Going Above and Beyond the SCRA

As we discussed in the last issue, the multistate settlement agreement, filed on March 12, 2010, has imposed settlement terms and agreements that operate much more like newly promulgated regulations than settlement terms. This assessment holds particularly true in the section of the agreement dealing with servicemembers. In recent months, the Department of Justice has made it very clear that it expects servicers to comply with the federal Servicemembers Civil Relief Act (SCRA). Clearly, our servicemembers deserve nothing less. The new settlement agreement, however, takes this sentiment one step further. In accordance with the agreement, servicers must now offer additional protections to servicemember-borrowers that far exceed those required under the SCRA.

First and foremost, the agreement vastly expands the class of individuals entitled to foreclosure protection. The SCRA prohibits foreclosure without a court order if the borrower is currently serving on active duty, or is within nine months of separation, if the loan was originated prior to the borrower’s entering military service. This restriction primarily protected members of the reserves and the national guard who were ordered to active duty or newly enlisted/commissioned members of the armed forces. By contrast, under the new settlement agreement, a servicer may not foreclose without a court order (or waiver) if the servicemember is eligible for Hostile Fire/Imminent Danger Pay and serving at a location outside the United States or more than 750 miles from the secured property, regardless of when the loan was entered into. This restriction will now protect all servicemembers who obtained mortgage loans while serving on active duty who are subsequently deployed to combat destinations.

While the foreclosure protection is the most significant departure from the SCRA, there are a number of additional requirements. Under the agreement, servicers must now provide a delinquency notice to all servicemembers who are 45 days delinquent. While HUD has required a similar delinquency letter on FHA loans since 2006, there is no such requirement under the SCRA. If a servicemember requests the 6 percent interest rate reduction, in lieu of providing military orders, which are required under the SCRA, a servicer must now accept a letter on official letterhead from the servicemember’s commanding officer that includes certain specific indentifying information or any other documentation that the Department of Defense deems sufficient as a substitute for official orders.

The SCRA allows a servicemember to waive various protections if the waiver is in writing in 12-point font and specifies the legal instrument to which it applies. Further, the waiver must be executed during or after the period of military service. The settlement agreement broadens these threshold requirements to provide that, in order to waive the foreclosure protection, the waiver must be executed at least 30 days prior to any anticipated foreclosure sale date and the servicer must send a notice with a copy of the proposed waiver to the servicemember in a format that is set forth in the agreement.

Lastly, the agreement mandates the use of the Defense Manpower Data Center to verify SCRA eligibility at additional times during the life of the loan. Now, in addition to other due diligence efforts, a servicer must search the DMDC database within seven days before a foreclosure sale, and either promptly after the sale or within three days of the end of the redemption period, whichever is later. If the servicer is pursuing a judicial foreclosure, it must search the DMDC database prior to moving for a default judgment if the servicemember borrower fails to answer. At the conclusion of the SCRA protection period, the servicer is required to search DMDC before returning the borrower’s interest rate to the pre-service interest rate.

- Emily G. Miller

Tweaking Dodd-Frank’s Treatment of Force-Placed Insurance in the Multistate Settlement

As we continue to examine various aspects of the multistate AG settlement, we will highlight areas of particular interest, including any that may give rise to private or governmental litigation arising out of the servicing standards in the settlement. Today, I want to talk about the treatment of force-placed insurance in the multistate settlement, and how it builds on the force-placed provisions in Dodd-Frank.

By way of background, Section 1463 of Dodd-Frank created a set of restrictions on force-placed insurance, codified in RESPA (12 U.S.C. Section 2605(k) and (l)), that were similar to procedures already used by some industry participants. The restrictions prohibit servicers from force-placing insurance until after sending two notices to the borrower with specific disclosures, at least 30 days apart, and then waiting until 15 days after the second notice. Dodd-Frank also provides that the servicer must accept “any reasonable form of written confirmation” that the borrower has obtained insurance, and requires both the cancellation of force-placed insurance following such confirmation, and a refund of force-placed premiums for any period of time during which the borrower’s coverage was in effect. Finally, Section 1463 requires the premiums for force-placed insurance to be “bona fide and reasonable,” except for charges regulated by state law as the “business of insurance” (which would seem to cover the premiums for the insurance itself, as those premiums are subject to state regulation and approval).

