Friday, October 5, 2012

FYI: 1st Cir Reverses Dismissals in Two Putative Class Actions Alleging Unauthorized Charges or Demands for Increased Flood Insurance Coverage

The U.S. Court of Appeals for the First Circuit recently considered two putative class-action lawsuits involving alleged unauthorized charges or demands for increased flood insurance coverage. 
 
Although the terms of the mortgages in the two cases differed appreciably -- one explicitly gave the lender discretion to determine the amount of flood insurance, while the other did not contain an explicit grant of discretion -- the First Circuit reached the same conclusion as to both actions, holding that the lower courts' dismissals must be vacated due to ambiguity "as to the lender's authority to increase the coverage requirement" for flood insurance. 
 
We refer to the former matter as the "Lass litigation," and the latter as the "Kolbe litigation," after the names of the respective plaintiffs.  Copies of the opinions are available at: 
 
 
and
 
 
A bank sent letters to borrowers Lass and Kolbe, requiring them to obtain additional flood insurance on their homes.  Both letters provided that if the borrowers did not do so voluntarily, the bank would obtain insurance on their behalf and charge them accordingly. 
 
Lass' mortgage provided that the amount of flood insurance was to be determined by the lender.  In addition, Lass received a document at the time of her closing that notified her of the amount of flood insurance she was to obtain, and further provided that "[t]his insurance will be mandatory until the loan is paid in full" (the "notification").  
 
Kolbe's mortgage included a paragraph titled "Fire, Flood and Other Hazard Insurance," which provides as follows:  "Borrower shall insure all improvements on the Property...against any hazards, casualties and contingencies, including fire, for which Lender requires insurance.  This insurance shall be maintained the amounts and for the periods that Lender requires.  Borrower shall also insure all improvements on the property...against loss by floods to the extent required by the Secretary [of HUD]." 
 
Kolbe bought the insurance that the bank required.  Lass did not, and the bank purchased additional flood insurance on her behalf.  The insurance certificate was supposedly "backdated" to provide coverage for two months' prior to the purchase.  The bank allegedly purchased Lass' insurance through an affiliated company. 
 
Both borrowers filed putative class actions.  Lass argued that the bank had improperly forced her to purchase excessive amounts of flood insurance, and had improperly profited through supposed "kickbacks, commissions or 'other compensation'" paid in connection with the same. Kolbe brought a breach of contract claim, arguing that his mortgage did not give the bank authority to demand increased flood insurance coverage. 
 
In both instances, the bank moved to dismiss the complaint, which the lower courts granted.  Both Lass and Kolbe appealed. 
 
On appeal, Kolbe raised two arguments: first, that the general hazard insurance provision and the provision regarding flood insurance in his mortgage are mutually exclusive; and second, in the alternative, that his preferred construction was one of two reasonable constructions of the mortgage.  Thus, Kolbe argued that the provision affording the lender with discretion to determine the amount of insurance required did not apply to flood insurance, such that the lender could only require that Kolbe obtain insurance to the extent required by the HUD Secretary. 
 
The First Circuit began by scrutinizing the terms of the mortgage.  It noted that the relevant paragraph "is structured to address two different categories of insurance, with the first and third sentences containing identical introductory language..."  This structure, according to the First Circuit, "arguably denotes two parallel statements of coverage..."  The Court also emphasized that the title of the paragraph specifically mentions "fire" and "flood" insurance in its title, which "further supports the view that the flood coverage was handled by the separate, linguistically parallel third sentence." 
 
The bank argued that the contract should be interpreted such that the "extent required by the Secretary" clause imposes only a floor, but not a ceiling, on the discretion afforded to the lender.  The First Circuit disagreed, noting that had that been the intention of the drafter of the contract, it "arguably" would have been framed as such.  Instead, the sentence as drafted "is not framed as a qualification on the previous sentence, but as an independent, further requirement." 
 
