The Results From the Legal Collections Test
In mid-February, the law firm began filing suit against the remaining 66 accountholders. This is the point at which the indication of changes started to become apparent. 16 of the cases had to be closed because either the debtor had moved out of state (3 cases) or we were unable to obtain service. Of the 13 cases in which we were unable to obtain service, 11 of them were homeowners.
So out of 66 cases, Prosper was unable to affect service on 13 -- about 20%? WTF? I call bullshit on Prosper's long-winded explanation about inaccurate addresses. There are a variety of commercial databases available to locate people -- not just the Lexis-Nexis one DF talks about, but also ones run by Westlaw and other vendors. These are relatively cheap to access. Moreover, as a creditor, Prosper had the legal right to pull credit reports on these deadbeats. Those often have addresses as well.
And last (but not least), in California a plaintiff can apply to the court to use service by publication once diligent efforts to affect service have been tried and have failed. This request is routinely granted. Service by publication is just what it sounds like -- you run a classified ad in a certain type of newspaper under a particular schedule (something like once a week for 4 weeks), and voila! -- service is deemed made (even though everyone understands that the chances of the defendant actually seeing the notice is about nil). Did Prosper make any attempt to serve these 13 defendants by publication? Not so far as we have seen (and since I'm sure DF would have mentioned it if they had, I think it is safe to assume that Prosper didn't bother).
The final issue encountered was environmental. In California, there are two types of default judgments – a Clerk’s Judgment vs. a Court Judgment. A Clerk’s Judgment is used in “cut and dried” cases. At the recommendation of the law firm, we initially filed Clerk’s Judgments on these cases. We knew there was a chance that the courts might not accept this approach due to the novel nature of the Prosper loans, but H&H felt that it was worth trying for the Clerk’s Judgment with its lesser level of required documentation. As it turned out, the vast majority of courts rejected the requested Clerk’s Judgment.
IIRC, several of the court dockets that we were following indicated that Prosper simply failed to file the appropriate paperwork in a proper and timely manner.
The environmental aspect is twofold. The courts have exercised a marked increase in consumer protectionism as foreclosures and mortgage related defaults have skyrocketed.
So what? I issue default judgments (sometimes 10 or more) every time I sit as a Judge Pro Tem. The majority of these are consumer debt cases -- debt from retail installment purchases, debt from car loans, debt from bad checks, etc. Yes, the creditor/plaintiff has to prove their case -- they show me the contract, a statement showing any payments made and the balance due, evidence about the repossession and sale of the collateral in the case of the car loans, etc. And then they win (usually). This isn't rocket science, and Prosper is not sufficiently different from other creditors to make it qualitatively different. Especially under the structure of the NAT, where Prosper repurchased all the pieces of the NAT loans, so it was clear that Prosper was the proper plaintiff. Prosper should have been able to easily put together a standardized packet of pertinent documents and a brief summary explaining them that would have been highly convincing to the judges. Apparently, it failed. Badly.
The second aspect involves the timing of these suits versus Prosper entering its quiet period. In October, 2008, I met with H&H to develop an account affidavit and documentation package necessary to support a Request for Default Court Judgment. Before the new motions were filed, we entered the quiet period. At the recommendation of the law firm, we decided to wait for completion of the registration process to pursue the cases.
I call more bullshit. Prosper's "quiet period" is irrelevant to the NAT cases. Unless what Prosper is really saying is that it was concerned that something in the affidavit would adversely affect its SEC registration, so it put its own interests ahead of the NAT lenders' interests, breaching its duties (once again) to the NAT lenders.
The length of our quiet period resulted in some cases being dismissed without prejudice rather than risk losing a motion in front of a leery judge.
Prosper's registration was complete what, 3 months ago? So why didn't it refile the cases the day afterwards?
Regarding the accounts in this test – in cases on which service was not obtained or were dismissed due to the quiet period – if they are still suit worthy, new cases will be filed. In some cases, the debtor has moved out of state or their credit score has dropped so low that re-filing is not worthwhile (there are several accounts that had credit scores above 700 that now have a score in the low 400’s).
Who cares what their credit scores are? What matters is do they have any assets and/or jobs and/or other judgments against them that might take priority.
At this point, I have no expectation that this legal test is going to be the financial success that I had predicted.
There's a surprise.
Prosper fucked this up badly and, as usual, lenders bear the brunt.
Most critical was that since Prosper did not own the loans, it took an extraordinary act for Prosper to have the standing to bring a lawsuit (the loans had to be assigned back to Prosper – and each step of assignment increases the complexity of a debt collection case).
I'm not so sure that repurchase was necessary, but regardless, who cares? Prosper did repurchase the loans. The "complexity" could easily have been dealt with. Prosper made loan to borrower. Prosper assigned pieces of the loans to lenders, and then lenders assigned pieces back to Prosper. Thus, Prosper once again owns entire loan. What is so "complex" about that?
This is resolved with the new loan/Payment Dependent Note structure. Since Prosper owns the loan, there is no question of our standing to bring suit.
That's nice for the Prosper 3.0 lenders -- how about the 40,000 schmucks left holding the bag on all the Prosper 1.0 loans?
The second issue is creating a mechanism to pay upfront court costs. In the case of the current test Prosper paid the upfront court costs. Depending on state, this can be between $150 and $400 dollars per loan. Typically these costs are covered by “pooling” legal accounts – meaning that recoveries from accounts with recoveries pay the costs of the sued accounts on which no recovery is made. This approach does not work with the Prosper concept of lenders receiving the revenue from the specific loans that they selected for investment. We have some ideas and will be working out a viable plan to address this problem.
The NAT avoided this problem entirely, because the NAT loans WERE pooled. So what's the problem (other than the fact that Prosper doesn't want to invest any of its own time and money on behalf of lenders)?
Another key question is how to determine what loan would be suit eligible given the current environment. For the last 10 to 15 years, the fact of homeownership has been the most important determinant for suit eligibility. That is no longer the case. We are investigating possible mechanisms for recovery scoring.
Didn't DF trumpet his expertise in doing exactly this (picking the right loans for suit)? Didn't he tell us that Prosper carefully cherry-picked the NAT loans in order to find excellent loans to sue on with high likelihoods of success (both on the cases and in collection of the resulting judgments)? So in other words, Prosper's careful selection of a mere 66 loans turned out to be just as incompetent as pretty much everything else that Prosper does? So after almost two years (an insanely long time for collections cases), out of 66 cases, Prosper has won exactly ONE so far as we know? Way to go Prosper.
Creating an effective legal strategy is a critical component of collection efforts in unsecured lending.
Given the environment and the uniqueness of the Prosper structure, developing the optimal strategy is going to take work.
Maybe it would have been a good idea to do some of that work BEFORE starting the NAT, and/or DURING the intervening 22 months.