The Return of the Mortgage Cramdown?

Washington Revives the Mortgage Cramdown
As foreclosures continue to surge, congressional Democrats are pitching courtroom solutions to homeowners' woes. The Administration is wary

By Theo Francis

With foreclosures continuing to climb and midterm elections just a year away, Congress once again is preparing to tackle the mortgage crisis aggressively. High on many a wish list: a renewed push to allow so-called cramdown, which would let bankruptcy judges adjust the terms of home loans to give borrowers relief.

The banking industry hates cramdown (from the idea of cramming deals down lenders' throats), but Democrats argue that earlier efforts to fix the housing mess have not done as well as hoped. Moody's Economy.com (MCO) estimates that 3.8 million homes will enter foreclosure this year, up 41% from 2008. No surprise, then, that lawmakers are getting an earful. "We have folks calling our office every day," says Senator Jeff Merkley (D-Ore.), who is pressing Treasury to streamline its program to restructure mortgages.

"TRYING TO LIGHT A FIRE"

So Capitol Hill is poring over more ideas. One bill, introduced by Senator Jack Reed (D-R.I.) on Sept. 30 and co-sponsored by Merkley and two other senators, would force lenders to pause before they foreclose and to offer borrowers a break on their mortgage bill if they qualify for help under the Treasury program. Under the same proposed law, states could require mortgage servicers to enter mediation with borrowers before being allowed to foreclose. The bill also would give the states $6.4 billion to help homeowners stay put. "We're really trying to light a fire under the Administration," Merkley says.

Others in the Senate are considering the temporary suspension of home-loan payments or brief monthly mortgage subsidies for unemployed homeowners. House Financial Services Committee Chairman Barney Frank (D-Mass.) is drafting similar legislation.

The Administration is considering new options, too. One would support the broader housing market by extending a homebuyer's tax credit and making it easier for Fannie Mae (FNM) and Freddie Mac (FRE) to finance mortgages. Another would fund state housing agencies and independent mortgage banks. A Treasury spokeswoman noted that the Administration's programs have done more than previous efforts but said it "aggressively continues to build on our progress to date."

Many congressional Democrats think mortgage lenders need to feel the lash before they'll speed up mortgage workouts. Those critics, led by Senator Richard J. Durbin (D-Ill.), figure banks and mortgage servicers will do their best not to cut principal or interest rates on a mortgage. Lenders want to avoid, or at least delay, the loss they take from lowering what homeowners must pay, critics say. And despite an Administration plan that gives subsidies to mortgage servicers who agree to rework loans, many believe the service firms still gain too much from the fees they collect in foreclosure to bother working out a loan.

Durbin and other lawmakers are calling on Democrats to support what is seen as the party's nuclear option: cramdown. The proposal, which sailed through the House last spring, only to stall in the Senate on a 45-51 vote, authorizes bankruptcy courts to adjust mortgages. If Durbin's bill were to pass, a judge could reduce principal or interest rates on home loans and stretch out mortgage payments—something bankruptcy courts can do already with virtually every other kind of debt.

Supporters say cramdown would free homeowners from debt they can't afford while prodding lenders to cut deals before reaching the courthouse. A bankruptcy-court solution would also cost taxpayers little or nothing. Detractors argue cramdown would spook the mortgage market, driving up borrowing costs and making loans harder to get.

Undeterred, Durbin, the second-ranking Senate Democrat, is willing to attach a cramdown provision to any convenient bill if it won't get a hearing on its own. The proposal "will always be part of the conversation, if for nothing else than to scare the [daylights] out of everyone," says one senior Senate aide.

The financial industry, which used major muscle to kill the provision last spring, is arming for the fight, too. "The vote in the Senate was so overwhelmingly close, we're always worried," says one lobbyist. The big banks are leaning on community banks for help: These institutions were largely innocent of the worst excesses of the crisis and tend to be viewed much more favorably on Capitol Hill. "We are kind of the white hat," says a lobbyist for smaller financial institutions. "You'll see a lot of the industry try to hide behind us."

Given the industry's stance, supporters of cramdown say a forceful campaign by the White House would help. President Barack Obama supported it during the campaign and soon after his election, while his chief economics adviser Lawrence H. Summers wrote columns in favor of the proposal last year. But congressional sources say the Administration did little to push for passage of the bill last spring—possibly because Obama was reluctant to place further stress on already fragile banks. Now one Treasury official says the department has "no immediate plans" to revive the measure. Yet even without stronger White House support, Durbin might attract enough senators to embrace the bill if foreclosures continue to surge.

With Jane Sasseen in Washington

Francis is a correspondent in BusinessWeek's Washington bureau.

Copyright 2000-2009 by The McGraw-Hill Companies Inc. All rights reserved.

Junior Mortgages in Bankruptcy

At Shenwick & Associates, we hear from many clients who have multiple mortgages on their property and want to stay in their home while reducing their debt burden. Chapter 13, which allows individual debtors to reorganize their debts and pay off secured creditors, is often a good choice for these clients. However, the treatment of unsecured junior mortgages has been a confusing one for both Debtors and Bankruptcy Courts alike.

In In re Pond, 252 F.3d 122 (2d Cir. 2001), the Second Circuit Court of Appeals held that a Debtor could void a wholly unsecured junior mortgage loan. The Debtors in In re Latimer, (Bk. No. 08-21242, Bank. W.D.N.Y., Ninfo, J., Oct. 27, 2008) wanted to bifurcate a second mortgage on their house into a secured claim and an unsecured claim, arguing that Pond didn’t address the plain language of 11 U.S.C. §§ 1322(c)(2) and 1325(a)(5)(B), which appears to specifically allow this type of bifurcation.

Relying on precedents from other Circuit Courts of Appeal, the Bankruptcy Court agreed and held that the Debtors could bifurcate the second mortgage on the real property into an allowed secured claim and an unsecured claim. Although the Second Circuit Court of Appeals (which has appellate jurisdiction over cases from New York) has not yet considered this issue, this case provides authority for debtors to bifurcate and strip down undersecured junior mortgages on their home in Chapter 13.

For more information about Chapter 13 bankruptcy and how to preserve the equity in your home in bankruptcy, please contact Jim Shenwick.

Bloomberg News: Consumer, Celebrity Bankruptcies May Hit 1.4 Million

By Linda Sandler and Andrew M. Harris

Aug. 10 (Bloomberg) -- Consumer bankruptcies show no sign of abating after rising more than a third this year and may hit 1.4 million by Dec. 31 as jobs are lost and loans are harder to get, according to the American Bankruptcy Institute.

More than 126,000 consumers filed for bankruptcy in the U.S. last month, 34 percent more than in July 2008, the ABI said in its latest report on Aug. 4. The increase came after a 36.5 percent rise in personal bankruptcies nationwide in the first six months, to 675,351, according to the ABI research group, which interprets data collected by the National Bankruptcy Research Center.

“Rising unemployment on top of high pre-existing debt burdens is a formula for higher bankruptcies through the end of this year,” ABI Executive Director Samuel Gerdano said in a statement. The group, composed of lawyers, accountants, bankers and judges, is based in Alexandria, Virginia.

Debt problems don’t stop with sub-prime borrowers. Celebrities who filed for bankruptcy in July included movie actor Stephen Baldwin, who sought protection from creditors after lenders began foreclosure procedures against his home. Lenny Dykstra filed for Chapter 11 bankruptcy in a petition that says the former Major League Baseball All-Star owes between $10 million and $50 million.

Banks Hurt

Also last month, con man lawyer Marc Dreier’s luxury Manhattan condominium sold for $8.2 million, 21 percent less than what he paid two years ago, in an auction at U.S. Bankruptcy Court in Manhattan. Proceeds will be used to pay creditors in Dreier’s bankruptcy case and victims of Dreier’s fraud, said Salvatore LaMonica, trustee in the Chapter 7 bankruptcy case.

Steeply rising filings by consumers are hurting commercial banks. JPMorgan Chase & Co., the second-largest U.S. bank, predicted more losses on consumer loans last month even as it announced a rise in second-quarter profit on record investment banking fees. Chief Executive Officer Jamie Dimon said he doesn’t expect the credit card business to make a profit this year or in 2010, and the company increased its loss projections for prime and subprime mortgages.

Credit Card Losses

JPMorgan said losses in its Chase credit-card portfolio may be 10 percent next quarter and will be “highly dependent” on unemployment after that. Losses for cards issued by Washington Mutual, which the bank acquired in September, may reach 24 percent by the end of the year, the company said.

JPMorgan’s credit cards lost $672 million, compared with income of $250 million in the second quarter last year. Home- equity charge-offs climbed to $1.3 billion, or 4.61 percent. Prime mortgage defaults rose to $481 million, or 3.07 percent, from $104 million, or 1.08 percent a year earlier.

Dimon, 53, said the company supported “proper consumer protection” and that pending legislation setting up an agency to monitor consumer lending practices would hurt short-term profits in credit cards.

Congress, in October 2005, enacted the Bankruptcy Abuse Prevention and Consumer Protection Act, a legislative reform package intended to make it harder for consumers to get court orders wiping out their uncollateralized debt.

The act required debt counseling and a means test for would-be filers.

Copyright 2009 Bloomberg L.P. All rights reserved.

Short Sales of Real Estate

At Shenwick & Associates, with the continuing fall in the value of real estate, we have received many inquiries regarding short sales of real estate (where the balance on the loan exceeds the value of the real estate in residential or commercial properties). Section 363 of the Bankruptcy Code concerns the use, sale or lease of property, and has been in the news of late with the GM and Chrysler bankruptcies. There are two ways to sell real estate or other assets in bankruptcy. One is pursuant to Section 363 of the Bankruptcy Code, and the other is pursuant to a confirmed bankruptcy plan.

