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Mortgage Industry Needs to Prepare For Litigation Now as Pandemic Portends Market Turmoil Mortgage Industry Needs to Prepare For Litigation Now as Pandemic Portends Market Turmoil

Mortgage Industry Needs to Prepare For Litigation Now as Pandemic Portends Market Turmoil

Home ownership has long been part of the American dream. Increasing unemployment and rising loan defaults threaten to turn that dream into a nightmare from the Great Recession of 2008. Mortgages are not just an American ideal; they are an integral investment for millions of Americans. Indeed, mortgages are still made, packaged, and sold. But when mortgagors cannot pay, investors suffer, and suffering breeds lawsuits. 

Lenders, servicers, investment managers, and other mortgage industry participants should not ignore the signs. Instead, they must heed the lessons of the Great Recession and prepare today for the litigation of tomorrow.    
 
  1. Trouble is Brewing
In the wake of the Great Recession, millions of American households underwent foreclosure. Amid other reported causes, a rise in subprime mortgages, lax underwriting guidelines, and increasingly complicated securitizations of mortgages contributed to the chaos.

A decade later, for many, the financial crisis may seem like a distant memory. We have experienced a decade of economic growth. But even before the COVID-19 pandemic, America’s economic condition was not as stable as most believe. A recent report from the Financial Health Network demonstrates that the majority of Americans belie the illusion of financial stability. Specifically, according to the Financial Health Pulse 2019 Trends Report, only 29% percent of Americans are financially healthy, whereas 43 million individuals are financially vulnerable and 135 million are struggling. Indeed, 12% of survey respondents did not have a week’s worth of living expenses saved, and 55% of individuals aged 26-49 did not have three months of living expenses saved.
  
And now, as a result of the pandemic, the vast majority of the country is sheltering in place, and millions of Americans have lost their jobs in just the last two months. Like workers, businesses and entire industries are struggling, resulting in the passage of the CARES Act. The Act provided emergency relief funds to millions of Americans and over a trillion dollars in relief to U.S. businesses. The Act also imposed a 90-day foreclosure moratorium on all GSA-backed mortgage loans. 
Despite these steps, millions of Americans find themselves unemployed and loan defaults are on the rise. Indeed, recent reports indicate that millions of mortgages are in forbearance—a significant jump in mere months. 
 
  1. Déjà vu all over again—Defaults will impact investments and spur litigation
Pain shared is pain lessened. During the Great Recession, those impacted sought to lessen their pain via litigation. Defaults led to foreclosures; foreclosures spawned reduced returns for mortgage-backed investments; and economic trouble begat endless lawsuits. Shareholders sued companies that had invested heavily in mortgage markets. Consumers sued lenders and loans who they believed had defrauded them. Investors sued mortgage trustees. Trustees sued the lenders from whom they had purchased the loans, and so on. Counterparties became adversaries and friends transformed into foes. 

Today, though residential mortgage-backed securities (MBS) are less prevalent, mortgages—both commercial and residential—are still common collateral for a host of investment vehicles. There are mortgage real estate investment trusts (mortgage REITs), MBS, and collateralized loan obligations. 

And as in crises past, as these investments lose value, dissatisfied investors will seek to share the pain. In late March, for instance, the Royal Bank of Canada was sued by a commercial mortgage REIT after the lender made margin calls based on the declining value of commercial mortgage backed securities due to the crisis. 
 
  1. Mitigating Risk in Advance of a Potential Litigation Boom
If past is prologue, then cases like the aforementioned REIT dispute will just be the start for lenders and others in the mortgage industry. Anticipating and preparing for litigation could greatly reduce litigation risk and exposure going forward. To that end, businesses can take a number of measures now. 

First, industry participants should be careful to monitor and adjust for new legislation and new regulations. The failure to follow new rules and regulations is certain to yield lawsuits, fines, and increased litigation costs. 

For example, the Making Home Affordable (MHA) program of the United States Treasury was launched in 2009 as part of the Troubled Asset Relief Program. The largest program within MHA was the Home Affordable Modification Program (HAMP). HAMP’s goal was to offer homeowners who were at risk of foreclosure reduced monthly mortgage payments that were affordable and sustainable over the long-term. While a potential boon for borrowers, lenders and servicers who failed to heed HAMP modification requirements faced costly lawsuits and fines.  In today’s crisis, the CARES Act’s foreclosure moratorium could similarly spell trouble for any lender/servicer who seeks to collect on a defaulted GSA-backed loan. And as the crisis continues, we are certain to see additional legislation aimed at keeping Americans in their homes. 

Next, companies should revisit their contracts. The mortgage industry is rife with loan sale agreements, servicing agreements, and investment agreements. Each type of agreement contains various obligations and representations. In the Great Recession, lenders, servicers, and other businesses were targeted in repurchase and other litigation for allegedly failing to comply with the underlying contracts. Today’s mortgage industry businesses should be careful to understand the scope of their agreements and how courts have interpreted similar clauses in the past (such as during the recent Financial Crisis). 

In addition, businesses should re-evaluate and re-consider their communications policies. In today’s economy electronic communications are ubiquitous. The Email Statistics Report estimated business would send 293 billion emails daily in 2019, and that number was only projected to rise in coming years. Emails are a common source of the sought-after litigation smoking gun. An effective, thorough communications policy, however, can help mitigate the risk that an employee’s colorful or sarcastic quip comes back to haunt your company in future litigation. 

Finally, industry participants can plan ahead by taking a closer look at their lending, servicing, and other internal policies and procedures—paying close attention to how their actions are documented. Litigators focus on what they can prove, often relying on the electronic breadcrumbs (i.e., emails and other documents) that businesses produce.  
Litigators, moreover, not only focus on what documents exist, but also what documents do not.  In myriad repurchase actions in the last decade, for example, plaintiffs’ lawyers highlighted lenders and servicers purported failure to follow their own processes and approved procedures, focusing on a lack of documentation. Businesses can avoid a similar fate by both ensuring that their policies and procedures are followed and that compliance is documented. 

The lessons and legacy of the Great Recession are still fresh in the minds of many attorneys. Preparing now can help companies in the event that the current pandemic and impending downturn push mortgage industry participants to seek to share their pain.

Justin Steffen is a litigation partner in Ice Miller LLP’s Chicago Office, a recognized FinTech trailblazer, a law professor focused on emerging technologies, and a cited authority on lending and technology issues. He has litigated cases for myriad traditional and FinTech lenders over the last decade. Bob Emanuel serves as counsel in Ice Miller LLP’s Chicago Office. For over 20 years, Bob has defended mortgage lenders and loan servicers in class and individual actions that arise under consumer lending statutes such as the Real Estate Settlement Procedures Act, the Fair Credit Reporting Act, and the Fair Debt Collection Practices Act. 

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader’s specific circumstances.   
 
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