FYI: 9th Cir Limits Scope of RESPA "Qualified Written Requests," Following Similar Seventh Circuit Ruling

The U.S. Court of Appeals for the Ninth Circuit recently held that written borrower demands seeking only information regarding loan origination issues, or modification of an existing loan, were not "qualified written requests" that triggered a servicer's duties under the federal Real Estate Settlement Procedures Act.

 

A copy of the opinion is available at:  http://www.ca9.uscourts.gov/datastore/opinions/2012/12/11/11-55412.pdf.

 

Plaintiffs borrowers ("Borrowers") obtained a home mortgage loan that was serviced by a bank ("Servicer').  The loan documents provided for, among other things, an escrow account into which Borrowers would make monthly payment to cover taxes, insurance, interest, and principal.  About a year after the loan agreement, Servicer notified Borrowers that the escrow account lacked sufficient funds to cover the upcoming 12-month period and that Borrowers would need to replenish the escrow account. 

 

Borrowers' attorney then sent a number of letters to Servicer disputing any obligation to make the increased payments.  One letter asserted that the loan documents did not accurately reflect the payment schedule that the loan broker had represented and demanded that Servicer revise the documentation to reflect the alleged original terms of the loan agreement.  A second letter made similar claims, but also stated that Borrowers would continue making the same payments as allegedly agreed in the original loan agreement.  

 

The final letter again asserted that the demand for increased payments was improper, even though the demand was consistent with the loan and documentation.  Servicer made no changes to Borrowers' account, and may allegedly not have responded to Borrowers' letters.

 

Borrowers first filed suit in California state court, alleging that Servicer violated state law, and later added claims under the federal Real Estate Settlement Procedures Act, 12 U.S.C. § 2605 ("RESPA").  Servicer removed the action to federal court.  The lower court dismissed the federal claims, ruling that the letters were not "qualified written requests" and remanded the action to state court.

 

Borrowers appealed.  The Ninth Circuit affirmed, ruling that because Borrowers' letters were not related to the servicing of the loan, they were not "qualified written requests" that triggered a duty to respond under RESPA.

 

As you may recall, RESPA requires servicers of federally-related mortgage loans to provide timely responses to "qualified written requests" seeking information relating to the servicing of the loan.  12 U.S.C. § 2605(e)(1)(A),(e)(2).  RESPA in turn defines a "qualified written request" as "a written correspondence, other than notice on a payment coupon or other payment medium supplied by the servicer, that – (i) includes, or otherwise enables the servicer to identify, the name and account of the borrower; and (ii) includes a statement of the reasons for the belief of the borrower, to the extent applicable, that the account is in error or provides sufficient detail to the servicer regarding other information sought by the borrower."  12 U.S.C. § 2605(e)(1)(B).

 

In addition, RESPA specifically defines "servicing" as "receiving any scheduled periodic payments from a borrower pursuant to the terms of any loan, including amounts for escrow accounts . . . , and making the payments of principal and interest and such other payments with respect to the amounts received from the borrower as may be required pursuant to the terms of the loan."  12 U.S.C. § 2605(e)(1)(A), (e)(2) (i)(3).  Failure to respond to such inquiries entitles the borrower to recover actual damages and, in some circumstances, statutory damages of up to $1,000.  12 U.S.C. § 2605(f).

 

Citing a Seventh Circuit opinion for its general approach to defining a "qualified written request," the Court of Appeals concluded that a qualified written request requires a response only if it relates to the servicing of a loan.  See Catalan v. GMAC Mortgage Corp., 629 F.3d 676 (7th Cir. 2011)(defining what types of requests constitute "qualified written requests" and thus trigger a servicer's duty to respond).  In so ruling, the Ninth Circuit noted that the duty to respond does not derive from the definition of "qualified written request," but from Section 2605(e)(1)(A), "which requires, as conditions for triggering the duty to respond, both (1) that the letter is a qualified written request and (2) that it requests information relating to servicing." 

 

The Ninth Circuit further reasoned that since servicing "does not include the transactions and circumstances surrounding a loan's origination – facts that would be relevant to a challenge to the validity of an underlying debt or the terms of a loan agreement," letters related only to a loan's validity or terms are not qualified written requests that require a servicer to respond. 

 

Turning specifically to Borrowers' letters in this case, the Ninth Circuit concluded that their content merely challenged the terms of the loan and mortgage documents.  As such, the Court ruled, the letters did not relate to the servicing of the loan.  As the Court explained, although RESPA does not require "magic words," because the letters alleged fraud or mistake associated with the original loan agreement, and requested a loan modification to reflect the "original terms" of the agreement, they were not qualified written requests that related to the servicing of the loan. 

 

Accordingly, because Borrowers' letters did not relate to servicing, the Ninth Circuit ruled that the letters, while written requests generally, were not the sort of "qualified written requests" that triggered Servicer's duty to respond under Section 2605(e). 

