed, said Mary Watts, who lives on Braille
Street and complained to a bankruptcy court
trustee in March. Now we have rats. Id be
surprised if anything gets fixed.
The Michigan regulator said his investigators
found MCA had taken mortgage payments of
thousands of customers and put them in its
general operating fund rather than crediting
customers accounts.
MCA Financial was servicing about 4,700 mortgages
totaling 355 million and about 7,000 land
contracts valued at 181 million, bankruptcy
court records show.
Dozens of MCA borrowers received foreclosure
notices despite making full monthly payments, . .
.
Most of the homes owned by MCA and managed by
RIMCO are in neighbor-hoods where the average
annual income is less than 10,000, according to
maps generated by the U.S. Department of Housing
and Urban Development.
One example cited in court involves RIMCOs
purchase of a Detroit house for 10,000 at a tax
sale. Within weeks, it mortgaged the house to
outside Investors for 50,000.
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? The company also made payments for a boat owned
by Quinlan and leased six luxury cars for
executives, including a Mercedes 500 SL, two
Cadillacs and two Jeep Grand Cherokees. ? One of
the biggest MCA investors was the Detroit Police
and Firemens Pension Fund, which gave the
company 60 million in unsecured loans. Nick
Degel, administration secretary for the pension
fund, declined to discuss the loan.
? The firms may owe Detroit as much as 5
million in property taxes and an untallied sum in
unpaid water bills.
? The year before MCA laid off 900 employees . . .
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BANKRUPTCY OVERVIEW

• Lender Claim
• Bank Funded Mortgage Originator pursuant to
  Warehouse Line of Credit
• Bank Takes Lien on Mortgages Generated by
  Mortgage Originator
• Perfect Pursuant to Applicable Law

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SECURED CLAIM

• Mortgage Originator Files Bankruptcy
• Automatic Stay - Section 362
• Except as provided in subsection (b) of this
  section, a petition filed under section 301
  operates as a stay, applicable to all entities,
  of
• the enforcement, against the debtor or against
  property of the estate, of a judgment obtained
  before the commencement of the case under this
  title
• any act to obtain possession of property of the
  estate or of property from the estate or to
  exercise control over property of the estate
• any act to create, perfect, or enforce any lien
  against property of the estate

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• any act to create, perfect, or enforce against
  property of the debtor any lien to the extent
  that such lien secures a claim that arose before
  the commencement of the case under this title
• any act to collect, assess, or recover a claim
  against the debtor that arose before the
  commencement of the case under this title and
• the setoff of any debt owing to the debtor that
  arose before the commencement of the case under
  this title against any claim against the debtor.

8

• Ipso Facto Default Clause - Section 365
• Notwithstanding a provision in an executory
  contract or unexpired lease, or in applicable
  law, an executory contract or unexpired lease of
  the debtor may not be terminated or modified, and
  any right or obligation under such contract or
  lease may not be terminated or modified, at any
  time after the commencement of the case solely
  because of a provision in such contract or lease
  that is conditioned on
• the insolvency or financial condition of the
  debtor at any time before the closing of the case
• the commencement of a case under this title or
• the appointment of or taking possession by a
  trustee in a case under this title or a custodian
  before such commencement.

9

• The Lender is Prevented from
• Liquidating Collateral
• Accelerating Loan/Enforcing It against Mortgage
  Originator (IPSO Facto Default Clause - in
  Documents)
• Offsetting Against Obligation of Mortgage
  Originator
• Impact of Bankruptcy
• Collateral Property of Estate Disposed in Plan
• Claim Addressed in Plan
• Bifurcation Secured/Unsecured Claim
• Competing with Other Creditors for Limited Dollars

10

• MCA Financial Corp.Case No. 99-42172U.S.
  Bankruptcy CourtEastern District of Michigan,
  Southern Division
• On January 22, 1999, the MCA entities dismissed
  their 900 employees and ceased operations. On
  January 28, 1999, the Commissioner of the
  Michigan Financial Institutions Bureau appointed
  B. N. Bahadur as Conservator of Debtors.
• On February 10, 1999, Debtors filed voluntary
  Chapter 11 petitions, which cases were
  subsequently consolidated.

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• During the cases, Debtors ceased nearly all
  operations and liquidated most of their assets.
• Lenders holding mortgage loans as collateral
  formed the Bank Group.
• Unsecured Creditors Committee was also formed.
• Many other creditors/interests secured lenders,
  taxing authorities, investors, employees, City of
  Detroit, unsecured creditors.