While Section 363 is the quicker way to sell assets, there is a benefit to selling real estate through a confirmed bankruptcy plan, due to the fact that the seller (the bankrupt entity or individual) will not have to pay city or state real estate transfer taxes, based on the U.S. Supreme Court case Florida Department of Revenue v. Piccadilly Cafeterias, Inc., 554 U.S. __ (2008). Accordingly, it may be beneficial to all parties for the debtor to file a simple, boilerplate Plan and Disclosure Statement and then sell the real estate pursuant to that Plan.

Recently, Shenwick & Associates represented a lender who was foreclosing on a property in which the borrower's principal had guaranteed the debt. The borrower filed for Chapter 11 bankruptcy to stay the foreclosure. A deal was reached in which the property would be conveyed to the secured lender pursuant to a confirmed Chapter 11 Plan. The transaction was a win-win situation for all parties. The debtor was able to transfer property that was "underwater," the debtor's principal was relieved of liability under his personal guaranty and the secured creditor obtained title to property, without paying city and state transfer taxes.

Any parties having questions regarding this or other transactions involving real estate in bankruptcy should contact Shenwick & Associates.

NYT: Stores Go Dark Where Buyers Once Roamed

By CHRISTINE HAUGHNEY

Among the marks of Manhattan’s prosperity in recent years were the thousands of restaurants and shops that opened to meet an ever-growing demand. Confident in the appetite for spending — on expensive shampoo at 24-hour drugstores, cheese plates at sleek wine bars and clothes at minimalist boutiques — store owners signed high-rent leases with little haggling.

But as New Yorkers have drastically cut back, the shops that line the streets, from chain outlets to family-run shops, have started to disappear.

The storefront vacancy rate in Manhattan is now at its highest point since the early 1990s — an estimated 6.5 percent — and is expected to exceed 10 percent by the middle of next year, according to data gathered by Marcus & Millichap Research Services, a national real estate investment brokerage based in Encino, Calif.

And those numbers do not capture the full story. Some of the more desirable shopping districts are littered with empty storefronts. For example, Fifth Avenue between 42nd Street and 49th Street, the stretch just south of Saks Fifth Avenue, has a vacancy rate of 15.3 percent, according to the brokerage Cushman & Wakefield.

In SoHo, from West Houston Street to Grand Street and Broadway to West Broadway, among the high-end boutiques, art galleries and restaurants, 1 in 10 retail spaces are now empty or about to be.

“I’ve never seen such an across-the-board problem,” said Lorraine Nadel, a lawyer who has represented tenants and landlords for 18 years. “Store owners can’t pay their rent, and they can’t keep their businesses going.”

It has long been difficult to run a small business in Manhattan, but a number of struggling store owners cite high rents and their landlords’ unwillingness to negotiate as the leading obstacles to their survival.

“It’s a crisis,” said Stephen Null, director of the Coalition for Fair Business Rents, which has been promoting legislation to protect small businesses in lease negotiations since 1984. “Lease renewals are the single biggest killer of small businesses in New York City.”

Manhattan, with its high density, high incomes and near-constant foot traffic, has maintained a strong storefront culture while other urban areas have seen their downtowns empty out and lose customers to suburban malls.

Stores and restaurants in New York are open longer hours, increasing the potential for revenue, and residents tend to shop near where they live, if just by necessity.

But because stores are such a part of their neighborhoods, the closings can have more of an emotional impact on residents.

“New York is different than the rest of America because it is the last bastion of storefronts,” said Kenneth T. Jackson, a historian at Columbia University. “You don’t live in a city of eight and a half million people. You live in a city of neighborhoods.”

“We feel a loss when the store is gone,” he added.

In one block alone, on the west side of Lexington Avenue between 74th and 75th Streets, three stores have closed in the past few months: a women’s clothing shop called Cantaloup, a luggage shop and a design store — places that the locals say had thrived for years. Those closings followed that of a sandwich shop across the street.

“The fabric of the neighborhood is up for grabs right now,” said Elaine Abelson, a professor of history at the New School who has lived in the neighborhood for 35 years.

The outlook is even worse in other boroughs. Hessam Nadji, managing director of research services at Marcus & Millichap, estimates that vacancy rates in Brooklyn and Queens, currently at 7 to 10 percent, will rise to 12 to 15 percent by year’s end. He said some neighborhoods have been ravaged by vacancy rates of 25 to 40 percent.

The problem is so bad that the city has become involved. It has offered grants for worker training, and it held a session last Wednesday on how to negotiate leases. Scott M. Stringer, the Manhattan borough president, held a conference called “Rescue and Recovery for Small Businesses” on July 13 that drew 320 people, among them owners of an organic grocery store, a wine bar, and a coffeehouse and bookstore who swapped advice on how to keep their businesses afloat.

High rents in the recession are the “last straw for small business in New York City,” Mr. Stringer said, “and I hear it everywhere I go.”

Without these storefronts, he said, the city loses “our special sauce that gives us our panache.”

The City Council is weighing in, too, considering a Small Business Survival Act that would require businesses to have the option of 10-year leases, renewals and the right to mediation if they cannot reach an agreement.

The legislation does not have the support of the Bloomberg administration, which argues that tracking lease negotiations would be too costly because of expenses like hiring staff, and that the need for such a law has “greatly dissipated” because rents have declined.

But as jobs disappear and neighborhoods suffer, the tide of opinion is growing that the government may need to step in. While data on the challenges of small business owners is limited, a survey of 937 Hispanic small business owners conducted by the U.S.A. Latin Chamber of Commerce between November 2008 and January 2009 found that most of them said they would not stay in the city because their rents had become so high.

The closing of stores has started to chip away at the city’s tax collections. Sales tax revenues have declined by 3 percent through May, to $4.15 billion from $4.3 billion the year before, according to the city’s Office of Management and Budget.

Some neighborhoods seem better positioned to hold on to their storefronts. Times Square has had relatively fewer closings because more people have been staying in town for vacations and attending Broadway shows, said Tim Tompkins, president of the Times Square Alliance. Doug Griebel, president of the Columbus Avenue Business Improvement District and an owner of the Rosa Mexicano restaurants, said there were only two vacant storefronts on Columbus between 67th and 82nd Streets.

Gary Schwartzman, broker with Grubb & Ellis, a commercial real estate firm, said many landlords were trying to find ways to keep retail businesses open.

“The risk of losing a good tenant is something that landlords don’t want,” Mr. Schwartzman said. “Right now, it’s all about tenant retention.”

Ms. Nadel, the lawyer, says that if a landlord tells her that he or she will not negotiate with tenants, she points to a stack of eviction files and says the chances of finding a new tenant are slim.

“You can’t maintain the rents,” she says she tells them. “People have run through their savings. They’ve run through everything.”

Copyright 2009 The New York Times Company. All rights reserved.

Closing Down a Business

In these trying economic times, many clients have contacted us about closing down their business. One of the questions we’re often asked is, “Is it better to file a business Chapter 7 bankruptcy or just close down the business (also known as "going dark")?”

In general, if a company has assets that can be sold, or is concerned about an orderly liquidation of assets, or if they want or need an independent third party (i.e. a bankruptcy trustee) to close a business to protect their reputation in their industry, then they should consider a chapter 7 bankruptcy filing. However, for many businesses, going dark may be more beneficial and less costly. If a company wants to wind down its business in an orderly manner, the following actions should be taken by the company’s management:

1. The Board of Directors should adopt a resolution closing the business;

2. All members (in an LLC) or directors should resign from the Board of Directors;

3. The company should terminate and pay all of its employees;

4. Secured creditors (such as equipment vendors) should be notified and asked to remove their property from the company’s premises;

5. A shutdown letter should be sent to all unsecured creditors, employees and shareholders notifying them that the business is closing;

6. If shareholders or principals have guaranteed a lease, or if a good guy guaranty is in effect, the company should negotiate a settlement with their landlord; and

7. The company’s accountant should finalize and file all tax returns, which should be indicated as final returns, and all taxes should be paid.

The decision as to whether a company should file for bankruptcy or close down is a complicated one that requires assessing many variables and should be made in consultation with an experienced bankruptcy attorney. Anyone having questions regarding corporate bankruptcy or the closing down of businesses should contact Jim Shenwick.

Village Voice: An Unlikely Rescuer from the Jaws of Debt

By Elizabeth Dwoskin

By 9:30 a.m., the 11th-floor hallway of a courthouse in downtown Brooklyn is filled with tight huddles made up of people in debt and the lawyers who are after them to pay.

The goal of the conferences is almost always the same: to cut a deal in the hallway before going into the packed courtroom to appear before the judge.

The people who owe money are anxious. They ask legal advice from just about anyone wearing a suit. The attorneys, for their part, talk to them sweetly about how to settle their cases.

Some of the people are angry, and some are confused—they had no idea they were in debt until letters came in the mail announcing they were being sued.

But if there's a dispute, the lawyers are quick to blame the collection agencies—their employers—for not giving them the correct paperwork or enough information. They reassure the debtors that everything will be taken care of quickly. And the people seem to believe them—better to settle things with these nice people in the hall who give them the impression that it's the proper procedure.

Beverly Smith, an African-American woman in her late forties, has already come to court three separate times. She works in the bridal section at Bloomingdale's and found out the hard way that someone believed she owed money—she received a letter stating her wages would be garnished.

Believing she was a victim of identity theft, she went to the police to file a report. But they handed her some forms to fill out and told her there was nothing they could do.

The first time that Smith came to the courthouse, an attorney from a firm called Pressler and Pressler, working for an agency called Palisades Collections, told her that in order to prove she didn't owe the money, she needed to fax them proof of her residency and a copy of her Social Security card. The second time, a different attorney from the same firm told her in another hallway conference that he had never received her fax and didn't have enough information to verify her identity. The third time, in April, the lawyer still didn't have the paperwork he required, so Smith agreed to a fourth court date.

