REQUIRED READING: As the default servicing landscape continues to evolve, it is clear that the long-term repercussions of the foreclosure crisis are far from over. While some of these changes may be reactive in nature and others may be the result of political, rather than professional, calculations, few people would disagree that changes are inevitable.
To mortgage servicing professionals, one of the most heartening aspects of this extended period of analysis and review is the ability to address existing structural problems and implement real and lasting reform. One problem that has not garnered a great deal of attention outside the industry, but that has increasingly become a hot topic of conversation among the mortgage servicing community, is the issue of compensation for default servicing law firms.
In many ways, this is an issue that has become more prominent as other regulatory changes are put in place. As audits, regulatory scrutiny and timeframes for foreclosures have all significantly increased, so have the costs associated with processing each and every file. With greater procedural logistics and oversight comes additional expense.
However, the existing flat-fee billing model has not evolved accordingly. Industry analysts and default servicing professionals alike are starting to ask whether this is a sustainable model.
Understanding where the industry needs to go first requires an appreciation for where things stand today, and exactly what problems are emerging as professional realities evolve.
The typical nonjudicial foreclosure fee is billed on a flat-rate basis. This model, which has long been the industry standard, has a lot to recommend: the simplicity of a standard flat-fee billing model is an obvious selling point, and the servicing industry has historically liked its straightforward nature for estimating fees and reimbursements.
While this model has been popular in the past, it was predicated upon a system where it was relatively uncommon for a foreclosure to stray from the usual processing and servicing path. Because the typical foreclosure followed a predictable route, the costs associated with servicing the more complex files comprised a fairly small slice of the overall pie and, thus, were easily absorbed into the system.
In the last few years, however, two trends have emerged that have led some default servicing professionals to question whether this approach still makes logistical and financial sense. First, all foreclosures are much more complex today. Second, the industry has experienced significant mission creep, and today there is simply much more involved in servicing the average file than ever before. Default servicing professionals are now routinely required to execute a range of additional and, sometimes, significantly more costly and time-consuming tasks.
In the wake of the robo-signing controversy and a series of other highly publicized scandals, there has been a strong push from both inside and outside the industry to re-examine the foreclosure process. This kind of periodic review is both healthy and justified – and there is an argument to be made that, prior to the real estate market collapse, routine processing in substandard law firms had sometimes become a little too routine, and some of the legal rigor had leached out of the process.
While responsible servicers at every step in the foreclosure processing chain have always been conscientious, it is certainly true that technical, legal and procedural safeguards are now baked into the system in a way that makes fact checking and oversight more rigorous than ever before. With that enhanced oversight comes more expense, however, and every new step in the process requires another body to do it. If the industry is operating on a flat fee, that additional work decreases the profit margin on the flat fee.
For example, executing a Servicemembers Civil Relief Act (SCRA) search to determine if the borrower is not an active duty member of the military may require a relatively modest amount of work. But while some clients require that search to be performed once, others might request it at every step in the foreclosure process. Responsive servicing professionals will be sensitive to the needs of their clients, but, at a certain point, the current compensation structure will no longer be feasible.
There are also additional requirements and responsibilities that fall under the category of mission creep. These include the following:
Increased cost of compliance and growing IT requirements. This is, indisputably, a large and rapidly growing cost of doing business. Servicing professionals who wish to remain competitive in the marketplace understand that enhanced technical capability – with the ability to search, secure and service files with greater flexibility and efficiency – is no longer optional; it is mandatory.
Dynamic and enhanced documentation. Creating ‘living files’ to provide ongoing documentation that appropriate steps were taken and that any changes to the file were recorded is now a universal requirement.
Greater auditing and oversight demands. Creating chronological summaries of each file in anticipation of possible auditing and review once was the exception and is now becoming standard policy, and the frequency with which audits are occurring makes proactive documentation and file preparation a necessity.
Additional procedural demands and detailed research and reviews. Expectations for servicers have risen significantly, and due diligence is more rigorous. The aforementioned SCRA-related searches to ensure that the defaulting borrower is not an active member of the military have increased in number and are now sometimes expected/required at multiple stages of the process. Pacer searches – similar to military searches, but for bankruptcy filings – are now also far more frequent, and even common requirements have become more difficult to fulfill, necessitating more bodies and more time investment.
Growing uncertainty and inconsistency. Servicing professionals need to engage in constant updating and process changes – sometimes more than daily – to meet individual procedural and oversight demands that can differ significantly from client to client. At a time when legislative updates occur with greater frequency than ever before, the resulting uncertainty creates a wide range of different responses from clients looking to minimize liability and protect their interests.
The most obvious solution to increased costs is to simply increase the basic fee structure. There is growing concern that such a move may be little more than a short-term bandage that fails to address the underlying structural issues that continue to reshape the industry.
Another worry is that, while any fee increase becomes effective only after a certain date, it is the inventory of existing files that is already causing the most trouble and generating the lion's share of additional expense. Those costly files can linger for months and frequently years, creating a backlog of files that are essentially grandfathered into a fee structure that is insufficient to compensate default servicing law firms for their work.
While it would require a true mindset change, one possible alternative is to switch to an hourly billing model. This would clearly represent a sea change for the industry, but it is a legal standard that is commonly practiced in other areas of the law.
An alternative pricing reform would be to clearly redefine what the extra steps are in the process and to make it clear that default servicing law firms will need to be compensated on more of an ‘a la carte’ basis. Implementing this effectively, however, would require new and more uniform industry standards.
Another possible solution might be to implement a new system that compensates according to a different classification of foreclosures. Determining how to define various ‘categories’ of foreclosure is one obstacle, and dealing with concerns about purposeful foot-dragging in order to secure higher fees is another. The latter should not really be an issue, however, as free-market competition would dictate that servicers that do not maximize their efficiency will be at a competitive disadvantage, as is the case for traditional law firms that bill on an hourly basis.
Whatever the final answer may be, it is clear that the flat-fee structure currently in place is becoming outdated, and with new policies, procedures, and economic and legislative realities in place, a new fee structure will likely be necessary in the not-too-distant future.
Jeff Weisserman is general counsel at Trott & Trott PC, based in Farmington Hills, Mich. He can be reached at firstname.lastname@example.org.