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Total Number Of Filed Claims 3193
Total Amount Claimed Total Amount Allowed
Unsecured 59,848,278.62    
Secured 158,823,028.40    
Priority 23,571,317.71    
Unknown 73,889,567.08    
Administrative   829,342.57  
Total 316,132,191.81   829,342.57  
13

• Goal of Bank Group to protect position and
  maximize recovery on collateral.
• Financing order entered allow Debtors to
  utilize Bank Groups cash collateral.
• Bank Group did not pursue motion for relief from
  stay (recognizing documentation issues minimal
  value of collateral/expense associated with
  disposition of collateral). Forced to oppose
  numerous motions made by third parties.
• On June 21, 2000, the Court entered an Order
  Approving Settlement Agreement with the Bank
  Group. The Settlement Agreement provided, inter
  alia, that Debtors would receive 40 from the
  sale of all Title-Mismatch Collateral and 25 of
  all related entity collateral.

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• The Debtors Plan
• Debtors filed a Second Amended Consolidated Plan
  and Disclosure Statement on July 19, 2000.
  Confirmed August 21, 2000.
• The Plan was a liquidating plan. The Agent was
  authorized to liquidate the remaining assets of
  the Debtors and distribute them to creditors in
  accordance with priorities established under the
  Bankruptcy Code.

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Class Description Status Amounts
1. Professional Fees and Expenses
2. Other Administrative Expense Claims
3.-9. Various Secured Claims Impaired
10. Holders of Debenture Series 1994 Secured Claim Impaired value of collateral
11. 507(a)(3) Priority Wage Claims Impaired 8,2681 (est)
12. 507(a)(4) Priority Benefit Claims Not Impaired 74,926 (est)
13. 507(a)(6) Priority Deposit Claims Not Impaired 20,382 (est)
14. 507(a)(8) Priority Tax Claims Impaired 1,972,687 (est)
17. General Unsecured Claims Impaired 232,399,222 (est)
18. Subordinated Claims Impaired
19. Claims against Pool Liquidating Trust Impaired
20. Interests Impaired
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• Class 11 wage claimants to receive 25 of their
  allowed claims on the effective date. Class 12
  Benefit Claims and Class 13 Deposit Claims to be
  paid 100 of their allowed claims on the
  effective date. The Bank Group agreed to allow
  use of its cash collateral to fund these payments
  in connection with settlement.
• In general, secured creditors were paid to the
  extent of the value of their collateral. Allowed
  unsecured claims were to receive distributions,
  but only after payments of administrative claims
  and repayment of postpetition and emergency
  loans. Unsecured claims estimated to exceed
  180,000,000. Shareholders would not receive any
  distribution.

17
Bank Group Claim/Implementation of Settlement

• Treatment of Bank Group Claim
• Secured portion equal to value of remaining
  collateral to be paid as liquidated subject to
  surcharge.
• Unsecured balance of claim in separate class of
  unsecured claims.
• Plan provided for Bank Group to receive release
  from Debtors bankruptcy estates, Debtors, The
  Pools, Sigma Financial, Certificate holders in
  the Pools.

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• Bank Group transferred 1450 properties to Pool
  Liquidating Agent.
• Bank Group agreed to provide up to 1,250,000 to
  Plan Agent for post-confirmation expenses and to
  fund priority classes 11-14 in the Plan.
• Agreed to split proceeds of certain notes with a
  face value of 4,204,681.86 with the Debtors.
• Unsecured Claim share pro-rata, but waived
  right to share in first 500,000 distributed.

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• Debtors Liquidation Analysis
• Best case scenario 7.4 distribution to
  unsecured creditors.
• Most likely case 0.

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• Settlement
• On June 13, 2001, this Court entered (a)
  Stipulated Order Transferring Title to HCDC
  consistent with Debtors Second Amended and
  Restated Combined Consolidated Plan Under Chapter
  11 of the Bankruptcy Code and Disclosure
  Statement and (b) Stipulated Order Transferring
  Title to DNDC Consistent with Debtors Second
  Amended and Restated Combined Consolidated Plan
  Under Chapter 11 of the Bankruptcy Code and
  Disclosure Statement. Under the above sale
  orders 1,306 properties that had been surrendered
  to Bank Group for disposition at the Bank Groups
  discretion were sold to the Housing and Community
  Development and the Detroit Neighborhood
  Development Corporation for a total of 7,500,000.