She's tired of taking days off to come back to court. "I told the lawyer: Enough is enough," she says. She's determined to make her fourth court date, in June, her last. It has never occurred to her to ask to see a judge.

Time and again, people in the hallway insist that they've provided the correct documentation, that the debts aren't theirs, and that there's been a mistake. The attorneys, however, explain in reassuring tones that it's best just to settle matters with a payment to make it all go away, or to schedule yet another court date later on. It's better not to get the judge involved.

After the hallway conferences, the people file into the packed and noisy courtroom.

And then, something unusual happens.

A man and an older woman are called up to appear before the bench. They ask for a Russian interpreter. Through the interpreter, the man explains that the woman is being falsely accused of a debt, and that the lawyer suing her can't prove that it was hers. After some questioning, the collection agency's attorney concedes that, in fact, he doesn't have the documents he needs to prove that she owes the money. He asks for more time.

The judge, a small man with a tight beard and a yarmulke, refuses. With a wave of his hand, he dismisses the case.

"Dasvedanya," he says to the couple in Russian, and tells them they can be on their way.

But the couple doesn't budge. Stunned, they can't believe that the ordeal is so suddenly over.

"God bless you, sir," the man says to the judge.

"Have a nice day," he answers.

On the way out of the courtroom, the judge sees the Russian man stopping to say something to the lawyer who sued him and lost.

"Don't talk to him," the judge orders.

The couple shuffles out the door.

It's a scene that will be repeated over and over again in the courtroom of Judge Noach Dear, as he repeatedly dismisses lawsuits, denies attorneys seeking payment, and sends people on their way, amazed that they are free from further harassment by collection agencies.

Twice on a recent morning, his rulings are met with standing ovations.

The straightforward, clear-eyed justice being meted out in Dear's debt court sessions is not what many were expecting from a man who, they assumed, would be a disastrous addition to the local judicial system.

In fact, Noach Dear's reputation was so lousy from his years as one of the City Council's most reprehensible members, some predicted calamity once Dear—who had never practiced law—donned judge's robes.

The New York City Bar Association found Dear "unqualified," and the Brooklyn Bar Association refused to endorse his candidacy, but his political connections and name recognition in the district made his election in 2007 all but foreordained.

An Orthodox Jew from Borough Park, Dear was a City Councilman for 18 years, serving for a decade on the Transportation Committee, until, in 2001, term limits forced him to seek a new job. He then served for six years on the city's Taxi & Limousine Commission.

In Borough Park, Dear was known as a fixer with the juice to make things happen, but he's also been ridiculed for his ham-fisted manner. In 1996, for example, Dear was a top fundraiser for Bill Clinton and Al Gore—at a fundraising dinner, Dear walked a New York Times reporter over to Clinton and said to him, "Tell her what you think of me."

Time and again, Dear has been criticized for dubious schemes: In the late 1980s, he started a foundation called Save Soviet Jewry, assigned himself a salary, and then proceeded to spend the organization's money flying himself and his family first-class on fact-finding missions to Russia and Israel. In 1993, Attorney General Robert Abrams made him repay the foundation $37,000. He was prohibited from ever starting a charity again.

And talk about tone-deaf: As chairman of the City Council's Human Rights Commission, Dear organized a trip to South Africa—but the Council's black members pulled out when they found the trip was sponsored by the white pro-apartheid government. Dear also got involved advocating for a group of ethnic Tamils that had fled the violence of their native Sri Lanka. In 1983, he went to Congress to chastise the government for turning a blind eye to the problems there. But he also got the Tamils to send him to Europe and to put $170,000 into a kosher restaurant he owned in Borough Park. According to the Tamils, he never repaid it: "If I was permitted to hit him, I'd break his head," one Tamil leader told the Times.

Taking money and not repaying it also got Dear in trouble with the Federal Election Commission. In 2000, when running for Congress for the second time, Dear's campaign treasurer took out ads in The Jewish Press costing $52,800, but never paid for them. The newspaper told the FEC that they didn't press the matter because of the close-knit religious community, where powerful ties mean a great deal. The Commission cited Dear for not paying for the ads, as well as for receiving illegal contributions from 325 individuals. Dear was never charged, but the money had to be refunded to the donors.

"It's like they rewarded him for being a crook," says Sandy Aboulafia, a longtime Midwood activist and political opponent to Dear.

After so many scandals, two failed runs for Congress, and a futile bid for the State Senate, Dear finally turned to a more attainable goal: municipal judge.

Many court observers predicted disaster.

On a recent morning, a woman and a collection agency attorney approach Judge Dear. The lawyer announces that after working out a deal together in the outside hallway, the woman is prepared to pay her years-old debt. The woman—whose records show a history of mental illness—earns only $300

a month from disability payments, but the lawyer announces she has agreed to pay a $100 monthly settlement to the collection agency. The woman, however, begins to have what looks like a panic attack. She starts shaking her head in an erratic way and sobbing uncontrollably. She manages to tell Dear that she never meant to make such an agreement.

"Look what you have done to this woman!" Dear says to the lawyer in a voice so loud that it fills the noisy courtroom. The lawyer begins to make excuses. He claims that the woman didn't seem out of sorts when they had cut the deal in the hallway and says he assumed she had other sources of income when she agreed to the payment.

Shaking his head, Dear stops the lawyer in mid-sentence and dismisses the lawsuit. He asks the court officer for an escort for the disoriented woman.

"You mean I can leave now?" the woman ekes out between sobs. "Yes," says Dear, and motions for the next case.

Around the courtroom, the people sitting on benches loosen their grips on their ragged file folders stuffed with credit card statements and Con Ed bills, stand up, and, one by one, break into applause.

"Money-grubbing!" one woman mutters.

"He ain't smiling‚ now!" another whoops. "Fair is fair!"

The Voice was told by numerous people at the courthouse that Judge Dear's sessions in debt court are out of the ordinary.

"He takes the issue seriously," says Sidney Cherubin, who runs a volunteer legal clinic the city created in 2006 to help the growing number of New Yorkers contesting false claims of debt. Dear is one of about a dozen judges who take turns on the debt court rotation.

Collection lawyers dread getting placed with Dear.

"He just rules from his biases, from his heart," lamented a frustrated attorney who preferred not to give his name for fear that it would impact him negatively in court. "He doesn't know the law," the attorney added.

Dear says that he prefers to be assigned to this tiny court, full of small claims with big effects on the lives of people of modest means. He refuses to allow the court to become an arm of the collection agency—which, according to statistics, is what has effectively happened in recent years.

Of the nearly $1 billion in claims that collectors filed in 2007 against New Yorkers, about $800 million was won by debt collectors in judgments. That's not surprising when about 80 percent of the people who are accused in such claims don't bother to show up to court. But complaints against collectors are rising so fast that, last year, they outpaced gripes against housing contractors to become New Yorkers' number-one complaint.

Of the fraction of people who do show up in court, nearly all of them represent themselves, which, Dear says, is another part of the problem.

"When you're a referee and someone else doesn't know the rules of the court, it's very hard," he says. In order to illustrate what he sees on the bench, Dear gave the Voice unusual access: He allowed a reporter not only to observe his sessions and talk with him about them, but to sit behind the bench with him to see the court operate from his vantage point.

Dear starts most days with a speech: He welcomes people, introduces himself, and then launches into a series of warnings. He tells the people being sued to be careful about asking for legal advice from the attorneys who are suing them.

"Just remember: They are your adversaries," he announces. He explains that when they sign a contract in the hallway, they are admitting to owing their debt. "Come see me," he offers as an alternative.

A typical day has about 80 to 100 cases, all handled before lunchtime. One morning, with the noon meal approaching, Dear deals with another collection agency lawyer who has come to court without the proper documents to prove that the man he is suing actually owes a debt.

"You're telling me that you had one year to do discovery on this case, and you still haven't been able to get documents?" he asks. "Do you think it's fair for you to ask this court to do your job for you?"

The lawyer sheepishly reminds the judge that it is within his power to dismiss the case.

"I will," Dear says, leaning over the bench to see the man more closely. "Dismissed."

Dear tells the Voice that he did not know much about the growing problem of debt lawsuits when he first began working on the court. But he learned quickly—taking cues from deputy chief administrative court judge Fern Fisher—and soon wanted to "make a mark."

"I like to shake things up," he says.

Throughout the day, Dear is presented with one tale of financial misery after another.

A middle-aged African-American woman approaches the bench and tells Dear she has come to pay her debt. "Don't you want to know the amount?" he asks. "I just want to pay it," the woman answers. "What was it for?" the judge asks. "Anesthesiology," she replies. "What happened?" he asks. The woman says she lost her job and, with it, her health insurance. (Dear agreed to let her pay the debt.)

Another middle-aged African-American woman approaches the bench. She is so visibly upset that it is hard to make out her words, but it is clear she is angry because money was taken from her empty bank account. The judge asks her to calm down. "I can't calm down," she replies. "I'm a black female—little people. I'm not a lawyer. I'm a regular citizen. They can do what they want," she says, and pauses. "I wish I could do whatever I wanted." The judge then tries to get her to work out a payment plan with the collection lawyer. The woman says it doesn't matter what plan they come up with—she's broke. (Dear often tries to bargain with the lawyers to get them to lower their demands, sometimes sounding like a haggler in an open-air market.)

One recent college graduate comes to the bench and tells the judge that she was served papers at a wrong address—a frequent complaint. She says that although she has lived in New York for years, the collection agency served her papers at an old address in Wisconsin. She also says that the collection lawyer had threatened her the night before on the phone: He told her that if she didn't settle, "the gloves would come off." When the lawyer doesn't deny that he threatened the woman, Dear becomes enraged. "Telling a defendant, pro se, that now the gloves are off?" he says. "To me, that's a threat."

"It's a euphemism," says the anxious lawyer, and makes another attempt to excuse himself. "It was born out of frustration," he balks. Once again, Dear dismisses the case.

