November 24, 2015

by Joshua Schaer
RCO Legal, P.S. – USFN Member (Oregon, Washington)

On October 22, 2015 the Supreme Court of the State of Washington issued its decision in Brown v. Washington State Department of Commerce, unanimously concluding that a note holder is legally entitled to modify and enforce the obligation under state law. The court rejected Brown’s claim that only a note “owner” could be a proper beneficiary.

Brown demanded statutory mediation with M&T Bank. In response to a notice from the Washington Department of Commerce (Commerce), which oversees the mediation program, M&T produced a declaration stating that it was the actual holder of Brown’s note. M&T also asserted a mediation exemption based on a statute excluding beneficiaries with a low volume of secured mortgage loans in the state. Brown’s lawsuit arose after Commerce denied her an opportunity to mediate with M&T.

Brown contended that Freddie Mac (the owner of the loan) should be compelled to mediate because the Washington Deed of Trust Act (DTA) requires a beneficiary to also be the note’s owner, and Freddie Mac would not qualify for the same exemption as M&T.

The Supreme Court analyzed a statute that allows “[a] declaration by the beneficiary made under the penalty of perjury stating that the beneficiary is the actual holder of the promissory note or other obligation secured by the deed of trust” to establish sufficient proof of the note’s “ownership.” The court decided that the legislature intended for the party holding authority to modify a loan to act as the beneficiary under the mediation law. The court also reaffirmed its holding in Bain v. Metropolitan Mortgage Company — i.e., that a beneficiary is strictly defined in Washington as the note holder.

The court limited the recent decisions of Lyons v. US Bank and Trujillo v. NW Trustee Services to situations where a beneficiary’s declaration contains alternative language concerning non-holder authority under the state law equivalent to UCC 3-301 (which governs a “Person Entitled to Enforce” negotiable instruments).

In summation, the court found that “a party satisfies the proof of beneficiary provisions” in the DTA when “it submits an undisputed declaration under penalty of perjury that it is the actual holder of the promissory note.” Thus, Commerce acted properly to deny Brown’s request for mediation.

The Brown case resolves a longstanding question concerning authority to foreclose in light of the “proof of ownership” requirement. The law is now clear in Washington that loan owners such as Freddie Mac or Fannie Mae need not initiate nonjudicial foreclosures in their own names or directly participate in mediation, and loan servicers can execute declarations of note holder status in order to satisfy the DTA. Brown is a significant victory that supports the legal position of servicers, investors, and trustees.

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November/December e-Update

November 24, 2015

by Richard M. Leibert
Hunt Leibert – USFN Member (Connecticut)

In an important ruling, the Connecticut Appellate Court has affirmed the trial court’s application of the doctrine of equitable subrogation in reordering the priority of interests, despite the defendant bank having had constructive notice of the plaintiff’s recorded mortgage. [AJJ Enterprises, LLP v. Herns Jean-Charles, AC 36838 (Conn. App. Ct. Oct. 13, 2015)].

Facts — As sellers, Pascarelli and Bartolo, dba AJJ Enterprises LLP (AJJ), entered into a purchase and sale agreement with Jean-Charles (J-C) to sell 18 Monroe Street, Norwalk, Connecticut for a price of $675,000, with a first mortgage of $500,000 provided by First County Bank. The balance of the price (as well as closing costs advanced by the sellers) was paid through a secured promissory note in the amount of $195,000 to AJJ. The AJJ note was to be secured by a “blanket mortgage on properties that [J-C] owns.” At the time, J-C owned his residence at 10 Carlin Street, Norwalk.

On May 24, 2002 the transaction closed, and the AJJ mortgage was recorded on 18 Monroe and 10 Carlin that same day. AJJ had not done a title search on 10 Carlin; AJJ believed that its mortgage was a second mortgage, as reflected in the promissory note from J-C — ‘“secured by a second mortgage on real property known as 18 Monroe … and 10 Carlin …’” (In fact, at the time the mortgage from J-C to AJJ was recorded, it was subsequent to two mortgages that encumbered 10 Carlin: a first mortgage in the face amount of $288,000 and a second mortgage in the face amount of $30,300.)

At the time of closing with AJJ, J-C had undertaken to refinance his mortgage on 10 Carlin. There were two mortgages being paid off through this 10 Carlin refinance, requiring $314,156.49. Aegis Mortgage Corporation (Aegis) provided the refinancing funds in the amount of $348,000. Aegis intended to hold a first mortgage position. The initial title search carried out by Aegis on May 16, 2002 could not have discovered the AJJ blanket mortgage recorded on May 24, 2002. Aegis closed the loan and its refinancing mortgage was recorded on June 11, 2002 — subsequent to the recording of the AJJ mortgage. The Aegis loan paid off the first and second mortgages, enabling the AJJ mortgage to move into first lien position. This was not discovered until J-C defaulted and a foreclosure was commenced.

Foreclosure as to 18 Monroe — First County commenced a foreclosure on 18 Monroe, with a sale date set for August 16, 2008. Pascarelli and Bartolo, who had personally guaranteed payment, formed JP Asset Management LLC to purchase the First County note and mortgage. JP Asset obtained a judgment of strict foreclosure on 18 Monroe August 2, 2010 (two years later).

Foreclosure as to 10 Carlin — AJJ brought a foreclosure action on 10 Carlin, claiming first position. Aegis (which had assigned its mortgage to Bank of New York Mellon, as trustee for the Amortizing Residential Collateral Trust, mortgage pass-through certificates, series 2002-BC7) defended, claiming by the theory of equitable subrogation that it had a first mortgage. AJJ contended that Aegis had constructive knowledge of the AJJ mortgage when Aegis recorded its mortgage on June 11, 2002 and that Bank of New York Mellon, Trustee (substitute defendant bank in the case), was precluded from obtaining the benefit of equitable subrogation.

The trial court ruled in favor of Bank of New York Mellon, Trustee, and placed its mortgage in first position; AJJ appealed. The appellate court found that the trial court did not abuse its discretion in applying the doctrine of equitable subrogation despite the defendant bank’s constructive knowledge of the plaintiff’s lien. The Connecticut Appellate Court specifically cited to the Restatement (Third), Property, Mortgages § 7.6, comments (e) and (f), (1997):

“‘Under [the] Restatement … subrogation can be granted even if the payor had actual knowledge of the intervening interest; the payor’s notice, actual or constructive, is not necessarily relevant. The question in such cases is whether the payor reasonably expected to get security with a priority equal to the mortgage being paid. Ordinarily, lenders who provide refinancing desire and expect precisely that, even if they are aware of an intervening lien … A refinancing mortgagee should be found to lack such an expectation only where there is affirmative proof that the mortgagee intended to subordinate its mortgage to the intervening interest.’ … “The Restatement is careful to emphasize that the court considering equitable subrogation must be convinced that no injustice will result to the intervening lienholder before applying the doctrine[.] … ‘In virtually all cases in which injustice is found, it flows from a delay by the payor in recording his or her new mortgage … The delay may lead the holder of an intervening interest to take detrimental action in the belief that that interest now has priority.’”