The bank further argued that the "any hazards, casualties and contingencies" language in the contract must be read to include flood insurance, under any reasonable understanding of those terms.  The First Circuit acknowledged that this argument had some force, but opined that the borrower's construction of the same terms was also reasonable.  Therefore, having found the mortgage to be ambiguous, the First Circuit considered the relevant extrinsic evidence to determine the meaning of the provision in question. 
 
The First Circuit found that the relevant extrinsic evidence bolstered Kolbe's position.  Specifically, the Court observed that HUD's handbook for the administration of mortgages "treats hazard insurance and flood insurance separately."  Further, the Court found that HUD's treatment of flood insurance indicated Congress' finding that floods "were not customarily among the hazards protected by standard homeowners' insurance policies."  Because HUD documents show that the agency "routinely treats hazard and flood insurance separately," the First Circuit concluded that "a rational jury could construe [the relevant provision of the mortgage] in favor of either Kolbe or the Bank." 
 
The First Circuit also considered Kolbe's allegation that the bank violated the covenant of good faith and fair dealing.  The Court observed that requiring additional insurance company, without more, would fall short of constituting bad faith.  Under the facts at issue here, however, the First Circuit held that the bank's behavior could constitute bad faith if it could be shown that the bank required Kolbe to obtain additional insurance in order that it could profit financially. 
 
Accordingly, the First Circuit reversed the judgment of the lower court in the Kolbe case, and remanded the matter for further proceedings. 
 
The facts alleged in the Lass litigation differed from those alleged in the Kolbe litigation in that Lass' mortgage explicitly gave the mortgage lender discretion to determine the required amount of flood insurance, and in that the bank obtained lender-placed flood insurance on Lass' property.  Nevertheless, the First Circuit reached similar conclusions in both matters. 
 
On appeal, Lass challenged the lower court's dismissal of her claims for breach of contract, breach of the implied covenant of good faith and fair dealing, unjust enrichment, and breach of fiduciary duty.  She argued that regardless of whether the mortgage gave the lender discretion to determine the amount of flood insurance, the notification created an ambiguity as to whether the bank could require more flood insurance than the notification provided for. 
 
The First Circuit began by considering Lass' breach of contract claim.  Lass emphasized the notification's provision that the flood insurance required at the time of the closing "will be mandatory until the loan is paid in full."  She contended that the notification indicated that the amount of flood insurance would be fixed for the duration of the loan.  The bank countered that the notification merely established a minimum amount of insurance, and did not include any language indicating that the bank would never increase the insurance obligation. 
 
As it did in the Kolbe litigation, the First Circuit held that the language in the mortgage and notification was ambiguous.  It reached that conclusion by first rejecting the bank's contention that the notification should not be considered part of the contract, because it did not bind both parties and required only Lass' signature.  The Court's view was that "the Notification was an essential part of the transaction because it represented the exercise" of the discretion afforded to the lender by the mortgage. 
 
Next, the First Circuit found that the mortgage and notification, taken together, could be read in two ways.  First, the notification could be construed to provide that the specified amount of flood insurance obtained by the borrower was "the amount of insurance Lass was to maintain until she paid off her loan."  The First Circuit also found the reading urged by the bank to be plausible, finding that the notification could be read to "highlight the duty under federal law to maintain an amount of insurance linked to the principal balance of the loan..." 
 
With that determination in place, the First Circuit determined that the lower court erred in rejecting Lass' construction of those agreements as unreasonable. 
 
The First Circuit continued to consider Lass' good faith and fair dealing claim.  The Court held that the Lass' claims that (1) the bank demanded insurance coverage greater than it was permitted to under the mortgage and related documents; (2) and that the bank improperly backdated the insurance coverage it obtained on Lass' behalf; and (3) alleged self-dealing related to the bank's payment of commission to a related entity, if proved, were sufficient to state a claim.
 
