Saturday, March 11, 2017

FYI: Ill App Ct (2nd Dist) Holds FHA's "Face to Face" Meeting Not Required When Loan Discharged in Bankruptcy

The Appellate Court of Illinois, Second District, recently affirmed summary judgment in favor of a mortgagee that failed to meet the FHA requirement to either have a face-to-face meeting with the borrowers or to make "a reasonable effort" to arrange a face-to-face meeting before filing foreclosure, because doing so would have been a futile act after the borrowers' mortgage loan debt was discharged in bankruptcy and they did not reaffirm the debt.

 

A copy of the opinion is available at:  Link to Opinion

 

A mortgagee initiated a foreclosure action against borrowers based upon a mortgage loan between the parties.  The Federal Housing Administration, a division of the United States Department of Housing and Urban Development (HUD), insured the mortgage.

 

Before the foreclosure, the borrowers filed for Chapter 7 bankruptcy protection.  They did not reaffirm their mortgage. The bankruptcy court discharged the borrowers' debt to the mortgagee.

 

The parties in the foreclosure filed cross-motions for summary judgment.  The borrowers argued that the mortgagee violated HUD's pre-foreclosure requirements because (1) before the mortgagee filed its foreclosure complaint neither borrower received written information from the mortgagee about HUD's counseling programs or written information from the mortgagee about a request to meet face-to-face, and (2) the mortgagee made no effort to arrange such a meeting. 

 

The mortgagee claimed that it complied with HUD's pre-foreclosure requirements.

 

As you may recall, HUD's FHA regulations, specifically, title 24, section 203.604, of the Code of Federal Regulations (24 C.F.R. § 203.604 (2014)), among other things require a mortgagee, before filing a foreclosure action against a defaulting borrower, either to have a face-to-face meeting with the borrower or to make "a reasonable effort" to arrange a face-to-face meeting.

 

The trial court granted summary judgment in favor of the mortgagee and denied the borrowers' motion.  Thereafter, the property was sold at a judicial sale to the mortgagee and the trial court granted the mortgagee's motion for an order approving the sale of the property.

 

This appeal from the husband borrower followed.

 

First, the Appellate Court noted that the failure to comply with HUD's FHA mortgage servicing requirements contained in its regulations is a defense to a mortgage foreclosure action as to an FHA-insured mortgage loan.

 

Specifically, HUD's FHA rules require the mortgagee to conduct "a face-to-face interview with the mortgagor, or make a reasonable effort to arrange such a meeting, before three full monthly installments are unpaid." 24 C.F.R. § 203.604(b) (2014). A reasonable effort is defined as dispatching a minimum of one certified letter by the Postal Service to the mortgagor and making at least one trip to see the mortgagor at the mortgaged property. 24 C.F.R. § 203.604(d) (2014). 

 

The mortgagee did not meet face-to-face with the borrowers, so the issue for the Appellate Court was whether the mortgagee made a reasonable effort to arrange a face-to-face meeting as required by section 203.604(d). 

 

The Appellate Court took judicial notice that the United States Postal Service provides a proof of mailing form certificate.  Here, the mortgagee lacked a proof of mailing form certificate that it sent the required certified letter.  Thus, the Appellate Court determined that the mortgagee did not make a reasonable effort to arrange a face-to-face meeting because it did not have proof that it sent the letter to the borrower by certified mail. 

 

However, this did not end the Appellate Court's inquiry because it may affirm the circuit court for any reason in the record.  The Appellate Court observed that where the borrower claims only a technical defect in notice and there is no resulting prejudice, it would be futile to vacate the foreclosure to permit new notice. See Aurora Loan Services, LLC v. Pajor, 2012 IL App (2d) 110899.

 

Here, the borrowers' mortgage loan debt was discharged in bankruptcy and they did not reaffirm the debt. The Appellate Court noted that the borrowers' "discharge in bankruptcy without reaffirmation means that they are no longer bound by the mortgage contract between the parties and should not be allowed to enjoy any benefits of the mortgage contract that their own volitional act has nullified."

 

As such, the Appellate Court reasoned that "[s]ending the letter seeking a face-to-face meeting would be meaningless and futile."   Further, the Appellate Court found that in this situation "[t]here is neither purpose nor policy that would countenance a determination of prejudicial error."

 

As the law does not require performing useless acts as a prerequisite to file a legal proceeding, the Appellate Court concluded that the trial court correctly entered summary judgment in favor of the mortgagee.

 

Accordingly, the Appellate Court affirmed the trial court's judgment in favor of the mortgagee.