 

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:
http://updates.kw-llp.com

 

FYI: 8th Cir Rules Against Bank on "Floating Lien" Defense to BK Trustee's Avoidance Action

The Bankruptcy Appellate Panel for the Eighth Circuit recently held that a Chapter 7 trustee could recover funds used to pay down a loan as a preferential transfer, ruling that, because the bank waited until the start of the 90-day preference period under Section 547(b) to perfect a lien on a loan it previously made to the debtor, the "floating lien" or "inventory/accounts receivable" defense was not available to prevent the trustee from avoiding the preference. 

 

The BAP also ruled that:  (1) the bank could not use the "ordinary business terms" defense under Section 547(c)(2)(B) to keep funds from the mutually agreed liquidation of debtor's business because liquidation was not in the "ordinary course"; (2) the bank's release of liquidation proceeds to debtor did not constitute "new value" allowing bank to setoff funds in debtor's bank account, as the liquidation proceeds were transferred during the preference period and were expressly intended to satisfy the debt owed to the bank; (3) the bank was not entitled to the fees it paid to a consultant to analyze its chances of recovering the outstanding debt from the debtor; and  (4) the bank held a security interest in the deposited funds at the start of the preference period as a result of its setoff rights under the loan documents and state law.

 

A copy of the opinion is attached.

 

A business ("Debtor") obtained a loan from defendant bank ("Bank") for purposes of purchasing inventory for one of its chain stores.  Debtor granted Bank a security interest in its personal property, including inventory, accounts, fixtures, and proceeds.  Bank did not perfect its security interest at the time of the loan.

 

Several years later, concerned about Debtor's ability to repay the loan, Bank hired a consultant to conduct an analysis of Debtor's business and to determine the best strategy for recovering on the outstanding debt.  Debtor stopped making payments on the loan shortly thereafter, and Bank demanded immediate payment of over $250,000 still owing on the loan.

 

Bank and Debtor later entered into an agreement whereby Debtor would retain a liquidation service and conduct a going-out-of-business sale.  A few days after entering the agreement to liquidate the business, Bank perfected its lien on Debtor's inventory, accounts, fixtures, and proceeds by filing a UCC financing statement with the Minnesota Secretary of State.  As of the date of the filing of the financing statement, the estimated value of Debtor's inventory exceeded Debtor's debt to Bank.  Further, Debtor had funds on deposit at Bank on the day the financing statement was filed that were subject to Bank's setoff rights under the loan agreement. 

 

All the proceeds from the subsequent going-out-of-business sale, approximately $427,000, were deposited into Debtor's account at Bank.  Debtor's loan obligation to Bank was thus repaid in full from the liquidation sale proceeds deposited in Debtor's account.  An additional amount of roughly $6,000 was also paid to Bank from Debtor's account to pay for the services of the liquidation company.

 

About a month after the completion of the liquidation sale, an involuntary Chapter 7 bankruptcy petition was filed against Debtor.  The bankruptcy trustee ("Trustee") sought to avoid the payment of the Bank's debt as a prohibited preferential transfer.  Moving for summary judgment, Bank argued that it had a "floating lien" or "inventory/accounts receivable" defense under Section 547(c)(5), thereby arguing that the bank's lien automatically attached to Debtor's inventory and receivables after the loan was made.  Bank also asserted that it had setoff rights to Debtor's deposit account, regardless of whether it had a perfected security interest in other assets of Debtor.

 

The Bankruptcy Court denied Bank's summary judgment motion, ruling that the perfection of Bank's lien occurred within the 90-day perfection period under Section 547(b) and that Bank's "floating lien" defense thus did not apply to a security interest perfected during that period.   After a trial, the Bankruptcy Court entered judgment in favor of Trustee for the proceeds of the liquidation sale relating to the payment of the debt owed to Bank, roughly $250,000, but not for the pre-liquidation funds in Debtor's deposit account against which Bank had exercised its setoff rights.

 

Bank appealed the denial of its motion for summary judgment.  Trustee cross appealed as to Bank's setoff rights to Debtor's pre-liquidation funds on deposit and the payment of Bank's consulting fees.

 

The Bankruptcy Appellate Panel ("BAP") affirmed in all respects, except for the credit given to Bank for its consulting expenses, on which point the BAP reversed.

 

As you may recall, a chapter 7 trustee may recover certain preferential transfers made "on or within 90 days before the filing of the [bankruptcy] petition . . . ."   11 U.S.C. § 547(b).  The trustee, however, may not avoid a so-called "floating lien" on inventory and receivables acquired during that preference period. 