Lass' claim of unjust enrichment proceeded along similar lines to her good faith and fair dealing allegations.  The bank countered these allegations by arguing out that claims for breach of contract and unjust enrichment are mutually exclusive, and that an unjust enrichment claim was inappropriate where, as here, the parties' expectations are governed by a contract.  The First Circuit acknowledged that the bank's argument had some force, but nevertheless rejected it on the grounds that the lower court "will be in a better position once the record is more developed to determine whether the unjust enrichment claim should survive." 
 
Finally, the First Circuit considered Lass' claims that the bank breached its fiduciary duty to her.  Using similar reasoning as described above, the First Circuit again determined that the lower court improperly dismissed this claim. 
 
Accordingly, the First Circuit again reversed the judgment of the lower court in the Lass case, and remanded the matter for further proceedings.  
 


Ralph T. Wutscher
McGinnis Wutscher LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct: (312) 551-9320
Fax: (312) 284-4751
Mobile: (312) 493-0874
Email:
RWutscher@mtwllp.com
 

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Thursday, October 4, 2012

FYI: Ill App Ct Thwarts Mortgagee's Effort to Undo Foreclosure as to Worthless Property

The Illinois Appellate Court, First District, recently rejected a lender's motion to vacate a foreclosure sale, which asserted that newly discovered evidence rendered its interest in the subject property worthless, and in so doing held that the lender's claim of newly discovered evidence did not constitute a "meritorious defense" under the relevant Illinois statute. 
 
 
A lender instituted foreclosure proceedings against a borrower.  The subject property was located in a cooperative building.  The owner of the cooperative building ("building corporation") filed an answer, asserting that its interest in assessments and fees had priority over the lender's interest. 
 
The lender filed a motion for default against the borrower, and a motion for summary judgment against the building corporation.  The lower court granted both motions, and entered the judgment of foreclosure and order of sale.  The judgment of foreclosure provided that the lender's mortgage was superior to all other liens, rights or claims on the subject property.  The lender then purchased the property at the foreclosure sale. 
 
The building cooperation filed a forcible entry and detainer action concerning the subject property, apparently without knowledge of the judgment of foreclosure.  When the lender brought that action to its attention, the building cooperation filed a motion to vacate the judgment of foreclosure.  The lower court granted the motion to vacate in part, and amended the judgment of foreclosure to indicate that the building cooperation's interest was superior to the lender's interest.
 
The lender then filed a motion to vacate the judicial sale and judgment of foreclosure entirely, pursuant to 735 ILCS 5/2-1401 ("Sec. 2-1401").  The lender stated that it had been unaware that the cooperative apartment was to be converted into a condominium, and also unaware of the amount of the past-due assessments.  According to lender, those costs rendered its interest worthless.  The lower court denied the motion to vacate, and the lender appealed. 
 
As you may recall, Sec. 2-1401 allows a party to obtain relief from a final judgment.  To be entitled to that relief, a petitioner must establish, among other things, "the existence of a meritorious defense or claim."  Smith v. Airoom, Inc., 114 Ill. 2d 209, 220-21 (1986). 
 
On appeal, the lender first argued that it was not required to comply with the "meritorious defense or claim" requirement, because the judgment it sought to vacate was in its favor.  The Court scrutinized the statutory language, as well as relevant case law, and found no support for the lender's position.  Accordingly, the Court stated that "we find no basis to create an exception to section 2-1401..." 
 
The lender also argued that newly discovered evidence -- specifically, the amount of unpaid assessments, and costs relating to the conversion of the building to condominiums -- constituted a meritorious defense or claim.  The building corporation disputed that the evidence was in fact newly discovered.  It referenced a recognition agreement executed by the lender which gave the building corporation priority over the lender as to "sums due under the by-laws and the lease."  The building corporation also referenced the fact that in its answer, it referenced the past-due amounts of the assessments and other charges.  Finally, the building corporation produced an email from it to the lender's counsel, wherein the conversion plan was referenced. 
 
The Court began by reciting that a petitioner establishes a "meritorious defense" for the purposes of Sec. 2-1401 where he alleges facts that would have prevented entry of the judgment, had those facts been known by the trial court. 
 
