Author Archives: David Reiss

No Scarlet Letter for Robo-Signing

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An “admitted robo-signer” and her bank were let off the hook in Grullon v. Bank of America et al.  (Mar. 28, 2013, No. 10-5427 (KSH) (PS)) (D.N.J.). (19)  Grullon, a homeowner, alleged that he, and others similarly situated, was entitled to relief under New Jersey’s Consumer Fraud Act because of BoA’s “bad practices, including: robo-signing, foreclosure documents, concealing the true owner of loans from the borrowers, and initiating foreclosure proceedings before it had the right too, resulted in unreliable and unfair foreclosure proceedings and ascertainable losses.” (1)

Grullon alleged a variety of fraudulent robo-signing practices, including for affidavits and assignments.  The Court found that in “light of the lack of- or de minimis nature of- the errors found on the documents said to have been “robo-signed,” and Grullon’s lack of standing to challenge the Assignment, the Court is not satisfied that Grullon has proffered sufficient evidence to support his NJCFA claim on this basis.” (21) The Court was also not satisfied that Grullon “has adequately shown that he suffered any ascertainable loss as a result of the 2009 NOI [Notice of Intention to Foreclosure] or the ‘robo-signed’ documents.” (24)  The Court also appears to find that the “robo-signing” of assignments presents no problem as the signer is not attesting to the truth of such a document. (20-21)

Bottom line:  one needs to demonstrate that there was a wrong and that harm resulted from it. Scatter shot allegations of robo-signing don’t work.

imcsnet.org/gfetw/www/

 

Cherryland, Very Strange

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I looked at the Cherryland decision yesterday. Law360 ran a story (behind a paywall) about it today, quoting me and others.  To recap, the original Cherryland case appeared to unexpectedly open up many commercial borrowers in Michigan to personal liability. The most recent Cherryland opinion reversed this result as a result of Michigan’s newly passed Nonrecourse Mortgage Loan Act.

The story reads in part:

Cherryland and Schostak reaped the benefits of the NMLA. But many CMBS loan documents are similarly written, and other borrowers and guarantors “may not have the saving grace of a politically connected developer getting a law passed very rapidly,” said Brooklyn Law School professor David Reiss.

“If I was an existing borrower [or borrower’s counsel], I would look at this very carefully,” Reiss told Law360. “And new borrowers should try to negotiate new language that protects for this, saying that becoming insolvent is not something that is going to trigger the bad boy guarantee.”

After the initial decision was handed down last year, attorneys say they and their colleagues all took a hard look at the language in their clients’ nonrecourse loan documents to be sure that if they found themselves in a similar situation they would be protected without the cover of a law like Michigan’s NMLA or Ohio’s Legacy Trust Act, which followed shortly thereafter.

In fact, experts say they don’t believe many other states will likely follow suit with their own guarantor-protecting statutes. So even though Wells Fargo lost out in the Cherryland row, lenders will likely keep the case in mind when considering deals.

Although “most people believe that the [pre-NMLA] decision in Cherryland was not what was intended by virtue of the documents,” said Schulte Roth & Zabel LLP real estate partner Jeff Lenobel, the solvency covenant was drafted in a way that allowed it to be read as a bad boy trigger.

This has led many who represent borrowers and guarantors to seek more due diligence and spend more time making sure loan language is just right.

More than $1 trillion in CMBS loans are coming due over the next several years, and Lenobel said he wouldn’t be surprised to see the issue come up again in a different court.

While the Cherryland case is all but over, another similar suit — Gratiot Avenue Holdings LLC v. Chesterfield Development Co. LLC — is making its way through Michigan’s federal courts. And attorneys aren’t ruling out the possibility of an appeal to the U.S. Supreme Court to ultimately determine the responsibilities of a guarantor in a nonrecourse loan.

“It may be a very smart move by the lending industry to appeal to the Supreme Court,” Reiss said.

Cherry Bombs in Michigan

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An ongoing Michigan state case, Wells Fargo Bank, N.A. v. Cherryland Mall L.P. et al.,  has been generating a lot of heat over an obscure but important issue for commercial mortgage borrowers, the scope of carveouts from standard nonrecourse provisions in loan documents.  And now the most recent opinion issued in the case raises important constitutional issues as well.

This case (as well as the similar Chesterfield case (a federal court case also in Michigan)) took many in the real estate industry by surprise by reading language in the loan documents at issue in those cases so as to gut their nonrecourse provisions.  Michigan (as well as neighboring Ohio) quickly passed legislation to return the nonrecourse language to how it was commonly understood.

