FYI: DOJ Announces $21MM Loan Pricing Discrimination Settlement

The U.S. Department of Justice announced a $21 Million discriminatory pricing settlement with the mortgage lending subsidiary of the nation's 11th-largest commercial bank.  The settlement also requires the company to continue the anti-discrimination policies and practices it already adopted prior to the settlement.  The settlement was reached without contested litigation and without any factual findings or adjudications, and is subject to court approval.

 

A copy of the consent order is available at:

http://www.justice.gov/iso/opa/resources/313201253116253830420.pdf

 

A copy of the complaint is available at:

http://www.justice.gov/iso/opa/resources/656201261104918372098.pdf

 

The DOJ's complaint alleges violations of the Fair Housing Act and Equal Credit Opportunity Act in connection with alleged higher fees and interest rates, allegedly not based on borrower risk, for more than 20,000 African-American and Hispanic borrowers.  The allegations involve loans made to African-American borrowers between 2005 and 2008 through more than 200 retail offices directly operated by the company, as well as loans made to African-American and Hispanic borrowers between 2005 and 2009 through the company's national network of mortgage brokers. 

The DOJ challenged the company's past practice of allowing its loan officers and mortgage brokers to vary a loan's interest rate and other fees from the price it set based on the borrower's objective credit-related factors.  This subjective and unguided pricing discretion allegedly resulted in African-American and Hispanic borrowers paying more. 

The company changed its practices prior to the settlement, by substantially reducing the discretion of its loan officers and mortgage brokers to vary a loan's interest rate and other fees from the price it set based on the borrower's objective credit-related factors, and by requiring the reasons for variations to be documented and reviewed by a supervisor.  According to the DOJ, "[t]hose policies, operating in concert with rules imposed by the Federal Reserve in April 2011 and incorporated into the settlement, restrict compensating loan officers and mortgage brokers based on the terms or conditions of a particular loan." 

The settlement requires the company to maintain these policies for at least the next three years, to monitor its lending for signs of discrimination, and to provide monitoring reports to the United States.

The proceeds of the settlement will be used to compensate the alleged victims identified by the DOJ, through an independent administrator. 

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
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FYI: 3rd Cir Holds Commercial Second Lien Holder Unsecured Based on Appraisal, Not Projected Plan Revenue

The U.S. Court of Appeals for the Third Circuit recently held that a creditor with a second lien mortgage in a Chapter 11 proceeding was properly determined to be an unsecured creditor under Section §506(a) of the Bankruptcy Code where: (1) the appraised value of the debtor's collateral was less than the first position lender's claim; and (2) the debtor's reorganization plan projected enough revenue from the future sale of the collateral to pay off both the first and second liens in full.

 

A copy of the opinion is available at:
http://www.ca3.uscourts.gov/opinarch/111889p.pdf
 
Debtors were real estate developers who had obtained a series of construction loans that they ultimately defaulted on.  Debtors filed a voluntary petition for Chapter 11 bankruptcy.  A group of banks (the "First Lenders") had first position mortgage liens on all property owned by the Debtors with an approximate balance due of $12,000,000.  An investment group (the "Second Lender") had a second position mortgage lien on the debtor's property with an approximate balance due of $1,400,000.  

 

Debtors submitted a reorganization plan that was confirmed by the bankruptcy court.  The parties stipulated that "[b]ased on the Appraisal, the total fair market value of the Project as of the Confirmation Date [wa]s $9,543,396.23."  Additional assets held by Debtors raised the total value of the collateral securing liens to $11,165,477.15.  As a result, the total value of Debtors collateral as of the Confirmation Date was less than the balance due to the First Lenders. 

 

However, Debtors final plan included a projected budget that anticipated full payment of both the First Lenders and Second Lender through the development and sale of lots with completed townhouses and single-family homes over the course of  47 months.   According to the budget, unsecured claimants would receive distributions amounting to approximately 45% of their claims.

 

The Official Committee of Unsecured Creditors (the "Unsecured Creditors Committee") filed a motion to value the secured claims of the Second Lender pursuant to 11 U.S.C.  § 506(a) and Federal Rule of Bankruptcy Procedure 3012.  The Unsecured Creditors Committee argued that the Bankruptcy Court should value the secured claims at zero because the collateral securing the Second Lender was worth less than the First Lenders' senior secured claim.  As proof of the collateral's worth, the Unsecured Creditors Committee submitted the aforementioned appraisal previously accepted by the Bankruptcy Court.

