FYI: 9th Cir Holds Loan Secured by Property Held in Trust for Family Member Can Be "Consumer" Loan

The U.S. Court of Appeals for the Ninth Circuit recently reversed the dismissal of a trustee borrower's claims under the federal Truth-In-Lending Act, Real Estate Settlement Procedures Act, and California's Rosenthal Fair Debt Collection Practices Act seeking rescission of a loan obtained to effectuate repairs upon a property inhabited by the trust's beneficiary.

 

In so ruling, the Ninth Circuit concluded that in her capacity as trustee, the borrower did not lose her rights and protections under the federal and state consumer protection statutes merely because she did not reside at the property, and the loan remained a consumer credit transaction.

 

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

 

A borrower ("Borrower") obtained a loan (the "Loan") in her capacity as a trustee from a lender ("Lender") to make repairs to a home occupied by her niece, the trust's beneficiary.  The property was the main asset of the trust and secured the Loan.

 

The Borrower subsequently filed suit against the Lender in federal court seeking rescission of the loan under the federal Truth-in-Lending Act, 15 U.S.C. § 1601, et seq. ("TILA") and the Real Estate Settlement Practices Act, 12 U.S.C. § 2601, et seq.  ("RESPA"), alleging that the Loan's disclosures were materially inconsistent with its terms in that they led her to believe the final payment was one year later than the date provided in the loan documents.  The complaint additionally sought damages against the Lender under section 1788.1(b) of California's Rosenthal Act California Civil Code §§ 1788 et seq. ("Rosenthal Act") for alleged unfair means to collect a consumer debt.

 

As you may recall, these remedies are available only in "consumer credit transactions." 15 U.S.C. § 1635(i)(4); 12 U.S.C. § 2606(a); Cal. Civ. Code § 1788.2(e).  For a loan to qualify as such under TILA, a borrower must demonstrate that the loan was extended to (1) a natural person, and was obtained (2) "primarily for personal, family, or household purposes"; extensions of credit to organizations and credit transactions performed for non-consumer purposes, such as loans for a business purpose are excluded, even if the loan is obtained by a natural person. Id. § 1603. 15 U.S.C. § 1602(i).  Like TILA, RESPA does not apply to "credit transactions involving extensions of credit primarily for business, commercial, or agricultural purposes" (12 U.S.C. § 2606(a)(1) and the Rosenthal Act defines a consumer credit transaction as a loan extended to a natural person for consumer purposes.  Cal Civ. Code. § 1788.2(e).

 

The Lender moved to dismiss the complaint, arguing without statutory or regulatory authority that a residential loan to a trust can be considered a consumer credit transaction only when the trustee-borrower lives at the residence.  The trial court granted the motion, and agreed with the Lender's position that the Loan was not a consumer credit transaction and did not afford the Borrower protections under TILA, RESPA, and the Rosenthal Act because the trust property securing the Loan was not her primary residence, but that of her niece.  The instant appeal followed.

 

On appeal, the Ninth Circuit analyzed the federal Consumer Financial Protection Bureau's Official Staff Commentary to Regulation Z, noting that following its general consumer credit rule would result in a different outcome from the trial court. 

 

Specifically, the Commentary's guidance is that "[c]redit extended for consumer purposes to certain trusts is considered to be credit extended to a natural person rather than credit extended to an organization." 12 C.F.R. pt.1026, Supp. 1, § 1026.3 Comment 3(a)-10. These "certain trusts" include trusts that were created for tax or estate planning purposes. Id. For consumers who place assets in a trust, the regulation thus effectuates TILA's definition of consumer credit transactions: those that are "primarily for personal, family, or household purposes." 15 U.S.C. § 1602(i). Because the trust in this case was for the benefit of the trustee's niece, it would be considered a consumer credit transaction under the Commentary.

 

The Commentary further explains that it is the substance of the transaction that matters, and that trusts should be considered natural persons under TILA so long as the transaction was obtained for a consumer purpose. 12 C.F.R. pt. 1026, Supp. 1, § 1026.3 Comment 3(a)-10.i.

 

On appeal, the Lender neglected to meaningfully address the relevant Commentary to Regulation Z, and instead relied upon the facts of three federal cases to support his proposition that when a trust borrows funds to finance repairs to a residence, the collateral for the loan must be the primary domicile of the trustee. 

 

The Ninth Circuit found these cases unpersuasive, as none stood for the general proposition that a trust cannot be a party to a consumer credit transaction under TILA unless the trustee resides at the property or that borrowing for a familial, personal or household purpose of the trust beneficiary is not a consumer credit transaction and makes a loan commercial in nature. See Amonette v. Indymac Bank, 515 F. Supp. 2d 1176 (D. Haw. 2007); Shirley v. Wachovia Mortg. FSB, No. 10-3870 SC, 2011 WL 855943 (N.D. Cal. Mar. 9, 2011); Galindo v. Financo Fin., Inc., No. 07-03991 WHA, 2008 WL 4452344 (N.D. Cal. Oct. 3, 2008).