Dear knows that the collection lawyers aren't thrilled with how he runs debt court. "I'm just calling it like it is," he says.

Over the past 10 years, the subprime credit card industry—like the subprime mortgage industry, aimed at lower-income people and larded with hidden fees and variable rates—has exploded and, with it, the number of people in debt. In a place like New York, the problem of credit card debt is particularly acute. New York is a city of people who are highly mobile—their addresses change, and it is harder to track them down, as required by law. It's also a city of renters, and, unlike in other parts of the country, people here often don't have home equity to fall back on when they get into economic trouble. An economic downturn has forced more people than ever into debt court and has turned the Brooklyn Civil Courthouse into one of the busiest in the nation.

That has led to a new kind of gold rush: debt buying. In the past, when a company was owed money by a customer, it would hire a collection agency to get the money back, paying the agency a percentage. But today, the vast majority of collection agencies in debt courts have purchased those debts as a business plan.

Called "third-party debt buyers," companies like Palisades Collections buy consumer debts from major companies—Chase, Citibank, Fingerhut, Sears—long after those companies have given up trying to get their money back. Buying the debts in multi-billion-dollar bundles for pennies on the dollar, debt buyers are then free to go after the creditors for the full amounts, and, with fees and service charges tacked on, they can collect about twice what the customer originally owed.

Debts can be purchased and repurchased—sometimes, it's even difficult for the attorneys to say how the debts were originally created.

There's plenty of evidence that these debt buyers are using the courts to go after people who don't actually owe the money they're being sued for. In a sample study of 600 cases that the Urban Justice Center conducted for cases brought in 2006, 99 percent didn't hold up to basic legal standards of evidence. Debt collectors frequently neglect to do the simple legwork it would take to verify a person's Social Security number, address, or bank account. Last month, Attorney General Andrew Cuomo sued a debt buyer named Lamont Cooper and shut down two of Cooper's companies. Cuomo alleged that Cooper's firms had routinely failed to serve people court papers where they actually lived and wasn't properly verifying the identities of the people they sued. Last week, Cuomo announced that he was fining three additional collection agencies on similar charges, and was pursuing a dozen more.

Many of the people who come to Dear's courtroom say they never received a summons. They make their way to court on their own after they go to an ATM machine and find that their bank accounts have been frozen, or when they receive a notice that their credit has been ruined. For many, it's the first time they've heard anything about a debt at all.

The Urban Justice Center's 2006 study found that 40 percent of the 600 lawsuits examined were filed by one company, Palisades Collections, and its law firm, Pressler and Pressler—a ratio that suggests Palisades is filing about 125,000 lawsuits each year. In 2004, the city found that two-thirds of defaulted credit card debts had been purchased by only 10 companies.

Palisades has no website of its own. But do a search on its name, and you'll find page after page of horror stories by people claiming they were wrongly sued for debt. (Multiple attempts to speak with someone at Palisades resulted in a manager answering that the volume of calls they receive prevented anyone there from answering questions.)

When Palisades purchases debts, it usually gets little more than a spreadsheet with names, account numbers, and debt amounts. Sometimes, there are addresses and Social Security numbers; sometimes, there aren't. The information is often years old by the time the company gets it.

Yet instead of spending the resources to track down and confirm that information, collection agencies seem to have adopted a different strategy: sue. Assume the defendants won't show up. Then, go after bank assets.

The debt buying industry "is crying out for regulation," says the city's commissioner of consumer affairs, Jonathan Mintz. He describes debt collection agencies as bottom-feeders, an industry that is "far down the food chain."

Recently, there have been some signs that things are shifting. On the national level, President Obama has called for sweeping changes: He recently called credit card executives to Washington and denounced the billing practices that have led Americans ever deeper into debt. (Dear's reaction: "I would say to the President, 'If you want to know how to resolve this issue, come down to 141 Livingston Street.' ")

Besides Cuomo's settlement, Dan Garodnick, the City Councilman who represents Stuyvesant Town, recently pushed through a bill that closed a loophole that allowed third-party agencies to purchase debts without a license. (They do have to be licensed to bring a lawsuit, but the collection agencies were able to exploit a loophole in the law and get around that, says Harvey Epstein of the Urban Justice Center.) The City Council and the city's Consumer Affairs Department have each held hearings about cleaning up the industry. Judge Fern Fisher—whom Dear considers a mentor—created the Thursday-afternoon clinic at the courthouse, one of the first of its kind in the nation. She has commissioned research into why people don't show up to court. As of April 2008, she has been making debt collection agencies send summonses through the court—if the notices comes back "return to sender," the collection agencies are no longer able to bring the suit. Fisher says that that measure alone has eliminated about 10,000 mistaken lawsuits and has brought more people into court.

"I do not believe it's because people are callous and irresponsible," Fisher says, speaking of the many New Yorkers who don't show up. "Some people are afraid. Some people just don't understand the significance. Some people are hopeless."

But the industry is still rife with problems—for one, the firms hire people to drop off the summonses at people's addresses, and they often leave the forms with someone who has no connection to the person actually being sued for debt. This was at the heart of Cuomo's recent lawsuit.

Additionally, in each of these cases, a debt collector has to sign and swear that they have "direct knowledge of the facts of the case." Usually, the companies hire lawyers to do that, too. For instance, in the case of one law firm, Mel S. Harris & Associates, a man named Todd Fabacher has personally signed off that he has "direct knowledge of the facts" of hundreds (and perhaps thousands) of cases. "I don't know how that's humanly possible," says Nasoan Sheftel-Gomes, a lawyer for the Urban Justice Center who works with people being sued by debt collectors. (Calls to Fabacher have not been returned.)

By the late 1990s, subprime was the fastest growing sector of the credit card industry. Today, 400,000 of the city's poorest households pay about 40 percent of their monthly income to credit card and installment plans. Most of the rest goes to rent.

While Dear gave the Voice unusual access to his courtroom, he was reticent about his troubled political record. He didn't want to "dredge up what happened 30 years ago," and, he says, "There are people who would like to see me fail."

He recalls, one afternoon, that his life seems to have come full-circle: The first bill he sponsored as a councilman was a bill to license debt collectors. He says he has taken a special liking to pro se court, where defendants represent themselves, and often requests to be placed there on the rotation of judges. "I feel like I'm contributing something," he says.

"I like to fight for the underdog."

Copyright © 2009 Village Voice LLC. All rights reserved.

NYT: The Debt Settlement Industry Is Busy, but It's a Bit Nervous, Too

By DAVID STREITFELD

CHICAGO — This should be a triumphant time for the debt settlement industry. If ever there was a moment when masses of people needed help so they were not smothered by the weight of their credit card bills, it is now.

But at a conclave of settlement professionals here this week, the mood was more of crisis than celebration. One sober question hung in the air: Would the industry exist in anything like its present form in a few years?

A formidable array of forces is concerned about the way the settlement companies solicit consumers and negotiate lower payments on their debts. The industry is in the cross hairs of the Federal Trade Commission, state regulators, members of Congress and state legislatures. Credit card companies are not fond of it, and many consumer advocates practically loathe it.

The common complaint among all these groups is that too many debt settlement companies are more interested in helping themselves earn fees than aiding their beleaguered clients. Their ads promise the clients will get out of debt but, critics say, the reality is that they often become even more enmeshed.

Noting “the legal firestorm that has subsumed the debt settlement industry” in recent years, Jeffrey Tenenbaum, a lawyer representing dozens of settlement firms, warned that many companies could be “legislated, regulated or litigated out of business.” Like the other speakers, he stood on a conference stage outfitted as a boxing ring.

Some attendees confronted the prospect of new laws with foreboding. “I think regulation is going to be a killer,” said David Fishman of Arbitronix, based in Las Vegas.

But others saw it as good news. “There’s a lot of bad apples in this industry,” said David Jenkins of First American Debt Relief in Newport Beach, Calif. “Let’s clean it up.”

A third group said it was all a problem of miscommunication.

Regulators and attorneys general “don’t understand what we do and how we do it, and the benefits we provide for consumers,” said Peter McLaughlin of Preferred Financial Services in Andover, Mass.

Understanding might be on the upswing, although whether it will lead to appreciation is a separate issue. Preferred Financial was one of numerous settlement companies that received a subpoena from the New York attorney general, Andrew M. Cuomo, last month as part of a wide-ranging investigation.

The settlement companies, which number about 2,000, have varying business models but generally develop programs for strapped individuals to pay off a percentage of their credit card debt and avoid bankruptcy.

Only a handful of the companies came to this convention, which was run by a trade group called the United States Organizations for Bankruptcy Alternatives. Participants stressed that that it was the people who were not there who were the problem.

“The bottom feeders are ruining our reputation,” said John Ansbach, the general counsel for EFA Processing in Frisco, Tex. “The good stories are not being told.”

Part of the problem with industry, Mr. Ansbach said, is that there are few barriers to entry. Many of the smaller firms are virtual outfits, contracting with outsourcing companies to do all the back-end work of talking to the debtors, enrolling them and negotiating settlements.

EFA itself is one of these outsourcers, handling settlement programs for dozens of corporate clients. Mr. Ansbach says EFA rejects more new clients than it takes on.

There are even companies to help secure the customers. Max Bruck is the vice president of sales for Find Your Customers Inc., which develops print, radio and television spots. The most successful ads, he said, emphasize words like “stress” and “anxiety” and showcase notions like the inability to sleep or frequent fights with a spouse..

Mr. Bruck has just finished a radio ad that begins with an employer calling a job applicant, ominously wondering why the job-seeker went bankrupt. “Bankruptcy stays with you forever,” the announcer warns.

Listeners’ calls are funneled to clients of Mr. Bruck who pay $80 each. The average ad generates 500 to 1,000 calls, he said.

Copyright 2009 The New York Times Company. All rights reserved.