 

The Second Lender contended that the appraisal did not control because § 506(a) requires that the value of property "be determined in light of [its] proposed disposition or use" and the plan budget demonstrated that the Debtors would be able to pay their claims in full over time as more homes were sold.  The Second Lender also urged the court to adjudicate its claims fully secured, arguing that to deprive them of Project revenue to be generated over and above the appraisal value would constitute impermissible lien stripping.   

 

Both the Bankruptcy Court and the District Court agreed with the Unsecured Creditors Committee, and ruled that the Second Lender's collateral was valued at zero putting the Second Lender into a class of unsecured creditors.

 

The Third Circuit affirmed.  Central to the Third Circuit's resolution of this case was the text of § 506(a), which as you may recall provides in pertinent part:

 

"An allowed claim of a creditor secured by a lien on property in which the estate has an interest . . . is a secured claim to the extent of the value of such creditor's interest in the estate's interest in such property . . . and is an unsecured claim to the extent that the value of such creditor's interest . . . is less than the amount of such allowed claim.  Such value shall be determined in light of the purpose of the valuation and of the proposed disposition or use of such property . . . ."

 

The Third Circuit rejected the Second Lender's argument that the Debtors plan budget constituted a determination of collateral value "in light of the disposition or use of the property."  Rather, the Court noted that both the Bankruptcy Court and the District Court accurately characterized the budget as simply a set of projections offered in support of the plan's feasibility, i.e., to demonstrate  that the plan would have a "reasonable probability" of success.  The Third Circuit noted that the plan was not intended to function as anything more, and most certainly not as a determination of the value of the Second Lender's interest in the Project.  A "probability" of realizing the budget is not a certainty of its realization.  In sum, valuations must be based upon realistic measures of present worth.

 

The Third Circuit further noted that the appraisal's determination of the discounted fair market value of the property as of the confirmation date, best approximated just how secure the liens held by creditors  — namely, the First Lenders and Second Lender — were at the relevant point in Debtors' bankruptcy.

 

The Third Circuit also rejected Second Lender's argument that denying them future lot sale proceeds that exceed the Project's  judicially determined value as of confirmation constitutes a form of lien stripping disallowed by the Supreme Court's  decision in Dewsnup.  In Dewsnup, the Supreme Court considered "some ambiguities" in § 506 and its relationship to other provisions of the Bankruptcy Code when a Chapter 7 debtor's property increases in value between the time of its judicial valuation and the time of its foreclosure sale.  Guided by the principle that liens are to pass through bankruptcy unaffected, the Dewsnup Court rejected the notion that a mortgagee could be forced to accept the judicially determined value, even if the foreclosure sale produced more.

 

The Third Circuit held that Dewsnup is only applicable to Chapter 7 bankruptcy cases.  The Court explained that the rationales advanced in the Dewsnup opinion for prohibiting lien stripping have little relevance in the context of rehabilitative bankruptcy proceedings under Chapter 11 -- Chapter 7 liquidation proceedings involve the sale of liened property; Chapter 11 reorganizations involve the retention and use of that property in the rehabilitated debtor's business.  The Code makes that clear: "the process of lien stripping is ingrained in the reorganization provisions of the Bankruptcy Code to such an extent that any attempt to extend the holding in Dewsnup to Chapter 11 cases would require that numerous provisions of the statute be ignored or construed in a very convoluted manner."

 

Lastly, even though it was not an issue raised by the parties, the Third Circuit addressed the burden of proof for valuing secured collateral under Section 506(a).  Neither the Code nor the Federal Rules of Bankruptcy Procedure allocates the burden of proof as to the value of secured claims under § 506(a).  Although the courts have divergent opinions on who is to bear the burden of proof, the Third Circuit held that the initial burden should be on the party challenging a secured claim's value, because "11 U.S.C. § 502(a) and Bankruptcy Rule 3001(f) grant prima facie effect to the validity and amount of a properly filed claim." 

 

The Court reasoned that it is only fair, then, that the party seeking to negate the presumptively valid amount of a secured  claim — and thereby affect the rights of a creditor  — bear the initial burden.  If the movant establishes with sufficient evidence that the proof of claim overvalues a creditor's secured claim because the collateral is of insufficient value, the burden shifts.  The purportedly secured creditor thereafter bears "the ultimate burden of persuasion . . . to demonstrate by a preponderance of the evidence both the extent of its lien and the value of the collateral securing its claim."