There were no circumstances reflecting that AJJ changed its position in detrimental reliance; moreover AJJ did not bargain for first mortgage position, while Aegis did. The fact that AJJ found itself in first position was due to windfall and not anything for which it negotiated.

The significance of this holding is its effective restatement of three Connecticut Supreme Court holdings, reversing a trend that had occurred at the appellate court level, which — in a series of decisions — appeared to claim that constructive notice of an intervening interest in property served as a per se bar to the application of the doctrine of equitable subrogation.

Editor’s Note: The author’s firm represented the Bank of New York Mellon, as trustee for the Amortizing Residential Collateral Trust, mortgage pass-through certificates, series 2002-BC7 (substitute defendant bank) at the trial and appellate levels in the case summarized in this article.

©Copyright 2015 USFN. All rights reserved.
November/December e-Update

November 24, 2015

by Christine E. Howson
The Wolf Firm – USFN Member (California)

Demurrers are often the first line of defense for lenders, servicers, and foreclosure trustees sued by borrowers in California state courts. Similar in many respects to motions to dismiss filed in federal court cases, demurrers challenge the pleading of the complaint (or cross-complaint or answer) — such as whether the allegations sufficiently plead a cause of action.

On October 1, 2015 the governor of California signed into law SB 383 which, among other things, adds Section 430.41 to the California Code of Civil Procedure. Effective January 1, 2016, Section 430.41 imposes a number of new requirements in connection with the filing of demurrers. These requirements apply to all demurrers filed in civil actions in California state courts with the exception of proceedings for forcible entry, forcible detainer or unlawful detainer, or actions in which a party not represented by counsel is incarcerated.

The most notable provision in the new statute is the requirement that the demurring party and the party that filed the objectionable pleading meet and confer at least five days before the demurrer is filed. The statutory purpose of the meet-and-confer requirement is to determine whether an agreement can be reached resolving the objections (challenges) to the pleading that would be raised in the demurrer. If no agreement is reached as to all of the objections to the pleading, a declaration by the demurring party regarding the outcome of that process is required to be filed at the time of the filing of the demurrer.

Moreover, this new law also provides that if the parties are not able to meet and confer at least five days prior to the due date of the responsive pleading, the demurring party will have an automatic 30-day extension of time within which to file a responsive pleading by filing and serving (on or before the date on which a demurrer would be due) a declaration stating under penalty of perjury that a good-faith attempt to meet and confer was made, and explaining the reasons why the parties could not meet and confer. The statute also states that “[a]ny further extensions shall be obtained by court order upon a showing of good cause.”

Despite the mandatory language of this new statute pertaining to the meet-and-confer process in connection with the filing of demurrers, subdivision (a)(4) of Section 430.41 provides that even if the court determines “that the meet and confer process was insufficient, that determination shall not be grounds to overrule or sustain a demurrer.” Thus, Section 430.41 lacks any mechanism to hold the parties or their attorneys accountable for failing to comply in good faith with the meet-and-confer process. It remains to be seen whether the new requirement will significantly reduce the maintenance of frivolous and insufficiently pled complaints seeking to delay the foreclosure process.

©Copyright 2015 USFN. All rights reserved.
November/December e-Update

November 9, 2015

by Linda J. St. Pierre
Hunt Leibert
USFN Member (Connecticut)

and

by Michael J. McCormick
McCalla Raymer, LLC
USFN Member (Georgia)

On Writs of Certiorari to the U.S. Court of Appeals for the Eleventh Circuit, the United States Supreme Court rendered a decision in the consolidated cases of Bank of America, N.A. v. Caulkett and Bank of America, N.A. v. Toledo-Cardona, 575 U.S. ___ (June 1, 2015). The Supreme Court held that a debtor in a chapter 7 case cannot “strip-off” or void a wholly unsecured junior mortgage under section 506(d) of the Bankruptcy Code.

This decision stems from the cases of In re Caulkett, 566 Fed. Appx. 879 (2014), and In re Toledo-Cardona, 556 Fed. Appx. 911 (2014), where the debtors moved to strip-off or void the junior mortgages of Bank of America in their chapter 7 cases. In each of these cases, the bankruptcy court granted the debtors’ motions, which were upheld by both the District Court and the Court of Appeals for the Eleventh Circuit. After granting Bank of America’s Writ of Certiorari, the U.S. Supreme Court reversed the judgments of the Court of Appeals.

In its analysis, the Supreme Court stated that a debtor may strip-off a junior mortgage only if the bank’s claim is “not an allowed secured claim,” and that a claim filed by a creditor is deemed “allowed” under § 502 if no interested party objects; or if, in the case of an objection, the bankruptcy court determines that the claim should be allowed under the Bankruptcy Code. In this case, the parties agreed that the claims were allowed claims but disagreed on whether the claims were secured.

In upholding its prior decision in Dewsnup v. Timm, 502 U.S. 410 (1992), the Supreme Court stated that Dewsnup defined the term “secured claim” in § 506(d) to mean a claim supported by a security interest in property, regardless of whether the value of that property would be sufficient to cover the claim. Under this definition, § 506(d)’s function is reduced to “voiding a lien whenever a claim secured by a lien itself has not been allowed.” The Supreme Court rejected the debtors’ argument that Dewsnup should be limited to partially unsecured liens.

The Supreme Court held that a “secured claim” does not depend on whether a lien is partially or wholly underwater. Additionally, the Supreme Court rejected the debtors’ argument that § 506(d) could be redefined as any claim that is backed by collateral with some value. The Supreme Court reasoned that embracing that reading would give a different meaning to “secured claim” under § 506(a) and § 506(d). Lastly, the Supreme Court rejected the debtors’ argument that Nobelman v. American Savings Bank, 508 U.S. 324 (1993), controlled.

The Supreme Court observed that Nobelman involved the interaction between § 506(a) and § 1322(b)(2), which was an entirely separate provision. Further, the Supreme Court determined that to limit Dewsnup to that case would effectively give the term “secured claim” different definitions depending on the value of the collateral, and that doing so would effectively leave an odd statutory framework in place. If a court valued the collateral at one dollar more than the amount of the senior lien, the debtor could not strip the lien; but if it valued the property at one dollar less, the debtor could strip the lien.