Modification of Mortgages in the Southern District of New York

As many of you may know, a bill to modify the bankruptcy laws to allow Bankruptcy Judges to modify mortgages on debtors' primary residences passed the House of Representatives in March, but unfortunately, due to intense opposition by mortgage bankers and a lack of support from President Obama, that bill failed to pass the Senate last month. Notwithstanding that, due to the current recession, the United States is experiencing a record number of personal bankruptcy filings. 1.2 million Americans filed for bankruptcy from April 2008 to last month, and experts predict that bankruptcies could reach 1.5 million this year before leveling off at 1.6 million next year.

Despite the failure of the new bankruptcy bill, the U.S. Bankruptcy Court for the Southern District of New York (NYSB) adopted Loss Mitigation Program Procedures in January 2009. It has been our experience to date that filing for bankruptcy (either Chapter 7 or Chapter 13) in conjunction with requesting loss mitigation is one of the most effective ways to modify a first mortgage (the purpose of the proposed bill).

Last week we were negotiating with outside counsel for Chase Home Finance regarding a modification of a first mortgage for a debtor's primary residence, and they indicated that the quickest way to modify a first mortgage would be to move for loss mitigation through the NYSB procedures. Use of the NYSB Loss Mitigation Program Procedures requires that: (1) the individual must reside in the Southern District of New York (which includes the counties of New York, Bronx, Westchester, Rockland, Putnam, Orange, Dutchess, and Sullivan) and (2) loss mitigation can only be requested for an individual's primary residence.

Additionally, for individuals that file for bankruptcy, there is a $50,000 homestead exemption per spouse under the New York State Debtor & Creditor Law, so an individual can file for Chapter 7 bankruptcy, and if they're married, they can keep their house by reaffirming the debt (which means that the debtor(s) agree to that the debt will not be discharged in bankruptcy and will be continue to be paid) on a primary residence that has no more than $100,000 in equity.

Due to the sharp decrease in residential real estate values that has left many homeowners with no equity (or "underwater"), many individuals can file for Chapter 7 bankruptcy, wipe out credit card, business debt or guaranties and other debts, retain their house, request Loss Mitigation to modify the terms of the mortgage, reaffirm the mortgage and then emerge from bankruptcy with their homeownership intact.

Anyone with questions regarding personal bankruptcy or the Loss Mitigation Program in the Southern District of New York should contact Jim Shenwick.

QuickJump

This law firm recently started using a new product from Tech Hit called “QuickJump.” QuickJump lets users navigate to the right Windows folders by using a few keystrokes-a valuable shortcut for attorneys and other users who need to save documents such as e-mail messages and Word files. We have been using QuickJump in conjunction with MessageSave, another Tech Hit product that allows users to quickly save e-mail messages on their C: drive. We have found both programs to be invaluable products that save us much time and effort in saving and filing documents, and we highly recommend them.

Jim Shenwick

NYT: Weighing the Options With Credit Card Debt

By TARA SIEGEL BERNARD

Many consumers are buckling under the weight of mounting credit card debt.

So it should come as no surprise that some have been lured in by often-hollow promises from debt settlement companies, claiming they can reduce debts to a small fraction of what is owed by negotiating with creditors.

But as their customers have learned, debt settlement companies are not debt genies — they do not have special powers to make your debt disappear. Andrew M. Cuomo, New York State’s attorney general, recently announced an investigation into more than a dozen debt settlement companies. Many companies require hefty upfront fees — often 15 percent of your total debt — but often don’t deliver on their promises, experts say.

Of course, figuring out a reasonable way to shed debt may seem an insurmountable task, especially if you have lost your job or you are simply not earning enough. The numbers are not pretty: if you carry $10,000 on a credit card with an 18 percent rate and make only the minimum payment (say, 1 percent of the balance plus interest), it will take 32 years to pay it off — for a grand total of $24,834. That does not count late fees or over-the-limit charges.

So it is important to assess your options before you fall too far behind. This is probably best accomplished with a reputable credit counselor. But before you pick up the phone, familiarize yourself with the pros and cons of the various options.

DO IT YOURSELF If you have only a few thousand dollars in debt on one or two cards, you may try calling your card issuer and asking it about any repayment plan for people facing financial hardship. The company may be willing to work with you. But keep in mind that it is likely to reduce your credit limits to your current balance, experts said.

“Most people are very hesitant to call their creditors,” said Gail Cunningham, spokeswoman for the National Foundation for Credit Counseling. “But they are the first ones they should consult. They have programs for short-term financial hiccups.”

FIND A COUNSELOR If you are knee-deep in debt, or your debt is spread across multiple cards, consult with a financial counselor. A credit counselor can assess your entire financial picture and help determine the best course of action. It may be as simple as setting up a payment plan that you can handle on your own.

But you need to be careful when choosing a counselor. Stick with someone who is affiliated with one of the legitimate, nonprofit umbrella organizations like the National Foundation for Credit Counseling or the Association of Independent Consumer Credit Counseling Agencies. Their fees should be reasonable (about $30 to $50 to set up, say, a debt management plan) and they should not turn you away if you cannot afford the nominal fee. They should also be willing to spend an hour with you, at the least.

DEBT MANAGEMENT PLAN A credit counseling agency should be able to determine whether this type of plan will work for you. Here is how they operate: the agency negotiates a lower interest rate and payment with the card companies, to a level you can afford. All late fees and over-the-limit fees stop. You then make a single payment to your counseling agency, which disburses the payment to all your creditors. The agency usually charges a fee of about $25 a month. Most plans last three to five years, at which point your existing debt will be paid off.

“A debt management plan doesn’t reduce the balance, but one of the big advantages is that the interest rates go down, usually significantly,” said Rick Phillips, vice president of debt management plan services at Consumer Credit Counseling Service of Greater Atlanta. He said most people who came to them were paying rates from 25 to 29 percent, which usually drop to 6 to 12 percent, or lower.

But these days, fewer people can afford traditional debt management plans. As a result, two credit counseling groups struck a deal with the top 10 credit card issuers this month to make the debt management plans more affordable. That may include lowering the minimum payment and the interest rate even further.

Participating in these plans will not necessarily hurt your credit score, but it is a gray area. It depends on how your creditor reports it to the credit rating agencies. Still, digging out of debt should be the priority; your credit score will eventually improve. Missing payments remain on your record for seven years.

DEBT SETTLEMENT So should debt settlement companies be avoided at all costs? They certainly should not be your first call.

“Sometimes, there are no good solutions, but of the solutions, debt settlement ends up being their best bet,” Gerri Detweiler, a credit adviser at Credit.com, said. “There is a segment of people who cannot afford to pay the full amount through a debt management, but they either don’t want to file for bankruptcy or they can’t file for bankruptcy.” (Credit.com refers prescreened consumers to debt settlement companies through its Web site; the settlement company pays Credit.com a fee each time a consumer fills out an application. Credit.com vets the companies to be sure they disclose all costs.)

But consumer advocates said that many people ended up dropping out of these plans because of the high fees. When you sign up, many firms require you to pay a sizable fee upfront. Or they may levy initial set-up and monthly fees, and charge a percentage of the amount they saved you. They typically advise you to stop paying your debts and tell you to put aside money each month in a separate account over a period of two or three years. That sum will eventually be used to negotiate a settlement, usually about 60 percent of what you owe. In the meantime, though, credit card companies continue to charge interest and late fees. The creditor may sue. And the phone will probably continue to ring incessantly. The companies can offer no guarantees — except that your credit score will drop.

“I wouldn’t rule out the possibility that there is a good company out there, but the basic business model is not a good one for consumers,” said Deanne Loonin, a lawyer at the National Consumer Law Center who has researched the companies. “A lot of creditors won’t even work with debt settlement companies.”

And here is another little-known fact: Any debt forgiven exceeding $600 is considered taxable income unless you can prove you are insolvent (your liabilities exceed your assets).

BANKRUPTCY For some people, at least, it pays to visit a bankruptcy lawyer, where the initial consultations should be free. A lawyer can advise you of your rights and walk you through the many implications of bankruptcy. “It’s not a bad idea if you’re under a lot of financial stress or you are afraid of losing your assets,” Ms. Detweiler said. It also pays to meet with a bankruptcy lawyer and a credit counselor before you consider debt settlement. “If you do it the other way around, you are very vulnerable to being led down the wrong path,” she said. “And what I find is that people hear what they want to hear.”

Copyright 2009 The New York Times Company. All rights reserved.

NYT: Slow Start to U.S. Plan for Modifying Mortgages

By TARA SIEGEL BERNARD

The Obama administration’s plan to help millions of troubled homeowners avoid foreclosure by reducing the size of their mortgage payments is just getting off the ground.

So far, two months after the program went into effect, about 55,000 homeowners have been extended loan modification offers, according to a senior administration official. At the same time, foreclosures continue apace. RealtyTrac reported Wednesday that foreclosure filings reached 342,000 last month, up 32 percent from April 2008. Moody’s has estimated that more than 2.1 million homeowners will lose their homes this year.

Because of the size and complexity of the modification program, the administration has only recently assembled most of the pieces. In late April, officials fleshed out their plan to modify or forgive second mortgages — one of the big stumbling blocks in modifying primary mortgages — and provided more details on the Hope for Homeowners program, for borrowers who owe more than their homes are worth. Congress is close to acting on legislation to protect mortgage servicers from potential lawsuits from investors, while also expanding the Federal Housing Administration’s ability to modify loans.

The banks, too, are just now beginning to get their mortgage modification machines up and running.

While it is still too early to know how effective the program will ultimately be, many homeowners who have tried to gain entrance say they have been successful only through persistence — and sometimes, the help of a lawyer.

What may be a larger issue, however, is the continuing deterioration of the economy, experts say. The longer it takes to set the program in motion, they say, the fewer people will qualify for modifications. The expected rise in unemployment in coming months may keep a growing number of homeowners out of the program.