With that standard in place, the Court held that the lender "has failed to establish a meritorious defense or claim."  In so ruling, the Court agreed with the building corporation that the lender had notice of the assessments and other costs, in light of the recognition agreement and the allegations in the building cooperation's answer. 
 
The Court also found the lender's claims regarding the conversion process unpersuasive.  The Court observed that the lender's claimed "meritorious defense" consisted of the fact that the lender would not have proceeded with the sale had it known that the building was to be converted to condominiums.  However, the Court emphasized that this claim did not "establish that the trial court would not have entered the order confirming sale had the conversion information been presented..." 
 
The lender also argued that the building corporation had an affirmative duty to disclose the ongoing conversion project.  The Court again disagreed, noting that the building corporation's claims that it had in fact notified the lender of the project was part of the record, and accordingly concluded that the trial court had "reviewed and considered its contents".  Further, the Court noted that the lender did not reference case law supporting its position. 
 
Because "[t]he record is devoid of evidence indicating that [the lender] exercised due diligence before participating in the foreclosure sale," and is "also devoid of evidence demonstrating that [the building corporation] purposely concealed and withheld information," the Court concluded that "no change in circumstances occurred that warrants the granting of [the lender's] section 2-1401 petition."   
 

Ralph T. Wutscher
McGinnis Wutscher LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct: (312) 551-9320
Fax: (312) 284-4751
Mobile: (312) 493-0874
Email:
RWutscher@mtwllp.com
 

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FYI: 7th Cir Limits Title Policy Exclusion for Losses "Created or Suffered" by Insured

The U.S. Court of Appeals for the Seventh Circuit recently held that a title insurer breached its duty to defend a mortgageedespite the title insurer's attempt to apply the exclusion for claims "created, suffered, assumed or agreed to" by the lender, ruling that the exclusion only applies to losses caused by "the insured's own intentional misconduct, breach of duty, or otherwise inequitable dealings."   A copy of the opinion is attached.
 
A property developer obtained a construction loan commitment from plaintiff bank ("Bank") for over $95 million, to be disbursed in installments, in order to finance the construction of an ethanol production plant in Indiana.  To secure its loan, Bank took a mortgage on the property and protected its mortgage against conflicting claims and liens with title insurance purchased from Defendant title insurance company ("Insurer").  
 
Pursuant to the title insurance policy, Insurer was required to conduct a title search "[a]t the time of each disbursement of the proceeds of the loan . . . for possible liens" filed up to "the date of such disbursement," thus protecting Bank against any mechanic's liens that might be filed against the property.  As construction proceeded, Bank would disburse loan funds to the developer, obtain lien waivers from the contractors paid with the funds, and provide those waivers to Insurer as part of its process of updating the policy after each title search.
 
The policy required Insurer to defend Bank in litigation against liens and other risks, and insured Bank to the extent of amounts already disbursed to the developer, up to the amount of the total loan commitment.   Importantly, however, the policy also contained an exclusion from coverage for claims "created suffered, assumed, or agreed to" by Bank. 
 
As additional protection against mechanic's liens, Bank purchased a mechanic's lien endorsement ("Endorsement") to the policy to insure against "enforcement or attempted enforcement" of mechanic's liens "having priority over or sharing on a parity with" Bank's mortgage and arising from construction work on the ethanol plant before or after the effective date of the title policy.
 
The property developer eventually defaulted on the loan, Bank thereafter withheld disbursement of the final installment of the loan, and the developer's general contractor filed a mechanic's lien on the property.  Bank subsequently filed a lawsuit against the property developer in Indiana state court to foreclose on the ethanol plant property.   Also named as a defendant was the general contractor, which counterclaimed against Bank and cross-claimed against the developer, asserting in part that its $6 million mechanic's lien claim was superior to Bank's mortgage.     
 