As of the effective date of the Caulkett decision, debtors in chapter 7 cases will no longer be able to strip-off or void a wholly unsecured junior mortgage under § 506(d) of the Bankruptcy Code. Unfortunately, for those creditors who have had orders entered stripping their junior liens in chapter 7 cases since the Eleventh Circuit first decided In re McNeal, 735 F.3d 1263 (11th Cir. 2012), there is likely little remedy.

For cases involving statutory interpretation, the Supreme Court has long recognized the importance of being able to rely on prior decisions and the “equitable consequences of retroactive application.” See Chevron Oil Co. v. Huson, 404 U.S. 97, 107 (S. Ct. 1971). Although the Supreme Court did not eliminate the possibility of retroactive application by specifically stating its decision only applied to future cases [a technique called “sunbursting;” see Great N. Ry. v. Sunburst Oil & Ref. Co., 287 U.S. 358, 364 (1932)], the Supreme Court’s decision in Caulkett did establish a new principle of law by overruling the Eleventh Circuit case law allowing lien-strips in chapter 7 cases. See Huson, 404 U.S. at 106-07 [quoting Linkletter v. Walker, 381 U.S. 618, 629 (S. Ct. 1965)].

Copyright © 2015 USFN. All rights reserved.
Autumn USFN Report

November 9, 2015

by Michael J. McCormick
McCalla Raymer, LLC
USFN Member (Georgia)

Just when all of the issues and ambiguities arising from the 2011 federal bankruptcy rule changes have been resolved (pardon the wishful thinking of this author), a chapter 13 form plan (referred to here as the Official Form Plan or OFP) has completed two rounds of public comment. In addition, effective implementation of the form plan will require conforming amendments to Federal Bankruptcy Rules 2002, 3002, 3007, 3012, 3015, 4003, 5009, 7001, and 9009.

According to U.S. Bankruptcy Judge Eugene Wedoff (N. Dist. Ill.), the lack of a national form makes it difficult for lawyers who practice in several districts, adding transactional costs that are passed on to debtors. Moreover, a recent survey of the bankruptcy bench established that a majority of chief bankruptcy judges support developing a national form plan and simultaneous amendments to the bankruptcy rules to harmonize practice among the courts and to clarify certain procedures.

The Official Form Plan is divided into ten parts. In addition, there are two exhibits: one for lien avoidance, and one for showing feasibility of the plan. Some of the parts relevant to mortgage servicers are:

• Part 1 – Notice to Interested Parties
• Part 2 – Plan Payments and Length of Plan
• Part 3 – Treatment of Secured Claims, along with subsections 3.1: Mortgage Arrears; 3.2: Treatment of Secured Claims (only effective if warning box in Part 1 is checked); 3.3: Hanging Paragraph Claims; 3.4: Lien Avoidance (only effective if warning box in Part 1 is checked); and 3.5: Surrender of Collateral
• Part 7 – Order of Distribution of Trustee Payments, along with subsection a: Trustee’s Fee
• Part 9 – Nonstandard Plan Provisions
• Part 10 – Signatures

Fortunately, the OFP and rule changes in their present form take into consideration input from creditors and their attorneys after meetings, mini-conferences, and conference calls. For instance, the early draft of the plan and rules provided that in the event of a conflict between the plan and the proof of claim, the plan would control. Putting aside for a moment the fact that 11 U.S.C. 502(a) provides that a claim is deemed allowed unless a party in interest objects, and the fact that a bankruptcy rule cannot trump a section of the Bankruptcy Code, consider that a debtor rarely knows the correct amount of the mortgage arrears. Of course, one of the consequences of a provision that the plan controls would be a significant increase in the number of objections to confirmation that would need to be filed. The latest draft of the plan provides that the amounts listed on a proof of claim with respect to the monthly payment and the amount of arrears will control over contrary amounts listed in the plan. Therefore, a debtor will need to object to the claim to contest those amounts, consistent with Section 502(a) of the Bankruptcy Code. On the other hand, the current draft of Rule 3015(g) provides that the plan will control other aspects of the claim’s treatment.

Rule 3001(c)
There is a perception that the chapter 13 process would improve if proofs of claim were filed before plan confirmation. But mortgage servicers participating in the rulemaking process expressed concern with the proposal by the Chapter 13 Form Plan Working Group (Working Group) to change the bar date to sixty days after the filing of the petition. Specifically, while servicers felt sixty days may be sufficient time to determine the amount of arrears, it might not be an adequate period within which to produce other supporting documentation required under Rule 3001.

The latest draft of Rule 3001(c) provides that for a claim secured by the debtor’s principal residence, the bar date is bifurcated. So a proof of claim will be considered timely if it is filed within sixty days of the petition date and includes the mortgage proof of claim attachment required by Rule 3001(c)(2)(C). The documentation required by Rule 3001(c)(1) and (d) may be filed as a supplement not later than 120 days after the petition.

Several questions and issues are created by this latest amendment. First, does the provision now cap the amount of time for amending or supplementing the proof of claim? Second, when a creditor supplements its original claim to add documents, is it allowed to add documents only, or can it also amend the amounts listed in the original claim? A reasonable argument can be made based on the current draft of Rule 3002(c) that a creditor can only add documents when supplementing the original claim. Consider further that this bifurcated process means that both the servicer and its law firm will have to touch the file at least twice to complete the proof of claim process.

Many of the comments submitted during the public comment periods have been highly critical of having a bifurcated or dual bar date and have instead suggested that the Rules Committee adopt a bar date of ninety days after the filing of the petition.

Adequate Protection
With regard to adequate protection, the Working Group is currently discussing a separate form, as opposed to including a provision in the plan for adequate protection payments. The Official Form Plan allows for nonstandard provisions under Part 9. However, any nonstandard provisions will only be effective if the appropriate box on the first page of the OFP (see Part 1) is checked, indicating the presence of nonstandard provisions. Moreover, Part 10 of the OFP, the signature box, includes language so that the debtor’s attorney (or the debtor, if appearing pro se) can certify that the plan is identical to the OFP except for any nonstandard provisions contained in Part 9.

Termination of Stay
Section 3.1 of the proposed OFP, read together with the Committee Notes for Section 3.1, indicates that upon termination of the stay, the provisions of Rule 3002.1 will no longer apply, as the plan doesn’t provide for the treatment of the claims under 11 U.S.C. § 1322(b)(5) (curing arrears and maintaining current payments).

The latest version of the OFP provides that along with surrender of the collateral, the debtor consents to termination of the automatic stay and co-debtor stay at confirmation. This is an improvement over previous versions of the OFP where these provisions appeared in the Committee Notes. Moreover, previous versions of the OFP did not mention the co-debtor stay under Section 1301 of the Bankruptcy Code, which was also a major omission of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. Nevertheless, it is still not clear how the debtor consents to termination of the co-debtor stay, especially when the co-debtor is not participating in the case, or may not be represented by counsel. Further, does consenting to relief mean that the stay is lifted upon confirmation?

