The legal infrastructure of ex post consumer debtor protections.

• Author: Jacoby, Melissa B.

Introduction I. Functional Categories of Ex Post Debtor Protection II. Channels of Production of Ex Post Debtor Protection III. Implications of the Legal Infrastructure A. Should Debtor Protections be Bundled or Unbundled? B. How Does Legal Infrastructure Hinder Effective Use of Intermediaries? Conclusion INTRODUCTION

On the first Tuesday of the month, a few dozen people stand staggered on the steps of the county courthouse. They appear to be reading aloud to themselves from a sheaf of papers. Passersby steal glances but often are unaware that these readings carry great legal significance: foreclosure auctions of homes. Those representing the mortgagees have neither podium nor microphone, let alone a gavel. Murmuring simultaneously, they don't take turns. As the law requires, these auctions likely have been advertised in small print in newspapers. But, for a variety of reasons, interested third-party bidders with the requisite cash, cashier's check, or wiring instructions are few and far between. Absent a higher third-party bidder, the mortgagee becomes the owner of the home in a matter of minutes. Absent a later challenge, the process is over. (1)

Just a few city blocks away, people with distressed mortgages file bankruptcy petitions in a federal courthouse. These filings will usually stop a scheduled foreclosure auction of their houses, at least temporarily. Many of these homeowners will propose repayment plans that will cure their mortgage arrears, although completion of those plans is far from certain.

These observations illustrate how bankruptcy and foreclosure systems address very similar legal and economic issues. But, as a formal matter, they are entirely distinct. Different judges, different lawyers, different rules. The division of debtor-creditor law among multiple legal systems has many perfectly reasonable explanations. Yet, the consequences for the delivery of consumer protection are too often overlooked and not yet well understood.

This Cooper-Walsh Colloquium contribution reviews the legal infrastructure of tools that protect debtors' assets or income, or that enable debtors to resolve secured credit problems during ordinary times (e.g., not specific crisis interventions). Part I divides consumer protection tools into functional categories: protection of assets and future income, and retention of property subject to a security interest in default. Part II identifies the location of similar tools in federal law, uniform state law, and non-uniform state law. Part III examines implications of this divided system, with a special focus on the bundling of debtor protections and the role of intermediaries. This discussion helps us imagine improvements to consumer protection whether or not new legal tools are added.

1. FUNCTIONAL CATEGORIES OF EX POST DEBTOR PROTECTION

   In the traditional law school model, the concept of a remedy is equated with an action for money or injunctive relief in a lawsuit. Indeed, many federal and state statutes or common law doctrines offer these forms of relief to consumer debtors. (2) Damages might be compensatory, punitive, and/or include attorneys' fees for a prevailing debtor. (3) For example, section 9-625 of the Uniform Commercial Code (part of Article 9 governing secured transactions in personal property) explicitly authorizes damages to a defaulting debtor if a secured creditor fails to comply with Article 9's requirements, such as conducting a commercially reasonable foreclosure sale, providing reasonable notice of the sale, and not breaching the peace during any self-help repossession of collateral. (4)

   Scholars and advocates have long recognized a variety of impediments to consumers' effective use of traditional litigation-based remedies. Many consumers with viable claims do not seek advice on pursuing such claims either offensively or defensively. (5) Or, if they do, they wait too long for such actions to be any use. People with viable claims may have trouble obtaining legal representation when the dollar value of the remedy is modest. (6) This is a problem even if a law authorizes treble damages, fee-shifting, or other mechanisms to magnify the value of the litigation to lawyers. (7) Although Congress and state legislatures contemplated that litigants with small claims could join forces and bring their claims collectively, (8) obtaining certification of a consumer class action remains difficult. (9) And, in some contexts, doctrines such as the holder in due course limit the ability to pursue a damage remedy or to present a related defense to nonpayment. (10)

   Debtor-creditor law includes other kinds of tools for defaulting debtors, however, based on a somewhat different model (although sometimes still premised on litigation). Categories of these tools are explored below.

