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An Unholy Confluence: Bankruptcy Fraud Meets Mortgage Fraud and What Attorneys General Can Do About It

Karen Cordry, Bankruptcy Counsel

The current housing crisis has led some predators to afflict hapless homeowners with both bankruptcy and mortgage fraud. In a recent case, In re White, 2007 WL 4333279 (Bankr. N.D. Tex. 12/7/07), the Whites were unable to make the required mortgage payments on their home. They filed a Chapter 13 bankruptcy in June 2006 in an attempt to restructure their past due payments and save their home. An order was entered that maintained the automatic stay in place so long as they made their payments, but allowed the lender to proceed with its foreclosure rights if the debtors defaulted on the payments in the future. Unfortunately, the debtors once again fell behind and a foreclosure sale was scheduled for February 2007.

Before that happened, however, the Whites were contacted by North American Foreclosure (“NAF”), which promised to help them with a “completely legal” procedure that would stop the foreclosure. They were told they would need to deed a one percent interest in their home to NAF, that it would file bankruptcy in California, that the filing would stop the foreclosure, and that they would be required to pay NAF $650 a month to pay off the one percent interest. (Of course, since NAF had been given an interest in their home, it logically should have been paying the Whites, not the other way around, but this was yet another way in which NAF was cheating them.) The agreement required them to make the payments for so long as they were using NAF’s services, i.e., delaying the foreclosure. Supposedly, some of that money was to go to the original lender but that never happened. The debtors agreed to do what NAF proposed and executed a deed conveying the interest to a Ms. Casey, who they thought represented NAF.

The deed to Ms. Casey was purportedly dated January 2, and she did indeed file a pro se bankruptcy case in California on January 4. She did not list the one percent interest in her petition – because the deed was not executed until early February, and was merely backdated to January 2 and, as she later explained to the lender, she knew nothing about the transfer, was not part of this scheme, and claimed no interest in the property. In short, NAF had simply hijacked her bankruptcy case as a means of creating a basis for claiming that an automatic stay now existed with respect to the property. (A bankruptcy filing automatically bars any party from taking any action to control “property of the estate,” and even the one percent interest purportedly held by Casey would be enough to invoke that stay.) NAF faxed a copy of her bankruptcy petition to the lender on the day of the foreclosure sale and the lender prudently treated the notice as valid and took no further steps to complete the foreclosure sale that day.

The lender informed the bankruptcy court of the problem and the court required the debtors to show cause why they should not be held liable for this scam. After reviewing all the facts, the court concluded that the debtors had been duped by NAF (which concealed its activities by barring the debtors from having any contact with the lender) and that Ms. Casey was not involved at all. At bottom, the court concluded, the purpose of this scheme was simply to allow NAF to squeeze payments out of these debtors for as many months as possible until the scheme collapsed for each debtor and the foreclosure process resumed. Moreover, the lender informed the court it had been subject to this same process “multiple times per month” and the debtors testified that they had been approached by many parties making claims similar to those of NAF.

In view of the facts developed to that point, the court voided any purported transfer to Ms. Casey, and confirmed that the stay did not apply to the foreclosure sale. It then referred NAF and its representatives to the U.S. Attorney’s office for investigation of whether they had committed criminal bankruptcy fraud under 18 U.S.C. 152. It also notified the Texas Attorney General’s office for them to consider whether they wished to take any action.

One can readily find similar schemes on the Web. At for instance, one can find a company guaranteeing to postpone a foreclosure by up to 12 months. How is this done? Simple – the company says:

  • We ask for an undivided one eighth interest in your property, held by our corporation;
  • We file B/K in the corporation name, NOT in YOUR name
  • We are able in most cases to postpone trustee sale up to a year
  • We release the 1/8 interest back to you only when YOU say to,
Choosing these steps insure that you are not ruining your chances of refinancing. The reason is because: the B/K goes under the corporation name....not YOURS. Therefore it does not show under your name, only your late payments. . . . In other words: Let OUR company take the B/K hit so you can still try to refinance.