The NACTT Mortgage Committee has suggested the following language to the Working Group to help clarify that the stay is indeed lifted: “Upon confirmation of the Plan, any stay created by the filing of the petition pursuant to 11 U.S.C. §§ 362 and 1301 shall be deemed modified to allow in rem disposition of the collateral to effect the surrender without further order of the bankruptcy court.”

Unfortunately, the Advisory Committee was unwilling to alter the language in the OFP regarding the co-debtor stay.

Other Rule Amendments
Rules 2002 & 3015(f) — The Working Group has proposed an amendment to Rule 3015(f) that would require chapter 13 confirmation objections to be filed at least seven days prior to the confirmation hearing. Rule 2002 currently requires twenty-eight days’ notice of the time to file an objection to confirmation. Therefore, Rules 2002 and 3015(f) together would impose a thirty-five-day notice period before the confirmation hearing, which the Working Group considered to be excessive, especially for a pre-confirmation modification. Thus, to keep the notice period at twenty-eight days, in light of the new time period delineated in Rule 3015(f), Rule 2002 is being amended to require twenty-one days’ notice of the time to file objections to confirmation.

Rule 3002 — This rule has been amended to clarify that creditors must file a proof of claim to have a secured claim and receive distributions. As previously discussed, Rule 3002(c)’s proposed sixty-day bar date has been adjusted to provide additional time to file supporting documentation for mortgage claims when the subject property is the debtor’s principal residence. Furthermore, additional language now clarifies that the bar date runs from the time of conversion of a case to chapter 12 or chapter 13. Finally, the language providing for an explicit exception to the bar date when the debtor fails to timely file a list of creditors’ names and addresses under Rule 1007(a)(1) has been refined.

Rules 3012 & 4003(d) — Rule 3012 is amended to provide that the amount of secured claims may be determined in a plan, subject to objection, thus removing the need for a motion as required by the present Rule 3012. However, as previously stated, with respect to the amount of mortgage arrears, a proof of claim will control over a contrary amount in the plan. Further, the plan will not control the amount of a priority claim, or a contrary claim filed by a governmental unit.

At the September 2012 meeting of the Advisory Committee on Bankruptcy Rules (Advisory Committee) in Portland, Oregon, the committee discussed drafts of the OFP and rule amendments prepared by the Working Group. One amendment was a proposed amendment to Rule 4003(d) providing that — consistent with amended Rule 3012 — chapter 12 and chapter 13 plans could seek the avoidance of liens encumbering exempt property pursuant to Section 522(f) of the U.S. Bankruptcy Code, provided the plan was served pursuant to Rule 7004. This is one proposed amendment where the draft version has not changed since the Portland meeting.

Rule 9009 — This rule will be amended to ensure use of the OFP (and other Official documents) without alteration, except as otherwise provided in the rules or in a particular Official Form.

The Next Step
The latest meeting of the Advisory Committee was held on April 20, 2015 in Pasadena, California. Among other things, the committee discussed the adoption of Form 113, the national form chapter 13 plan.

The Advisory Committee took into consideration the number of comments against the adoption of a mandatory plan that were received during the latest round of public comments that ended in February 2015, including a comment submitted by 144 judges (approximately forty percent of the bankruptcy bench), along with a compromise proposal (Compromise) with an opt-out provision endorsed by nine individuals, including several creditor attorneys, judges, and trustees. The Advisory Committee voted almost unanimously in favor of a form of compromise. One feature of the Compromise is that instead of an initial sixty-day deadline to file a proof of claim, and then an additional sixty days to supplement for documents for claims involving the debtor’s principal residence, there would just be one uniform seventy-day deadline. In addition, the Compromise provides for clearer and stronger language that terminates the co-debtor stay at confirmation when the debtor’s plan provides for surrender of the collateral.

The Working Group spent the summer reviewing and refining the Compromise. By the time that this article is published, the Advisory Committee will have met on October 1-2 in Washington, D.C., to consider and vote on a refined compromise, along with a recommendation from the Working Group as to whether there is a need for re-publication. If there is no need for re-publication [i.e., because the Compromise (as refined) represents a lesser-inclusive change and a comment than the original proposal], this will still allow the entire package of the plan and rule changes to go into effect in December 2016.

Additionally, when the rule changes go into effect in 2016, Fed. R. Bankr. P. 3002.1 will be modified to provide that compliance with that rule is not required after termination of the automatic stay.

Copyright © 2015 USFN. All rights reserved.
Autumn USFN Report

November 9, 2015

by Craig Rule and Ryan Byrd
Orlans Associates, P.C.
USFN Member (Michigan)

When faced with a proposed cramdown in a chapter 13 case, many mortgage servicers and their attorneys focus primarily on value and interest rate when objecting to confirmation of the plan. There exist, however, a number of other potential objections to confirmation which, depending on the facts of the case, could result in more favorable cramdown terms, or even the complete abandonment of the cramdown attempt by a debtor. This article looks at two of these other possible objections to cramdowns that may not always be on the radar of servicers and their attorneys.

Bait And Switch: A Debtor’s Principal Residence
Beyond value and interest rate, it is important for a mortgage creditor facing a cramdown to investigate whether the claim is protected by 11 U.S.C. § 1322(b)(2), which prohibits cramdowns and other modifications of a debtor’s principal residence. Among the most crucial questions is timing: at what point must a property be a debtor’s principal residence to qualify for the protections of 11 U.S.C. § 1322(b)(2)? Bankruptcy courts have generally adopted a bright-line test, with a majority of courts finding that the relevant date is the bankruptcy petition filing date. A minority of courts reach back to the date that the loan was originated. See In re Baker, 398 B.R. 198, 202 (Bankr. N.D. Ohio 2008).

In recent years, however, it has become common for debtors in jurisdictions that have not adopted the loan origination standard to move out of their residences shortly before or after the petition date in attempts to avoid the application of 11 U.S.C. § 1322(b)(2). Often, these debtors fully intend to move back into the properties after confirmation or plan completion, and bide their time by renting the property, usually to a relative or close acquaintance. On its face, this scheme appears to fly in the face of 11 U.S.C. § 1322(b)(2), which is intended to protect the mortgage market from principal residence cramdowns. See Nobleman v. American Savings Bank, 508 U.S. 324, 332 (1993) (J. Stevens, concurring). A strict adherence to a bright-line standard of the petition date (or even the confirmation hearing date) to determine principal residence results in a debtor, nevertheless, being able to cramdown in the situations mentioned above.