 

Because the Borrower alleged a personal, consumer purpose for the Loan — that it was obtained to support a family member — and under the CFPB's Commentary to Regulation Z and TILA's general purpose to "construe the Act's provisions liberally in favor of the consumer", the Ninth Circuit concluded that the Borrower sufficiently alleged that the Loan was obtained for a consumer purpose and that the trial court erred in dismissing the complaint by construing the relevant statutes too narrowly.

 

In so ruling, the Ninth Circuit did not hold that the TILA remedy of rescission or cancellation is available when the collateral property is not the borrower's principal residence.

 

Accordingly, the trial court's dismissal of the complaint was reversed and 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

 

 

 

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FYI: Texas Sup Ct Holds Subrogation Available for Mortgagee That Fails to Cure Constitutional Defect

Answering a question certified to it by the U.S. Court of Appeals for the Fifth Circuit, the Supreme Court of Texas recently held that a lender is entitled to equitable subrogation where it failed to correct a curable constitutional defect in the loan documents under Tex. Const. art. XVI, 50.

 

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

 

In 2007, the borrower obtained a loan from original mortgagee to buy a homestead and secured the loan using her homestead as collateral.  In 2011, the borrower refinanced with a home-equity loan from another mortgagee. The borrower used the homestead as collateral, and the subsequent mortgagee paid the balance of the borrower's original loan to the original mortgagee.

 

In 2015, the borrower notified the subsequent mortgagee that the loan documents did not comply with Article XVI, § 50 of the Texas Constitution because the subsequent mortgagee had not signed a form acknowledging the homestead's fair market value. The borrower's letter requested the subsequent mortgagee to cure the defect within 60 days as required by § 50. The subsequent mortgagee sent the borrower another copy of the fair-market-value acknowledgment but failed to sign it. The subsequent mortgagee later sold and assigned the loan.

 

The borrower sent letter to the assignee notifying it of the constitutional defect and offering an opportunity to cure. The assignee did not respond, and the borrower sued to quiet title under the theory that the assignee failed to cure the constitutional defect in the loan documents within 60 days of notification, and therefore that the assignee did not possess a valid lien on her property.

 

The assignee argued that it is subrogated to original mortgagee's lien because its assignor paid off the balance of original mortgagee's loan to borrower. Both parties moved for summary judgment.

 

The federal trial court granted the borrower's motion and denied the assignee's motion. The court concluded that the assignee was not entitled to equitable or common law subrogation because it was negligent in failing to cure the constitutional defect in the loan documents.

 

The assignee appealed. 

 

On appeal, the U.S. Court of Appeals for the Fifth Circuit observed that it "has applied equitable subrogation in the face of a constitutionally-invalid home-equity loan" "[s]ince at least 1890," but none of the rulings "involve[d] a constitutional defect that is exclusively the fault of the lender, as is the case here" and interpreted prior rulings as being silent on the question "If the party seeking equitable subrogation could have satisfied the requirements of § 50(a)(6)(Q)(ix) but failed to do so, does that failure preclude it from invoking equitable subrogation?"

 

As you may recall, Article XVI, § 50 of the Texas Constitution -- specifically, § 50(a)(6)(Q)(ix) -- provides that the loan must be "made on the condition that" "the owner of the homestead and the lender sign a written acknowledgment as to the fair market value of the homestead property on the date the extension of credit is made." The lender has a 60-day window to cure its failure to sign the fair-market-value acknowledgment after being notified of the deficiency by the borrower; if the lender does not cure, it could be required to "forfeit all principal and interest" on the loan in an eventual foreclosure action. 

 

Having interpreted its prior rulings as being silent, the Fifth Circuit certified the following question to the Texas Supreme Court:

 

Is a lender entitled to equitable subrogation, where it failed to correct a curable constitutional defect in the loan documents under § 50 of the Texas Constitution?

 

The Texas Supreme Court noted that "[c]ommon law subrogation has coexisted with this constitutional scheme for more than a century. In the mortgage context, the doctrine allows a lender who discharges a valid lien on the property of another to step into the prior lienholder's shoes and assume that lienholder's security interest in the property, even though the lender cannot foreclose on its own lien. This Court has recognized the doctrine in the § 50 context since at least 1890."

 

The Court looked to one of its earliest cases, Texas Land & Loan Co. v. Blalock, which also involved a culpable lender but the Court ultimately held "despite the lender's knowledge that its own lien was unconstitutional, the lender was still entitled to subrogation because it paid off the purchase-money loan encumbered by [borrower's] property."  The Court also noted that "[n]one of our subsequent § 50 decisions has considered any factor other than the lender's discharge of a prior, valid lien. To the contrary, in this context, we have said that a lender's right to subrogation is "fixed" when the prior, valid lien is discharged."

 

The borrower argued that Texas voters eliminated subrogation in the 1990s by adopting specific amendments to § 50 thus eliminating the historical justification for the doctrine.

