Here is a cautionary tale of how a seemingly minor error can end up costing a financial services company big if left unaddressed.
A jury last month awarded $16.2 million in damages to a California homeowner who waged a three-year battle to block a foreclosure by the private-label mortgage servicer PHH Corp. The verdict is among the largest ever awarded in a mortgage case and $6 million more than PHH's mortgage servicing business earned in the second quarter.
And, according to the plaintiff's attorneys, it all started with a $616 shortfall in an escrow account.
PHH is appealing the judgment, which may eventually be reduced. But the case encapsulates many of the problems that have plagued the mortgage servicing industry in recent years -systems errors, confusing and contradictory information sent to borrowers and apparent indifference to their situations.
"There was a lack of communication, a lack of policies and procedures within the company to show the left hand didn't know what the right hand was doing," said Andre Chernay, one of the plaintiff's attorneys.
Mortgage servicers have been under public and regulatory scrutiny in the years since the housing bust. The plaintiff's bar has been aggressive in trying to stave off foreclosure for some borrowers, often in the hopes of getting principal reductions and other loan modifications.
The large judgment against PHH comes amid concerns about a crackdown by the Consumer Financial Protection Bureau. The CFPB has vowed to punish servicers that fail to adapt to new rules requiring better communication with borrowers who have fallen behind on their mortgage payments.
The agency's new rules require that servicers follow certain procedures when a borrower asserts there has been an error on an account. Servicers also are required to send borrowers statements explaining the allocation of their mortgage payment that goes to principal, interest, taxes and insurance, some of which are held in escrow accounts.
PHH, of Mount Laurel, N.J., said in a statement that the Yuba County Superior Court verdict "is not supported by the facts presented in the case against PHH or by applicable law."
The jury award of $514,000 in compensatory damages and $15.7 million in punitive damages "is grossly disproportionate to any alleged damages," said the company, which would not discuss the matter further.
Punitive damages are intended to send a message that a company needs to reform the practices that led to such a lawsuit. Such damages are considered excessive if they are 10 times the amount of compensatory damages, which is why the judgment against PHH could be reduced on appeal.
Industry members, when asked about the case, complained about the plaintiff's bar, the CFPB's clampdown on servicers and the difficulty that companies handling millions of loans generally face in providing good customer service.
Others note that borrowers typically only have negative responses to their mortgage servicer, because their only interaction is when the servicer makes a mistake.
"It's rare that borrowers have a real relationship with their mortgage servicer," said Rudy Orman, a senior vice president and director of marketing and business development at Residential Credit Solutions, in Fort Worth, Texas.
PHH is in the process of improving the profitability of its private-label mortgage business, which originates and services loans on behalf of small banks and some large financial firms including Morgan Stanley and HSBC Holdings.
The company reported a second-quarter loss of $59 million, or $1.02 a share in the second quarter, on revenues of $196 million. Those results include PHH's fleet management business, which was sold on July 1.
PHH could have avoided the eight-figure judgment had it admitted it made an error and apologized, said Chernay, an attorney at United Law Center in Roseville, Calif. He and Jon Oldenburg represented homeowner Phillip Linza, a salesman from Plumas Lakes, Calif., about 30 miles north of Sacramento.
After Linza got a loan modification in 2011, PHH began sending letters demanding a different amount each month for his mortgage payment, Chernay said. "We asked PHH at trial why they simply didn't send a three-line letter saying what the borrower's mortgage payment would be going forward," he said. "Their response was they weren't required to."
It was later learned that the $616 shortfall in Linza's escrow account caused the company's computer systems to automatically generate the letters demanding different amounts each month that he owned on his mortgage, Chernay said.
Linza's attorneys claim the jury was swayed to award huge damages, in part, because PHH refused to produce certain documents and also because the company never sent Linza a letter clarifying the correct amount of his mortgage payment and overriding the ones that contradicted each other.
"PHH wouldn't own their own mistake and find a reasonable solution, which was to do the decent act of writing a letter to clarify everything," said Oldenburg.
"It's a pretty consistent theme that servicers in this context very rarely admit that they've done anything wrong," he said. "You don't see many servicers own up to their part in the process. They think that because the borrower went into default, they don't have any legal claims."
After the loan modification reduced his monthly mortgage bill to $1,543 from $2,100, Linza made three consecutive payments, Chernay said. Then, in April 2011, Linza got a letter saying his monthly payments were short by $809 a month and the real payment was actually $2,352. The letter never explained why the payment had suddenly increased, Chernay said.
Linza, who bought his home in 2006 for roughly $280,000, knew something was wrong when he got yet another letter demanding that he pay $7,056. Despite repeated attempts to find out what the problem was, PHH would not resolve it, Chernay said.
Letters from PHH kept coming over the next few months, each one stating a different amount that Linza owed on his mortgage. By then, PHH had stopped applying any of Linza's monthly mortgage payments to his principal balance. The company continued to claim he had a deficiency, which Linza had always claimed was incorrect.
In July 2011, PHH sent out an escrow statement a document that would prove critical at trial that showed Linza did not owe the additional $809 a month and that there was no $7,056 deficiency.
Eventually, Linza stopped making mortgage payments. When PHH initiated foreclosure proceedings in 2012, Linza filed a lawsuit to block the action.
His attorneys ultimately pieced together that there had been a $616 shortage in an escrow account in January 2011. When PHH processed Linza's loan modification, the company failed to apply the $34 a month that he had already been charged in his monthly payments to the escrow account.
One of the big thorns in Linza's side came in mid-2011 when he threatened to sue PHH after repeated attempts failed to resolve the mix-up, Chernay said. PHH's response "was to tell him to go ahead, file a lawsuit, and get in line because they had deeper pockets than he had to litigate this."
Linza also continued to ask for a letter from PHH stating the amount he owed on his mortgage every month. "Month in and month out, he was getting a different number of what to pay on his mortgage," said Chernay.
He called the whole fiasco "an administerial failure." Fixing the error would only have required a different department within PHH to update the computer system. A loss mitigation manager could have spearheaded the effort but did not, he said.
"We just don't know why they wouldn't come to the table with something more reasonable to make this all go away," Oldenburg said. "When that issue came out in the trial, it was really offensive to the jury."
His colleague Stephen Foondos, the managing partner at United Law Center, said an appeal may ultimately lower the total judgment, but he's confident it will stay in the "high millions."
"Juries don't award $15 million unless there is some serious bad conduct," Foondos said.
The law firm, which specializes in foreclosure matters, has 10 other cases going to trial in the next few months.
"This is not a fluke and I think we'll see similar verdicts in the future," Foondos said. "Banks and servicers are recognizing that homeowners need to be taken seriously."