Author Archives: David Reiss

Stalled Foreclosures in NY Not a Violation of Federal Law

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Judge Townes (EDNY) dismissed a putative class action, Cole v, Baum, 11-cv-3779 (July 11, 2013), against notorious foreclosure mill Steven J. Baum, P.C. and its principal relating to their failure to submit filings that would have triggered mandatory settlement conferences for homeowners under a new New York law.  The plaintiffs alleged that the defendants violated the federal Fair Debt Collections Practices Act. Judge Townes found that the failure to comply with the NY law was not the equivalent of an unfair debt collection prohibited by the FDCPA.

In reaching its result, the Court stated that not “every violation of state or city law amounts to a violation of the FDCPA.” (16, quoting Nero v. Law Offices of Sam Streeter, P.L.L.C., 655 F. Supp. 2d 200, 209 (E.D.N.Y. 2009)). It further found that even “debt collection practices in violation of state law are not per se violations of the FDCPA.” (17) The Court concluded that in the present case,

the defendants’ debt collection practices did not violated the provisions of the FDCPA. Defendants allegedly violated 22 NYCRR § 202.12-a, a procedural rule promulgated by the Chief Administrator of the New York Courts to facilitate implementation of CPLR 340B. However, CPLR 340B is not a state analog of the FDCPA. That statute does not prohibit unfair, misleading or deceptive collection practices, but merely furthers a state interest  in  forestalling or preventing foreclosures. Although defendants may be debt collectors, and their alleged violation of Section 202.12-a may be characterized as unfair, defendants’ violation of this state procedural provision neither resulted in, nor contributed to, the sort of unfair debt collection practices prohibited by the FDCPA. (18)

I am not sure if I see the principled difference between the scope of the FDCPA and the NY law.  The Court acknowledges that the FDCPA, is meant “to protect consumers from deceptive or harassing actions taken by debt collectors with the purpose of limiting the suffering and anguish often inflicted by independent debt collectors.” (10, quoting Gabriele v. American Home Mortg. Servicing, Inc., No. 12-985-cv, 2012 WL 5908601 at *3 (2d Cir. Nov. 27, 2012)). The mere fact that the NY law was an amendment to the Civil Practice Law and Rules (CPLR) does not seem to undercut the fact that it was passed expressly to address the “mortgage foreclosure crisis.” (2) I would think that if procedural violations amounted to a substantive injustice, it could be sufficient to violate the FDCPA.

Laches Upends Priority of Mortgagee in Utah

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Professor Wilson Freyermuth posted this summary of the Utah Supreme Court’s opinion, Insight Assets, Inc. v. Farias, ___ P.3d ___, 2013 WL 3990783 (August 6, 2013), to the DIRT listserv:

Synposis:   Although vendor purchase money mortgagee may generally have a superior claim to priority over a third-party purchase money mortgagee under the Restatement, vendor purchase money mortgagee was barred from asserting that priority by the doctrine of laches.

Facts:  In 2004, the Phalens sold land in Ogden, Utah to the Boecks for $88,000.  The Boecks financed the purchase with a $70,300 institutional mortgage loan from First Franklin Financial Corp. (First Franklin) and $17,600 in seller purchase money mortgage financing from the Phalens.  At closing, the Boecks executed deeds of trust to First Franklin and the Phelans.  After closing, the title company recorded the two deeds of trust together, but with First Franklin’s deed of trust being recorded first.  First Franklin later assigned its mortgage to Wells Fargo.

After closing, the Boecks defaulted to both Bank and to Sellers.  In June 2005, Wells Fargo foreclosed on the property and acquired the property by a trustee’s deed.  The Phelans did not attempt to foreclose on the property.  Wells Fargo sold the property, which ultimately passed by intervening conveyances to Farias.

In 2009, the Phelans assigned their interest under their deed of trust to Insight Assets (“Insight”), who executed a substitution of trustee, recorded a notice of default, and instituted foreclosure proceedings.  Farias sought summary judgment, claiming that he had held free and clear title as a bona fide purchaser.  The district court entered judgment for Farias, and Insight appealed.