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• Based on the Settlement Agreement, the Agent and
  the Bank Group agreed that 319 of the rental
  Properties sold and 118 of the retail Properties
  sold were Title-Mismatch Collateral, and that 520
  of the rental Properties and 75 of the retail
  Properties were Related Entity Collateral.
• The parties also agreed to a pro-rata
  apportionment of the 7,500,000 sale proceeds of
  3,332 per rental Property and 14,078 per retail
  Property.
• Based on the above, Debtors received 1,786.720
  of the sale proceeds and the Bank Group received
  4,395,471 of the sale proceeds.

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• USA Commercial Mortgage CompanyCase No.
  06-10725U.S. Bankruptcy CourtDistrict of Nevada
• USA Commercial Mortgage Company (USACM),
  which sometimes did business under the trade name
  USA Capital, is a Nevada corporation with its
  main office in Las Vegas. USACM filed a
  voluntary Chapter 11 case on April 13, 2006.
• Prior to the petition date, USACM was in the
  business of underwriting, originating, brokering,
  funding and servicing commercial loans primarily
  secured by undeveloped land and residential and
  commercial developments, both on behalf of
  investors and for its own account.

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• As of the petition date, the loan portfolio USACM
  was servicing consisted of approximately 115
  loans having a combined outstanding balance of
  approximately 960 million.
• USACMs business also included soliciting
  individual investors to purchase fractional
  interest in loans, as well as originating and
  servicing the loans. As of the petition date,
  there were approximately 3,600 investors whose
  names appear as a Lender in the documents for
  one or more of the serviced loans.
• Same story six years later.

24

• Prior to April 2006, USACM regularly made monthly
  interest payments to direct lenders regardless of
  whether the particular loans in which the direct
  lenders had an interest were performing or
  nonperforming. For example, during the first
  three months of 2006, USACM collected on average
  approximately 5.3 million per month in interest
  payments on the serviced loans but paid out on
  average approximately 9.7 million per month to
  the direct lenders.
• It is reported that prior management diverted at
  least 46 million in principal repayments for use
  as interest payments to investors.

25

• USACMs inability to continue making monthly
  payments to all direct lenders was a significant
  contributing factor in the Debtors decision to
  file for bankruptcy protection.
• Another significant contributing factor was an
  investigation by the U.S. Securities Exchange
  Commission. Prior to the petition date, USACM
  and an affiliate received notice from the SEC
  that they were the subject of a Regulatory
  Investigation. Results indicate

26

• USACM made monthly payments to the direct lenders
  regardless of whether the borrower had paid the
  interest due. Full principal repayments by at
  least four borrowers were collected by USACM but
  not disbursed to the appropriate direct lenders.
• Failure to obtain collateral to secure at least
  one loan, loans without properly perfected
  security interests, loans secured by second liens
  and other potential violations of the Nevada
  mortgage lending statute.

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• Many of the non-performing loans appear to have
  been extended to borrowers who were affiliated or
  otherwise related to USACMs pre-petition
  management, such that the owners and officers of
  USACM were partial owners of the borrower
  entities through one or more of their various
  entities.

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• USACMs loan servicing database contained
  substantial errors, including but not limited to
  the following (a) some borrower payments were
  not entered into the system (b) most interest
  payments from borrowers were not posted in a
  timely manner (c) payments were not applied
  according to the governing loan documents, which
  indicate that payments are applied first to
  outstanding interest, then principal (d) the
  amount of interest owed by borrowers was not
  calculated with the correct number of days
  outstanding or correct amount of principal owing
  (e) check numbers used were not in sequence or
  were used multiple times and (f) servicing fees
  were not charged or were calculated incorrectly.

29

• The primary shareholders relinquished
  management authority to Thomas J. Allison of
  Mesirow Financial Interim Management, LLC, who
  became the President, Chief Restructuring
  Officer, and Chief Executive Officer of USACM
  continues to serve in that capacity.

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The Bankruptcy Case
Total Amount Claimed Total Amount Allowed
Unsecured 281,576,090.00  
Secured 169,535,584.00 200,000.00
Priority 5,035,809.00  
Unknown 24,023.66  
Administrative 10,575,543.00  
Total 466,687,885.00 200,000.00
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• Orders approving debtors use of cash to continue
  operating
• Approval of motion to hold funds pending a
  determination of the proper recipients
• Records reconstructed/investors statements mailed
  to all direct lenders and fund members
• 65 million distribution to investors approved by
  Court one of the primary goals of Debtors new,
  post-petition management was to distribute to
  investors, as promptly as possible after the
  initial accounting work and reconstruction of the
  loan records was completed, a significant portion
  of the funds USACM had collected and was holding.