The multistate settlement also contains provisions regarding force-placed insurance. At first glance, one might think they were simply copied from Section 1463 of Dodd-Frank, but there are several subtle and not-so-subtle differences that have a significant impact on force-placed insurance:

  • More disclosures are required, including one that calls the borrower’s attention to the fact that force-placed insurance is more expensive than other coverage probably available to the borrower.
  • For first-lien loans on the servicers’ primary servicing systems, the servicer is required to offer the borrower the opportunity to handle the payment of insurance via escrow, and if the borrower accepts, the servicer is required to advance the premiums for the insurance, subject to recovery from the borrower later via escrow payments.
  • The amount of insurance purchased is limited to the greater of the replacement value of the property, the borrower’s last-known coverage, or the amount of the debt owed.
  • The policy of insurance “must be purchased for a commercially reasonable price.”

To me, the second bullet point is perhaps the most significant. Today, a servicer is required to advance premiums for hazard insurance only if it already has an escrow arrangement in place for such premiums. So force-placed insurance today is mainly an issue with non-escrowed loans, and the borrower is given a choice—either buy insurance or have the lender force-place separate coverage. But under the settlement, the servicer must offer to pay the premium for the borrower’s insurance if the borrower will agree, at the time of an insurance lapse, to set up an escrow arrangement. In essence, the settlement gives borrowers who fail to keep their properties insured the right to force-place their own insurance on the lender—and require the lender to foot the bill for it—subject only to later repayment by the borrower through the escrow.

Further, the settlement endorses the idea that insurance premiums for force-placed insurance may be challenged under state UDAP laws, when traditionally it has been argued that such premiums were immune from litigation challenges under the filed rate doctrine, which vests exclusive power in state insurance commissioners to regulate the prices of insurance. If this concept were to gain judicial acceptance, it would represent a fundamental change in the regulation of insurance and a significant increase in litigation potential arising from all types of insurance connected with lending. This is just one of the aspects of the settlement that the industry must resist to avoid its becoming some sort of “precedent” in litigated cases that attempt to follow the settlement’s provisions as some sort of legally binding authority.

- Christopher J. Willis

Preparing Your Company for Sale: The Role of Investment Banks

After determining to sell a business, a potential seller must decide whether to hire an investment bank to facilitate the sale process or to rely on the company’s owners, management, and legal advisers to manage the transaction. Given that investment banking fees can range from 1 percent to 5 percent of the transaction value, usually depending on deal size, engaging an investment bank can be costly; however, the expertise an investment banker provides often increases the sale price for a business enough to offset the fees and net additional proceeds to the seller. Investment banks also provide a number of services that ease the burden of selling a business.

Outsourcing Time-Consuming Activities
One of the primary benefits of hiring an investment bank is that the bank, in collaboration with the seller’s legal advisers, will handle many of the time-consuming aspects of the sale process. These services typically include the preparation of marketing materials and financial models for the business, communication with potential buyers, coordination of the due diligence process, and even negotiating key business terms of the purchase documents. With the time from the commencement of due diligence to the closing of a transaction often in the range of three to six months, attempting to run both the sale process and the business to be sold can be a difficult task. The distractions caused by the sale process often lead to decreased performance of the business itself. With the recent uncertainty in the economy and fluctuations in the markets, buyers are increasingly requiring that a portion of the purchase price for a business be contingent on post-closing performance. That means a decline in business performance that begins during the sale process and continues following the consummation of a transaction has the potential to affect the proceeds to the seller. Hiring an investment banker to coordinate the process allows the seller to focus on its business and minimize the risk of adverse purchase price adjustments due to declining business performance.