“We have a debt crisis, and mortgage is at the center of it,” said Alan M. White, an assistant professor at Valparaiso University School of Law in Indiana who specializes in foreclosures. “To get out of it, we need to reduce the debt, and that is not really happening.”

The administration remains confident that the program will end up offering help to as many as three million to four million homeowners, with the pace of modifications beginning to pick up in coming months.

“If you think about the context and scale involved, it is an extraordinary, rapid effort,” said Jenni Engebretsen, a Treasury spokeswoman. She noted that 14 mortgage servicers had signed up for the program, covering 75 percent of the market.

A vibrant mortgage modification program is a necessary bulwark against the wave of foreclosures. Without it, housing prices will continue their downward spiral longer, said Mark Zandi, chief economist at Moody’s Economy.com.

“It prolongs the economic agony,” he said. “The pain will not go away until foreclosures subside.”

Mr. Zandi was not as optimistic that the program would help as many as the administration expects. He estimated it would end up assisting only 1.5 million to 2 million homeowners over the next few years. Even so, he added, the program will, in the end, “make a meaningful difference.”

The Obama plan aims to lower monthly payments to 31 percent of the borrower’s gross income by reducing interest rates to as low as 2 percent, extending the loan term or deferring principal. Mortgage servicers can reduce principal but are not required to.

The mortgage modifications to date have come in various forms, but some have not reduced monthly payments and most have not reduced the balance owed — crucial for people who owe more than their homes are worth. Still, the number of loan modifications with lower payments has increased in recent months, an encouraging sign.

In April, 59 percent of loan modifications reduced payments, 29 percent increased payments and 12 percent of modifications kept payments steady, according to Professor White at Valparaiso. Borrowers with loan modifications that have not cut their payments tend to default again within six to 12 months.

To persuade mortgage servicers and investors to sign on to mortgage modifications, Democrats originally sought legislation that would have given bankruptcy judges the power to reduce primary mortgages. The threat of a principal reduction in bankruptcy would have served as a stick to have modifications done outside court, experts said. But the measure failed in the Senate last week after intense lobbying by the banking industry.

Several experts said reducing the amount of principal would go a long way toward helping borrowers who owe more than a home is worth — those informally known as under water.

“Even if they do drop your loan payment, you can still be in deep negative equity, which is not an immediate crisis,” said Adam J. Levitin, an associate professor at Georgetown University Law Center. “But let’s say you need to relocate because the auto manufacturer you work for is radically downsizing. You are faced with losing your house in foreclosure or a huge balloon payment. And neither of those is palatable.”

“If you don’t want all of the spillover effects from foreclosure, you have to keep people in their houses,” he added.

But the modifications may not be enough for the underwater homeowners. “In many ways, we are kicking the can down the road,” Mr. Zandi said. “Many of these homeowners are under tremendous amounts of financial pressure, and they have significant negative equity positions. Lowering their mortgage debt-to-income ratio helps, but it doesn’t solve their problem in a significant way and many will redefault in the future.”

About 15.4 million borrowers, 20 percent of single-family homeowners, are underwater, up from 13.6 million at the end of last year, according to Moody’s. Being underwater is one of the biggest indicators of default, experts said.

The administration tries to address the problems of the underwater homeowners through its Hope for Homeowners refinancing program. In its previous incarnation, the program was deemed a failure after it produced only about 50 new loans.

Under the new initiative, mortgage servicers are required to vet borrowers for Hope for Homeowners after they have qualified for a trial loan modification. If borrowers are qualified, they refinance into new loans through the Federal Housing Administration. Mortgage investors must accept a write-down on their investment and the government backs the new loan.

Despite the federal backing, lenders must also be willing to make the new loans, said Rod Dubitsky, a mortgage analyst at Credit Suisse.

Many homeowners, consumer advocates say, do not even know they are eligible for a modification. Others may think they are eligible, but have to navigate a maze of rules and bureaucracies.

Amy and Robert Darr, of Coshocton, Ohio, for instance, fell behind on their payments in October after Robert’s hours were cut; he is a maintenance worker at a foundry. They tried to catch up on their payments when they received their tax refund, but by that time the couple had received a foreclosure notice. They contacted their lender to see if they would qualify for a loan modification, and provided the lender with the required paperwork.

But CitiMortgage refused to suspend the foreclosure proceedings. Citigroup declined to comment.

“Hopefully, we will qualify,” Mrs. Darr said, “because I don’t want to lose my home.”

The couple contacted Southeastern Ohio Legal Services, which filed a motion with the local court to suspend the foreclosure and is currently waiting for a response.

“The right hand doesn’t know what the left hand is doing,” said Melissa Benson, a staff lawyer with the legal services organization. “Most people who get foreclosure complaints don’t even know how to put up a fight at all. And they lose fairly quickly.”

Ashley Southall contributed reporting.

Copyright 2009 The New York Times Company. All rights reserved.

NYT: Banks Brace for Credit Card Write-Offs

By ERIC DASH and ANDREW MARTIN

It used to be easy to guess how many Americans would have problems paying their credit card bills. Banks just looked at unemployment: Fewer jobs meant more trouble ahead.

The unemployment rate has long mirrored banks’ loss rates on card balances. But Eddie Ward, 32 and jobless, may be one reason that rule of thumb no longer holds. For many lenders, losses are now starting to outpace layoffs.

Mr. Ward, of Arkansas, lost his job at a retail warehouse in April and so far has managed to make minimum payments on his credit card debt, which he estimates at $15,000 to $20,000. Asked whether he thinks he will be able to pay off his balance, he said, “Not unless I win the lottery.”

In the meantime, he said, “I’m just doing what I can.”

Experts predict that millions of Americans will not be able to pay off their debts, leaving a gaping hole at ailing banks still trying to recover from the housing bust.

The bank stress test results, released Thursday, suggested that the nation’s 19 biggest banks could expect nearly $82.4 billion in credit card losses by the end of 2010 under what federal regulators called a “worst case” economic situation.

But if unemployment breaches 10 percent, as many economists predict, the rate of uncollectible balances at some banks could far exceed that level. At American Express and Capital One Financial, around 20 percent of the credit card balances are expected to go bad over this year and next, according to stress test results. At Bank of America, Citigroup and JPMorgan Chase, about 23 percent of card loans are expected to sour.

Even the government’s grim projections may vastly understate the size of the banks’ credit card troubles. According to estimates by Oliver Wyman, a management consulting firm, card losses at the nation’s biggest banks could reach $141.5 billion by 2010 if the regulators’ loss rate was applied to their entire credit card business. It could top $186 billion for the entire credit card industry.

In the official stress test results, regulators published losses only on credit cards held on bank balance sheets. The $82.4 billion figure did not reflect another element in their analysis: tens of billions of dollars in losses tied to credit card loans that the banks packaged into bonds and held off their balance sheets. A portion of those losses, however, will be absorbed by outside investors.

What is more, the peak unemployment level that regulators used to drive their loss estimates is roughly what current rates are on track to reach. That suggests that if the unemployment rate gets much worse, credit card losses could be worse than what regulators projected.

And many economists expect the number of job losses to climb even higher. On Friday, the unemployment rate reached 8.9 percent as the economy shed 539,000 jobs. The unemployment rate and the rate of credit card charge-offs, or uncollectible balances, have been aligned because consumers who lose their jobs are more likely to miss payments.

Banks wrote off an average of 5.5 percent of their credit card balances in 2008, while the average unemployment rate was 5.8 percent. By the end of the year, the rate of credit-card write-offs was 6.3 percent; more recent data was not available.

Experts predict that the rate of credit-card losses could eventually surpass the jobless rate because of the compounding effects of the housing crisis and lackluster consumer confidence. Shortly after the technology bubble burst in 2001, credit card loss rates peaked at 7.9 percent.

“We will blow right through it,” said Inderpreet Batra, a consultant at Oliver Wyman, which specializes in financial services.

Unlike in prior recessions, cardholders who recently lost their jobs are unlikely to be able to extract equity from their homes or draw down retirement accounts to help pay off their debts. That means borrowers who fall behind on their bills are more likely to default, leading to higher losses.

After writing off about $45 billion in bad debts during 2008, credit card lenders are bracing for the worst year in the industry’s history. Not only are losses spiraling, but also lawmakers are on the verge of passing a set of tough new consumer protections that could have a devastating effect on profits. This week, the Senate is expected to take up the Credit Cardholders Bill of Rights after the measure passed in the House with a strong bipartisan vote of 357 to 70.

Over the weekend, President Obama pressed lawmakers to approve the new rules, which would curb the ability of card issuers to raise interest rates retroactively on consumers and would require them to reduce hidden fees and penalties. He hopes to sign the legislation by Memorial Day.

For the banks, the economics of the credit card business are increasingly troubling. As the recession has dragged on, cardholders have sharply reduced spending. New customers with strong credit histories are increasingly hard to find.

And the most troubled borrowers are so deeply mired in debt that card companies are willing to strike deals to remove late fees and reduce card loan balances. The average American household is saddled with nearly $8,400 of credit card and other revolving debt, according to Moody’s Economy.com.

Every major credit card issuer has been approving fewer new applicants, reining in credit lines and canceling unused accounts. And Meredith A. Whitney, a prominent banking analyst, expects credit card lenders to cut the lines of credit they extend to borrowers by a total of $2.7 trillion through 2010. That is equivalent to a 57 percent reduction in the credit they made available two years ago at the height of the boom.

Within the card industry, all eyes are now focused on the sharp increase in unemployment. At Citigroup, executives noted that the company’s 10.2 percent credit card charge-off rate for the first quarter had broken its “historic correlation with unemployment” and showed no sign of letting up.

American Express, Bank of America and Capital One Financial showed first-quarter loss rates that hovered around 8.5 percent, roughly tracking the unemployment rate. All three said they expected higher losses in the coming months. Even Chase Card Services, which charged off just 7.7 percent of its card loans in the first quarter, expects its loss levels to surpass unemployment by the end of the year.