Bank tendered the defense of the mechanic's lien claim to Insurer.  Insurer acknowledged in a letter to Bank that the mechanic's lien claim was an attempt to obtain a judgment determining that its lien was prior to and superior to Bank's mortgage.  Nevertheless, Insurer refused to defend and indemnify Bank.  Bank eventually settled with the general contractor on the counterclaim without any contribution from Insurer.
 
Subsequently filing suit against Insurer in federal district court, Bank alleged that Insurer acted in bad faith and breached its duty to defend against the counterclaim and to indemnify Bank for its settlement with the general contractor. 
 
Both parties filed cross-motions for summary judgment.  The district court granted summary judgment for Insurer based on the policy exclusion for claims "created suffered, assumed, or agreed to," reasoning that Bank had withheld loan funds that could have satisfied the mechanic's lien.  The Seventh Circuit reversed and remanded.
 
Addressing Insurer's various assertions as to why it had no duty to defend against the counterclaim, including the contention that the counterclaim did not trigger that duty because the counterclaim was not an "attempted enforcement" of a statutory lien seeking priority over or parity with Bank's mortgage, the Seventh Circuit examined the Endorsement and the policy exclusion for liens "created, suffered, assumed or agreed to" by Bank.  
 
In so doing, the Seventh Circuit noted among other things that the Endorsement expressly required Insurer to defend and indemnify against the enforcement or attempted enforcement of any claims asserting priority over or parity with the mortgage.  In addition, as the Court further noted, although the policy limited the amount of any recovery to the amount actually disbursed, the Endorsement specified that Insurer would cover and thus defend against any construction-related claims arising before or after the effective date of the policy. 
 
The Court also rejected Insurer's other arguments, including that it had no duty to defend because the contractor's lien could not legally be equal or superior to the mortgage, because applicable Indiana law gives priority to commercial construction mortgages over all later-recorded liens.  See Ind. Code § 32-28-3-5(d).   Pointing out that the insurance policy required defense of all claims attempting to enforce a lien as having priority over or parity with the mortgage, the Court ruled that Insurer had a contractual duty to defend irrespective of the merits of such claims.  
 
Moreover, the Seventh Circuit rejected Insurer's arguments that Bank improperly withheld the final disbursement of loan funds to the property developer, and thereby essentially caused the mechanic's lien claim, and that Bank was merely seeking an inequitable windfall.  Noting that there was no disbursement agreement in this case to disburse funds after the developer's default, and that the Endorsement covered claims filed after the effective date of the policy, the Court ultimately concluded that Bank owed no duty to Insurer to continue funding the loan after default and that the overwhelming weight of authority limited the applicability of the "created suffered, assumed, or agreed to" policy exclusion to losses caused by "the insured's own intentional misconduct, breach of duty, or otherwise inequitable dealings."  
 
Citing a lack of evidence that Bank had engaged in intentional misconduct and the absence of a disbursement agreement, the Seventh Circuit ruled that Insurer breached its duty to defend and was estopped from denying liability for the settlement of the counterclaim.
 
Accordingly, the Seventh Circuit reversed and remanded with instructions to enter summary judgment in favor of Bank.
 


Ralph T. Wutscher
McGinnis Wutscher LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct: (312) 551-9320
Fax: (312) 284-4751
Mobile: (312) 493-0874
Email:
RWutscher@mtwllp.com
 

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Monday, October 1, 2012

FYI: Ill App Ct Rules Mortgagee Lacked Standing, Affidavit Inadmissible, TILA Disclosure that Loan "May" Have Discount Feature Not Apparent on Face of Loan Documents

The Illinois Appellate Court, Second District, recently held that an asset securitization trustee lacked standing to foreclose on a borrower's property, where the assignment of the mortgage contradicted the trustee's assertion that it owned the debt at the time it filed the foreclosure action and the affidavit it submitted to show standing lacked a proper foundation.  
 
The Court also ruled that the trustee was not liable as an assignee for the original lender's alleged violation of the federal Truth in Lending Act, involving an allegedly improper origination disclosure that the loan "may" have a discount feature, where such violation was not apparent on the face of the loan documents and required outside examination of historical LIBOR rates.
 