 

 

 

Ralph T. Wutscher
Maurice 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@MauriceWutscher.com

 

Admitted to practice law in Illinois

 

 

 

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Friday, March 10, 2017

FYI: 11th Cir Holds CAFA's "Local Controversy" Exception Does Not Preclude Federal-Question Jurisdiction

The U.S. Court of Appeals for the Eleventh Circuit recently held that the federal Class Action Fairness Act's ("CAFA") local-controversy provision, 28 U.S.C. § 1332(d)(4), does not preclude a federal trial court from exercising federal-question jurisdiction. 

 

Accordingly, the Eleventh Circuit affirmed the federal trial court's denial of the plaintiffs' motion to remand the matter to state court following the defendants' removal. 

 

A copy of the opinion is available at:  Link to Opinion

 

The litigation involved a defendant doctor's alleged performance of unnecessary heart procedures on the plaintiffs.  Specifically, the plaintiffs alleged that the defendant doctor would falsely tell a patient that the patient needed heart surgery, and then perform the procedure at a facility operated by one of the defendant hospitals, which then billed the patient for the unnecessary procedure. 

 

As a result, the plaintiffs filed a complaint in state court asserting, among other things, claims under the civil Racketeer Influenced and Corrupt Organizations Act ("RICO").  The defendants timely removed the case to the federal district court based on federal-question jurisdiction.

 

The plaintiffs moved to remand and argued that CAFA's local-controversy exception prohibited the federal district court from exercising jurisdiction.  Around the same time, the defendants filed a motion to dismiss the RICO claims.  The district court denied the motion to remand because it found that CAFA was inapplicable.  It also granted the motion to dismiss the RICO claims. 

 

On appeal, the plaintiffs asserted two arguments in support of their claim that CAFA's local-controversy provision precludes federal jurisdiction.  First, the plaintiffs argued that CAFA's local-controversy exception requires district courts to abstain from exercising jurisdiction over all local class actions.  Second, and in the alternative, they argued that CAFA assigns jurisdiction over local class actions exclusively to the state courts. 

 

The Eleventh Circuit rejected both arguments.

 

In so ruling, the Eleventh Circuit observed that with the enactment of CAFA, Congress amended 28 U.S.C. § 1332 to include section 1332(d).  Section 1332(d)(2) grants district courts jurisdiction over class actions "in which the matter in controversy exceeds the sum or value of $5,000,000" and there is diversity between any class member and any defendant. 

 

However, under section 1332(d)(4), district courts must refrain from exercising jurisdiction over certain class actions that otherwise meet section 1332(d)(2)'s requirements. Specifically, section 1332(d)(4) instructs district courts to "decline to exercise jurisdiction under" section 1332(d)(2) over class actions that involve local parties and controversies.  This is the so-called "local controversy" exception.

 

The Eleventh Circuit noted that courts in the Seventh and Eighth Circuits have held that section "1332(d)(4) is similar to abstention and does not eliminate federal jurisdiction."  See Morrison v. YTB Int'l, Inc., 649 F.3d 533, 536 (7th Cir. 2011); Graphic Commc'ns Local 1B v. CVS Caremark Corp., 636 F.3d 971, 973 (8th Cir. 2011).

 

Still, the plaintiffs argued that section 1332(d)(4) requires district courts to decline to exercise jurisdiction over any class action that meets the requirements of section 1332(d)(4), even where there is federal-question jurisdiction by virtue of federal law claims raised in the lawsuit.

 

The Eleventh Circuit disagreed.  The Court noted that 1332(d)(2) grants district courts jurisdiction over minimally diverse class actions in which more than $5,000,000 is in dispute, and section 1332(d)(4) proscribes the exercise of that jurisdiction over local cases.

 

Thus, the Court held, "[section] 1332(d)(2) grants district courts jurisdictional power they did not previously have, and [section] 1332(d)(4) removes their ability to exercise that specific grant of jurisdiction in certain cases."  Accordingly, "when the requirements of federal-question jurisdiction are met, district courts may exercise jurisdiction over class actions, even if they involve only local parties."

 

The plaintiffs further argued that section 1332(d)(4) grants state courts exclusive jurisdiction over local class actions, including those based on federal-question jurisdiction. 

 

The Eleventh Circuit disagreed, holding that "[n]othing in the language of [section] 1332(d)(4) indicates that Congress intended to divest district courts of jurisdiction under [section] 1331. Rather . . . [section] 1332(d)(4) prevents district courts from exercising the jurisdiction that they otherwise possess under that statute."

 

The Eleventh Circuit therefore affirmed the district court's denial of the plaintiffs' motion for remand. 