   Protection of unencumbered assets and future income: A variety of laws in this category prevent creditors from satisfying even undisputed claims out of particular assets or future income of individual debtors. Examples include limits or bans on deficiency judgments in foreclosure actions, (11) limits or bans on garnishment of wages, and exemptions of property interests from judgment lien enforcement. Bankruptcy law essentially represents a combination of these tools with other types relating to secured credit. (12)

   Retention of property encumbered by a security interest: The prior category, protection of unencumbered assets and future income, has only limited direct effect on consensual secured creditors, at least as measured on an ex post basis. So, for example, property exemptions do not bar consensual secured creditors from reaching the full value of an asset. Tools to retain property that secures a debt by contract are of considerable interest to many consumer debtors, but also to policymakers concerned about the broader impact of the loss of homeownership. Consider this menu of possibilities:

   (1) Property redemption from a secured loan--A baseline protection of all foreclosure law is to permit debtors in default to redeem collateral prior to a foreclosure sale. This principle applies both to real and personal property. (13) Various laws set the price of redemption differently, with most state laws requiring payment of the full debt plus the creditor's costs, but with bankruptcy law permitting redemption of personal property based on the value of the collateral. (14) Less uniformly available is a post-sale redemption of real property (which is not recognized for personal property under Article 9 of the Uniform Commercial Code).

   (2) De-accelerate, cure, and reinstate mortgages and security interests--Some laws permit borrowers with defaulted mortgages to retain their homes by curing arrears and paying associated costs in a lump sum even if the mortgage holder already had properly accelerated the loan in accordance with the terms of the agreement. (15) In bankruptcy law's version of this reinstatement right, a debtor can pay those arrearages over time. (16)

   (3) Modification of a secured loan--Bankruptcy law permits debtors to restructure some (but not all) kinds of secured debts over the secured party's objections. (17) This potentially includes reducing secured debt to the collateral's value, paying that value with interest over time (essentially an installment redemption), and treating the remainder as an unsecured claim payable pro rata with other unsecured claims. As a foreclosure management effort, members of Congress have proposed to expand the circumstances under which at least high-risk mortgages could be modified in Chapter 13. (18)

   (4) "Avoidance" of mortgages or security interests--Property retention is also occasionally accomplished through legal avoidance of a security interest. For example, a trustee in a bankruptcy case steps into the shoes of a hypothetical bona fide purchaser and may seek to strip a mortgage from real property if a bona fide purchaser would have had rights superior to the mortgagee. (19) This power is used to police compliance with state law formalities for "perfecting" security interests and mortgages that maximize creditor protection. (20) Alternatively, a trustee may seek to avoid a mortgage as a preferential transfer of an interest in the debtor's property. (21) Notably, the exercise of avoidance rights by a trustee depends on significant lender mistakes or omissions. Neither needs of the debtor nor motives of the creditor tend to be relevant to the formal legal analysis.

2. CHANNELS OF PRODUCTION OF EX POST DEBTOR PROTECTION

   The debtor protections and tools discussed in Part I are generated through federal law, uniform state law, and non-uniform state law. Consumer bankruptcy law is a prominent example of federal law. Its discharge of debt, which effectively protects assets and future income, is used as a remedy for a wide variety of debtor-creditor problems. (22) It also contains many of the tools for working with secured debt discussed in Part I. Separately, federal law sets a floor on the proportion of wages that may be garnished. (23) Occasionally, federal regulation promulgated pursuant to a statute produces these kinds of debtor protections. For example, the Federal Trade Commission long ago promulgated a rule that deems non-purchase-money, non-possessory liens on household goods, to be an unfair credit practice. (24) The new Bureau of Consumer Financial Protection's rulemaking and enforcement authority could affect ex post debtor protections as well. (25)

   The uniform law process produces a significant portion of commercial law, including some relevant to this discussion. A uniform act is a model statute...