The Michigan courts’ interpretations of the language in the loan documents was inconsistent with how such provisions were typically understood in the industry.  While the new statutes returned things to how they were commonly understood to be before the cases were decided, they did so in a way that raises more fundamental issues.  Most importantly, such statutes potentially violate the Contracts Clause of the United States Constitution which bars the “impairing” of “the Obligation of Contracts.”

The most recent Cherryland opinion upheld the constitutionality of the new Michigan statute and rightly notes that the Contracts Clause is not read literally. This has been true at least since the Depression era U.S. Supreme Court case of Home Building & Loan Association v. Blaisdell did not invalidate Minnesota’s mortgage moratorium.  The U.S. Supreme Court had thereby given states some leeway pursuant to their police power to remedy social and economic problems, notwithstanding the text of the Contracts Clause.   The situation in the Cherryland case is less sympathetic than that in Depression-era Blaisdell, where many, many homeowners were being foreclosed upon.  The Cherryland borrower, in contrast, is a politically-connected real estate developer. But the point remains that the Contracts Clause is not an absolute bar to legislative revision of privately negotiated contracts.  How politically connected, you might ask.  The court indicates that

defendant [David] Schostak is co-chief executive officer of defendant Schostak Brothers & Company, Inc., and that Robert Schostak is co-chairman and co-chief executive officer.  . . . Robert Schostak is “a high ranking Republican Party leader in Michigan, with many years of involvement in assisting the party’s candidates to gain election in the legislature.” We note that Robert Schostak has been chairman of the Michigan Republican Party since January 2011, was finance chairman through the 2010 election cycle, and had served on campaign fundraising teams for prominent Republicans. (8, note 3)

The borrowers here are as well positioned to get helpful legislation passed as anyone. There is much to chew over here, not the least of which is the Court’s finding that the statute was not “intended to benefit special interests.” (8)

There are also important practical aspects to the case. For instance, it is quite possible that courts in other jurisdictions will read the typical CMBS nonrecourse language similarly to how the Michigan courts read it.  Lenders will want to take a look at their loan documents to determine whether they mean what they say and say what they mean. And borrowers should read the language in their loan documents carefully before signing on the dotted line. They have been warned.

Robo-Signing Complaints Must Sing A Different Toone

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The Court of Appeals for the 10th Circuit took a hard look at a complaint alleging robo-signing misbehavior relating to a promissory note and its various endorsements in Toone v. Wells Fargo Bank, N.A. et al., (Mar. 8, 2013, No. 11-4188).  The court noted that

Ordinarily, we accept the well-pleaded factual allegations of the complaint as true for purposes of resolving a motion under Rule 12(b)(6). But there are exceptions to this rule. Courts are permitted to review “documents referred to in the complaint if the documents are central to the plaintiff’s claim and the parties do not dispute the documents’ authenticity.” The Note falls squarely within this exception: We may consider it in evaluating the plausibility of the Toones’ claims because it is mentioned in the complaint, it is central to their claims, and its authenticity is not disputed. (7, citations omitted)

The Court found that

The face of the Note contradicts the Toones’ allegations. The first endorsement states that Accubanc is Premier’s “agent and attorney in fact,” Aplt. App., Vol. II at 209 (capitalization omitted), and the Toones present no argument why the endorsement would be invalid when signed by Premier’s agent. Likewise, the other endorsements look regular on their face. Of course, the endorsements may be forged or otherwise fraudulent. But the complaint alleges no facts from which one could infer such misconduct. It does not explain what “robo-signing” is or why it renders the endorsements fraudulent, let alone include factual content indicating that it occurred in this case.(8)

The 10th Circuit now joins many other courts in finding that “bald allegations of “robo-signing” do not suffice under the Rule 8(a)(2) standard set by Iqbal.” (8)

Judiciary’s Take on the Subprime Zeitgeist

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The 2nd Circuit’s opinion in FHFA v. UBS Americas Inc. et al. (April 5, 2013, No. 12-3207-cv) offers an interesting window into how at least some members of the judiciary understand the Subprime Crisis. On its face, the case was about some technical issues of procedure — whether the case was untimely and whether the FHFA lacked standing.  The Court’s reasoning, however, delved into some deep issues.

In discussing the timeliness issue, the Court concluded that given the statute’s plain language and the particular provision as a whole, “a reasonable reader could only understand” it to resolve the issue in favor of the FHFA. (17) Then, seemingly gratuitously, the Court delved into the legislative history of the statute.  But this legislative history seemed to be drawn as much from the Court’s understanding of recent events as from the record.  It wrote

Congress obviously realized that it would take time for this new agency to mobilize and to consider whether it wished to bring any claims and, if so, where and how to do so. Congress enacted HERA’s extender statute to give FHFA the time to investigate and develop potential claims on behalf of the GSEs — and thus it provided for a period of at least three years from the commencement of a conservatorship to bring suit.

