October 2008
By Thomas Brom

No one likes to take the loss from a bad bet. But it's tough to get your money back--even if you didn't understand the rules of the game, or if the tables were rigged. It's especially awkward to ask the owners of the casino to help you out.

Such is the predicament of subprime mortgage borrowers whose timing was bad.

In the past year thousands of those borrowers have been flattened by real estate devaluation, and thousands more are at risk when step-ups in their adjustable-rate mortgages come due. Foreclosed and vacant houses now threaten to lower property values in entire communities. In July, Congress and the state Legislature finally passed foreclosure-relief measures, but the bills offered little help to borrowers seeking to challenge lenders or mortgage brokers in court.

That's where legal-services groups would logically step in, representing clients or passing on cases to the pro bono committees of large law firms. "The need is huge--we get more than 100 calls a week on our consumer hotline," says Hernan D. Vera, president and CEO of Public Counsel in Los Angeles. "The majority of the calls are from homeowners behind in their payments looking for loan modifications--not necessarily representation. The Consumer Law Project represents homeowners victimized by fraud, and placing these cases with pro bono attorneys is tough because of the conflicts."

Ah, conflicts. For many large firms, pro bono cases against lenders raise potential legal or "strategic" conflicts of interest--meaning that representation might be bad for business. "It's nigh-on impossible to place a lender-fraud case with a large firm," says Tai Glenn, directing attorney of the housing unit at the Legal Aid Foundation of Los Angeles. "Last year we prevented 279 homeowners from losing homes to foreclosure, without pro bono help. I can't get the corporate firms to touch banking in any way, shape, or form."

Elissa D. Barrett, pro bono director of Bet Tzedek Legal Services in Los Angeles, estimates she's placed only a handful of lender-fraud cases in the past year. "Due to the conflicts issues, there have been distinct challenges in placing cases involving real estate fraud," she says. "I don't fault the firms. We need the banking industry to respond."

Sure, as if the banking industry didn't have enough problems without consenting to have its own outside counsel represent potentially adverse parties. But in late May something extraordinary happened. Thomas C. Baxter, general counsel and executive vice president for the legal group of the Federal Reserve Bank of New York, announced that the New York Fed would cosponsor a pilot program to provide borrowers with limited pro bono representation for mortgage counseling, negotiation, and bankruptcy filings. Administered by the City Bar Justice Center of the New York City bar association, the proposed citywide Lawyers' Foreclosure Intervention Network (LFIN) would help homeowners at all income levels.

"The Federal Reserve's action was incredibly important," says Esther Lardent, president and CEO of the Pro Bono Institute in Washington, D.C. "Until then the banks and the big firms were just circling each other, not willing to make the first move. It reminded me of girls and boys at a mixer, each too shy to ask the other to dance."

Baxter played DJ and host at this particular dance, using the moral suasion of his office. "About a year ago some of my colleagues asked, "Why not use lawyers to do more than counseling, to actually represent clients?" Baxter says. "In a series of meetings, we explored the options with major banks and large law firms, many of whom either have a financial institution as a client or are praying to have a financial institution as a client."

To help make his case, Baxter and the City Bar Justice Center requested a formal ethics opinion from the New York City bar association that outlined circumstances in which conflict waivers could--and could not--be used. A non-consentable conflict, even in a limited-scope representation, would include matters in which the financial institution's confidences and secrets could be turned against it. With the opinion as authority, LFIN drafted a conflicts-waiver form and a model engagement letter.

Baxter told a panel at the ABA Annual Meeting in August that he persuaded a number of major banks, including Citibank and Bank of America, to sign on to his project. He then approached the big law firms that represented them. "The big firms said yes, with a qualifier," Baxter says. "They were happy to represent borrowers facing foreclosure, but they didn't want to be involved in class actions that were going to create a horrible precedent their banking clients would be living with forever."

So LFIN installed gatekeepers to screen out potential lender-liability cases before sending them out for pro bono assistance and a potential waiver request. Still, there were problems. "Would it be ethical to entirely foreclose a pro bono client's options?" Baxter asks. "We decided that we couldn't. So if a negotiated settlement with the client's lender is not possible, the file is handed back to a case coordinator for possible action by an unconflicted attorney."

Lynn Kelly, executive director of the City Bar Justice Center, says that since June about six cases a week have been coming to LFIN. "We've already had 27 foreclosure cases," she says, "and all involved litigation."

Exporting the LFIN project to California, however, will require some tinkering. Limited-scope representation isn't an issue--last year the Judicial Council extended its availability under California Rules of Court 3.35 and 3.36 to all civil matters. The problem is potential conflicts of interest under the California rules of professional conduct, which differ from the ABA Model Rules and the ABA Code that New York still uses.

According to Mark L. Tuft, a partner in the San Francisco office of Cooper, White & Cooper and vice chair of the State Bar's rules-revision commission, conflict waivers are governed by rule 3-310, which requires informed written consent of the parties and prohibits lawyers from handling matters that might give them access to privileged information. The rule lacks the general guidance on conflict imputation provided under ABA Model Rule 1.10, and the more specific guidance provided under Model Rule 6.5.

"Under MR 6.5," Tuft says, "an attorney may be disqualified for a conflict produced by a limited representation, but that conflict will not necessarily be imputed to others in the attorney's law firm. The model rule permits short-term legal service that doesn't potentially wipe out an entire firm."

In California, says Tuft, case law rather than ethics rules determine conflict-imputation issues. Still, he sees no reason why large firms couldn't adopt a program similar to LFIN, with its built-in safeguards. "There is nothing to stop California firms from using a limited waiver of conflicts," he says. "You don't need a new ethics rule, though one would be helpful in this area."

So far, however, large firms in California and their banking clients are still eyeing each from other across the dance floor. "Basically, it's arms-in-the-air frustration with the conflicts-waiver issue," says Peter H. Carson, a partner at the San Francisco office of Bingham McCutchen and chair of the ABA Business Section.

"Business conflicts are always a concern," adds David A. Lash, managing counsel of pro bono services at the Los Angeles office of O'Melveny & Myers. "It's just a minefield for a lot of firms."

Translation for homeowners facing foreclosure: Don't expect the owners of the casino to help you out.