Valuation, Terms, and Industry Experience
Another significant benefit of hiring an investment bank is its ability to provide realistic valuation information as well as the terms and conditions that are typical for such a sale. Given that valuation multiples and transaction terms can vary significantly depending on the type of business for sale, engaging an investment bank familiar with the seller’s industry and its specific business assures that the proposed sale price for the business is reasonable and that the terms and conditions of the sale are customary. An investment banker with industry-specific knowledge will also be able to produce marketing materials that are tailored to the buyers of a specific type of business and generally will be able to assist the seller with issues that commonly arise in the sale of a business in that industry.

A Greater Pool of Potential Buyers
The most common way in which an investment bank creates value for a potential seller is through the marketing of the business to a much broader spectrum of potential buyers than the seller could otherwise reach on its own. Sellers often think only of strategic buyers (companies operating in the same or similar markets as the seller) as a potential acquirer, and lack the knowledge or contacts to reach a broader buyer base. Investment bankers have relationships with a wider range of potential buyers, including private equity firms and companies the banker knows are looking to enter a new market. This allows the banker to present an acquisition opportunity to numerous potential buyers that are unknown to the seller. This expanded group of potential buyers greatly increases the chance of obtaining multiple offers for the business, which in turn may result in competitive bids and a higher sale price.

After identifying one or more potential buyers for a business, an investment banker often handles a significant part of the negotiation of the transaction terms, which can be beneficial to a seller in several ways. First, investment banks negotiate purchase agreements much more frequently than a typical seller and will generally be far more knowledgeable about the reasonableness of the buyer’s proposed transaction structure and terms. Second, allowing an investment banker to negotiate on the seller’s behalf may permit the seller to adopt more aggressive tactics without hampering the negotiations, as the buyer will often view the investment bank as the driver of the aggressiveness. This is particularly beneficial when a seller will remain involved in the business for some time following the closing and contentious negotiations could put a strain on the post-closing relationship. Finally, buyers who frequently work with investment banks will have a general understanding of what terms and conditions the investment bank will accept and may take more reasonable positions at the outset, which can facilitate a more efficient sale process.

Objectivity and Independence
Throughout the sale process, the seller of a business must objectively examine its alternatives and may need outside perspective and guidance to realistically assess its options. This is particularly true where there is a large gap between a seller’s asking price and the offers made—a circumstance seen more frequently in recent years. In these cases, investment bankers will work with the seller in considering the reasonableness of the bids and alternative transactions or transaction structures that could be more lucrative for the seller. Having this objective guidance can assist a seller in overcoming unrealistic expectations that could hinder the ultimate goal of selling the business.

Investment Banking Contracts
A typical investment banking contract will describe the services to be performed by the investment banker and whether the engagement is exclusive; the expectations of the seller to participate in the process; the compensation, which usually includes a retainer, reimbursement of expenses, and the contingent sale fee and how it is calculated; a term and termination rights; and indemnification provisions. Ballard Spahr’s Mergers and Acquisitions/Private Equity Group has extensive experience negotiating investment banking contracts for clients who want to sell their companies.

For further information, please contact Karen C. McConnell at 602.798.5403 or mcconnellk@ballardspahr.com.

- Karen C. McConnell



CFPB Rulemaking Portends Unilateral Modification of Privileges

The Consumer Financial Protection Bureau has issued a proposed rule to govern the effect of voluntary or involuntary submission of otherwise privileged information to the Bureau and the question of whether the privileges attaching to that information would be waived if it were shared with a third party.

The proposed rule‘s privilege preservation regime would apply only to a waiver for information finding its way into the hands of third parties (such as other federal or state agencies, including state attorneys general) and does not purport to preserve the privilege vis-à-vis the CFPB.

The comment period for this CFPB rulemaking is relatively short for a rule with such significant ramifications. Comments are due on April 14, 2012, just 30 days after publication in the Federal Register.

