Tips for In-House Counsel

January 24, 2012

In re Taylor: Attorneys May Not Rely Solely on “Default Management” Databases to Prepare Mortgage Bankruptcy Pleadings

By Andrew Erskine of Zuber Lawler & Del Duca

Attorneys and law firms handling mortgage foreclosure-related matters cannot rely solely on factual information contained in a “default management” database maintained for their client in preparing bankruptcy and other court pleadings, the U.S. Court of Appeals has concluded.  In a significant decision, the Third Circuit held that attorneys in federal court a have a duty to conduct reasonable investigation with respect to information provided by their clients, whether by way of a database or otherwise.  In so doing, the court upheld sanctions against a mortgage lender’s law firm and one of its attorneys for filing allegedly inaccurate pleadings in a bankruptcy proceeding seeking to secure relief from the automatic stay.

Background

The court concluded that the pleadings, which were prepared from information on a computerized database maintained by a third party default management provider for their lender client, without further inquiry, did not evidence reasonable investigation by the law firm and attorney, as required under Federal Rule of Bankruptcy Procedure 9011, the bankruptcy equivalent of Rule 11 of the Federal Rules of Civil Procedure.  The bankruptcy court rule requires that parties making representations to the court must certify that the allegations and other factual contentions have evidentiary support or, if specifically so identified, are likely to have evidentiary support.’

Where the Pleadings Fell Short

In upholding the sanctions, the Court of Appeals, in In re: Taylor, 655 F. 2nd 274 (3rd Cir. 2011), focused on a request by the lender for relief from the automatic bankruptcy stay and, a pleading responding to the debtor’s objection to the lender’s proof of claim.  Both pleadings, the court concluded, contained inaccurate information.  The relief from stay pleadings simply stated that the debtors had failed to make post- petition monthly payments, without further elaboration.  The court noted an ongoing dispute between the lender and debtor as to whether the property securing the loan was in a flood zone.  Concluding that it was, the lender had “force-placed” flood insurance, resulting in an approximate $180 increase in the monthly payment on the mortgage. The debtors disputed the lender’s position and continued to pay their regular mortgage payment without the additional insurance costs.  In preparing the relief from stay pleading, the law firm did not mention the flood insurance dispute nor did it mention the partial payments made by the debtors and accepted by the lender.  In addition, the relief from stay pleadings understated the equity in the subject property, the court stated.

The pleadings relating to the lender’s proof of claim alleged that all figures contained in the proof of claim (which had been filed by another law firm on the lender’s behalf) accurately reflected actual sums expended by the lender and charges the lender is entitled to receive and that debtors were obligated to pay.  In fact, the court concluded, the proof of claim misstated the monthly payment that was actually required, and understated the value of the property by about $100,000.

Reliance on Client Information

The attorneys claimed that they were required by their lender client to rely solely on the database, entitled “NewTrak” maintained by a vendor on behalf of their client in preparing the pleadings and were prohibited or discouraged from contacting lender personnel to investigate or confirm information contained in the database.  The court found that the database provided the firm with only the loan number, debtor’s name and address, payment amounts, late fees and amounts past due. It did not provide any evidence of the flood insurance dispute, nor did it contain any information regarding the value of the debtors’ home or the amount of equity remaining.

The court stated that it is usually reasonable for a lawyer to rely on information provided by a client, especially where that information is superficially plausible and the client provides its own records which appear to confirm the information.  In holding the behavior of the law firm and attorney unreasonable, the court commented “[A]n attorney must, in her independent professional judgment, make a reasonable effort to determine what facts are likely to be relevant to a particular court filing and to seek those facts from the client.  She cannot simply settle for the information her client determines in advance—by means of an automated system, no less—that she should be provided with.”  The court continued that it should have been evident to the attorney that the lender was not providing adequate information simply from reviewing the information on the NewTrak database.  As an example, there was no information on the debtors’ equity in the home, although the attorney made a statement to the effect that the debtors had no such equity.  Had she made such inquiry, the court asserted, the lender would have been likely to provide her with information on the flood insurance dispute, and the attorney could have included such information in the filings, or perhaps advised the client that seeking a motion for relief from the stay was inappropriate under the circumstances.

Use of Databases Not Inappropriate So Long as Attorneys Can Investigate

The court continued that “[W]e .. do not mean to suggest that the use of computerized databases is inherently inappropriate.  However, the NewTrak system, as it was being used at the time of this case, permits parties at every level of the filing process to disclaim responsibility for inaccuracies. [Lender] has handed of responsibility to a third party maintainer ..., which, judging from the results in this case, has not generated particularly accurate records.  [Vendor] apparently regards itself as a mere conduit of information.  Appellees, the attorneys and final link in the chain of transmission of this information to the court, claim reliance on [Vendor’s] records.*** In the end, we must hold responsible the attorneys who have certified to the court that the representations they are making are “well grounded in law and fact.”

The court let stay in place sanctions against the lender, which had not appealed the original order of the bankruptcy court.  However, the court refused to reinstate sanctions against the sole shareholder of the law firm, concluding that he had no involvement in the preparation of the pleadings in question.

Conclusion

Lenders who utilize automated default management solutions, and the vendors who design and market them, will need to reassess their business processes in light of the Court’s decision.  While the Court’s decision will surely mandate more human intervention into the default management process, with some attendant higher costs, it is likely that greater pleading accuracy will result.

About the Author

Also See:

Guide to Legal Representation in Middle Market Mergers and Acquisitions

Waging a Privacy War In The Global Marketplace: How Are Targeted Advertising Business Models At Risk?

Accommodating Marijuana In The Workplace After Prop 19

Hertz Corp. v. Friend: A Corporation's Principal Place of Business Is Its “Nerve Center”

New FDIC Guidelines Offer Helpful Hints for Real Estate Workouts

The most advanced document                
         management system in the world.

Only $59 / person / month
FeaturesLawLoop Demo
FeaturesWelcome to the Future
Play LawLoop Demo

Further Reading

Other Recent Tips for In-House Counsel

More Tips for In-House Counsel

Recent Expert Legal Commentaries

More Expert Legal Commentaries