 

Specifically, section 547(c)(5) provides that the trustee may not avoid a transfer "(5) that creates a perfected security interest in inventory or a receivable or the proceeds of either, except to the extent that the aggregate of all such transfers to the transferee caused a reduction, as of the date of the filing of the petition and to the prejudice of other creditors holding unsecured  claims, of any amount by which the debt secured by such security interest exceeded the value al all security interests for such debt on the later of – (A) (i) [preferential transfers made] 90 days before the date of the filing of the petition; or (ii) with respect to a [preferential] transfer . . . one year before the date of the filing of the petition; or (B) the date on which new value was first given under the security agreement creating such security interest.  11 U.S.C. § 547(c)(5)("Section 547(c)(5)").

 

In addition, a trustee may not avoid a transfer – "(2) to the extent that such transfer was in payment of a debt incurred by the debtor in the ordinary course of business or financial affairs of the debtor and the transferee, and such transfer was . . . . made in the ordinary course of business .  .  . of the debtor and the transferee; or (b) made according to ordinary business terms."  11 U.S.C. § 547(c)(2). 

 

Finally, the "new value defense" prohibits the trustee from avoiding a transfer "(4) to or for the benefit of a creditor, to the extent that, after such transfer, such creditor gave new value to or for the benefit of the debtor – (A) not secured by an otherwise unavoidable security interest; and (B) on account of which new value the debtor did not make an otherwise unavoidable transfer to or for the benefit of such creditor."  11 U.S.C. § 547(c)(4).

 

Noting that Section 547(c)(5)'s floating lien defense is not available to the extent that a creditor's position is improved as a result of after-acquired inventory and receivables, the BAP focused on Bank's position at the beginning of the 90-day preference period.  Citing In re Qualia Clinical Service, Inc. 652 F.3d 933, 939 (8th Cir. 2011), the BAP observed that "[a] creditor who . . . enters the [preference] period unperfected is properly deemed, for purposes of section 547(c)(5) to have an interest of zero value."   In so doing, the BAP noted that the Bank entered the preference period unperfected, but that the Bank perfected its security interest precisely on the 90th day prior to the filing of the involuntary bankruptcy petition.  Accordingly, the BAP ruled that the perfection of Bank's security interest on that 90th day constituted an avoidable preference, notwithstanding the fact that once its lien was perfected, Bank did not improve its position since it became oversecured and remained so until the loan was repaid in full.

 

The BAP also rejected Bank's arguments that:  (1) the payments it received from the going-out-of-business sale were made "according to ordinary business terms" under Section 547(c)(2(B) pursuant to the agreement between Debtor and Bank to retain a liquidation company to run the sale; and (2) Bank gave "new value" to Debtor's estate by paying the liquidation company for its services and releasing funds from the deposit account in which Bank supposedly had setoff rights.  

 

In ruling that neither the "new value" defense nor the "ordinary course" defense applied to Trustee's preference action, the BAP noted that a going-out-of-business sale resulting in the cessation of the business was not in the "ordinary course" and further that, although an account with setoff rights is considered a secured claim, the proceeds from the liquidation sale were transferred into Debtor's account during the preference period while Debtor was insolvent and for the express purpose of paying the debt owed to Bank.  See Kroh Bros. Development Co. v. Commerce Bank of Kansas City, N.A., 86 B.R. 186, 191-92 (Bankr. W.D. Mo. 1988) (ruling that a deposit is a voidable preference and setoff is not allowed if the deposit is made with the purpose of satisfying a bank's claim and the other statutory elements are met).  Observing that no other creditors had been paid on preexisting debts and that Bank did not release any of the liquidation proceeds until it was satisfied that it would be paid in full, the court explained, because "the purpose of the liquidation, and deposit into the account, was to pay the Bank's debt . . . the Bank did not obtain a setoff right against the liquidation proceeds."

 

As to Trustee's cross-appeal with respect to Debtor's funds on deposit prior to the liquidation sale, the BAP focused on the fact that Bank held a security interest in those funds at the start of the preference period as a result of its setoff rights under the loan documents and state law, rather than on whether Bank actually exercised those setoff rights at the start of the 90-day preference period.  In so doing, the BAP ruled that the payment to Bank from the funds on deposit prior to the liquidation was not a preferential transfer or improper setoff avoidable by the Trustee.

 

Finally, the BAP also ruled that Bank was not entitled to the consulting fees it paid for purposes of assessing whether Bank would be able to recover on its loan.  These fees, the BAP reasoned, were for a service ordered by Bank to analyze its strategy for recovering the outstanding debt.

 

Accordingly, the BAP agreed with the Bankruptcy Court that the payoff of the loan was a preferential transfer to Bank, and thus affirmed the judgment in favor of Trustee.  However, disagreeing that Bank was entitled to a credit against the judgment for the consulting fees, the BAP reversed on that issue and increased the amount of the judgment in Trustee' favor.

 

 

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:
http://updates.kw-llp.com