32

• The Plan/Disclosure Statement Filed
• Asset Sale/Liquidating Plan
• USACM and First Trust propose to sell certain
  assets including, servicing rights and specific
  loans, free and clear of liens and interests, to
  SPCP Group, LLC for the total cash purchase price
  of 47.5 million, pursuant to the terms of an
  asset purchase agreement. SPCP is acting as a
  stalking horse. Specific bid procedures have
  been put in place.

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• Plan provides for assumption and assignment of
  agreements to purchaser and distribution of sales
  proceeds and liquidation of remaining proceeds.
• USACM is requesting that the exclusivity period
  to confirm plan be extended to the end of the
  year.

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General Comments on Mortgage Companies in Distress

• 1. Changes in Market Conditions, in the Business
  Environment, Can Take a Company Down.

35

1. When a Mortgage Company Resorts to Fraud to
   either (a) Save the Company, or (b) Make Money, a
   Lot of Innocent Bystanders Get Hurt.

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• 3. Other Notes from Bankruptcy Cases involving
  Mortgage Companies.
• In Re First Alliance Mortgage Company, 298 B.R.
  652 (C.D. Cal. 2003)
• Debtors repayments of fully secured
  obligations, where each payment by debtor results
  in dollar-for-dollar reduction in debtors
  secured debt, do not hinder, delay or defraud
  creditors, and are not avoidable as fraudulent
  transfers, because they do not put assets
  otherwise available in bankruptcy distribution
  out of creditors reach and do not result in
  diminution of debtors estate.

37

• Creditors committee could not set aside, as
  fraudulent transfers subject to strong-arm
  avoidance, payments that debtor had made to
  financial institution that provided it with
  secured warehouse line of credit, where each
  payment that debtor made to financial institution
  to satisfy particular extension of credit
  resulted in release of mortgages with value in
  excess of amount repaid, which payments did not
  result in diminution of estate assets available
  to debtors creditors.

38

• In re SGE Mortgage Funding Corp. 278 B.R.
  653(Bkrptcy. M.D. Ga. 2001)
• Residential mortgage brokers assignment of its
  interest in mortgage notes and in mortgages
  securing them to investors who funded its
  mortgage loan businessthe fact that these
  assignments were or were not recorded had no
  bearing on whether investors interest were
  perfected. Perfection could only be
  accomplished if investors took possession of
  the notes.

39

• In re Leedy Mortgage Company, Inc., 111 B.R. 488
  (Bkrtcy. E.D. Pa. 1990)
• Mortgagees, whose accounts the debtor had agreed
  to service, were not entitled to secured claims
  for shortages in accounts, as funds which debtor
  had misappropriated could not be traced and
  mortgagees were unable to identify any specific
  property held by debtor at time of Chapter 7
  filing that belonged to any of the mortgagees.

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BANKRUPTCY CODE CHANGES IMPACTING MORTGAGE
WAREHOUSE LENDING
Recent amendments to the Bankruptcy Code may
however provide a way for a lender restructure
its transactions with the mortgage originators to
lessen, and possibly eliminate, the costs of a
mortgage originators bankruptcy to lender.

• Since 1984, non-debtor participants in repurchase
  agreements involving certain financial
  instruments have enjoyed special protections
  under the Bankruptcy Code.

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• (1) enforceability of ipso facto default clauses
  in the repurchase agreement,
• (2) limited exemptions from the automatic stay,
• (3) additional defenses to preference claims
  asserted by a trustee or debtor-in-possession.
• In 2005, Congress amended Section 101(47)(A)(i)
  of the Bankruptcy Code to include mortgage loans
  as a type of financial instrument that could be
  the subject of a repurchase agreement and thus
  entitled to the protections afforded such
  agreements under the Bankruptcy Code.

42

• Bankruptcy Code Definitions
• 11 U.S.C. 101(46) The term repo participant
  means an entity that at any time before the
  filing of a petition has an outstanding
  repurchase agreement with the debtor.
• 11 U.S.C. 101(47)(A)(i) The term repurchase
  agreement means an agreement, including related
  terms, which provides for the transfer of one or
  more mortgage loans with a simultaneous
  agreement by such transferee to transfer to the
  transferor thereof mortgage loans ..., at a
  date certain not later than 1 year such transfer
  or on demand.