Card executives say there will little improvement until the economy stabilizes and consumers are more optimistic.

Cindy Schneider of Connecticut, 53, is a long way from being confident about her finances.

She is not making any money from her job as a real estate agent and cannot find work elsewhere. Her husband’s pay was just cut 10 percent. And she worries about how they will pay off a $5,000 balance on their credit card.

When her credit card company recently raised her interest rates, saying she was three days late with a payment, Ms. Schneider transferred the balance to another card with a lower rate.

“We are borrowing from Peter to pay Paul,” she said.

Copyright 2009 The New York Times Company. All rights reserved.

The Practical Implications as Chrysler Goes to Court

By MICHELINE MAYNARD

Chrysler is the first major automaker since Studebaker in 1933 to try to reorganize in bankruptcy and emerge as a viable company. The process can be complicated. Here is a quick look at how it is likely to play out.

Q. Is Chrysler going out of business?

A. No. Chrysler is reorganizing under Chapter 11 of the United States Bankruptcy Code. The law allows companies to shed assets, restructure debt, cancel contracts and close operations that normally would have to continue running. Once they secure financing to emerge from bankruptcy, these companies are reconstituted as new legal entities.

Should Chrysler fail to successfully reorganize, it might turn to a Chapter 7 bankruptcy, which would mean a liquidation.

Q. How long will this take?

A. The Obama administration spoke of a “surgical bankruptcy” that it said could be completed in 30 to 60 days. It plans to use Section 363 of the bankruptcy code to sell assets, rid the company of liabilities and restructure its debt, creating a new Chrysler.

In reality, most bankruptcies take much longer. United Airlines spent more than three years under bankruptcy protection. Delphi, the auto parts supplier, has been in Chapter 11 since 2005. The bankruptcy by LTV, a steel maker, took seven years to resolve.

Bankruptcy law changed in 2005 to give management of a company the exclusive right to draft a plan of reorganization. A judge can extend that period exclusivity for 18 months, but creditors or potential buyers for a company can present a competing plan once that period expires.

Q. What happens to Chrysler dealers?

A. Chrysler is able under bankruptcy to cancel franchise agreements with its dealers, and the government said that would happen. Dealers can sue to block the action, but a final decision would be up to the judge. In the meantime, Chrysler will continue to provide dealers with vehicles to sell.

Chrysler Financial will cease making consumer loans for Chrysler vehicles; GMAC, with support from the government, will provide financing through Chrysler dealers.

Q. What happens to Chrysler employees?

A. The White House said it did not expect any reductions in white- or blue-collar jobs as a result of the bankruptcy. However, Chrysler employees who are not union members do not have any job security. The company can ask a judge for an immediate pay cut for its salaried employees, and can announce job eliminations and close offices, just as it can outside bankruptcy,

Contracts covering members of the United Automobile Workers union and other unions will remain in force, until the company asks a judge to void them. U.A.W. members approved changes to their contract on Wednesday that presumably would mean the contract would stay in place.

But if the company asked for contracts to be terminated and replaced with terms it can more readily afford, the union would have a chance to respond in court. Negotiations would take place before any cuts were imposed. This process could take months.

Q. Are pensions and retiree health care benefits protected?

A. Companies have the right under bankruptcy law to ask to terminate their pension plans. If such a request was made, a judge would convene a brief trial on the subject and hear both sides. If pensions were terminated, employees would still receive about one-third of their benefits through financing from the federal pension agency.

A company also can eliminate retiree health care benefits for nonunion employees; they would subsequently be covered by Medicare. The U.A.W. and Chrysler agreed in 2007 to transfer responsibility for union retiree health care to a special fund, and the fund would administer those retiree benefits.

Q. What happens to Chrysler suppliers?

A. In its bankruptcy filing, Chrysler listed its 50 biggest creditors holding unsecured claims, meaning those that would have to get in line behind creditors whose debt is secured by collateral, like the company’s plants, brands and other assets. The unsecured creditors include its advertising agency, BBDO, and parts suppliers, like Johnson Controls, Magna International and Cummins Engine.

The White House said supplier contracts would remain in force, and it has created a program to provide federal help to parts makers. But in bankruptcy, supplier contracts can be canceled.

Chrysler is likely to tell the court which suppliers it wants to keep doing business with, and which contracts it wants to reject. Suppliers could challenge the rejection of their contract, but most likely they would have to reach a settlement with Chrysler.

Q. What happens next in the bankruptcy case?

A. Chrysler filed its initial paperwork with the federal bankruptcy court in New York on Thursday. On Friday, it will ask a judge to issue a series of rulings called the first day orders, which allow the company to keep operating. They may include authorizing the payment of routine expenses, like salaries and payments to vendors, including its lawyers, and whatever else Chrysler needs to run its business. Chrysler said it would halt production while it completes a deal with Fiat.

Once the case begins, Chrysler can ask a judge to issue an emergency order to temporarily reduce salaries, which is meant to conserve its cash. A committee will also be formed that represents Chrysler’s creditors.

Q. Should owners of Chrysler cars and trucks be concerned?

A. The federal government said it would back the warranties on vehicles bought from Chrysler while it is operating in bankruptcy. So, effective Thursday, warranties are underwritten by the government.

Owners of Chrysler vehicles bought before Thursday should expect their warranties to be honored until they expire. But the work may not be performed by a Chrysler dealer. Companies operating in bankruptcy sometimes ask a judge to let them assign warranty repairs to outside vendors, who charge the company less for their work than a dealer would expect to be reimbursed.

Owners whose vehicle warranties have run out are liable for any problems with their cars and trucks, as they are now.

Copyright 2009 The New York Times Company. All rights reserved.

NYT: Senate Refuses to Let Judges Fix Mortgages in Bankruptcy

By STEPHEN LABATON

WASHINGTON — The Senate handed a victory to the banking industry on Thursday, defeating a Democratic proposal that would have given homeowners in financial trouble greater flexibility to renegotiate the terms of their mortgages.

The House of Representatives, meanwhile, overwhelmingly approved a bill backed by the Obama administration that would limit the ability of credit card companies to charge high fees and penalties. The bill, approved 357 to 70, still faces obstacles in the Senate, where — as the action on Thursday illustrated — the industry has more clout, particularly among Republicans and moderate Democrats. In recent days the White House, partly in response to polls showing the significant public outrage over high fees charged by credit card companies, has begun to work for its passage.

The mortgage provision garnered only 45 votes in the Senate, falling well short of the 60 votes necessary to break a threatened filibuster to a measure sponsored by Senator Richard Durbin, Democrat of Illinois, that would give bankruptcy judges greater flexibility to modify mortgages. In recent weeks, major banks and bank trade associations worked closely with Senate Republicans to stop the measure. Twelve Democrats joined all the Republicans in voting against it.

The defeat clears the way for a final vote as early as Friday for the legislation, which has several features that the banking industry has sought. One provision would have the effect of reducing a proposed special premium the banks would owe the Federal Deposit Insurance Corporation later that year by more than 50 percent — a $7.7 billion saving. A second provision would make permanent the temporary increase in deposits guaranteed by the F.D.I.C., to $250,000, from $100,000.

Once the Senate completes its action on the legislation, it will have to be reconciled with a similar measure already adopted in the House before it can become law.

The House bill contains the bankruptcy provision. But the Senate’s defeat of the so-called bankruptcy cramdown measure all but makes certain it will disappear from the final bill.

It also demonstrates that, even though Democrats are close to gaining 60 votes in the Senate with the recent decision by Senator Arlen Specter to leave the Republican Party, the increasing number of Democrats does not prevent the Republicans — with the support of a handful of moderate or conservative Democrats — from blocking legislation. Mr. Specter voted against the provision.

Bank lobbyists had maintained that the legislation, if adopted, would have resulted in higher rates for all mortgage holders. A letter signed by 12 industry organizations this week to senators warned that the legislation would “have the unintended consequence of further destabilizing the markets.”

“Though interest rates today are at all-time lows, this legislation would result in higher costs for future borrowers,” the letter said.

But supporters of the legislation disputed that argument. President Obama sought the cramdown provision during the election, although the White House has done virtually nothing to move it through Congress.

Copyright 2009 The New York Times Company. All rights reserved.

NYT: Tracking Loans Through a Firm That Holds Millions

By MIKE McINTIRE

Judge Walt Logan had seen enough. As a county judge in Florida, he had 28 cases pending in which an entity called MERS wanted to foreclose on homeowners even though it had never lent them any money.

MERS, a tiny data-management company, claimed the right to foreclose, but would not explain how it came to possess the mortgage notes originally issued by banks. Judge Logan summoned a MERS lawyer to the Pinellas County courthouse and insisted that that fundamental question be answered before he permitted the drastic step of seizing someone’s home.

“You don’t think that’s reasonable?” the judge asked.

“I don’t,” the lawyer replied. “And in fact, not only do I think it’s not reasonable, often that’s going to be impossible.”

Judge Logan had entered the murky realm of MERS. Although the average person has never heard of it, MERS — short for Mortgage Electronic Registration Systems — holds 60 million mortgages on American homes, through a legal maneuver that has saved banks more than $1 billion over the last decade but made life maddeningly difficult for some troubled homeowners.

Created by lenders seeking to save millions of dollars on paperwork and public recording fees every time a loan changes hands, MERS is a confidential computer registry for trading mortgage loans. From an office in the Washington suburbs, it played an integral, if unsung, role in the proliferation of mortgage-backed securities that fueled the housing boom. But with the collapse of the housing market, the name of MERS has been popping up on foreclosure notices and on court dockets across the country, raising many questions about the way this controversial but legal process obscures the tortuous paths of mortgage ownership.

