Archives for July 2014

Resurrection of the subprime mortgage mess-this time in car loans

In the run up to the 2008 financial crisis, investment bankers were telling us they were flush with cash. In a real estate boom fueled by easy availability of credit, even buyers with poor credit histories could get mortgage loans, often with exotic terms and overstated income or values put onto credit applications by less than scrupulous mortgage brokers. The whole thing was fueled by securitization, in which large bundles of questionable loans were created for investors, with the risks hidden by overstated appraisal values and credit rating agencies that for one reason or another did not expose the risk.

The result was the crash in real estate and the crisis in financial markets that started in late 2008. The real estate market is only now starting to recover.

But subprime credit targeting the most vulnerable borrowers has come back. In a  July 21, 2014 report in the New York Times, In a Subprime Bubble for Used Cars, Borrowers Pay Sky-High Rates  we learn that in the past 5 years, auto loans to borrows with tarnished credit have gone up 130 percent, and that these loans are 25% of the total of auto loans being made. The Times investigation found loan rates as high as 24%, with the amounts borrowed typically about double the value of the car being purchased. The borrowers frequently default and the cars are repossessed. Many of the borrowers have a previous bankruptcy that prevents them from discharging the resulting deficiency debt.

As the Times reports, the money to make these loans is fueled by same process of loan securitization and investors looking for high rates of return in a difficult investing environment. Indeed, in some respects, auto loans are less risky that mortgage loans. A car can repossessed and sold in many states in a small fraction of the time to foreclose on a mortgage and sell the home at Sheriff Sale.

The victims of this process are the most vulnerable of borrowers. Most need reliable transportation in order to get to work and to feed themselves and their families. Without access to a ready chunk of cash, they have to borrow the money to buy a car.

We constantly counsel our bankruptcy clients to start with and keep a budget, and to accumulate cash for important needs such as auto repairs. But even the most diligent often find themselves backed into a financial corner, where getting an auto loan is the only option.

So availability of credit for this purpose is not necessarily bad. What is deplorable is the way that used car sellers and lenders are pawning off overpriced vehicles of questionable value on those who seek credit.

For the regulators, some controls on the credit industry and its used car seller partners is called for. For those who need to borrow money for basic transportation, the lesson is that “buyer beware”, and to borrow money for these purposes carefully and with full knowledge of the traps that unscrupulous dealers and lenders have lying in wait for them.

 

Supreme Court now decides to answer the questions it ducked in Arkison-what can a bankruptcy court decide, when and how?

A short time ago we reported on Executive Benefits v Arkison, where some critical questions about the powers of bankruptcy courts were left hanging.  In Wellness International Network, Limited v. Sharif,  the Supreme Court has now decided to take up a case where those issues are clearly presented. On July 1, 2014 it granted Certiorari to review a decision of the Seventh Circuit Court of Appeals in that case.

The issues presented in the case turn on the extent of the Bankruptcy Court’s power to render final decisions and in what types of matters. You will recall that Bankruptcy Courts are Article I courts, appointed without the lifetime tenure granted to federal district court judges and other Article III judges.

Generally, Article I jurisdiction is centered on “bankruptcy specific” issues, that would not exist as controversies outside of bankruptcy. What property is included in a bankruptcy estate would seem clearly to fall within this area, yet  in Sharif, the Court is being asked to decide whether the presence of a subsidiary state property law issue necessary to decide this question takes the controversy outside Article I territory, so that a bankruptcy court does not have the constitutional authority to enter a final order deciding that matter.

The second issue in Sharif concerns whether,  under Article III of the Constitution, litigants by either express or implied consent can empower bankruptcy courts to enter final decisions in matters that are beyond Article I. The Seventh Circuit said no.

Decision on these matters is expected next term. If the Court decides against bankruptcy court powers on either question, the result will be to upend bankruptcy practice, causing many or all routine bankruptcy matters to grind to a halt as much or all of the bankruptcy court docket is shifted to already-overburdened federal district court judges.

The Court has already upheld the power of another class of Article I judges to render final decisions by consent, and a different ruling here could have drastic effects across the Federal Court system. In Roell v. Withrow, 538 U.S. 580 (2003), the Court held that U.S. Magistrate Judges could proceed by implied consent of the parties based on their lack of objection and other conduct, even though the Federal Magistrate Act of 1979 required written consent. Magistrates work as an arm of the District Courts. The Magistrate Act specifically provides that “upon the consent of the parties, a full-time United States magistrate judge . . . may conduct any or all proceedings in a jury or nonjury civil matter and order the entry of judgment in the case, when specially designated to exercise such jurisdiction by the district court.” 28 U.S.C. § 636(c)(1) [28 USCS § 636(c)(1)]. Unlike  nonconsensual referrals of pretrial but case-dispositive matters under § 636(b)(1), which leave the district court free to do as it sees fit with the magistrate judge’s recommendations, a § 636(c)(1) referral gives the magistrate judge full authority over dispositive motions, conduct of trial, and entry of final judgment, all without district court review.  A judgment entered by “a magistrate judge designated to exercise civil jurisdiction under [§ 636(c)(1)]” is to be treated as a final judgment of the district court, appealable “in the same manner as an appeal from any other judgment of a district court.” § 636(c)(3).”  Roell v Withrow, 538 U.S., at 585.

Bankruptcy Courts are given jurisdiction by another Congressional enactment, embodied in 28 USC 157,  which gives them power to act as “a unit of the district court.” The statute provides that “with the consent of all the parties” the District Courts may refer Article III matters to the bankruptcy courts for final decision. In New Jersey and throughout the country, the District Courts have entered Standing Orders of Reference. 28 USC 157(c) also provides a mechanism for the parties to opt out and by a “withdrawal of the reference” insist on the district court making the rulings in the first instance.

We would hope that the Court would see this as putting bankruptcy courts in the same posture and status as US Magistrates. If not, the Court will have to confront whether Roell is still good law, and if not, how the federal courts can handle the enormous caseload now routinely disposed of by bankruptcy court as well as US Magistrates.

It is going to be an interesting year in bankruptcy practice. We can expect litigants interested in hindering or delaying decisions by the bankruptcy courts to raise these issues. Clarification has been delayed, and is overdue.

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