43
Benefits Afforded to Repo Participants under the
Bankruptcy Code which are not Available to
Secured Lenders

• Contractual Right to Liquidate, Terminate, or
  Accelerate a Repurchase Agreement
• 11 U.S.C. 559 which provides that the
  exercise of a contractual right of a
  repo-participant to cause the liquidation of a
  repurchase agreement because of a condition
  described in section 365(e)(1) shall not be
  stayed, avoided, or otherwise limited by
  operation of any provision of this title or by
  order of a court in any proceeding under title 11
  of the United States Code.

44

• Allows for the enforcement of so-called ipso
  facto default clauses in the repurchase
  agreement which generally allow for acceleration
  of the term of repurchase agreement, termination
  of the repurchase agreement, and/or liquidation
  of the securities held as part of the repurchase
  agreement.

45

• Exemption from Application of the Automatic
  Stay for Setoff Rights
• 362(b)(7) provides that a bankruptcy filing does
  not operate as a stay of the setoff by a repo
  participant, of any mutual debt and claim under
  or in connection with the repurchase agreements
  that constitutes a setoff of a claim against the
  debtor for a margin payment, as defined in
  section 741 or 761 of this title, or settlement
  payment, as defined in section 741 of this title,
  arising out of repurchase agreements against
  cash, securities, or other property held by,
  pledged to, under the control of, or due from
  such repo participant.to margin, guarantee,
  secure or settle repurchase agreements.

46

• 11 U.S.C. 362(o) provides that the rights not
  subject to the stay pursuant to 362(b)(7) shall
  not be stayed by any order of a court or
  administrative agency in any proceeding under
  title 11 of the United States Code.

47

• Affirmative Defense to Avoidance Actions
• The Bankruptcy Code and applicable state law
  provide a debtor-in-possession and/or a trustee
  with the power to avoid certain pre-petition
  transfers of property of the debtor. See 11
  U.S.C. 544-551.
• 11 U.S.C. 546(f) which provides
  Notwithstanding sections 544, 545, 547,
  548(a)(1)(B), and 548(b) of this title, the
  trustee may not avoid a transfer that is a margin
  payment as defined in section 741 or 761 of this
  title or settlement payment, as defined in
  section 741 of this title, made by or to a repo
  participant, in connection with a repurchase
  agreement and that is made before the
  commencement of the case, except under
  548(a)(1)(A) of this title.

48

• 11 U.S.C. 741(8) defines settlement payment
  as a preliminary settlement payment, a partial
  settlement payment, an interim settlement
  payment, a settlement payment on account, a final
  settlement payment, or any other similar payment
  commonly used in the securities trade.

49

• Impact of Amendments
• The amendments to The Bankruptcy Code were
  intended to address the uncertainty of the
  characterization of the transactions as either
  financial contracts or ordinary loans
• Commentators believe that all repurchase
  agreements are explicitly covered by the
  definition of Securities Contract and intended
  to eliminate any inquiry as to whether a
  repurchase or reverse repurchase transaction is a
  purchase and sale transaction or a secured
  financing.

50

• Prior to the amendment there were a number of
  cases interpreting whether a contract was a true
  repurchase agreement or a secured transaction.
  In almost every instance where a legal
  characterization of a repurchase has been
  litigated, the court ruled that the agreements in
  question were ambiguous and consideration of
  extrinsic evidence was required before a final
  determination on the legal character of the
  agreement could be made.

51

• In Bevill, 67 BR. 557 (D.N.J. 1986) the court
  concluded that the selected inclusionof terms
  customarily found in secured loan transactions
  does not automatically convert the repurchase
  agreements into secured loan instruments and
  does not nullify the express language of purchase
  and sale which the parties voluntarily choose to
  describe their transactions. However, the
  presence of such terms in the agreements does
  raise sufficient doubts as to the intent of the
  parties to justify examination of extrinsic
  evidence of intent.

52

• Conclusion
• The protections and benefits given to repo
  participants in a bankruptcy case are completely
  at odds with the primary purpose of the
  Bankruptcy Code the maximization of the
  debtors assets for the benefit of all creditors.
  Consequently, debtors and/or trustees are going
  to be preconditioned to litigate the character of
  purported repurchase agreements if there are
  contradictory terms in an agreement.
• It remains to be seen if the debtors and/or
  trustees will acknowledge that the repurchase
  agreements are protected transactions that fit
  within the formal definitions developed in the
  marketplace and included in the Code.