 

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: Cal App Holds Mortgage Loan Investor Not Subject to Quiet Title Action Pending Against Originating Lender

The California Court of Appeal, Second District, recently held that a mortgage loan investor which acquired a loan secured by property that was the subject of a quiet title action was not bound by the holding of that action, where the assignor originating lender was dismissed from the action prior to its resolution.  The Court reached that conclusion notwithstanding the fact that a lis pendens was filed prior to the assignment in question.   

 

A copy of the opinion is available at:

http://www.courtinfo.ca.gov/opinions/documents/B231591.PDF

 

 

A borrower defaulted on her home loan, and subsequently became involved in a purported fraudulent scheme wherein she was convinced to convey her property to a third party, who obtained a mortgage secured by that property and leased it back to the borrower.  This scheme resulted in the borrower losing both title to her home and all the equity she had built up prior to her default.

 

The borrower sued the individuals who had purportedly defrauded her, as well as the originating lender from which the mortgage loan was obtained (the "originating lender").  As part of that lawsuit, the borrower brought a quiet title action against all entities who claimed an interest in her home.  She recorded a lis pendens in connection with the same. 

 

During that litigation, the originating lender filed for bankruptcy, and assigned the note and deed of trust to an asset securitization trust ("Investor").  The borrower was not informed of the assignment, which was not immediately recorded. 

 

The borrower obtained defaults against the various defendants who were involved in the purported fraudulent scheme.  She elected to dismiss the originating lender, intending to pursue her claim in bankruptcy court.  The court in the bankruptcy action then quieted title in the borrower's favor. 

 

The borrower also reached a settlement with the liquidating trust in connection with the bankruptcy action, whereby it was agreed that neither the liquidating trust nor the originating lender had any remaining interest in the subject property. 

 

The Investor then brought a declaratory relief action, seeking a declaration that its deed of trust was valid.  The borrower argued that the Investor had no remaining interest in the property, as it took title subject to the resolution of the previous lawsuit, which quieted title in the borrower alone.  The Investor argued that because the originating lender was dismissed from the quiet title action, the lender's interests were not impacted by the outcome of that litigation. 

 

The lower court found in favor of the borrower, finding that because the Investor acquired its interest in the property after the borrower recorded a lis pendens, the Investor was bound by the quiet title judgment.  The Investor appealed. 

 

As you may recall, the relevant California statute provides that a quiet title judgment does not bind non-parties whose interest was of-record prior to the filing of a lis pendens.  See Code Civ. Proc., Sec 764.045, subd. (b). 

 

The Court relied on the above-referenced statutory provision to hold that "as the interest of [the originating lender] was not resolved in the quiet title action, its assignee [the Investor] is not bound by the quiet title judgment."  To reach that conclusion, the Court noted that the judgment in the quiet title action did not and could not address the validity of the originating lender's deed of trust, as the originating lender was dismissed from the action prior to its resolution.  Therefore, the originating lender was a "non-party" which, under the code provision cited above, was not bound by the quiet title action. 

 

The borrower argued that the California statute provides that entities holding unrecorded interests in a property at the time a lis pendens is recorded will be bound by a quiet title judgment.  Although the Court acknowledged that "this would appear to describe [the Investor]," it nevertheless concluded otherwise. 

 

The Court reasoned that because the Investor took title after the lis pendens was recorded, the Investor did so with knowledge that the quiet title action might invalidate its interest -- and if that action had resulted in the invalidation of the originating lender's interest, the Investor's interest would be voided.  However, the Court noted that that risk "never came to fruition," as the originating lender was dismissed from the action prior to any adjudication of its interest. 

 

Accordingly, the Court reversed and remanded the decision of the lower court, with instructions to determine whether the originating lender's loan was a valid encumbrance on the property.        

 

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: AZ Sup Ct Holds Proof of Authority to Enforce Note Is Not Required in Non-Judicial Foreclosures

The Supreme Court of Arizona recently held that a beneficiary under a deed of trust was not required to prove its authority to foreclose or to produce the underlying note before the foreclosure trustee could commence non-judicial foreclosure proceedings.

 

A copy of the opinion is available at: 

http://www.azcourts.gov/Portals/23/pdf2012/CV110115PR_CV110132PR.pdf.

 

Plaintiff-borrower defaulted on mortgage loans on two parcels of land, each of which was subject to a deed of trust.  In the ensuing foreclosures, the respective trustees recorded a notice of sale for each property, listing therein a successor beneficiary under each trust deed. 