This rulemaking will be of interest to all entities—bank and nonbank alike—that are subject to the supervisory and enforcement jurisdiction of the CFPB. Each entity may wish to revisit its policies with respect to privileged information subject to attorney-client privilege or work product protection, and may wish to comment on the Bureau’s proposed rule.

The CFPB rulemaking builds upon ground staked out by the agency early in January in its Bulletin 12-01, which likewise claimed unfettered access to the records of regulated entities and asserted that the information so obtained would not be subject to waiver of attorney-client privilege (other than vis-à-vis the Bureau). This rulemaking expands upon that position in two significant ways. First, whereas Bulletin 12-01 applied only to banks subject to the Bureau’s examination authority (those with more than $10 billion in assets), the proposed rule would apply to all nonbank entities, large and small. Second, whereas the Bulletin dealt solely with the attorney-client privilege, the proposed rule purports to cover other privileges as well and specifically refers to the attorney work product doctrine.

The Bureau asserts this position even though it is aware that there are two federal statutes providing for privilege preservation and that the existence of these statutes makes a change in that regime by any federal entity other than Congress questionable. Under 12 U.S.C. Section 1828(x), the submission by a financial institution of privileged information to a federal banking agency, a state bank supervisor, or a foreign financial regulator in connection with any supervisory or regulatory process does not waive any privilege applicable to that information (except as to the regulator to whom it has been submitted). Then, under 12 U.S.C. Section 1821(t), the sharing of any such information by a federal financial regulatory agency with any other federal agency also does not waive the privilege belonging to the privilege holder. Neither of these statutes, as currently on the books, applies to the Bureau (except in the limited sense that the Bureau would be a permissible recipient of shared information under § 1821(t)).

The Bureau is also aware that Congress is interested in a “legislative fix” for this oversight, and CFPB Director Cordray even proclaimed his support for such a statutory correction in his sworn testimony before Congress last month. Moreover, as the Bureau knows, bills have recently been introduced in both houses of Congress—S. 2009 and H.R. 4014—to effect such a “legislative fix.” Indeed, the House passed H.R. 4014 on March 26. Why the agency would “jump the gun” by seeking to accomplish the same thing by regulatory fiat is unclear. Combined with its recent MOU with state attorneys general, the CFPB’s action is suggestive of the eagerness with which it anticipates sharing information with state law enforcement authorities.

In short, the proposed rule would apply to submission of any information by any person and would, for example, subsume not only documents or analysis prepared by counsel in anticipation of litigation with a regulatory agency (including the Bureau itself!) but also privileged material belonging to any otherwise unregulated, nonbank entity over which the Bureau might assert authority. The Bureau’s privilege preservation approach tracks very closely language in the recently introduced bills mentioned above.

The breadth of rulemaking authority asserted in the agency release is unprecedented. To begin with, the Bureau claims derivative rulemaking power from the supervisory authority transferred by the financial institution regulatory agencies—OCC, FDIC, OTS, the Fed, and NCUA—as part of the grant of “all powers and duties . . . relating” to that transfer pursuant to Dodd-Frank Section 1061. Next, the agency claims “nearly identical authority” with respect to nonbanks and service providers pursuant to Section 1024(b), (e). Third, the Bureau claims delegated authority under Section 1022(c)(6)(A) to “prescribe rules regarding the confidential treatment of information obtained from persons in connection with the exercise of its authorities under Federal consumer financial law.” Finally, the CFPB invokes authority, pursuant to Section 1022(b)(1), to prescribe rules it determines are “necessary or appropriate to enable the Bureau to administer and carry out the purposes and objectives of the Federal consumer financial laws, and to prevent evasion thereof.”

The arguments made by the Bureau both in Bulletin 12-01 and in the notice of proposed rulemaking are reminiscent of the arguments made in the 1980’s and 1990’s by the bank regulators when they sought to prevent the plaintiffs’ bar from obtaining access to reports of examination. Those efforts were not uniformly successful, and some courts were willing to provide access to confidential exam reports if the plaintiffs could make a sufficient showing of need for the information.