 

However, because the Eleventh Circuit determined the plaintiffs adequately alleged damages for their RICO claim, it vacated the trial court's dismissal of the RICO claim, and remanded the matter back to the federal trial court for further proceedings. 

 

 

 

 

Ralph T. Wutscher
Maurice 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@MauriceWutscher.com

 

Admitted to practice law in Illinois

 

 

 

Alabama   |   California   |   Florida   |   Georgia  |   Illinois   |   Indiana   |   Maryland   |   Massachusetts   |   Michigan   |   New Jersey   |   New York   |   Ohio   |   Pennsylvania   |   Texas   |   Washington, DC   |   Wisconsin

 

 

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 and webinar presentations are available on the internet, in searchable format, at:

 

Financial Services Law Updates

 

and

 

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and

 

Webinars

 

and

 

California Finance Law Developments 

 

Thursday, March 9, 2017

FYI: 6th Cir Holds Bank Not "Transferee" as to Ordinary Bank Deposits In Fraudulent Transfer Action

The U.S. Court of Appeals for the Sixth Circuit recently held that a bankruptcy trustee seeking to recover fraudulent transfers could recover direct and indirect loan repayments made after the bank had knowledge of the debtor's Ponzi scheme, but could not recover deposits not applied to pay back the bank's debt because the bank was not a "transferee" under the Bankruptcy Code as to ordinary bank deposits.

 

A copy of the opinion is available at:  Link to Opinion

 

The principal of two bankrupt companies orchestrated a Ponzi scheme in which he fabricated invoices documenting phony purchases of computer equipment by one company from the other. The principal borrowed money from several equipment financing companies, and instructed them to send the money directly to the phony seller.  The principal would then move the money to the phony buyer's bank account. The money was then used to pay salaries and the phony buyer's earlier debts to lenders for earlier such fraudulent "purchases."

 

In September of 2003, the phony buyer deposited a check with the defendant bank for $2.3 million from the phony seller that bounced.  During a meeting in October of 2003 between bank employees and the principal, the principal explained that the phony seller was a recently-formed, wholly-owned subsidiary of the phony buyer and, while "not yet operational," the new company "was already collecting [the buyer's] receivables before sending them to [the buyer]." This explanation contradicted the principal's earlier representation that the seller was the buyer's "supplier of computer equipment" which if true would meant that the money would have flowed the other way.

 

The lead bank investigator suspected foul play in part because the phony buyer refused to use the bank's lockbox service supposedly because the phony buyer's customers refused to use it.

 

In January of 2004, the bank decided to end its relationship with the two companies due to several "red flags", such as doubts about the actual amount of buyer's receivables and overdrafts that were offset by increasing the loan balance.

 

Then, in April of 2004, while reviewing the buyer's "receivables aging report," the bank noticed that the buyer's customers included many large Fortune 500 companies that would never object to sending their checks to a lockbox. In addition, some of the alleged customers on the report were the buyer's competitors, not customers.

 

The bank's investigator then discovered that the phony buyer was under investigation by the FBI and the principal had committed bank fraud in Michigan and California for which he was incarcerated for 3 years. The investigator contacted the FBI, but did not reveal this information to the bank.

 

The bank wanted to contact the phony buyer's customer directly, but the principal objected and offered to have "big eight" accounting firm independently audit the buyer, to which the bank agreed. As it turned out, the principal also defrauded the accounting firm "by providing it with fake responses from [the buyer's] fake customers."

 

The phony buyer paid down the debt in the months the followed, making the last payment on October 29, 2004. The FBI then raided the phony buyer's offices and the principal committed suicide.

 

A state court appointed a receiver to take control of both companies, who filed bankruptcy for the phony seller. Creditors of the phony buyer then filed an involuntary bankruptcy proceeding against it.

 

The bankruptcy trustee for the phony seller sought to recover from the bank "all of the direct loan repayments, the indirect loan repayments, and the excess deposits."

 

After two trials and several opinions, and applying "the dominion and control test to determine whether [the bank] was a transferee of the loan repayments and excess deposits[,] the bankruptcy court "concluded first that the Trustee could potentially recover $72 million in loan repayments and excess deposits from [the bank]" because the bank was a "'transferee' under the Bankruptcy Code."  The bankruptcy court reasoned that once the loan payments were received, the bank could do as it pleased with the money. Likewise, the bank could do as it pleased with the excess deposits, "subject only to [the phony buyer's] right to withdraw them."

 

The bankruptcy court then ruled that the bank received the loan repayments and excess deposits in good faith only until April 30, 2004, but not thereafter, reasoning that had the bank's investigator shared his discovery of the principal's fraudulent past, the bank could no longer continue believing in good faith that the transfers from the phony seller were the phony buyer's receivables.