On appeal to the Utah Supreme Court, Insight argued that as a matter of law, the Phelans’ seller deed of trust was entitled to priority over First Franklin’s deed of trust under Restatement (Third) of Property — Mortgages § 7.2(c) (“A purchase money mortgage given to a vendor of real estate, in the absence of a contrary intent of the parties to it and subject to the operation of the recording acts, has priority over a purchase money mortgage on that real estate given to a person who is not its vendor.”).  By contrast, Farias made three arguments:  (1) that First Franklin did not know of the Phelans’ seller purchase money mortgage and thus the Restatement rule should not apply; (2) that even if First Franklin did know of the seller purchase money mortgage, that knowledge was irrelevant because Farias was a bona fide purchaser who took free and clear of the mortgage; and (3) that Insight’s claims was otherwise barred by the doctrine of laches.

Analysis:  The Supreme Court of Utah rejected Farias’s bona fide purchase argument, noting (correctly and obviously) that the recording act cannot protect Farias against a prior properly-recorded mortgage.  The Court also noted that while the Restatement rule generally gives a vendor purchase money mortgage priority over a third-party purchase money mortgage, that rule was subject to a caveat — “where only one of the parties has notice of the other,” the recording acts should govern and award priority to the party lacking notice.

Insight argued that its vendor purchase money mortgage should still prevail, because (a) First Franklin had actual knowledge of the Phelans’ seller purchase money mortgage and (b) the title company’s knowledge of the Phelans’ seller purchase money mortgage was imputed to First Franklin.  The court did not reach this argument, however, concluding that Insight’s priority claim was barred under the equitable doctrine of laches. Although Insight did file its notice of default within the applicable six-year statute of limitations, the court stated that this did not preclude the possible application of laches.  The court concluded that application of laches was appropriate due to the Phelans’ lack of diligence and Farias’s resulting injury.  The court noted that during the five years between the Boecks’ default and the Phelans’ assignment to Insight, the Phelans “took no action to clarify or assert their rights to the property.” The court held that this was inaction unreasonable because the Restatement rule involves a “multi-factor balancing test under which priority is determined by ‘the circumstances of the given case, the equities, and the effect of the recording act.’” Thus, in the court’s view, the Phelans “could not have rationally assumed that their interest had priority” without having brought an action to establish that priority.  By failing to bring such a claim during the Wells Fargo foreclosure proceedings, the Phelans “risked forfeiting their security interest entirely.”

The court also concluded that Farias would be injured if Insight’s untimely claim was allowed to proceed, noting that Farias had negotiated the price for his home without considering the $17,600 debt owed to Insight and that when Farias purchased the home years after the Phelans’ default, “it was reasonable for him to infer from [their] inaction that their security interest had been extinguished” by the Wells Fargo foreclosure.  The court also noted that the passage of time had harmed Farias by making it difficult to gather evidence in his defense, as First Franklin was now out of business (making it difficult for Farias to locate records or former employees who might have information relevant to the question of First Franklin’s knowledge).

Comment:  This is the second 2013 periodic development involving a case where the title company recorded a third-party purchase money mortgage prior to a vendor purchase money mortgage.  In the earlier case, Insight LLC v. Gunter, the Idaho Supreme Court rejected the Restatement rule and held that the third-party mortgage had priority under the recording act.  As noted in the critique of Gunter, https://dirt.umkc.edu/February%202013/InsightLLCvGunter.pdf, that decision wrongly opened the door for purchase money lenders to structure closings in a fashion likely to disadvantage the unsuspecting purchase money seller, particularly where the purchase money lender knew of the purchase money seller and could have easily required a subordination agreement as a condition of making the purchase money loan.  Gratifyingly, the Utah court rejected the reasoning of Gunter, noting that the Restatement rule is the appropriate starting principle for vendor vs. third party lender purchase money priority disputes.