- Keith R. Fisher

CFPB Issues First Annual Report on Fair Debt Collection Practices Act Activities

The clear takeaway from the Consumer Financial Protection Bureau’s first annual report to Congress on enforcement of the Fair Debt Collection Practices Act is that debt collection will be a major focus of both the CFPB and the Federal Trade Commission in 2012.

In addition to giving FDCPA enforcement and rulemaking authority to the CFPB, the Dodd-Frank Act transferred from the FTC to the CFPB responsibility for preparing the annual FDCPA report. Submitted to Congress on March 20, 2012, the CFPB’s report incorporates information from (and includes as an appendix) a letter dated March 13, 2012, sent by the FTC to the CFPB summarizing the FTC’s debt collection activities in 2011 and early 2012.

Highlights of the CFPB report and FTC letter include the following items:

  • Debt collection continues to be a leading subject of the consumer complaints submitted to the FTC, with the FTC receiving more complaints about the debt collection industry than any other specific industry. Of the FDCPA complaints received by the FTC in 2011, complaints about third-party debt collectors increased in absolute numbers and as a percentage of all complaints.
  • Before the end of 2012, the CFPB plans to add debt collection to the nonbank products and services covered by its complaint system.
  • The CFPB’s reach into the debt collection industry will extend much further than the debt collectors with more than $10 million in annual receipts that the CFPB has proposed to define as “larger participants.” (We summarized the CFPB’s proposal in a recent legal alert.) The CFPB report observes that Dodd-Frank gives the CFPB supervisory authority over service providers to large insured depository institutions as well as service providers to mortgage originators, payday lenders, and student lenders. Some service providers to smaller depository institutions are also subject to CFPB supervisory authority. Those service providers can include third-party debt collectors regardless of the collector’s size.
  • The CFPB is currently conducting “non-public investigations of debt collection practices to determine whether they violate the FDCPA or the Dodd-Frank Act.”
  • The FTC expects to issue a report in 2012 with findings and recommendations, if appropriate, on the debt-buying industry. Presumably this report will use information obtained by the FTC pursuant to the order it issued in 2009 to nine of the nation’s largest debt buying companies requiring them to produce “extensive and detailed information about their practices in buying and selling consumer debt.” The FTC also expects to issue a report in 2012 relating to debt collection technologies.
  • The FTC noted in its letter that, to improve deterrence, it has focused in recent years “on bringing a greater number of cases and obtaining stronger monetary and injunctive remedies against debt collectors that violate the law.” According to the FTC, the seven debt collection cases it brought or resolved in the past year represent the highest number of debt collection cases it has brought or resolved in any single year. The FTC also highlighted its willingness in five of these cases to use its authority under Section 13(b) of the FTC Act to obtain preliminary or permanent injunctive relief, with the preliminary relief in several of these cases including ex parte temporary restraining orders with asset freezes, immediate FTC access to business premises, and the appointment of receivers to run the collection business.
  • Both the CFPB report and the FTC letter describe recent FTC enforcement actions that “represent an extensive and concerted effort by the FTC to target debt collection practices that pose substantial risks to consumers.” The practices identified include collection activity undertaken by debt collectors based on information that is deficient in quantity and quality, collection of time-barred debts, and improper tactics used in the collection of payday loans. The FTC letter also references the FTC’s continued concerns about certain aspects of collection litigation and requirements for consumers to resolve debt collection through binding arbitration.

The debt collection industry, and creditors attempting to collect their own debts, are currently facing a rash of documentation-related challenges that have spread from mortgage foreclosures to encompass all manner of collection actions, including those involving credit card, student loan, and other types of non-mortgage debt. To assist clients in responding proactively to such challenges, Ballard Spahr’s Consumer Financial Services Group’s recently formed Collection Documentation Task Force conducts extensive reviews of collection procedures and counsels on best documentation practices. The task force brings together litigators in the group with experience defending mortgage lenders and other consumer lenders in documentation-related lawsuits nationwide and regulatory lawyers in the group with deep knowledge of the Office of the Comptroller of the Currency’s national bank foreclosure review process and federal and state debt collection laws.

