(Bloomberg) -- Bankrupt mortgage servicer Ditech Holding Corp. saw its reorganization plan rejected on Wednesday after a federal judge ruled the company couldn’t sell its mortgage-servicing rights and reverse-mortgage business free and clear of consumer claims.
Federal bankruptcy Judge James Garrity Jr. rejected the plan after two days of hearing evidence and arguments earlier this month from lawyers for Ditech and a consumer creditor committee. The committee asserted the company shouldn’t be able to sell its businesses if it meant wiping out the ability of homeowners to correct what they say are errors related to their loans.
The New York attorney general had also objected on grounds that the sales would strip households of claims or defenses that would help them save their homes from wrongful foreclosures.
Garrity wrote in his decision that Ditech failed to satisfy sections of the bankruptcy code by limiting homeowners’ ability to assert their rights against the buyer, as well as other issues. “For those reasons, the Debtors’ request for confirmation of the Second Amended Plan is denied,” Garrity wrote in his decision.
“What the decision means for homeowners is their rights aren’t going to be taken away from them unfairly,” said J. Samuel Tenenbaum, a professor of law at Northwestern University who filed a request for the creation of a consumer creditor committee earlier this year.
Garrity told Ditech lawyers during a brief appearance in federal court in Manhattan on Wednesday that he would schedule a hearing next week “to see how we can move forward.”
Ditech has signed agreements to sell its mortgage servicing rights to New Residential Investment Corp. -- which is managed by Fortress Investment Group LLC -- for about $1 billion and to sell its reverse mortgage business to Mortgage Assets Management LLC, which is affiliated with Waterfall Asset Management LLC.
More than 4,000 homeowners have complained to federal agencies in the past year that Ditech failed to properly credit payments and wrongly foreclosed on their homes. Company lawyers said the buyers would only complete the transactions if they were unencumbered by consumer claims.
“A decision that keeps the claims attached to the assets means that New Residential is likely out and will no longer purchase the assets and anybody else who comes along will likely pay a much smaller amount,” said David C. Smith, a professor at the University of Virginia who studies finance and bankruptcy. “At the end of the day, that means a lot less cash comes into the estate to pay claimants.”
Ditech filed for bankruptcy in February with a plan to cut more than $800 million in debt and continue operations as it sought options that included a sale of the company.
(Updates with quotes in fifth and ninth paragraphs and comment from hearing in sixth paragraph.)
--With assistance from Steven Church.
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