To avoid this apparent loophole, some bankruptcy courts have loosened the bright-line petition date standard to adopt one that looks more to the totality of the circumstances. Confronted with debtors who moved out of their residence and into a previous rental property two months after filing a chapter 13 case, the bankruptcy court in In re Kelly, 486 B.R. 882 (Bankr. E.D. Mich. 2013), found that the latter property was the debtors’ principal residence under 11 U.S.C. § 1322(b)(2). In reaching this conclusion, the Kelly court opined that relying solely on a single date, such as the petition date, to determine principal residence would be “subject to manipulation” and would do “a disservice to 11 U.S.C. § 1322(b)(2)”. Id. at 886. Accordingly, the Kelly court fashioned a six-part test that not only considered where the debtors lived on the petition date but also where the debtors intended to live during and after their bankruptcy case.

At least one other court, the bankruptcy court in In re Baker, 398 B.R. 198 (Bankr. N.D. Ohio 2008), has exclusively employed a hybrid approach to this question. Although the Baker court was not faced with the specter of debtor manipulation of the circumstances to evade application of 11 U.S.C. § 1322(b)(2), it determined that changing circumstances between the time of loan origination, and that of the bankruptcy petition date, required something more nuanced than a bright-line test and adopted a hybrid method that looks to the facts on both dates. Id. at 203. Applying this approach, the court determined that 11 U.S.C. § 1322(b)(2) prevented modification because the inclusion of a second parcel of real property into the mortgage at loan inception was intended to only be a temporary attribute of the agreement and, at the time that the bankruptcy case was filed, the loan was actually only secured by the debtors’ residence. Id. at 204.

Anytime a cramdown is proposed, mortgage creditors and their attorneys should carefully review the schedules and statement of financial affairs to determine if the debtor has recently moved. Question 15 of the statement of financial affairs (Official Form 7), for example, requires a debtor to list all addresses in the past three years. The answer to this question can be compared to the certificate of credit counseling to determine whether the move happened after meeting with a bankruptcy attorney. If this initial inquiry indicates that a debtor may have moved in contemplation of bankruptcy, an objection should be filed and relevant information (including rental agreements, rent payment receipts, municipal rental registrations, and utility bills for the property) should be requested from the debtor’s counsel. Further informal discovery can be obtained through attendance at the meeting of creditors, and an objecting creditor can request formal discovery and an evidentiary hearing from the bankruptcy court. Even if a judge has previously adopted one of the bright-line standards, it might be possible to change his or her mind if presented with facts that strongly infer that a debtor has manipulated the circumstances to avoid 11 U.S.C. § 1322(b)(2).

A Bad Faith Cramdown
A cramdown also may be successfully challenged if a debtor’s plan has not been proposed in good faith. Among other requirements, the Bankruptcy Code mandates that a debtor’s plan be proposed in good faith in order to qualify for confirmation. 11 U.S.C. § 1325(a)(3). If a debtor or a debtor’s dependent does not reside at the property, a cramdown may have been proposed in bad faith if the property does not deliver a net benefit to the bankruptcy estate. In re Brinkley, 505 B.R. 207 (Bankr. E.D. Mich. 2013); In re Jordan, 330 B.R. 857 (Bankr. M.D. Ga. 2005). To make this determination, the court will look at the monthly income that the property generates (most likely from rent) and then subtract the monthly payment by the chapter 13 trustee on the secured portion of the debt, any monthly homeowners or condominium association fees, and the monthly pro-rata taxes and insurance. Brinkley, 505 B.R. at 215-216. If the result is not a positive number, and the debtor cannot provide any other good faith justification for retention of the property, then the debtor will not be permitted to retain the property. Id. at 216.

When reviewing a proposed cramdown, mortgage servicers and their attorneys should have most of the information on hand necessary to make a rough version of the calculation on which the Brinkley court relied. The proposed monthly payment on the secured portion of the claim may be set forth in the plan or be easily calculated. If a debtor’s schedules are complete, the remainder of the information can be obtained in Schedule G (Executory Contracts and Unexpired Leases), Schedule I (Income), and Schedule J (Expenses).

In a very significant number of cases, this calculation results in a negative number. Even if there is a net benefit to the bankruptcy estate based on initial numbers, those can change as a consequence of a higher valuation, interest rate, or pro-rata monthly expense, or a decrease in rent. Consequently, it is recommended to preserve this bad faith objection by filing it timely and then requesting documentary verification of expenses and rent from the debtor’s attorney. While a successful challenge to a cramdown using bad faith will often compel a debtor to surrender the collateral, it could potentially result in the claim being treated as a 11 U.S.C. § 1322(b)(5) claim (maintain post-petition payments and cure pre-petition arrearage), if the total monthly payment is not excessive, or some other arrangement that allows a portion of the debt to extend beyond the length of the chapter 13 plan.

Conclusion
When reviewing a plan that proposes a cramdown, objecting to a “bait and switch” scheme and “bad faith” are options that creditors and their attorneys should always consider if the facts point toward either scenario. Keeping these two potential objections in mind when faced with a proposed cramdown could lead to much more favorable results at confirmation.

Copyright © 2015 USFN. All rights reserved.
Autumn USFN Report

November 9, 2015

by David E. Johnson
Lerner, Sampson & Rothfuss
USFN Member (Kentucky, Ohio)

During its 2015 regular session, the Kentucky General Assembly introduced House Bill 470 to add nonjudicial foreclosure as an option in Kentucky. Although the bill was subsequently withdrawn, it is expected to be reintroduced in 2016 and represents a marked departure from this state’s historical approach to mortgage enforcement. Kentucky long ago abolished the practice of “strict foreclosure” and requires a judicial process to foreclose a mortgage lien while protecting the homeowner’s equitable right of redemption.

The proposed new regime would add a nonjudicial foreclosure option by recrafting new mortgage originations as deeds of trust with a power of sale. This would not affect already-existing mortgages, and it would not eliminate current judicial foreclosure procedures. Rather, upon a default under a deed of trust, the beneficiary would have the option to pursue either judicial or nonjudicial recourse against the borrower. If it chooses the nonjudicial option, the borrower can still demand that the judicial process be used instead, and other parties objecting to the nonjudicial process can file suit to enjoin a trustee’s sale under certain conditions. Thus, the two systems are not mutually exclusive and appear likely to overlap. Interestingly, unlike existing judicial foreclosure statutes, the proposed law would provide for no right of redemption when a property is sold nonjudicially by a trustee.

