A new wrinkle has come up in the massive, nationwide problems with the foreclosure process that are becoming known as “Foreclosure-Gate.” A pair of Mississippi homeowners who lost their home to foreclosure, then filed for Chapter 13 bankruptcy, are suing two foreclosure processing technology firms — one based in Jacksonville — and their bank’s law firm.

The couple alleges that the defendants conspired in an illegal “fee-splitting” arrangement that resulted in unlawful fees being charged and being hidden from the Bankruptcy Court.

This month, Locke Barkley, a bankruptcy trustee for the U.S. Bankruptcy Court for the Northern District of Mississippi, joined the homeowners’ lawsuit as a co-plaintiff. Ms. Barkley’s job is to scrutinize the claims of both debtors and creditors in Chapter 13 cases on behalf of the court, and she believes the couple’s claim has merit.

One of the defendants, Jacksonville-based Lender Processing Services Inc. (LPS), is one of the biggest players in U.S. foreclosures. The company provides computer systems that banks use to keep track of mortgage payments and process foreclosures. LPS often works with another foreclosure processing technology firm, Prommis Solutions Holding Corp., another defendant. The third defendant is Johnson & Freedman, LLC, an Atlanta-based law firm that represents banks in foreclosures in eight states, including Florida.

Chapter 13 Bankruptcy Trustee Says Companies Conspired to Hide Unlawful Fees

The Mississippi homeowners and the Chapter 13 bankruptcy trustee are accusing the two technology companies and the foreclosure law firm of three types of improper practices.

Attorney ethics violations. Most states, including both Mississippi and Florida, prohibit law firms from sharing legal fees with non-lawyers and from paying others for recommending the firm’s services, other than in regulated advertising campaigns. The plaintiffs claim that Johnson & Freedman made an agreement to split fees with LPS whenever LPS referred cases to the law firm. LPS then split some of the fees with Prommis, bringing them into the scheme.

Concealing the fees. Homeowners in foreclosure are often charged for the bank’s reasonable foreclosure costs, including legal fees. They are entitled to know what they are being charged for and dispute the reasonableness of the charges. The plaintiffs claim that the two companies and the law firm disguised the fee-splitting contracts as “administrative fees, document review ‘views,’ document download fees, document execution fees, technology facilitation fees,” and that the fees were unreasonable.

Hiding the fees from the Bankruptcy Court. In any bankruptcy, creditors are required to account for the debts they claim to be owed, including all fees, penalties and interest. By concealing the fee-splitting arrangement, the homeowners and Chapter 13 bankruptcy trustee claim, they mischaracterized the nature of their debts from the Bankruptcy Court.

LPS denies the allegations. In a conference call, LPS’s CEO said that similar claims were brought up before in a 2008 bankruptcy case in Texas, but “it was clearly demonstrated that the allegations of fee splitting were meritless and the action was dismissed voluntarily by the plaintiffs.”

Prommis and Johnson & Freedman didn’t respond to the Wall Street Journal’s requests for comment.

Source: The Wall Street Journal, “Trustee in Bankruptcy Joins Foreclosure Case,” Carrick Mollenkamp and Dionne Searcey, October 15, 2010