If MERS began as a convenience, it has, in effect, become a corporate cloak: no matter how many times a mortgage is bundled, sliced up or resold, the public record often begins and ends with MERS. In the last few years, banks have initiated tens of thousands of foreclosures in the name of MERS — about 13,000 in the New York region alone since 2005 — confounding homeowners seeking relief directly from lenders and judges trying to help borrowers untangle loan ownership. What is more, the way MERS obscures loan ownership makes it difficult for communities to identify predatory lenders whose practices led to the high foreclosure rates that have blighted some neighborhoods.

In Brooklyn, an elderly homeowner pursuing fraud claims had to go to court to learn the identity of the bank holding his mortgage note, which was concealed in the MERS system. In distressed neighborhoods of Atlanta, where MERS appeared as the most frequent filer of foreclosures, advocates wanting to engage lenders “face a challenge even finding someone with whom to begin the conversation,” according to a reportby NeighborWorks America, a community development group.

To a number of critics, MERS has served to cushion banks from the fallout of their reckless lending practices.

“I’m convinced that part of the scheme here is to exhaust the resources of consumers and their advocates,” said Marie McDonnell, a mortgage analyst in Orleans, Mass., who is a consultant for lawyers suing lenders. “This system removes transparency over what’s happening to these mortgage obligations and sows confusion, which can only benefit the banks.”

A recent visitor to the MERS offices in Reston, Va., found the receptionist answering a telephone call from a befuddled borrower: “I’m sorry, ma’am, we can’t help you with your loan.” MERS officials say they frequently get such calls, and they offer a phone line and Web page where homeowners can look up the actual servicer of their mortgage.

In an interview, the president of MERS, R. K. Arnold, said that his company had benefited not only banks, but also millions of borrowers who could not have obtained loans without the money-saving efficiencies it brought to the mortgage trade. He said that far from posing a hurdle for homeowners, MERS had helped reduce mortgage fraud and imposed order on a sprawling industry where, in the past, lenders might have gone out of business and left no contact information for borrowers seeking assistance.

“We’re not this big bad animal,” Mr. Arnold said. “This crisis that we’ve had in the mortgage business would have been a lot worse without MERS.”

About 3,000 financial services firms pay annual fees for access to MERS, which has 44 employees and is owned by two dozen of the nation’s largest lenders, including Citigroup, JPMorgan Chase and Wells Fargo. It was the brainchild of the Mortgage Bankers Association, along with Fannie Mae, Freddie Mac and Ginnie Mae, the mortgage finance giants, who produced a white paper in 1993 on the need to modernize the trading of mortgages.

At the time, the secondary market was gaining momentum, and Wall Street banks and institutional investors were making millions of dollars from the creative bundling and reselling of loans. But unlike common stocks, whose ownership has traditionally been hidden, mortgage-backed securities are based on loans whose details were long available in public land records kept by county clerks, who collect fees for each filing. The “tyranny of these forms,” the white paper said, was costing the industry $164 million a year.

“Before MERS,” said John A. Courson, president of the Mortgage Bankers Association, “the problem was that every time those documents or a file changed hands, you had to file a paper assignment, and that becomes terribly debilitating.”

Although several courts have raised questions over the years about the secrecy afforded mortgage owners by MERS, the legality has ultimately been upheld. The issue has surfaced again because so many homeowners facing foreclosure are dealing with MERS.

Advocates for borrowers complain that the system’s secrecy makes it impossible to seek help from the unidentified investors who own their loans. Avi Shenkar, whose company, the GMA Modification Corporation in North Miami Beach, Fla., helps homeowners renegotiate mortgages, said loan servicers frequently argued that “investor guidelines” prevented them from modifying loan terms.

“But when you ask what those guidelines are, or who the investor is so you can talk to them directly, you can’t find out,” he said.

MERS has considered making information about secondary ownership of mortgages available to borrowers, Mr. Arnold said, but he expressed doubts that it would be useful. Banks appoint a servicer to manage individual mortgages so “investors are not in the business of dealing with borrowers,” he said. “It seems like anything that bypasses the servicer is counterproductive,” he added.

When foreclosures do occur, MERS becomes responsible for initiating them as the mortgage holder of record. But because MERS occupies that role in name only, the bank actually servicing the loan deputizes its employees to act for MERS and has its lawyers file foreclosures in the name of MERS.

The potential for confusion is multiplied when the high-tech MERS system collides with the paper-driven foreclosure process. Banks using MERS to consummate mortgage trades with “electronic handshakes” must later prove their legal standing to foreclose. But without the chain of title that MERS removed from the public record, banks sometimes recreate paper assignments long after the fact or try to replace mortgage notes lost in the securitization process.

This maneuvering has been attacked by judges, who say it reflects a cavalier attitude toward legal safeguards for property owners, and exploited by borrowers hoping to delay foreclosure. Judge Logan in Florida, among the first to raise questions about the role of MERS, stopped accepting MERS foreclosures in 2005 after his colloquy with the company lawyer. MERS appealed and won two years later, although it has asked banks not to foreclose in its name in Florida because of lingering concerns.

Last February, a State Supreme Court justice in Brooklyn, Arthur M. Schack, rejected a foreclosure based on a document in which a Bank of New York executive identified herself as a vice president of MERS. Calling her “a milliner’s delight by virtue of the number of hats she wears,” Judge Schack wondered if the banker was “engaged in a subterfuge.”

In Seattle, Ms. McDonnell has raised similar questions about bankers with dual identities and sloppily prepared documents, helping to delay foreclosure on the home of Darlene and Robert Blendheim, whose subprime lender went out of business and left a confusing paper trail.

“I had never heard of MERS until this happened,” Mrs. Blendheim said. “It became an issue with us, because the bank didn’t have the paperwork to prove they owned the mortgage and basically recreated what they needed.”

The avalanche of foreclosures — three million last year, up 81 percent from 2007 — has also caused unforeseen problems for the people who run MERS, who take obvious pride in their unheralded role as a fulcrum of the American mortgage industry.

In Delaware, MERS is facing a class-action lawsuit by homeowners who contend it should be held accountable for fraudulent fees charged by banks that foreclose in MERS’s name.

Sometimes, banks have held title to foreclosed homes in the name of MERS, rather than their own. When local officials call and complain about vacant properties falling into disrepair, MERS tries to track down the lender for them, and has also created a registry to locate property managers responsible for foreclosed homes.

“But at the end of the day,” said Mr. Arnold, president of MERS, “if that lawn is not getting mowed and we cannot find the party who’s responsible for that, I have to get out there and mow that lawn.”

Copyright 2009 The New York Times Company. All rights reserved.

Commercial Real Estate Negotiations

At Shenwick & Associates, as a result of the current hard times that we are facing, and the increased number of bankruptcy filings, we are receiving a number of calls from clients regarding the consequences of a bankruptcy filing by their Landlord or Sublandlord, and what protections they need when negotiating a lease or sublease with a Landlord or Sublandlord who may be in financial trouble.

First, let’s talk about the situation where a Landlord or Sublandlord files for bankruptcy. Section 365(h) of the Bankruptcy Code says that if a debtor files for bankruptcy (the debtor would be a Landlord or Sublandlord) and seeks to reject an unexpired lease of real property under which the debtor is the lessor, if the lease term has commenced, the tenant or subtenant may retain its rights under the lease. These rights include rights related to the timing and amount of the payment of rent and other amounts payable by the tenant or subtenant, and any right of use, possession, quiet enjoyment, subletting, assignment or hypothecation for the balance of the lease term, and any renewal or extension of such rights, to the extent that those rights are enforceable under applicable non-bankruptcy law. Section 365(h) also provides that if the tenant or subtenant retains its rights under its lease, then the tenant or subtenant may offset against the rent reserved under the lease for the balance of the term after the date of the rejection of the lease and for any renewal or extension of the lease:

1. The value of any damage caused by the nonperformance after the date of rejection;

and

2. Any obligation of the debtor/Landlord or Sublandlord;

but the tenant or subtenant shall not have any right against the estate of the debtor on account of the damage occurring after such date due to nonperformance. In plain English, 365(h) provides that if a Landlord or Sublandlord files for bankruptcy, then the tenant or subtenant may vacate the space or remain in the space pursuant to the terms of the lease or sublease and may offset against rent any damages resulting from the Landlord/Sublandlord’s bankruptcy filing.

As a result of the protections provided to tenants and subtenants by Section 365(h), they may use the opportunity of a Landlord/Sublandlord’s bankruptcy filing as an opportunity or leverage to renegotiate their lease/sublease, particularly if the real estate market has dropped. With respect to a tenant or subtenant that is concerned about the Landlord/Sublandlord’s financial condition, provided below are some tips regarding lease clauses that they may want incorporated into their lease/sublease:

1. The ability to review financial statements from Landlord/Sublandlord.

2. Tenant/subtenant improvement funds from Landlord/Sublandlord should be in
escrow or in a letter of credit.

3. Large tenants/subtenants (full floor) should obtain a non-disturbance agreement from Landlord/Sublandlord’s mortgage lender.

4. In the case of a sublease, negotiate the right to remain in the space with the Landlord if the Sublandlord defaults or files for bankruptcy through a recognition or attornment agreement with the Landlord in the Landlord’s consent to sublease.

5. The right to take over Landlord/Sublandlord work if the building owner falls behind on maintenance or upgrades (“self help rights”), and to reduce the amount paid for building maintenance from the payment of rent (right of offset).

6. The right to deal directly with a Landlord/Sublandlord’s lender if the Landlord/Sublandlord goes bankrupt (a non-disrupt clause).

7. The right to terminate a lease if the tenant/subtenant’s business condition deteriorates.

8. The right to sublet space to whomever the tenant/subtenant chooses at any price.

9. The right to open negotiations for a lease renewal eight months before the lease expiration instead of the standard 24 months.

If any parties are interested in additional information regarding a potential bankruptcy filing by their Landlord or Sublandlord, or assistance in negotiating a lease, please contact Jim Shenwick.