FYI: Cal App Ct Confirms Possession of Note Not Required for Nonjudicial Foreclosures, Rules Against Foreclosed Out Second Lienor

The California Court of Appeal, Sixth District, recently held that under California nonjudicial foreclosure law:  (1) an assignee of a first deed of trust that expressly referred to the underlying promissory Note did not need physical possession of the Note in order to proceed with a property foreclosure sale; and (2) the holder of a second deed of trust on the same property was not entitled to declaratory judgment or quiet title to the property, as he was not prejudiced by a Notice of Default that did not adequately identify the name of the beneficiary under the first trust deed and which named the foreclosing trustee prior to the recording of a Notice of Substitution of Trustee. 

 

A copy of the opinion is available at: 

http://www.courtinfo.ca.gov/opinions/documents/H036379.PDF.

 

A borrower allegedly defaulted on a loan secured by a second deed of trust.  The second-lien lender ("Second Lender") foreclosed on the loan and a trustee's sale of the property was held.  Subsequently, a bank, which was the final assignee of a first deed of trust on the property ("Prior Lender") initiated nonjudicial foreclosure proceedings based on the borrower's default on a separate loan. 

 

In an effort to stop the foreclosure, the Second Lender filed a complaint against the Prior Lender, its loan servicer, and the foreclosing trustee (collectively the "Prior Defendants"), seeking a declaratory judgment and to quiet title to the property and remove the first deed of trust.  In his complaint, the Second Lender alleged that the foreclosure under the first deed of trust was improper, because the Prior Lender allegedly did not have physical possession of or ownership rights to the original promissory Note, and that any assignment of the deed of trust alone, without the underlying promissory Note, supposedly was of no effect. 
 
The Second Lender further alleged that the foreclosing trustee's Notice of Default was defective, because that notice insufficiently identified the Prior Lender as the beneficiary under the first deed of trust, and the Notice of Default further improperly named the foreclosing trustee before the Notice of Substitution of Trustee was recorded.   

 

The Prior Defendants demurred, arguing in part that possession of the original note was not required under applicable foreclosure law.  Rejecting Second Lender's arguments that the "chain of assignment" was improper, the lower court sustained the demurrer and dismissed without leave to amend, ruling that all assignments of the first deed of trust, including the final assignment to the Prior Lender, conveyed all beneficial interest in the first deed of trust together with the Note and that physical possession of the underlying note was thus not required. 

 

The Second Lender appealed, again arguing that the assignment of the deed of trust to the Prior Lender was of no legal effect, because the original underlying promissory Note had not been transferred to the Prior Lender.  In addition, the Second Lender also claimed that the Prior Lender was attempting to unlawfully take the property, as the Prior Lender could not produce a copy of the Note or other evidence of indebtedness as required by the applicable foreclosure statute.  However, the Court of Appeal affirmed the trial court's ruling.

 

The Second Lender argued on appeal that because the promissory Note was a negotiable instrument, it could not be assigned without a valid indorsement and physical delivery to the assignee, and therefore that the assignment of the deed of trust was invalid.  Rejecting Second Lender's assertion that the assignment of the deed of trust should be governed by the California Commercial Code, the appellate court concluded that California's exhaustive and comprehensive framework for nonjudicial foreclosures applied and did not require that the Note be in the possession of the foreclosing party.  See Cal. Civ. Code § § 2924-2924k. 

 

In so ruling, the Court noted that the nonjudicial foreclosure statutes specify that a Notice of Default may be filed by the "trustee, mortgagee, beneficiary, or any of their authorized agents," and do not require the foreclosing party to have physical possession of the underlying note.  See Cal. Civ. Code § 2924(a)(1). The Court also observed that California appellate courts have refused to read additional requirements into the non-judicial foreclosure statutes, such as a requirement to have a beneficial interest in both the Note and the deed of trust in order to commence a non-judicial foreclosure sale. 

 

The appellate court was similarly not persuaded by the Second Lender's arguments based on the Ninth Circuit Bankruptcy Appellate Panel's opinion in In Re Veal, 2011 WL 2652328, 450 B.R. 897 (9th Cir BAP 2011) ("Veal").  Among other things, the Court noted that the parties in Veal had stipulated to the applicability of the Uniform Commercial Code to the issues in that case, the loan involved a mortgage governed by a different state's law while another state's law controlled the Note, and, significantly, the assignment in Veal failed to adequately identify all the rights and obligations transferred under the mortgage.  The Court also pointed out that the Veal opinion implicitly acknowledged that California law does not require the production of the original Note in a nonjudicial foreclosure under a deed of trust.  Accordingly, the Court distinguished Veal and rejected Second Lender's arguments based on that opinion.

 

Turning to the Second Lender's assertion that the Notice of Default was defective because it did not identify the beneficiary under the deed of trust, and listed the name of the foreclosing trustee even though no Substitution of Trustee had yet been recorded, the Court noted that the "Fair Debt Collection Practices Notice" attached to the Notice of Default clearly identified the Prior Lender as the creditor and provided the loan servicer's address and telephone number.   In addition, the Court pointed out that the Second Lender was not prejudiced or adversely affected by any technical defect in the Notice of Default or any alleged premature substitution of the foreclosing trustee.  The Court moreover noted that California law expressly provides for the situation in which a substitution of trustee is executed but not recorded until after the recording of the Notice of Default.  See Cal. Civ. Code § 2934a(b). 

 

The Court thus ruled that the Second Lender had failed to set forth viable causes of action for declaratory judgment or quiet title, because he was unable to show invalidity of the assignment to the Prior Lender, title free and clear of the first deed of trust, or prejudicial effects of any technical deficiencies in the Notice of Default.