 

In addition, the bankruptcy court found that the bank's affirmative defense of good faith stopped applying even earlier, i.e., September of 2003, because it had "inquiry notice" of the fraud when the principal lied about the relationship between the two companies and the banks' own files showed otherwise. Thus, despite that the bank was acting in good faith until April of 2004, the fact that it was on "inquiry notice" negated its affirmative defense.

 

The bankruptcy court awarded $72 million in loan repayments and excess deposits to the trustee and awarded prejudgment interest "on a portion of that amount and under the federal statutory rate for postjudgment interest."

 

The trial court affirmed the bankruptcy court, and both the bankruptcy trustee and the bank appealed.

 

On appeal, the bank argued: (a) that it was not a transferee of the excess deposits because "it never gained dominion and control over those funds, as [it] was merely maintaining those funds, subject to [the phony buyer's] right to remove those funds at its will"; (b) "the bankruptcy court applied the wrong standard to assess its good faith[,]" which the bank argued continued beyond April 20, 2004; and (c) "Sixth Circuit precedent did not require the bankruptcy court to conclude that its affirmative defense ended earlier, when it gained inquiry notice of [the phony buyer's] fraud."

 

The trustee cross-appealed, arguing that the bankruptcy court applied the wrong test of good faith, and should have found that the bank's good faith ended prior to April 30, 2004, and also that the bankruptcy court's award of prejudgment interest was too low.

 

The Sixth Circuit first found that the trustee could not recover the phony buyer's "excess deposits (those deposits not applied to pay back debts to [the bank]) under the Bankruptcy Code provision for recovery of avoidable transfers from 'transferees' because banks are not 'transferees' with respect to ordinary bank deposits."

 

The Court reasoned that the bank was not a "transferee" of the excess deposits because fit "did not gain 'dominion and control' over them.'" Adopting the Seventh Circuit's test, the Court explained that "[t]he minimum requirement of status as a 'transferee' is dominion over the money or other asset, the right to put the money to one's own purposes.' … We have thus distinguished 'mere possession' from 'ownership,' so that 'a party is not considered an initial transferee if it is merely an agent who has no legal authority to stop the principal from doing what he or she likes with the funds at issue.'"

 

First, the Sixth Circuit noted, the bank "did not gain dominion and control over [the phony buyer's] excess deposits" because it held the funds on deposit. The Court stated, "[a]s our sister circuits have explained, the accountholder's right to withdraw the deposits keeps the bank from obtaining dominion and control."

 

The Sixth Circuit also noted that it was not enough that the bank "could use the cash as it pleased as long as it had enough liquidity to pay back deposits on demand. As the Eleventh Circuit explained, the depository bank's obligation to maintain liquidity is 'sufficiently important' to defeat any dominion and control that the depository bank might otherwise have exercised over those funds."

 

Second, the Court rejected the trustee's argument that the bank's security interest in the phony buyer's deposits gave it dominion and control over the money because the security interest covered only the $16 million dollar loan and not "over $64 million in deposits." Also, the loan agreements clearly stated that the borrower owned the deposits, despite the bank's security interest. Thus, "[e]ven though [the bank] was the recipient of a transfer of a security interest, [it] was not a 'transferee' of that transfer under the Bankruptcy Code."

 

The Court then addressed the bank's affirmative defense of good faith under section 548(c) and 550(b)(1) of the Bankruptcy Code. The bank conceded it was a "transferee" of the direct and indirect loan repayments.

 

Under section 548(c) of the Bankruptcy Code, "[a]n initial transferee is not liable for the transferred property if the transferee: (1) took the property 'in good faith'; and (ii) 'gave value to the debtor in exchange for such transfer.' [The bank] is an initial transferee of the direct loan repayments from [the phony seller] which [it] gave directly to the [the bank]…."

 

Under section 550(b)(1) of the Bankruptcy Code, "[a] subsequent transferee is not liable is not liable for the transferred property if the transferee took the property: (i) 'for value,' (ii) 'in good faith,' and (iii) 'without knowledge of the voidability of the transfer avoided.' … [The bank] is a subsequent transferee of the indirect loan repayments, which [the phony seller] sent to [the phony buyer], and which [the latter] later gave to [the bank] to pay down its debt…."

