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Hunter or Hunted? Mortgage Industry Players Should Consider Their Options

Philip R. Stein

In the mortgage industry, as in many others, uncertainty abounds as companies attempt to adjust to the “current normal.” One thing residential mortgage loan originators and servicers believe is clear, however, is that they are being unfairly squeezed from several directions during this time of especially fragile economic conditions. Recent government actions, new legislative mandates, and actions by contractual counter-parties have combined to create a real sense of alarm.

Here is a partial list of developments causing originators and servicers to feel besieged:

• Having been directed by the federal government in the CARES Act to exercise forbearance for up to 12 months with respect to homeowners experiencing financial hardship due to the COVID-19 emergency, originators and servicers are doing so. They are also finding that other mortgage industry participants expect them to make up for the shortfall that results from borrowers not being required to make their mortgage payments. Originators certainly did not expect aggregators (purchasers of loans sold by originators) to claim that forbearance triggers an EPD (early payment default) or establishes a contractual breach by the originator of purchase-and-sale agreements, requiring repurchase of the loan by the originator. To the originators’ profound surprise and dismay, some aggregators are taking that position;

• Aggregators, some originators contend, are also beginning to back out of purchase commitments on “locked” loans;

• Some warehouse lenders and other funding sources are allegedly withdrawing or altering funding in ways not permitted under applicable agreements;

Companies that are experiencing one or more of these circumstances, particularly under far-from-optimal economic conditions to begin with, may all too easily be overcome with a sense of doom. They may believe that there is little or no legal recourse for them under their contracts, or that the costs (financially and in terms of business relationships) of challenging these actions may be overwhelming. There is no denying the fact that many of those contracts include provisions that create significant hurdles for originators, and the potential costs and complications of taking aggressive legal action to protect oneself must, of course, always be considered. But so must the costs of inaction. Moreover, careful scrutiny of originators and servicers’ contracts often reveals that the steps being taken against them can and should be challenged. The “breach” being asserted to justify repurchase demands may not constitute a breach under the actual terms of the contract. The timing of a step taken against an originator or servicer, or the manner in which the step was taken, may be at odds with contractual requirements imposed on, for example, an aggregator or warehouse lender. The “material adverse change” cited as justification for backing out of a purchase or funding commitment may not satisfy the applicable agreement’s definition of such a change. A particular agreement may contain other helpful provisions as well.

Though at first blush, these issues may sound like defenses to be raised if an originator or servicer’s contractual counter-party files suit, the same arguments can also provide bases for going on the offensive. Under appropriate circumstances, it may make sense for an originator or servicer to take aggressive action as a plaintiff, whether it’s to protect itself from imminent and substantial damage or to remedy extensive harm already done to its business by a counter-party’s unjustified actions. In what may be desperate times for many mortgage industry participants, going on offense legally may not be a “desperate measure” – it may, in certain, cases be the most prudent course of action.

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