Ralph T. Wutscher
McGinnis Tessitore 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 Affirms Denial of Class Cert in RESPA Section 8 Putative Class Action

The U.S. Court of Appeals for the Seventh Circuit recently upheld the denial of class certification in a RESPA action for alleged kickbacks and fee splitting, confirming that resolution of the Section 8 allegations would require an individual determination of liability with respect to each putative class member's purported claim.

 

A copy of the opinion is available at:

http://www.ca7.uscourts.gov/tmp/GJ0JZ6RL.pdf.

 

Several Illinois consumers who purchased title insurance as part of their real estate transactions ("Plaintiff Borrowers"),  filed suit against an Illinois title insurance company ("Defendant Title Company") alleging in part that the Defendant Title Company's payments to real estate attorneys acting as agents ("Title Agents") for the Defendant Title Company  constituted illegal kickbacks and fee splitting in violation of the Real Estate Settlement Procedures Act, 12 U.S.C. § 2601 et seq. ("RESPA"). 

 

The Plaintiff Borrowers claimed that, pursuant to the contracts between the Title Agents and the Defendant Title Company to sell title insurance, the Title Agents' title examination work associated with Plaintiff Borrowers' real estate transactions amounted to mere nominal services or duplicative work actually done by the Defendant Title Company.  Specifically, the Plaintiff Borrowers alleged that the information provided by the Defendant Title Company to the Title Agents, including the legal description of a property, a list of any open liens, and the last known grantee, constituted a preliminary title examination that left little, if any, title examination work for the Title Agents to perform in order for the Defendant Title Company to prepare a title insurance commitment.  The Plaintiff Borrowers thus alleged that the contract fees paid to the Title Agents for title examination work were excessive and unreasonable and constituted improper kickbacks for referrals rather than payment for services actually performed. 

 

Plaintiff Borrowers sought class certification on behalf of consumers who purchased title insurance through the Title Agents, claiming that part of the premiums consumers paid went to the Title Agents who did not perform "core" title examination work in exchange for payment under their contracts.
 
The district court twice denied class certification, concluding that, because an individual determination of liability would be required for each class member's claim, the requisite element of commonality of issues did not exist for class certification.  The Plaintiff Borrowers appealed.  The Seventh Circuit affirmed.

 

As you may recall, class certification under Federal Rule 23 requires in part that plaintiffs establish commonality among claims, that common issues predominate over individual issues, and that a class action would be a superior method of adjudicating those claims.  See F.R.C.P. 23(b); Wal-Mart Stores, Inc. v. Dukes, 131 S. Ct. 2541, 2548-49 & n.2 (2011).  In addition, RESPA prohibits the payment of "kickbacks" in exchange for referrals for business, and prohibits payments "other than for services actually performed."  See 12 U.S.C. § 2607(a), 2607(b).  RESPA's implementing regulations clarify that prohibited charges include those where only "nominal services are performed," and that if a title agent is an attorney for the buyer or seller, the agent may not receive compensation as a title agent unless the agent performs "core title agent services (for which liability arises) separate from attorney services."  See 24 C.F.R. § 3500.14(c), 14(g).

 

RESPA, however, provides a safe harbor for payments by title companies to their agents "for services actually performed in the issuance of a policy of title insurance," and a safe harbor for the payment of "a bona fide salary or compensation . . .  for services actually performed."  12 U.S.C. § 2607(c)(1)(B), (c)(2).

 

The Seventh Circuit noted that RESPA's regulations explain that the services required to invoke the "core services safe harbor" must include:  (1) evaluation of the title search to determine the insurability of the title; (2) the clearance of underwriting objections; (3) the actual issuance of the title insurance policy; (4) conducting the title search and real estate closing; and, (4) where appropriate, issuance of the title commitment.  

 

Citing examples in the regulations and a federal agency's statement of policy, the Seventh Circuit noted that a Title Agent could violate RESPA's Section 8 by providing nominal or duplicative services, or if there is no reasonable relationship between the payment to the Title Agent and the value of the services provided, or where a title insurance company performs any of the core title services itself.   The Court also pointed out, however, that if a title agent fails to qualify for the "core title services safe harbor" under Section 8, RESPA regulations allow payment to the title agent, as long as the payment is reasonably related to the value of the services performed.  Accordingly, the Court determined that in order to proceed as a class, the Plaintiff Borrowers would have to show, first, that the fees paid to the Title Agents were not reasonably related to the services provided, and, that, moreover, the issue of the reasonability of fees paid could be resolved on a class-wide basis.

 

The Seventh Circuit rejected the Plaintiff Borrowers' position that payments under the Title Agents' contracts were essentially a class-wide per se violation of RESPA, and noted that the Plaintiff Borrowers' arguments failed to distinguish between the factors considered under the core services safe harbor test and the contractual compensation actually paid to the Title Agents.  In so doing, the Court pointed out that the payment of the full contract fee for a title examination may be proper even where the core services safe harbor is not available and that a determination of the impropriety of such payments would hinge on evidence showing that payment to an individual Title Agent was not reasonably related to the services the Title Agent performed. 

 

The Seventh Circuit concluded that the Plaintiff Borrowers presented no evidence that the compensation paid to the Title Agents or the services they performed were the same across the entire class.  Accordingly, the Court ruled that, because each claim would require an individual analysis as to reasonableness of the compensation, individual issues predominated over common ones and thereby precluded class certification.  See FRCP 23(b)(3). 

 

The Seventh Circuit also concluded that the Plaintiff Borrowers were unable to show that the Title Company split fees with the Title Agents.  

 

Ralph T. Wutscher
McGinnis Tessitore 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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