The DirtLaw Blog

Mortgage Pool in Bankruptcy - What Can Investors Do?

For those of monitoring the Cedar Funding implosion, it was not surprising to see that Cedar Funding, Inc. filed for Chapter 11 bankruptcy last week.

Cedar Funding is now a Debtor-in-Possession (DIP), and no doubt David Nilsen will seek to remain in control of the organization, and avoid the receiver recently appointed by a California Superior Court judge. 

What can creditors do?

In cases of fraud or wrongdoing, creditors can seek to appoint a Chapter 11 Trustee.  This would prevent the DIP (in this case Nilsen) from having ongoing control and management of the business.  However, many creditors should recognize that there is a cost associated with this, much the same as having a receiver in place.

Additionally, for unsecured creditors, the US Trustee will circulate a request that a creditor's committee be formed.

All of these steps are to part of evaluating the DIP's ultimate plan for reorganization.  The committee has voting rights, and in addition to the Trustee can object to a plan that is unlikely to be successful or in the best interest of creditors.

More aggressive steps? Creditors can determine if they should bring a motion to convert the bankruptcy to a Chapter 7.  Upon a conversion, the bankruptcy estate is controlled by the Chapter 7 Trustee and the goal of the Chapter 7 is a liquidation of assets rather than an a "re-organization."  While it can seem draconian, in reality, most Chapter 11 bankruptcies fail and the sooner the debtor liquidates, the higher likelihood of some recovery before the estate is eaten away.

How can a creditor decide?  A DIP has the obgliation to prepare operating reports and in this case, the operating reports may be more detailed than the reports that the investors may have sporadically received in the past.  The failure to supply these reports can be an indication that there is something to hide or that the debtor lacks the ability to satisfy the requirements of remaining in a Chpater 11 bankruptcy.

At a bare minimum, creditors will need to prepare their proof of claim and can decide to take a wait and see approach.

Private Money Investors Beware

Here in Northern California, we are all just wrapping up the mess that California Plan, Inc. made.  Michael Schneider was convicted and only recently sentenced.  He stole over $40M from investors, and was sentenced to 28 years.  Schneider's fraud was typical in that all investors claimed Schneider had their trust and was like family to them. 

Now the Cedar Funding fiasco in Monterey has surfaced.  Cedar Funding is a $70M+ fund, and the principal, David Nilsen, has been accused of running a giant Ponzi scheme, loaning money to insiders, (ie, himself to purchase his $4.2M posh home).  The DRE has suspended his license.  The Court has appointed a receiver to manage the fund and the DA is investigating.  Again, investors are saying that they trusted Nilsen.  The Montery Herald article says it all:

Nilsen was a member of her church, she said, and he instilled her with a sense of trust.

"I thought, 'This man is a God-fearing individual who would take good care of my money,'" said Abraham-North. "But he did not — he left me penniless."

The schemes fraudsters like Schneider use are not particularly creative.  Schneider was simply cutting and pasting investor names onto a Deed of Trust to make it look like it had been recorded for the investor.  In reality, Schneider photocopied investor names and glued them over the actual secured parties' name.  In this manner, he was able to make it look like the investor was secured when in fact, the Deed of Trust with their name was forged.

Additionally Schneider would not tell investors when their loans had paid off.  Instead, investors received their monthly interest payments for years, never realizing the borrower had re-financed and paid off their loan years ago.  Often, Schneider would tell investors after a payoff to leave their money in his trust account and he would "roll it over" into the next loan to allow them to continue to earn interest on their money.

How does an investor protect his or herself from this? 

Regardless of how trustworthy and conscientious a broker is, the investor must safeguard their financial future and take charge of their loan portfolio. If the investors had simply asked Schneider for the originals of their Deed of Trust, half their problem would have been eliminated. 

Additionally, a random spot check/audit of your Deed of Trust investing portfolio is never a bad idea.  You can search county records to see if your Deed of Trust has been reconveyed.  If it has, but you never received the payoff funds--you've got a problem.

Lastly, complacency puts the investor at risk.  If your loan pays off--take the money.  Wait for your broker to bring you the next investment opportunity and re-invest your money.  Losing out on a month of interest can spare the investor the heartache of losing the whole enchilada.

For investors in mortgage pools or collateralized mortgage obligations--you are entitled to monthly accountings.  If you are uncomfortable about not knowing the percentage loans held by insiders, hire an independent auditor to help you ask the right questions and get the right documentation from the fund manager.

Mortgage Fraud - The Appraiser's Role

Practicing real estate law in California can be a fun and diverse body of work.  The downside is seeing the surge in mortgage fraud and how it especially preys on elders.

As real estate values have risen, so too has the wealth of elders who have owned their homes for many years.  Additionally, as they have retired from the work force and have more time -- they are more likely to answer telephone cold calls or read their "junk mail" advertising mortgage schemes. 

Often, elders are receptive to the thought of converting the equity in their home into an income stream and think the "reverse mortgage" sounds right for them.