 

The Plaintiff-borrower filed actions against the trustees and beneficiaries (collectively "Defendants") seeking to enjoin the trustees' sales, arguing that the beneficiaries were required to prove that they were entitled to collect on the respective notes before the trustees could begin the non-judicial foreclosures.  The Defendants moved to dismiss.  The trial court granted the motions, and the Court of Appeals affirmed, ruling that Arizona's non-judicial foreclosure statute did not require presentation of the original note before a foreclosure action may commence.

 

The Arizona Supreme Court affirmed, ruling that a beneficiary is not required to prove its authority to enforce the underlying note before the foreclosure trustee may exercise its power of sale under the trust deed.
  
Rejecting the Plaintiff-borrower's assertion that beneficiaries under trust deeds must demonstrate their right to enforce the underlying note, the Arizona Supreme Court noted that Arizona's non-judicial foreclosure statutes neither impose such a requirement nor require presentation of the original note. 

 

Specifically, the Court observed that Arizona's non-judicial foreclosure statute authorizes a trustee to sell the real property securing the underlying note, but does not require a beneficiary to show possession of, or to otherwise document its right to enforce the note prior to the trustee's exercise of that power of sale.  See A.R.S. § 33-807.  The Court also observed that a trustee is only required to send the borrower notice of the default after recording notice of the trustee's sale.  See A.R.S. § 33-809(C); § 33-808.  The Court stated, "[t]he only proof of authority the trustee's sales statutes require is a statement indicating the basis for the trustee's authority."  See A.R.S. § 33-808(C)(5)(notice must set forth "the basis for the trustee's qualification"); A.R.S. § 33-807(A)(granting the trustee the "power of sale"). 

 

The Court also rejected the Plaintiff-borrower's argument that the trustees, as parties seeking to collect on the promissory notes, were required to demonstrate their authority to do so under Arizona's Uniform Commercial Code.  In so doing, the Court noted that the UCC does not govern liens on real property and, further, that the trustees were not seeking to collect on the underlying notes, but to sell the property under the trust deeds, which transferred interests in the property in order to secure repayment of the money owed under the notes. 

 

In addition, the Court rejected the Plaintiff-borrower's argument that if a beneficiary were not required to produce the original note, there was the risk that the original noteholder could later attempt to collect after the foreclosure had taken place.  The Court addressed this issue by noting that Arizona's anti-deficiency statutes precluded deficiency judgments against the type of residential properties owned by the Plaintiff.  A.R.S. § 33-814(g).

 

The Arizona Supreme Court concluded its analysis by observing that requiring beneficiaries to prove ownership of a note to defaulting borrowers before the commencement of a foreclosure would cause the mortgage foreclosure process to become time-consuming and expensive, and would also invite costly litigation. 

 

The Court thus ruled that the Plaintiff-borrower was not entitled to relief, and affirmed the dismissal of his complaints.

 

 

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: Cal App Ct Holds Lender's Purported Security Interest in Deposit Accounts Unenforceable

The California Court of Appeal, Second District, recently held that a lender's purported security interest in deposit accounts was unenforceable, because the debtor never had any "rights in the collateral" and never gave value for the security interest, so as to allow the lender's security interest to attach to the collateral.

 

A copy of the opinion is available at: 

http://www.courtinfo.ca.gov/opinions/documents/B224806.PDF.

 

As a result of a protracted dispute between developers over a real estate development partnership ("Development Partnership"), defendant developer ("Defendant Developer") bought out Plaintiff's partnership interest pursuant to a partnership sale agreement ("PSA").  The Development Partnership obtained a refinancing loan from a bank ("Claimant Bank"), which took a trust deed and security interest in the Development Partnership's real estate and personal property.

 

As set forth in the PSA, some of the proceeds from the loan were set aside to pay the Plaintiff for its partnership share and to pay lien claims against the Plaintiff.  The funds set aside were deposited into two separate accounts.  According to the PSA, the funds on deposit for Plaintiff's partnership share were to be released to the Plaintiff once Defendant Developer was satisfied that certain conditions had been met.  Plaintiff eventually transferred its partnership interest to the Development Partnership as set forth in the PSA, but Defendant Developer never transferred the funds on deposit to the Plaintiff.

 

Plaintiff filed an action, seeking a rescission of the PSA and damages, among other things.  The matter was referred to arbitration.  A partial final award found for Plaintiff on the rescission claims, and awarded Plaintiff almost $2 million in restitution plus sole ownership of the Development Partnership property.  The Superior Court confirmed the partial final award. 