This bill enjoys significant support from the Kentucky Bankers Association, whose members seek to reduce the expenses of foreclosure and to expedite the lien enforcement process. The streamlined notice procedures outlined in the new bill would enable a beneficiary to get to a sale date faster, while preserving the parties’ rights to resort to the courts, if necessary, to protect their interests. Certain other aspects of the process, such as distribution of surplus proceeds, appear to be reserved specifically for the courts, although there are some unanswered questions in the draft bill about exactly how this would work. In other words, there is some degree of hybridization contemplated between the new and old systems. The ability to pursue loss mitigation would remain, but the shorter timelines can be expected to put more onus on the borrower to pursue a resolution sooner before the abbreviated nonjudicial process can run its course.

For firms practicing foreclosure law in Kentucky, the proposed legislation can be expected to require substantial changes in existing procedures, forms, policies, and training of both attorneys and support staff. The notice requirements and procedural steps to complete a nonjudicial foreclosure will be very exacting and create ample pitfalls for the unwary. Also, the nonjudicial method will require a mechanism to coordinate with the judicial side of a practice when a party to an otherwise nonjudicial case invokes the jurisdiction of the courts. After enactment of the final version of the bill, firms should have a window of opportunity to make the necessary adjustments before seeing the first defaults under the newly-minted deeds of trust.

Copyright © 2015 USFN. All rights reserved.
Autumn USFN Report

November 9, 2015

by Joel W. Giddens
Wilson & Associates, P.L.L.C.
USFN Member (Arkansas, Tennessee)

The National Association of Chapter Thirteen Trustees (NACTT) held its annual conference in scenic Salt Lake City, Utah this past July. While there continued to be focus on mortgage issues, other topics (including recent U.S. Supreme Court decisions affecting chapter 13 practice and broader bankruptcy issues) took center stage at the event. This article is intended to highlight a few of the educational offerings and events of interest to the mortgage servicing industry.

Opened by U.S. Trustee
As in recent years, the Director of the Administrative Office of the U.S. Trustee program, Clifford J. White III, provided opening remarks for the conference. The Office of the U.S. Trustee (UST) falls under the Department of Justice and is responsible for overseeing the administration of bankruptcy cases and private trustees. Director White began with a rather ominous statement of looking forward to the day when he opened the conference without comments directed at the mortgage servicing industry. Unfortunately, he went on, this was not that day, and compliance by mortgage servicers was still an issue three years after the national mortgage servicing settlement (NMSS) had been in effect.

Director White commented that all of the regional offices of the UST were monitoring compliance of servicer proofs of claim and the Federal Rule of Bankruptcy Procedure (FRBP) 3002.1 notices. There was a particular focus in the past year by the UST offices with regard to FRBP 3002.1(b) Notice of Payment Changes (NPC). Highlighted in the director’s remarks was a case in the Eastern District of Michigan in which the UST’s office intervened to investigate a servicer that had filed an NPC that tripled the ongoing mortgage payment. After the servicer could not substantiate the change, the UST’s office and the servicer entered into a $50 million settlement agreement in which the servicer agreed to remediate its practices, subject to independent review. With the vast number of NPCs required nationally, UST scrutiny on servicer practices in this area is likely to continue. Despite these adverse remarks, Director White did comment that he is seeing some improvement in servicer practices in general and, especially, in regards to cooperation.

Apart from mortgage servicer practices, the UST’s office has recently focused on buyers of credit card and other unsecured debt (and their collection practices) in chapter 13 cases. Director White commented that debtors’ fresh starts were being interfered with by this practice and that his office was closely scrutinizing it. The problem occurs when debt purchasers do not review accounts to determine whether collection is barred by a statute of limitation and then file a proof of claim for the debt. This problem, along with suspected robo-signing of the claims, will continue to be a focus of the UST program.

Educational Program
Highlights of the educational program were a session on recent U.S. Supreme Court decisions impacting bankruptcy court jurisdiction and other areas of bankruptcy practice; a panel addressing current mortgage servicing issues, including the impending changes to the proof of claim form and attachment; bankruptcy judges Brown’s and Lundin’s and chapter 13 Trustee Hildebrand’s entertaining and informative chapter 13 case update; as well as a session on how the Consumer Financial Protection Bureau (CFPB) affects chapter 13 practice.

Attorney G. Eric Brunstadt, Jr. surveyed the history of jurisdiction of bankruptcy courts leading up to the recent Supreme Court’s decision in Wellness International Network v. Sharif, 575 U.S. __, 135 S. Ct. 1932 (May 26, 2015). Following the Supreme Court’s decision in Stern v. Marshall, 564 U.S. 2, 131 S. Ct. 2594 (2011), bankruptcy court jurisdiction was somewhat unsettled, leading to uncertainty about the extent to which parties could rely on bankruptcy courts to adjudicate certain claims.

In Stern, the Supreme Court held that while bankruptcy courts had the statutory authority under 28 U.S.C.S. § 157(b)(2)(C) to enter a judgment on a debtor’s core state law counterclaim (a counterclaim for an alleged tortious interference with a gift was involved in Stern), they lacked constitutional authority under Article III of the United States Constitution to enter a judgment. The Supreme Court said that this was because Article I bankruptcy courts were not subject to constitutional assurances of independence (i.e., life tenure of judges and non-diminishment of salaries) which would allow adjudication of such claims.

Left open by Stern was the question of whether parties in bankruptcy could cure the lack of constitutional authority by consenting to the entry of a final order by a bankruptcy court. If not, a party would be faced with the decision of either requesting that the district court withdraw the reference so that it could try the matter instead of the bankruptcy court, or having the bankruptcy court hear the matter and make proposed findings of fact and conclusions of law to be submitted to the district court. In Wellness, the Supreme Court calmed the unsettled state of bankruptcy jurisdiction by finding that parties could indeed consent to a bankruptcy court entering a final order on so-called “Stern claims.”

In so holding, the Supreme Court found that the constitutional right to have an Article III judge hear such claims is a personal right that can be waived by either express or implied consent of the parties. In Wellness, the Court appears to have limited the effect that the Stern decision had on bankruptcy court jurisdiction.

A panel of interest to the industry included a presentation on mortgage servicing issues by Russell Simon, standing chapter 13 trustee for the Southern District of Illinois; attorney Michael Bates (formerly Senior Legal Counsel for Wells Fargo Bank, N.A.); attorney John Crane; and Eduardo Rodriguez, Judicial Appointee for the Southern District of Texas. With the sunset of the NMSS on October 5, 2015, the group posed the question of whether the industry had learned anything from the NMSS requirements. The consensus of the panel was that, at least with the five servicers who were parties to the NMSS, mortgage servicing had significantly improved. Areas of improvement could be seen in a renewed emphasis in accuracy, increased transparency, robust internal compliance programs with multiple testing criteria, and in greater cooperation with compliance monitors.