 

Applying these provisions, the Sixth Circuit concluded that the bankruptcy court did not commit error when it found that the bank's good faith ended on April 30, 2004, and that the trustee could "recover all subsequent loan repayments, which include some of the indirect loan repayments and all the direct loan repayments." However, the Sixth Circuit held, "[w]ith respect to the earlier indirect loan repayments, the bankruptcy court erred in concluding that our precedents necessarily ended [the bank's] affirmative defense earlier — on September 25, 2003 — when [the bank] gained inquiry notice of [the phony buyer's] fraud."

 

The Court rejected the trustee's argument that Sixth Circuit precedent required a finding that the bank was on inquiry notice, reasoning that "[w]hile inquiry notice sometimes suffices to 'alert' a reasonable person to voidability, … on different facts, and viewing those facts holistically, a reasonable person may not be alerted to a transfer's voidability even if there was inquiry notice. What a reasonable person would be alerted to depends not just on whether there was inquiry notice, but also on what investigative avenues existed, whether a reasonable person would have undertaken those avenues given the situation, and what findings the reasonable investigations would have yielded."

 

The Sixth Circuit also rejected the trustee's argument that it could "recover the transfers made between the two dates … because the district court applied the wrong test to determine [the bank's] good faith[,]" finding that given "that courts have 'struggled' to define good faith in this context[,]" the trial court applied the right test — i.e., whether the bank "legitimately continued to believe that [the phony seller's] transfers to [the phony buyer's] account were merely [the latter's] receivables that [the phony seller] had collected."

 

The Court concluded that the trustee was entitled to recover from the bank "all direct loan repayments, of which [it] is an initial transferee, because [the bank] received them after its proven good faith ended on April 30, 2004." The trustee could also recover from the bank "those indirect loan repayments, of which [the bank] is a subsequent transferee, that [the bank] received after April 30, 2004, and that [it] received earlier, if the district court concluded on remand that [the bank] gained knowledge of the voidability of the transfers before April 30, 2004."

 

Turning to the bankruptcy court's award of prejudgment interest at the rate set forth in 28 U.S.C. § 1961 rather than the "market interest rate," the Court found no abuse of discretion because "[t]he bankruptcy court satisfied its duty to consider case-specific factors when it considered whether the statutory rate was fair in light of the type of conservative investment that a fiduciary like the Trustee would have pursued."

 

The Court explained, however, that on remand the trial court could "exercise its discretion to choose a different prejudgment interest rate, should it deem appropriate[,]" because "[w]hen the bankruptcy court chose the statutory rate to be the prejudgment interest rate, it did so in the context of a judgment that included about $55 million in [the phony buyer's] excess deposits. These are funds that [the bank] no longer has: [the phony buyer] withdrew them or the government seized them. But we hold that [the bank] is not liable for those excess deposits. [It] remains liable for the loan repayments only, which are funds that [the bank] received, as [the phony buyer's] creditor, in satisfaction of [the phony buyer's] debt to it. Once [the bank] received that money [it] was free to invest that money however it wished. Doing so, [the bank] may have profited more during this litigation than it will be ordered to pay under the statutory rate."

 

Accordingly, the trial court's judgment was reversed in part and the case remanded for further proceedings.

 

 

 

 

Ralph T. Wutscher
Maurice 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@MauriceWutscher.com

 

Admitted to practice law in Illinois

 

 

 

Alabama   |   California   |   Florida   |   Georgia  |   Illinois   |   Indiana   |   Maryland   |   Massachusetts   |   Michigan   |   New Jersey   |   New York   |   Ohio   |   Pennsylvania   |   Texas   |   Washington, DC   |   Wisconsin

 

 

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 and webinar presentations are available on the internet, in searchable format, at:

 

Financial Services Law Updates

 

and

 

The Consumer Financial Services Blog

 

and

 

Webinars

 

and

 

California Finance Law Developments 

 

FYI: Invitation: 2017 Annual Consumer Financial Services Conference | Chicago, IL | May 15-16, 2017

 

2017 Annual Consumer Financial Services Conference

 

We proudly announce our Annual Conference at the Loyola University Law School in Chicago, Illinois (May 15-16, 2017)

Click here to download a copy of the flyer.  

Registration and additional information can be found here

Would your firm be interested in sponsoring the Conference?  If so, please contact Ralph Wutscher  (rwutscher@mauricewutscher.com), or Jim Milano (milano@thewbkfirm.com).

We received nothing but good comments afterwards about the content and the location of our 2016 Conference, as we did for our 2015 Conference.  We kept the price low and the quality top notch and we're doing the same again this year. 

Be sure to consider who at your company or law firm -- as well as outside of your organization -- would benefit from attending the Conference.  You are of course welcome to forward this email to them.

Thank you for your interest,

Conference on Consumer Finance Law

 


The Conference on Consumer Finance Law
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