The Utah court’s judgment regarding the application of laches is harder to evaluate without the ability to review the factual record in greater detail.  On the one hand, the court is correct to note that because the Restatement rule is subject to the application of the recording act if the third party mortgagee lacks notice of the vendor mortgagee (or vice-versa), then the Phelans couldn’t be certain of their priority over First Franklin without a court decree.  On the other hand, Farias’s actions also seem similarly unreasonable.  Because the Phelans’ mortgage was recorded (and could have been entitled to priority over the First Franklin mortgage), Farias also couldn’t have been certain he was getting clear title without a court decree.  It’s not obvious where the equities lie here.

Regression Aggression: Statistics and Disparate Impact

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The Third Circuit affirmed, in Rodriguez et al. v. National City Bank et al., No. 11-8079 (Aug. 12, 2013), the denial of final approval “of the parties’ proposed settlement and certification of the settlement class” in a mortgage loan discrimination case brought by minority borrowers who claimed a disparate impact resulting from how the defendants charged borrowers. (4)

The part of the opinion that I found most interesting (but not compelling) was where it discussed the statistical work that the plaintiffs had done to support their case.  The Court states that

Even if Plaintiffs had succeeded in controlling for every  objective  credit-related variable – something no court could have reviewed because the analyses are not of record – the regression analyses  do not even purport to control for individual, subjective considerations.  A loan officer may have set an individual borrower’s interest rate and fees based on any number of non-discriminatory reasons, such as whether the mortgage loans were intended to benefit other family members who were not borrowers, whether borrowers misrepresented their income or assets, whether borrowers were seeking or had previously been given  favorable loan-to value terms not warranted by their credit status, whether the loans were part of a beneficial debt consolidation, or even concerns the loan officer  may have  had  at the time  for the financial institution irrespective of the borrower. While those possibilities do not necessarily rebut the argument that the Discretionary Pricing Policy opened the door to biases that individual loan officers could have harbored,  they  do undermine the assertion that there was a common and unlawful mode by which the officers exercised their discretion. (26-27)

I have not read the plaintiffs’ study, but the Court’s logic seems suspect to me. I can’t imagine how a statistician would “control for individual, subjective considerations,” particularly as that appears to be an infinite set of variables. Indeed, the Court gives little meaningful guidance as to what a comprehensive regression analysis would look like. What “individual, subjective considerations” would they include?  Where would that data exist to be studied?

The court does note some serious problems with the plaintiffs’ case, including the fact that they did not introduce their data or regression analyses into the record.  But those failings are not sufficient to explain the Court’s reasoning in the selection quoted above.

This case might be ripe for reconsideration or an en banc review, even if just to clarify what the Court wants from plaintiffs in future disparate impact cases.

Originator’s Repurchase Obligation Triggered by Loans’ Purchaser Sole Discretion

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Professors  Wilson Freyermuth and Dale Whitman posted this summary of the Eighth Circuit’s opinion Residential Funding Co., LLC v. Terrace Mortg. Co., — F.3d —-, 2013 WL 4007552 (Aug. 7, 2013), to the DIRT listserv.  Residential Funding held that held that a loan originator’s repurchase obligation can be triggered by the loans’ purchaser in its sole discretion.

 This case is a dispute between a buyer of residential mortgages and the originator with whom the buyer had a repurchase  agreement.  The agreement incorporated by reference the terms of the buyer’s “Client Guide” which provided that 1) the originator would repurchase a loan within 30 days if the buyer concluded that the originator was in default and demanded repurchase, 2) the originator could “appeal” by providing “additional information or documentation,” and 3) the buyer would “in its sole discretion” determine the validity of any appeal.