In bankruptcy, the NMSS shifted the focus to getting documents (motions for relief from stay, proofs of claim) right at the time of filing, instead of in the speed of getting them filed. The NMSS also has had positive effects in industry practices outside of the consenting servicers, as other servicers have voluntarily complied with the NMSS standards. The panel was of the opinion, that as an industry standard for “best practices,” NMSS quality controls would continue into the future to maintain the improvements seen in the servicing industry.

Trustees, Servicers, and Attorneys
Apart from the NACTT panels, a meeting of a group of trustees, mortgage servicers and their attorneys was held during the conference to discuss issues relating to mortgage servicing in chapter 13 cases. This meeting was a continuation of an effort initiated in Little Rock, Arkansas in January 2004 by this author’s firm and its founder, the late Robert Wilson, Jr., to bring together chapter 13 trustees, mortgage servicers, and attorneys to provide open communication on issues affecting mortgages in chapter 13 proceedings. Since 2004, the group has met by teleconference and at the annual NACTT conference. Over the past two years, the group has also held an interim meeting for planning and issue discussion.

During this year’s meeting, the focus of the group was narrowed to three specific areas: (1) bankruptcy compliance with CFPB regulations, particularly with monthly billing statements; (2) implementation of the new proof of claim Form 410 and proof of claim attachment Form 410A by the mortgage servicing industry; and (3) the national model chapter 13 plan. The committee felt that narrowing its focus to these three areas over the next year would help the group channel its efforts to ease any transition to come with new compliance standards and forms. In the wake of the NACTT conference, subcommittees were formed by the group to address each topic and prepare for the changes in the coming months.

Conclusion
As in years past, the NACTT conference provided many informative educational panels impacting chapter 13 practice and mortgage servicing. Once again, the conference proved to be a valuable experience for bankruptcy practitioners and mortgage servicers; a place to come together to discuss the issues impacting our world.

Copyright © 2015 USFN. All rights reserved.
Autumn USFN Report

October 8, 2015

by Graham H. Kidner
Hutchens Law Firm – USFN Member (North Carolina, South Carolina)

The purchaser at a judgment execution sale of the secured property (subsequently identified as a respondent in the later foreclosure proceedings) challenged the right of the petitioner mortgage company to foreclose the title to the property, arguing that the petitioner’s production of the original note indorsed in blank at the hearing de novo before the superior court did not establish that the petitioner possessed the note. Following the statutory procedure for power-of-sale special proceeding foreclosures in North Carolina, the respondent had appealed from the order of the Clerk of Superior Court authorizing the foreclosure sale, and appealed again from the order of the superior court that also authorized foreclosure.

In the case of In Re: Rawls, No. COA15-248 (N.C. Ct. App., Oct. 6, 2015), North Carolina’s Court of Appeals took the opportunity to provide a concise explanation of the process in which negotiable instruments may be transferred under North Carolina’s Uniform Commercial Code. In its decision, the appellate court rejected the respondent’s contentions. Respondent’s position was that the production of the original note indorsed in blank at the foreclosure hearing was insufficient to establish petitioner as holder based on a partial quote from an earlier appellate decision in which the court stated that “[p]roduction of an original note at trial does not, in itself, establish that the note was transferred to the party presenting the note with the purpose of giving that party the right to enforce the instrument[.]” Rawls at 9, quoting In re Simpson, 211 N.C. App. 483, 491, 711 S.E.2d 165, 171 (2011). The respondent also contended that the petitioner’s affidavits contained hearsay that should not have been considered by the superior court. Rejecting this contention, the court noted that Simpson, “which did not hold that production of an original note could never be adequate to establish a petitioner’s right to enforce a note, is factually distinguishable from the instant case.” Rawls, at 9-10 (emphasis in original).

Simpson involved a note that had been specially indorsed to an entity that was “‘not the party asserting a security interest in Respondent’s property.’ at 493, 711 S.E.2d at 172. Significantly, Simpson specified that it was ‘[b]ecause the indorsement does not identify Petitioner and is not indorsed in blank or to bearer, [that] it cannot be competent evidence that Petitioner is the holder of the Note.’ [Simpson] at 493, 711 S.E.2d at 173 (emphasis added).” Rawls at 10.

Looking to N.C. Gen. Stat. § 25-3-205(b), as well as case law rationale, the court in Rawls held: “that a petitioner’s production of an original note indorsed in blank establishes that the petitioner is the holder of the note. In this case it is undisputed that petitioner produced the original note indorsed in blank, and we hold that this was sufficient to support the trial court’s conclusion that petitioner was the holder of the note.” Rawls at 9. Given its holding, the appellate court found it “unnecessary to reach respondent’s arguments concerning the admissibility of the affidavits proffered at the hearing.” Rawls at 10.

Borrowers and their counsel will often seek to delay foreclosure proceedings even though they lack any valid basis to do so, providing them with more time in the property without having to repay the loan. In Rawls, the foreclosure process was delayed for at least eighteen months, not by the borrowers but by someone who had taken title from them and had no obligation to pay the loan — allowing him to either reside in, or rent out, the property without making mortgage payments. There was, arguably, no good faith basis to file this appeal, which could provide grounds to the successful party to seek sanctions including the recovery of legal fees.

It is not the general practice to produce the original promissory note at a residential property foreclosure hearing in North Carolina. Instead, the substitute trustee usually relies on an affidavit from a competent witness at the creditor bank or mortgage company testifying that the affiant’s employer is the holder of the note, and attaching a copy of the fully endorsed note to the affidavit. There are times, however, when the production of the original note is a wise move, so as to avoid incurring the expense of a postponement, a contested hearing, or an appeal. With this reported Rawls decision, which has precedential effect across the state, appeals of orders authorizing foreclosure on the basis that the creditor bank or mortgage company producing the original note at the foreclosure hearing is not entitled to enforce it should be rare indeed.

©Copyright 2015 USFN. All rights reserved.
October e-Update

October 7, 2015

by Jessica Rice
Trott Law, P.C. – USFN Member (Michigan)

Michigan law provides a mortgagor with the right to use and possess the property during the redemption period, which is typically six months following the foreclosure sale. However, the mortgage instrument usually contains a provision that allows the mortgagee to protect its interest in the property when the property is in jeopardy. As such, it may be necessary for mortgagees to consider taking some measures to protect their interest in the property during the redemption period by securing and winterizing the property.

When faced with the possibility of a property being damaged during the redemption period, always begin by reading the terms of the mortgage and ensure that there is a provision that allows for the mortgagee to protect its interest in the property. It is best to do as little as possible to interfere with the mortgagor’s redemption rights while, at the same time, doing what is necessary to protect the mortgagee’s interest in the property. This means mitigating the risks that may be encountered in securing and winterizing by keeping detailed records and notes, taking pictures of the property, and posting — in a conspicuous place — a sign with information as to whom the mortgagor can contact in order to obtain access, if necessary. If contacted by a mortgagor to gain access to the property after it has been secured and/or winterized, access should immediately be granted in order to avoid wrongful lockout claims or other similar issues.