 

While the arbitration was underway, Claimant Bank commenced a judicial foreclosure proceeding on the Development Partnership property, and filed a notice of default specifying that personal property collateral was also being foreclosed.  The trial court appointed a receiver to take possession of the Development Partnership property as well as "all rents, issues, profits, security deposits, royalties, tolls, earnings, income and other benefits payable."  The receiver was ordered not to take any action as to the funds in the two accounts until a determination was made that those funds constituted receivership assets.

 

In a second round of arbitration, Defendant Developer was found to have engaged in improper conduct, including:  (1) failing to cooperate in the transfer of the Development Partnership property to Plaintiff as previously ordered; (2) permitting the refinancing loan to go into default and foreclosure; (3) failing to release funds in the two accounts to the Plaintiff; and (4) alerting Claimant Bank to the funds in the deposit accounts.   

Accordingly, having concluded that it was no longer possible to restore ownership of the property to Plaintiff, the arbitrator awarded Plaintiff compensatory and punitive damages of around $26 million, as well as the funds on deposit in the two accounts, and attorneys' fees and costs.   The Superior Court confirmed the corrected final award and entered judgment for the Plaintiff.

 

Plaintiff then intervened in the foreclosure proceeding, claiming that it had superior rights to the funds in the two accounts because the funds were not "rents and profits" belonging to the receiver.  The trial court in the foreclosure action ruled in part that the two accounts were not part of the receivership estate, because "rents and profits" as defined by the deed of trust consisted of income from the property after the date of default.
 
Claiming to have a security interest in the deposit accounts, however, the Claimant Bank sought to intervene in the Plaintiff's action against Defendant Developer, arguing that the funds on deposit were the proceeds of its loan and were therefore covered by its security interest.  The trial court denied Claimant Bank's motion to intervene and granted the Plaintiff a writ of possession in the two accounts.  The county Sheriff levied the funds several months thereafter.  Claimant Bank, having acquired title to the Development Partnership property in the foreclosure action, pursued a deficiency for the amounts still owing on the loan, asserted a third-party claim to the funds in the deposit accounts and petitioned the court for a hearing on the validity of its claim. 

 

The trial court denied Claimant Bank's claim, reasoning that had the funds in the accounts been properly disbursed as originally contemplated by the PSA, those funds would not have been available at the time of the foreclosure action. 

 

Claimant Bank appealed.  The Court of Appeal affirmed, ruling that the Claimant Bank's security interest never attached to the two deposit accounts, because the Development Partnership never had "rights in the collateral" as required by Commercial Code Section 9203.

 

As you may recall, a security interest is defined as "an interest in personal property or fixtures which secures payment or performance of an obligation."  Com. Code § 1201(b)(35).  In addition, a security interest attaches and becomes enforceable if (1) "value has been given . . . (2) the debtor has rights in the collateral or the power to transfer rights in the collateral to a secured party," and (3) there is some evidence that the debtor intended to create a security interest in the collateral.  Com. Code §9203(b).

 

Noting that a security interest is enforceable if:  (1) the security interest has attached; (2)  the security interest has been perfected;  and (3) the security interest has priority over a conflicting claim, the Appellate Court examined the threshold question as to whether the security interest had attached to the loan proceeds  that were in the deposit accounts.  In so doing, the Appellate Court noted that a security interest attaches only to those rights which a debtor has in the collateral and that "mere possession of [. . .] collateral by a debtor is not sufficient to constitute 'rights in the collateral' under section 9203." 

 

Applying this test, the Appellate Court ruled that Claimant Bank's security interest did not include the funds in the two deposit accounts.  In so ruling, the Court noted that the Plaintiff was able to trace the funds in both accounts to the loan proceeds owed to it under the PSA, that the Development Partnership never had any "rights in the collateral," and that there was no evidence that the debtor intended the security interest to attach to funds due to the Plaintiff.

 

The Appellate Court further ruled that, because the funds were due to Plaintiff as payment for its partnership interest and to pay lien claims, Claimant Bank had given no value for the purported security interest in the deposit accounts and thus had no interest in those accounts.  Noting that Claimant Bank's security agreement and financing statement did not cover the proceeds of the refinancing used to buy out Plaintiff's partnership share,  the Court concluded that the proceeds on deposit were never intended to serve as security for the loan. 

 

Accordingly, the Appellate Court ruled that, because Claimant Bank's security interest never attached to the deposit accounts, the purported security interest was unenforceable, and the Court did not need to address any issues of perfection or priority to resolve the matter.   

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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Our updates are available on the internet, in searchable format, at:
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