 The two parties did business under this arrangement for many years without incident, but after the collapse of the mortgage market in 2008, the buyer demanded that the originator repurchase 13 loans. The basis for the demand was the claimed presence of misstatements in the loan applications and other documentation for the loans. When the originator refused, the buyer sued and was granted summary judgment by the district court, which apparently ruled that the originator had agreed in the contract to “contract away” its right to judicial review by granting the buyer the “exclusive right” to determine if an event of default had occurred — and that the originator could not then later ask a court to review the buyer’s determination.  The 8th Circuit agreed and affirmed, basically concluding that the contract was unambiguous.

 It may well be that on the underlying merits, there really were problems with the loans in question — that would hardly be surprising.

 Nevertheless, the court’s conclusion that the buyer’s decision was final and unreviewable is troubling. It seems to us that it makes these sales too much like “illusory” contracts, in which one party has not really agreed to do anything. In an ordinary contract, a provision giving one party the sole discretion, unreviewable, to withdraw or refuse to perform would be viewed as illusory.  Should the fact that this is a repurchase agreement somehow change that?  We don’t see any basis for saying so.

 In such a situation, a court usually has two options: (1) to declare the consideration for the contract illusory, and therefore to treat the contract as unenforceable, or (2) to read into the buyer’s rights an obligation to exercise them only “reasonably” or “in good faith” or something of the sort. The latter interpretation gets rid of the “illusory contract” issue, and the contract becomes enforceable.

 In the Eighth Circuit’s opinion, the court seems to say that Residential had a duty of good faith, but that good faith merely means that they have to go through the procedure of reviewing their decision, not that the decision has to be supportable on the merits. At a minimum, we would suggest that “good faith” means that the buyer would have to have an actual belief, founded in facts, that an event of default had occurred. But the court doesn’t seem to require that such a belief must exist. Instead, it seems to require only that the procedure be followed. We have serious doubts that this is enough.

 The court also seems off-base when it explains that the buyer gave consideration because it paid a premium for the loans. Whether it bought the loans at a premium, at par, or at a discount seems completely irrelevant to us. The point of the “sole discretion” clause, as the court interprets it, is that the buyer could get its money back simply by demanding that the loan be repurchased — even if, on the merits, there was no actual event of default and no basis for demanding a repurchase. The court doesn’t address this issue adequately.

 We are troubled by the suggestion in the court’s language that the originator had effectively “contract[ed] away judicial review by granting [the buyer] the exclusive right to determine an ‘Event of Default’ has occurred.”  There seems to be no logical bound on that — if that’s right, then one contracting party can effectively make itself both a party and an arbitrator of all disputes under the agreement.

Replacing Rating Agencies

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Although rating agencies have been the subject of much criticism, including much from yours truly, (here for instance) there is no clearly superior replacement for the existing business model.  Even worse, there is not even much theoretical work on alternatives. Thus, it is exciting to see that Becker and Opp have posted a new paper, Replacing Ratings, that at least considers a plausible alternative.

Their paper examines “a unique change in how capital requirements are assigned to insurance holdings of mortgage-backed securities. The change replaced credit ratings with regulator-paid risk assessments by Pimco and BlackRock.” (1) But their analysis did not “find evidence for more accurate inputs to regulation.” (3, emphasis removed) Indeed, their “empirical analysis reveals that the old system was better able to discriminate between risks. As a result, the old system based on ratings not only provided higher levels of capital, but also ensured that capital was more appropriately related to risks.” (3-4)

By the end of their analysis, they believe that “the new system only recognizes current (expected) losses, but does not provide any buffer against possible future losses. Our results are consistent with regulatory changes being largely driven by industry interests.” (21)

They find the new system is worse than the old system and that the new system benefits the industry.  So why should we care about this research at all?  For at least three reasons:

  1. it identified a change in the insurance industry that has implications way beyond that industry;
  2. it compared how two different MBS evaluation systems performed; and
  3. it identified the drawbacks of the new system.

This is how we begin to build a body of knowledge about “viable alternatives to ratings.” (2) But, of course, there is much more work to be done.