- Barbara S. Mishkin

Outside Marketer’s Text Spamming Poses Risk of Vicarious Liability

An outside marketing firm’s use of an autodialer to send text messages to consumers without their consent may trigger vicarious liability under the Telephone Consumer Protection Act (TCPA) for the company that hired the marketing firm, a federal judge in California has ruled.

The decision in In re Jiffy Lube International, Inc., Text Spam Litigation, issued on March 8, 2012, highlights the need for companies that use third-party marketing firms to consult with counsel regarding the steps they can take to reduce the risk of vicarious liability for the marketing firm’s TCPA violations, including appropriate contractual protections.

The TCPA prohibits use of an autodialer to make a non-emergency call to a cell phone unless the call is “made with the prior express consent of the called party.” Relying on Ninth Circuit authority that “implicitly accepted” vicarious liability for TCPA violations and other supporting case law, the Southern District of California court refused to dismiss a TCPA class action filed against a Jiffy Lube franchisee based on the text messages sent by its marketing firm.

The district court found that the franchisee “can be held liable even if it did not physically send the messages at issue.”

It also found that, to survive a motion to dismiss, the complaint did not have to provide specifics about how much control or information the franchisee had as to the marketing firm’s use of an autodialer. According to the court, the plaintiffs’ allegation that the franchisee “directed” the transmissions and “engaged” the marketing firm provided “sufficient detail and plausible factual allegations regarding [the franchisee’s] ultimate control to meet the federal pleading standard.”

The district court refused to take judicial notice of invoices submitted by the franchisee to show that, by providing their telephone numbers to the franchisee on the invoices when they received oil changes, the plaintiffs had consented to the text messages. In addition to observing that the invoices were not alleged in the complaint or relied on by the plaintiffs, the court commented that it was “not persuaded” the plaintiffs’ provision of their telephone numbers constituted “prior express consent” to the text messages.

The district court rejected the franchisee’s argument that the TCPA violated the First Amendment of the U.S. Constitution by restricting the use of smartphones or personal computers with the capacity to function as autodialers. The franchisee also failed in its attempt to compel arbitration with one of the plaintiffs based on a provision in that plaintiff’s invoice providing for mandatory arbitration of “any disputes, controversies or claims” between the franchisee and the plaintiff. The court was unwilling to find that the plaintiff’s TCPA claim was a dispute that “arises out of or relates to” the contract contained in the invoice.

We continue to see a high volume of class actions against companies alleging TCPA violations. In part, this is because penalties are draconian. Violations can yield damages equal to a minimum of the greater of $500 or actual damages per violation, triple damages for willful violations, and unlimited class action liability.

- Barbara S. Mishkin

Use of Unpaid Interns Under Attack

Three recent wage and hour class action cases filed in New York are calling into question employers’ practices with respect to unpaid interns, perhaps signaling an uptick in such claims under the Fair Labor Standards Act (FLSA).

The U.S. Department of Labor has outlined six criteria for the appropriate designation of unpaid interns. Employers who regularly use unpaid interns should review their practices and compare them to the six criteria outlined by DOL to ensure that such unpaid internship programs are in keeping with the law.

Click here to read the complete alert from our Labor and Employment Group.
If you have questions on your unpaid internship program, policies, or procedures, please contact Quinton J. Stephens at 801.531.3089 or stephensq@ballardspahr.com.


Copyright © 2012 by Ballard Spahr LLP.
(No claim to original U.S. government material.)




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This alert is a periodic publication of Ballard Spahr LLP and is intended to notify recipients of new developments in the law. It should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own attorney concerning your situation and specific legal questions you have.