 
Defendant borrower ("Borrower") obtained a home mortgage loan from a lender ("Lender") that was secured by a mortgage to Mortgage Electronic Registration Systems, Inc. ("MERS"), as nominee for Lender.  Although the loan was a variable rate loan based on the London Inter-Bank Offered Rate ("LIBOR"), the promissory note specifically provided for a fixed initial interest rate for the first two years of the loan.  At the time of closing, Lender provided Borrower with copies of the note, mortgage, and a disclosure document informing Borrower that "This [Adjustable Rate Mortgage] loan may have a discount feature, and your initial interest rate may not be based on the index used to make later adjustments." 
 
Borrower eventually defaulted on the mortgage loan and Plaintiff, the trustee of a pool of mortgage-backed securities ("Trustee"), filed a foreclosure action against Borrower.  In its complaint, Trustee alleged that it was the current holder of the debt.  Trustee attached copies of the note and mortgage to its complaint.
 
Several months after the filing of the foreclosure complaint, MERS executed an "Assignment of Mortgage" ("Assignment"), transferring its interest in Borrower's mortgage to Trustee.  Trustee then filed an amended complaint, attaching the Assignment as an exhibit. 
 
In his answer, Borrower raised the affirmative defense that Trustee lacked standing to foreclose because the Assignment showed that Trustee did not own the debt when it originally filed the foreclosure action.  Borrower also counterclaimed, alleging that Lender's disclosures at the time of the loan closing violated the federal Truth in Lending Act, 15 U.S.C. § 1601 et. seq. ("TILA") by stating only that the initial interest rate "may" be discounted, even though Lender knew for certain that the rate was discounted.  Borrower claimed that Trustee was liable as an assignee for Lender's alleged TILA violations.
 
Both parties moved for summary judgment. 
 
In response to Borrower's standing argument and counterclaim, Trustee contended that it had standing at the time it filed suit, as the Assignment simply memorialized an earlier transfer of the mortgage from MERS.  To support its assertion, Trustee submitted an affidavit from an employee of Trustee's loan servicer stating that according to his review of Borrower's loan file, MERS had assigned its interest to Trustee almost three years earlier. Trustee did not include any documentation showing that MERS had in fact assigned the mortgage to Trustee on that prior date.    Trustee also argued the requirements for assignee liability had not been met.
 
The lower court dismissed the foreclosure action, finding that Trustee was not the holder of the loan at the time it filed the law suit.   That court also denied both parties' motions for summary judgment on the counterclaim, because there were issues of fact as to the alleged TILA violations and assignee liability.
 
Trustee moved for reconsideration -- which the court granted -- and argued that the Assignment "clearly stated" that MERS had assigned its interest to it three years before Trustee filed the foreclosure action, that the counterclaim was time-barred, and that Trustee was not subject to assignee liability because the alleged TILA violations were not apparent on the face of the loan documents.
 
Upon reconsideration, the trial court reversed its prior ruling and granted summary judgment for Trustee on all claims.  The lower court ruled that the counterclaim was time-barred and that there was no assignee liability for the alleged TILA violations because the violations were not clear on the face of the loan documents.    The court entered a foreclosure judgment, and Borrower's property was sold to Trustee at the ensuing foreclosure sale.    Borrower appealed. 
 
The Appellate Court reversed the foreclosure judgment, dismissed the foreclosure action for lack of standing, but affirmed the dismissal of the counterclaim.
 
Observing in part that the note and mortgage attached to the complaint identified MERS as the holder of the mortgage, that Trustee's name did not appear on these documents, and that the Assignment attached to the amended complaint was dated after the initial filing of the foreclosure action, the Appellate Court ruled that Borrower had made a prima facie showing that Trustee lacked standing when it filed the lawsuit. 
 