For the last ten or 15 years, it has been common in some districts, particularly in California, for unscrupulous debtors to engage in a round-robin pattern of bankruptcy filings to delay an eventual foreclosure. First, the husband files and invokes the automatic stay for a few months, until the case is dismissed, then the wife files, and then the husband returns and files again. This can continue indefinitely, especially if expanded by granting other persons fractional interests. In recent years, a new scam has emerged on the mortgage front by which unscrupulous companies convince desperate home owners that they should deed their homes to the company and the company will sell them their homes back when they get back on their feet – but the owners never see their deed again.

We are now seeing creative predators, such as NAF and Equity Secur, combining the worst aspects of both scams. First, home owners are persuaded to sign away some or all of their equity (and charged for the privilege of doing so) and then that transferred equity is used as the basis for fraudulent bankruptcy filings that are intended to do nothing more than delay the inevitable foreclosure. Equity Secure, at least, offered to file bankruptcy in its own name; NAF raised the fraud one additional notch by finding a third party and forging documents to piggy-back onto that legitimate filing. The bankruptcy courts had begun to combat the serial filing scams in bankruptcy by issuing in rem orders, i.e., orders applicable to the property as such, and not any particular debtor, providing that the automatic stay would not apply to any foreclosure activities relating to that property. The new twist of transferring property to a person in a distant bankruptcy court (without that person’s knowledge or agreement) is presumably meant to confuse the process further and evade the effect of the in rem orders.

All that said, should these issues be the concern of the Attorneys General? Initially, as one panelist once suggested in an ethics discussion, “Didn’t the debtors get what they paid for? After all, they did manage to stay in their house for a while at a relatively cheap cost.” The Whites, for instance, wanted desperately to hold on because they were hoping that they would settle a personal injury case for enough cash to make up their arrearages. While there is some surface appeal to that argument, the reality is, as the judge noted here, that debtors may lose far more than the money they pay to these predators. At a minimum, they are likely to have their current case dismissed with prejudice. If they re-file after straightening out the problems, they have to spend substantial amounts on new filing and attorneys’ fees, and recent amendments to the Bankruptcy Code penalize them for having had cases dismissed within the prior year by limiting the automatic stay. The court may have also decided to issue an in rem order to protect the lender, which will further complicate their status. Finally, debtors could well face criminal sanctions unless they convince the bankruptcy court that they were victims and not accomplices of the attempted fraud. Even if they escape being charged, they will surely incur additional legal costs and emotional distress in confronting that possibility. In short, it is highly unlikely that many debtors would knowingly agree to run those risks to delay foreclosure for a month or two.

So, if Attorneys General should be concerned, is there a role for them? Clearly, yes. In fact, the new Code provisions specifically empower Attorneys General to help regulate “debt relief agencies.” Those agencies are defined in 11 U.S.C. 101(12A) as a person who provides “bankruptcy assistance” in return for money. Bankruptcy assistance, in turn, is defined at Section 101(4A) as being any “goods or services sold or otherwise provided . . .with the . . . purpose of providing information, advice, counsel, document preparation, or filing, or . . providing legal representation with respect to a case or proceeding under this title.” Section 526(a), in turn, states that debt relief agencies shall not make statements that are untrue or misleading or counsel the debtor to do so, or “misrepresent . . . the services that such agency will provide.”

Under Section 526(c)(3), whenever a state has reason to believe that any person is violating this section, it may, in addition to any other remedy under state law, bring an action to enjoin such violation or to recover actual damages for its residents, and is entitled to its costs and attorneys’ fees in bringing such an action. Section 525(d)(1) further provides that nothing in this section shall exempt any person from complying with state law, unless the law is inconsistent with the Code and then only to the extent of the actual inconsistency. Thus, while in many areas, the Code preempts state law remedies for conduct that is also subject to the Code’s requirements, this language is an unequivocal anti-preemption provision that not only allows, but welcomes the Attorneys General to regulate these activities, and even recover their costs in doing so.

There is much value to proactive steps by the Attorneys General – while bankruptcy courts can seek to extricate debtors who come before them, courts will usually be able to do so only after those persons have already lost significant funds and made improper filings that may severely prejudice them in the future if they try to start over and do things right. Debtors, lenders, and the court system would all greatly benefit by actions that attack these parasites on the mortgage market and the bankruptcy system before they obtain new victims.

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