It is also important to keep in mind state-specific foreclosure statutes. In Michigan, the foreclosure statute provides foreclosing lenders with the right to shorten the redemption period if a property is deemed abandoned via a specific process outlined in the statute. Bear in mind, there is a distinct difference between a property being vacant and a property being abandoned. If the property is truly abandoned, there is a legal process that can be implemented and, if successful, will result in a shortened redemption period. This is a very useful tool — especially in the winter months — as it may enable the foreclosing lender to take title to the property sooner than the statutorily-set redemption expiration date and, therefore, allow for measures to be taken to secure and winterize the property without the risk of claims that the mortgagor’s rights have been violated during the redemption period.

©Copyright 2015 USFN and Trott Law, P.C. All rights reserved.
October e-Update

October 7, 2015

 by Scott W. Neal
Orlans Associates, P.C. – USFN Member (Michigan)

The numerous Michigan Register of Deeds offices currently charge per page when recording documents. Traditionally, the first page costs $14, while all following pages cost $3. This creates uncertainty when providing consumers with a closing statement. It is difficult to predict actual figures for the cost of recording mortgages, notes, and other related documents at closing.

The number of pages will vary depending upon the length of the legal description (which those of us in the industry know can be as short as a sentence or as long as a story), the size of the paper that is used, the number of people who must sign the document, the quantity of notary blocks required, and so on. Mortgages tend to be about sixteen pages in length, but this can change if there are riders (such as a condominium rider) or lengthy legal descriptions. These variations often cause closing statements to need amendment and, occasionally, for refunds to be given.

Moreover, effective August 1, 2015, new CFPB regulations require that consumers are provided with certain exact recording charges as part of the “Closing Disclosure” document. With the laws in Michigan currently as they stand, this will present a potential area of conflict unless change happens. It seems that the rational adjustment would be for Michigan to adopt a fixed, flat fee for recording documents with the Register of Deeds. Many states have already implemented flat fees successfully. Michigan will likely follow suit in light of these new CFPB regulations as well as the needs of lenders and borrowers.

©Copyright 2015 USFN. All rights reserved.
October e-Update

October 7, 2015

by E. Edward Farnsworth, Jr.
Samuel I. White, P.C. – USFN Member (Virginia)

In Covarrubias v. CitiMortgage, Inc., No. 14-2420 (4th Cir. Va. Sept. 1, 2015)(unpublished), the U.S. Court of Appeals for the Fourth Circuit authored a chapter in the ongoing Virginia HUD face-to-face saga that began in 2012 with Mathews v. PHH Mortgage Corporation, 283 Va. 723, 724 S.E.2d 196 (2012). Mathews was a very favorable Virginia Supreme Court decision for borrowers seeking to challenge foreclosure sales based on allegations of failure to satisfy all conditions precedent to foreclosure. Indeed, the decision garnered national attention and has been cited in many jurisdictions outside of Virginia.

By way of background, the court in Mathews held that the right to foreclose does not accrue until all conditions precedent contained in the deed of trust have been satisfied. The relevant deed of trust specifically incorporated the HUD regulations, and indicated that foreclosure was not authorized if not permitted by the regulations. At issue was the face-to-face meeting requirement contained in 24 C.F.R. § 203.604. This regulation requires that prior to initiating foreclosure the servicer must have, or must make a reasonable attempt to arrange, a face-to-face meeting with the borrower before the loan is three months in default. The court in Mathews rejected the mortgage servicer’s defenses that the borrower’s default in payment excused performance, that the servicer was excused from performance because the term “branch office” (as it pertains to the 200-mile exception) only included loan servicing offices, and the deed of trust did not incorporate the HUD regulations. Accordingly, the lower court’s sustaining of the mortgage servicer’s demurrer (motion to dismiss) was reversed. In 2014, the Virginia Supreme Court reinforced the Mathews holding in Squire v. Virginia Housing Development Authority, 287 Va. 507, 758 S.E.2d 55 (2014).

Mathews and Squire concerned whether a borrower’s pleadings were sufficient to overcome initial demurrer. However, it remained to be seen whether the borrower might survive a motion for summary judgment, if discovery did not support the proposition that failure to conduct the face-to-face meeting caused the borrower’s alleged damages (particularly where the borrower was admittedly in default). The lower court’s decision in Covarrubias had given mortgage servicers hope for prevailing on summary judgment. [Covarrubias v. CitiMortgage, Inc., 2014 WL 6968035 (E.D. Va. 2014)]. Specifically, the U.S. District Court for the Eastern District of Virginia granted summary judgment in favor of the mortgage servicer, holding that “[t]he failure to follow the regulations, however, had no role in any losses suffered by the plaintiff. Rather, Covarrubias’s own actions caused the foreclosure and any resulting damages.” The District Court went on to opine that no reasonable jury could find that failure to satisfy the HUD regulations proximately caused the borrower’s damages. This victory was short-lived, as the Fourth Circuit Court of Appeals reversed the District Court’s decision and remanded the case for further proceedings.

In an unpublished opinion, the Fourth Circuit held that the record demonstrated that the mortgage servicer failed to hold, or reasonably attempted to arrange, a face-to-face meeting. Moreover, the plaintiff had produced prima facie evidence of causation and her ability to bring the loan current, had the meeting been arranged. Specifically, the appellate court held that “we conclude that a rational jury could reasonably conclude that a face-to-face meeting, as required, may have resulted in an outcome other than foreclosure and the consequent loss of Covarrubias’ equity.”

There has been significant litigation on this issue in the last few years at the Virginia Supreme Court level, and now in the U.S. Court of Appeals for the Fourth Circuit. While unpublished opinions are not binding authority in this circuit, Covarrubias — along with the other cases — seems to strongly indicate that breach of contract claims for failure to satisfy the HUD face-to-face requirements, where such regulations are specifically incorporated into the deed of trust, will likely go to trial. These cases also have implications for claims that other conditions precedent were not satisfied before proceeding to foreclosure. Accordingly, it would be prudent for the foreclosure trustee and mortgage servicer to both ensure that any conditions precedent expressly included, or incorporated by reference, in the deed of trust are satisfied before proceeding to foreclosure. More oversight on the front end of the file can likely eliminate costly and time-consuming litigation after the sale. This is particularly true in nonjudicial foreclosure states like Virginia, where there is no judicial sale ratification process requiring the borrower to raise such claims during a ratification period. As a result, in nonjudicial foreclosure states, these claims are often raised several months – if not well over a year – after the foreclosure sale.

©Copyright 2015 USFN. All rights reserved.
October e-Update