Significantly, the Appellate Court also ruled that the Assignment and affidavit that Trustee submitted to rebut Borrower's assertions lacked evidentiary value.  In so ruling, the court noted, first, that Trustee had abandoned its argument that the Assignment itself clearly showed that the transfer of the mortgage occurred three years previously and, second, that the Assignment failed to state explicitly when the mortgage was assigned to Trustee.        
 
As to the affidavit, the Court ruled it was not admissible into evidence, because it was unsupported by a statement as to how the affiant knew when the assignment to Trustee occurred and there were no documents supporting his assertion attached to the affidavit.  See Ill. Sup. Ct. R. 191(a)(affidavits in support of motions for summary judgment must set out the facts on which the affiant's claims are based, and all documents relied on by the affiant must be attached).
 
Rejecting Trustee's assertions that Borrower failed to meet his burden and that its complaint established its standing, the court ruled in part that the copies of the note and mortgage attached to the complaint actually contradicted Trustee's allegations that it owned the loan when it filed the foreclosure action.  See Triple R Development, LLC v. Golfview Apartments I, L.P., 2012 IL App (4th) 100956, ¶ 12 (party may not rely on allegations in its pleadings to contradict evidence produced by the movant that would entitle it to judgment); Burton v. Airborne Express,  Inc., 367 Ill. App. 3d 1026, 1034 (2006)(facts in an exhibit serve to negate inconsistent allegations contained in the body of the complaint).  Cf. Mortgage Electronic Registration Systems, Inc. v. Barnes, 406 Ill. App. 3d 1, 6 (2010)(plaintiff sufficiently pleads a cause of action for foreclosure if it alleges that it holds the mortgage and attaches a copy of the note and mortgage).
 
The Appellate Court thus ruled that Trustee lacked standing at the time of filing and accordingly reversed the foreclosure judgment, vacated the order approving the sale of Borrower's property, and dismissed the foreclosure.
 
Turning to the counterclaim, the appellate court ruled that Trustee was not liable as an assignee of the loan for Lender's allegedly improper disclosure that the loan "may" have a discount feature.  In reaching this conclusion, the Court noted that an assignee may be liable for defects in disclosures required by TILA only if the TILA violation "is apparent on the face of the disclosure statement."  15 U.S.C. § 1641(e)(1)(A).  As the Court pointed out, a TILA violation was not apparent on the face of the note and the various disclosures given to Borrower, because a determination that the loan was subject to a discounted interest rate required outside knowledge of LIBOR rates that the loan documents did not provide.   
 
Accordingly, the Appellate Court affirmed the grant of summary judgment in favor of Trustee on the counterclaim.
 


Ralph T. Wutscher
McGinnis Wutscher LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct: (312) 551-9320
Fax: (312) 284-4751
Mobile: (312) 493-0874
Email:
RWutscher@mtwllp.com
 

NOTICE: We do not send unsolicited emails. If you received this email in error, or if you wish to be removed from our update distribution list, please simply reply to this email and state your intention. Thank you.


Our updates are available on the internet, in searchable format, at:
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FYI: Cal App Ct Rules Constructive Notice Does Not Preclude Equitable Subrogation

The California Court of Appeal, Fourth District, recently applied equitable subrogation to allow one bank's deed of trust to take priority over a trust deed previously recorded by another lender, thus placing the two lenders in the same priority positions they had anticipated and intended at the time they made their respective loans to the borrowers.
 
A copy of the opinion is available at:  http://www.courts.ca.gov/opinions/documents/G045943.PDF.
 
Borrowers owned a residence subject to first and second deeds of trust that secured loans totaling over $3 million.   Borrowers subsequently paid off the two loans with a refinancing loan from a bank ("First Bank"). 
 
Based on a preliminary title report showing the first and second deeds of trust, First Bank had expressly instructed its escrow company to disburse funds only to pay off the existing first and second deeds of trust, that the refinancing loan was to be secured by a new first deed of trust, and that any second mortgage on the property was to be subordinate to First Bank's deed of trust.  First Bank filed its first deed of trust the same day the loan funds were disbursed.  
 