Of course, the collapse of the mortgage-backed securities market was a major cause of the GSEs’ financial predicament, and it must have been evident to Congress when it was enacting HERA that FHFA would have to consider potential claims under the federal securities and state Blue Sky laws. It would have made no sense for Congress to have carved out securities claims from the ambit of the extender statute, as doing so would have undermined Congress’s intent to restore Fannie Mae and Freddie Mac to financial stability. (17-18)

I agree with the Court on the substance, but I found it interesting that certain things about the legislative history were “obvious,” certain facts “must have been evident” and alternative interpretations would make “no sense.”  I am not sure if I could go that far.

This version of legislative history does, however, reflect a view that Congress intended the Executive Branch to take extraordinary measures to hold financial institutions accountable for their role in the financial crisis.

Are Baby Steps Enough for Fannie and Freddie?

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S&P issued a research report, The Implementation Of The FHFA’s Plan For Fannie Mae And Freddie Mac Still Has A Long Way To Go. The report addresses a number of recent events that will impact any reform program for the two Government-Sponsored Enterprises.  S&P strike an optimistic note in the opening lines:  “The U.S. government continues to gradually make progress on the reform of the” two Enterprises.” (1)  It is unclear to me that we are actually making any progress at all. S&P seem to acknowledge as much a few paragraphs later: “Fannie and Freddie are perhaps more entrenched in the housing market today than ever before. Including Ginnie Mae, the government-related housing entities have combined to purchase or guarantee more than 90% of mortgages underwritten in the U.S. since the housing crisis, up from about 50% before the crisis.” (1)

S&P notes that Fannie and Freddie’s financial health is improving as they “are now generating earnings, which reduces the urgency to try to minimize taxpayer costs.” (1)  Their underlying loans are also performing much better:  “At Freddie, loans originated after 2008 account for 63% of its single-family guarantee portfolio and have a seriously delinquent rate of 0.39%, versus 9.56% for loans originated from 2005–2008. At Fannie, loans originated after 2008 account for 66% of its single-family guarantee portfolio and have a seriously delinquent rate of 0.35%, versus 9.92% for loans originated from 2005–2008.” (2)

S&P takes heart that change is afoot because of “the new key aspect of the FHFA’s plan to build a secondary market infrastructure is the proposed creation of a joint venture (JV) between Fannie and Freddie. This JV would have a CEO and chairman that are independent from Fannie and Freddie, and its physical location would also be separate. The GSEs would initially own, operate, and fund this unit, but the JV also would be able to eventually act as a common securitization platform for the entire market, instead of a proprietary platform. Furthermore, the ownership structure would be one that is easily sold or that policymakers can use in housing finance reform once Fannie and Freddie have less of a role in the market.” (2-3)

S&P characterizes the federal government’s approach as “taking baby steps.” (4) I would characterize it as just so much muddling about.

Be Careful What You Contract For . . .

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Justice Ramos of the Commercial Division of the New York State Supreme Court NY County) issued an opinion in Assured Guar. Corp. v. EMC Mtge., LLC, 2013 NY Slip Op. 50519(U) (April 4, 2013).  Assured, a monoline insurer, “alleges that Bear Stearns grossly misrepresented the risk of the underlying pooled loans” that Bear Stearns had used as collateral in RMBS deals that it had underwritten. (1) Assured alleged that loan warranties in nearly 90 percent of the loans in one of the pools at issue had been breached.  The court noted that more than half of the loans in that pool had either “defaulted or are seriously delinquent.” (2) Bear Stearns’ successor-in-interest refused to repurchase the breaching loans.

The Court found that the deal documents make “clear that the parties intended to limit Assured’s remedies for breach of the representations and warranties relating to the quality and characteristics of the pooled loans to the Repurchase Protocol . . .” and the Court indeed so limited Assured’s remedies. (4) Justice Ramos relied on the opinion by Judge Rakoff (SDNY) in Assured Guar. Mun. v. Flagstar Bank, that reached a similar result.

One wonders how monoline insurers will seek to change deal documents going forward.  Will they be so willing to treat representations and warranties as mere risk allocation devices between the parties?  As risk allocation devices, the reps and warranties typically make only limited remedies available.  Or will they demand that they be treated as something more — perhaps as actual representations and warranties about the underlying transaction and upon whose shoulders broader remedies could be hung?