Not surprisingly, most of the time the "reverse mortgage" solicitication is an outright scam, where the fraudster takes title to the home, either in his or her name or LLC or through a straw buyer with good credit.  The elder is fed a volume of confusing information and at close of escrow believes he or she is going to receive payments from this "reverse mortgage loan" or that somehow the home will be deeded back to them.

This is where the appraiser fraud can come in.  With the straw buyer, the fraudsters are treating it as a new purchase, and in an effort to "double dip" will often try to get a credit back in the sales proceeds.  In some cases, we've seen as much as $50k back in a credit to the buyer.  How is that possible? Well, an inflated appraisal and sales price is usually the way to ensure that the property will appraise to value so that the lender's underwriting loan-to-value guidelines are met.  Even without the context of financial abuse of an elder, this is a common loan fraud scheme to squeeze money from the lender.  The new buyer will lose it in foreclosure if they can't afford to service the payments. 

After the Savings & Crisis, the bailout included strict legislation to deter appraisers from defrauding banks-FIRREA.   If appraisers are implicated, they will face stiff civil and criminal penalties.

After the S&L Crisis, the Appraisal Foundation was created.  They promulgated USPAP, the standards that are the generally accepted standards for professional appraisal practice in North America.

For single family residential real estate, the cost of an appraisal is generally less than $500.  For a certified MAI appraisal of commercial property, the cost is usually more than ten times that--in some cases $6,000-$8,000 for the appraisal report.

If at closing, you see an excessive amount of fees going to the appraiser, that is a red flag that the appraiser may be involved in the fraud.  Some fees are paid outside the escrow so it can be difficult to tell whether the appraiser was receiving extra compensation. 

The biggest question is whether the appraiser was merely negligent or whether they intentionally made a false appraisal.  That often can fall into the category of "I know it when I see it."  A property worth $300k, appraised at $650k exceeds the acceptable range of error.  A property appraised at $850k, when all homes in the neighborhood are comped at $750k is also difficult to treat as mere negligence.  An expert appraiser can testify as to what factors can make that higher value acceptable or unacceptable.

Bottom Line for Borrowers: Beware of loan products you do not fully understand.  Work only with licensed brokers in good standing that come from a reliable referral. Most importantly, in seeking out a reverse mortgage, make sure to go first to a large reputable bank for education about how the product works. 

Bottom Line for Private Money Lenders: Be skeptical of the appraisal report.  Your underwriting standards should involve more than one number in the appraisal report for you to calculate your LTV.  Working with a reputable broker will allow you to ask the questions that make sense--borrower's ability to repay, reliability of the appraiser, etc.

California Pre-foreclosure Investing and Foreclosure Sales - Do you know what's on record? Part II

Often times, a preliminary title report will show recent transfers.  Generally, the prelim lists those made in the last two years.  If it's not on your title report, you should request it from your escrow officer.

Why are previous transfers relevant?  Frequent transfers are a red flag that any prospective buyer should be wise to pay attention to.  If they are from an individual to their trust, that is fairly common.  If you see a back and forth transaction between the same individual multiple times, watch out!  That could a flag for fraudulent transfers. 

Sometimes a debtor will deed a property between family members or their spouse in order to hinder, delay or defeat creditor collections of judgments.  In California, a fraudulent transfer can be set aside by the Court many years after the discovery of the fraud. 

Other times, what may appear to be an innocent transfer between family members may also be the result of elder financial abuse--and those transfers are generally void ab initio, even as to bona fide purchasers.

Don't take what is on the public record at face value.  If you are a potential investor, purchaser, bidder or lender--it is prudent to make inquiry and see an experienced professional who spot these potential pitfalls and minimize your risk.

Mortgage Fraud

Today, a topic about something our firm is seeing altogether too much of these days–-Mortgage Fraud. Apparently, we are not alone as this column reports in the San Francisco Chronicle.

Mortgage fraud can appear in many ways, the most common of which also involves financial abuse of elders.

The Insider:

Often, an elder may rely on a friend, neighbor or relative to review financial documents as their eyesite fades. A relationship of trust is established and the confidante of the elder begins to realize that the elder is no longer paying close attention to their financial affairs. At some point, a grant deed or quit claim is being put in front of the elder, giving away the property. In some cases, the insider will refinance the elder’s home and then take all the equity by having the elder sign payment instructions at escrow. The insider takes the equity and splits town, leaving the elder facing the threat of foreclosure on an enormous loan.

The Stranger:

This is the true con artist, the supposed mortgage professional that convinces the elder that the ticket to smooth retirement is to get a reverse mortgage. The end result is the same as that of the insider scheme. The elder is defrauded and the equity drained out of the property.

What can be done? In some cases, the District Attorney can get involved. That is in situations where the fraudster is readily located and can be prosecuted. Threat of prosecution usually gets the fraudster to turn loose of the deed and any funds left from the loan.

Where there isn’t such a clear cut case, civil litigation is the remaining route. Usually the first priority is obtaining a restraining order to prevent the sale of the elder’s home at foreclosure. Unfortunately, the process can be a lengthy and expensive one. However, the California Welfare & Institutions Code provides for attorneys fees in the recovery. Assuming that the fraudster has not squandered the assets or funds, there is a possibility of some recovery.