 

Fannie, Freddie & Affordable Housing

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I was quoted in a Law360.com story, Affordable Housing May Trip Up Fannie, Freddie Fixes (behind a paywall).  It reads in part,

While the debate over housing finance reform in Washington has focused on the government’s role as market backstop, analysts say questions about federal funding for affordable housing add another potential pitfall for lawmakers looking to dismantle and replace Fannie Mae and Freddie Mac.

Fannie and Freddie long have been part of a broader government program to add to the country’s affordable housing stock. Republicans have been critical of that mission and targeted it as something that should be abolished along with the two mortgage giants, while Democrats want to keep programs promoting affordable housing in any reform of the housing finance system.

As the U.S. House of Representatives and Senate move forward with their own visions of a new system for financing home purchases, it is likely that those two perspectives on affordable housing promotion will clash, said Rick Lazio, a former four-term Republican member of Congress from New York.

“That will be a significant obstacle to getting an agreement,” said Lazio, now the chairman of Jones Walker LLP’s housing and housing finance industry team.

One of the main issues lawmakers will have to confront will be what to do with the National Housing Trust Fund, a program created by the 2008 Housing and Economic Recovery Act.

HERA required Fannie Mae and Freddie Mac to transfer a small percentage of the money from new business to the fund, which would then be used to subsidize the construction of rental housing for low-income families.

The fund’s inclusion in HERA was seen as a major victory for affordable housing advocates, but the benefits never materialized.

Soon after HERA passed, Fannie and Freddie were placed into conservatorship after mounting losses from exposure to subprime mortgages, and the two companies took a combined $187 billion bailout. The Federal Housing Finance Agency canceled all contributions to the fund.

Several housing advocacy groups have sued the FHFA to force the agency to allow Fannie Mae and Freddie Mac to resume their contributions now that the entities are generating profits and repaying the bailout money.

What seems more likely than getting the money the two companies were supposed to pay out is that the funds allocated to affordable housing will be shrunk under a new system, as envisioned by a Senate bill, or eliminated altogether, as proposed by a bill introduced by House Republicans.

“If it’s included at all, it will be smaller,” Brooklyn Law School professor David Reiss said of affordable housing money.

Underwater Mortgages Eminent Domain Battle Gears up

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I was quoted in a recent story in www.thestreet.com, Eminent Domain Mortgage Battle Is a Lose-Lose Situation.  It reads in part,

The move by Richmond, Calif., to seize “underwater mortgages” from private investors using its powers of eminent domain has drawn controversy and consternation within the mortgage industry.

The law has mostly been used to seize property for public purposes such as building roads, highways or schools and other critical infrastructure.

Richmond is now testing whether the rule can be applied to seizing underwater mortgages.

Home prices in Richmond, a city with a population of a little more than 100,000 and a significant Hispanic and African-American presence, are still far below peak levels. More than half of its homeowners are underwater — they owe more than their homes are worth.

Richmond Mayor Gayle Mclaughlin said eminent domain is the only way to help borrowers and repair the local economy, as investors of private-label mortgages have been either reluctant or too slow to provide relief to borrowers.

The city, partnering with San Francisco-based Mortgage Resolution Partners (MRP), began sending letters to owners and servicers of 624 underwater mortgages this week.

If the investors do not agree to sell at the negotiated price, the city will seize the property through eminent domain.

The mortgage industry is, predictably, threatening a legal battle.

* * *

“The constitutional challenges for this proposal are weak,” according to David Reiss, law professor at the Brooklyn Law School.

* * *

The bigger source of legal conflict, according to Reiss and other experts, would be on determining what is fair compensation for a mortgage, especially one that is still current.

* * *

“Courts tend to overcompensate properties taken under eminent domain as a general rule,” said Reiss. “The proponents of this rule may be underestimating how these mortgages will be valued.”

* * *

Eminent domain is “theoretically a great idea,” said Reiss. “States certainly have the legal authority to try this experiment. But it is not clear whether the outcome of all this is beneficial.”