Unbeknownst to First Bank, however, one of the Borrowers had earlier obtained a loan for over $2 million from another bank ("Second Bank") to fund a medical practice.  That loan was guaranteed by Borrowers and secured by the same property.   Aware that Borrowers' residence was already subject to the first and second trust deeds, Second Bank secured its loan against personal property of the medical practice and with a third deed of trust against Borrowers' residence.    Second Bank filed its deed of trust against the property roughly two months before First Bank closed on the refinancing loan.
 
The loan for the medical practice later went into default and Second Bank thus instituted judicial foreclosure proceedings against the residence.  First Bank filed a cross-complaint seeking an equitable lien on the property and declaratory relief, and moved for summary adjudication. 
 
The lower court granted First Bank's motion, establishing two equitable liens in favor of First Bank for the amounts paid toward the first and second deeds of trust.  Second Bank appealed.  The appellate court affirmed.
 
Noting among other things that First Bank anticipated that it would receive a first deed of trust on the property, that its escrow instructions expressly forbade disbursement of the loan proceeds if First Bank's deed of trust would not be in a primary position, and that Second Bank anticipated that its deed of trust would be in a junior position to the first and second deeds of trust, the Court of Appeal applied equitable subrogation as an exception to California's "first in time, first in right" system of lien priorities. See Cal. Civ. Code § 2897 ("Other things being equal, different liens upon the same property have priority according to the time of their creation . . . .").
 
In so doing, the Appellate Court applied the longstanding rule in California allowing equitable subrogation in situations involving competing liens where a lender advanced funds to pay off a prior lien with the understanding of all parties that the intent was for the lender to obtain a first lien on the property.  See Simon Newman Co. v. Fink, 206 Cal. 143, 146 (1928)("Simon")(setting forth the test for equitable subrogation, including requirements that parties intend for a lien holder to hold a superior position, that the lien holder not be "chargeable with culpable and inexcusable neglect," and that others not be prejudiced).
 
Also noting in part that the title report had been prepared prior to the recording of Second Bank's deed of trust, the Appellate Court ruled that First Bank was not "chargeable with culpable and inexcusable neglect" as it had no actual knowledge of Second Bank's deed of trust, breached no duty owed to Second Bank, and had not engaged in any misleading conduct. 
 
Ruling that constructive notice does not preclude application of equitable subrogation, the Court explained, "the failure to search the records does not itself preclude subrogation . . . . neither should reliance on a preliminary title report. . . .  By the same token, if the failure to make a records search does not reduce the lender's equity, neither should the lender's reliance on a preliminary title report that failed to reveal an intervening deed of trust."
 
Weighing the respective equities, the Appellate Court concluded that First Bank was entitled to equitable subrogation as a means to carry out the intentions of the parties.  In reaching this result, the Appellate Court observed that in paying off the existing first and second deeds of trust, First Bank expected a first deed of trust in return and expressly instructed that the loan funds were not to be disbursed unless First Bank had a first deed of trust on Borrowers' property.  In addition, the Appellate Court again pointed out that First Bank did not know of Second Bank's loan and deed of trust, and that Second Bank knew of the first and second deeds of trust and, as anticipated, received a third deed of trust for its loan to the medical practice. 
 
Rejecting Second Bank's argument that equitable subrogation in this case was prejudicial and punishing, the Appellate Court ruled that equitable subrogation provided Second Bank with exactly what it had bargained for:  a deed of trust third in priority and thus in the same position it would have held if Borrowers had not paid off their first and second deeds of trust with the refinancing loan.  
 
The Appellate Court also stated that the fact that First Bank may have a cause of action against the title insurance company for failing to conduct a subsequent records search closer to the date of the refinancing loan did not change the equities in this case. 
 
Accordingly, the Appellate Court affirmed the lower court's judgment.
 


Ralph T. Wutscher
McGinnis Wutscher LLP
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Chicago, Illinois 60602
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RWutscher@mtwllp.com
 

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