 

However, the Texas Supreme Court relied on its ruling in LaSalle Bank National Association v. White, which held Section 50(e) "does not destroy the well-established principle of equitable subrogation." It "contains no language that would indicate displacement of equitable common law remedies was intended, and we decline[d] to engraft such a prohibition onto the constitutional language." Adding, the constitutional provisions borrower relies on were enacted before LaSalle and indicate displacement of equitable common law remedies, furthermore, since LaSalle was decided, § 50 has been amended twice, but neither set of amendments added language addressing subrogation.

 

Finally, the borrower argued that "the availability of subrogation as a safety net erodes lenders' incentives to make loans that comply with all constitutional requirements and to promptly cure any defects." The assignee countered that "abolishing subrogation would result in a windfall to borrowers, that subrogation does not even make a lender whole because the amount of the subrogated first lien is usually less than the loan on which the borrower defaulted, and that abolishing subrogation would destabilize the Texas real-estate industry and increase the cost of borrowing money."

 

The Texas Supreme Court believed revisiting the wisdom of subrogation to be unwarranted given that home-equity loans have been legal in Texas for about twenty-four years while subrogation has been part of the common law for more than a century.

 

Accordingly, the Supreme Court of Texas held that under Texas law, a lender who discharges a prior, valid lien on the borrower's homestead property is entitled to subrogation, even if the lender failed to correct a curable defect in the loan documents under § 50 of the Texas Constitution. Therefore, it answered the certified question "yes".

 

 

 

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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FYI: 8th Cir Reverses Dismissal of Letter of Credit Claim Over Timing of Draw Request

The U.S. Court of Appeals for the Eight Circuit recently held that the failure to present the issuer of a letter of credit with draw request before the appointment of a conservator does not necessarily preclude recovery of damages by the beneficiary.

 

In so ruling, the Eighth Circuit reasoned that a contrary holding would require "letter of credit beneficiaries to be prescient of an impending conservatorship in order to recover damages."

 

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

 

At the request of a contractor, a credit union issued a letter of credit in the amount of $385,000 to an insurance company that provides contractor surety bonds. The insurance company issue several payment and performance bonds to contractor with the overall liability on the bonds exceeding four million dollars.

 

The letter of credit issued on July 8, 2015, provided: "We [credit union] warrant to you [insurance company] that all drafts under this CLEAN IRREVOCABLE LETTER OF CREDIT will be duly honored upon presentation of your draft on us . . . on or before the expiration date, or on or before any automatically extended date . . . ."  It then states that the letter of credit expires July 7, 2016 "but will be automatically extended for additional and consecutive one year terms" unless the credit union notified the insurance company of its intent to not renew at least thirty days before the original or any subsequent expiration date.

 

On May 25, 2017, the credit union notified the insurance company the letter of credit would mature July 6 and would not be renewed.

 

On June 23, 2017, the National Credit Union Administration Board (NCUAB) appointed itself conservator of credit union pursuant to 12 U.S.C. 1786(h).

 

On July 3, 2017, the insurance company timely presented the credit union with a request for payment in the amount of $385,000, but the credit union never issued the funds. Instead, on July 6, the credit union informed the insurance company it would not be issuing the requested funds, and notified the insurance company that on June 23 the NCUAB had appointed itself conservator of the credit union.

 

On July 20, the NCUAB sent the insurance company a letter explaining its broad authority as conservator under 12 U.S.C. 1787(b)(2) and (c), including the authority to repudiate contracts. The letter also explained how the NCUAB believed the continuation of the letter of credit would burden the credit union and hinder the orderly administration of its affairs. The NCUAB then concluded by repudiating the letter of credit, which it had determined was necessary to the conservation of the credit union's assets.

 

In response, the insurance company demanded the NCUAB pay it $385,000 in damages for repudiating the letter of credit. The NCUAB acknowledged 12 U.S.C. § 1787(c)(3) provides Insurance company a limited remedy for damages, but also noted that §  1787(c)(3)(A) limits a conservator's liability for repudiation damages to "actual direct compensatory damages determined as of the date of the appointment of the conservator," and because the insurance company had not presented the credit union with a draft as of the date the NCUAB appointed itself conservator on June 23, 2017, the insurance company had no claim for damages.

 

The insurance company filed a complaint in federal court seeking $385,000 in damages for wrongful repudiation and wrongful dishonor of a letter of credit under North Dakota's Uniform Commercial Code.

 

The NCUAB moved to dismiss the insurance company's complaint, asserting that the insurance company was entitled to no damages under § 1787(c)(3). The NCUAB also argued § 1787(c)(3) preempts North Dakota's Uniform Commercial Code to the extent that the state statute provides insurance company damages where the federal statute does not.

 

The trial court granted the NCUAB's motion and dismissed the insurance company's complaint. The trial court agreed with the NCUAB that § 1787(c)(3) preempted the North Dakota Uniform Commercial Code. It also agreed that the insurance company was not entitled to damages under § 1787(c)(3) because at the time of the NCUAB's appointment as conservator for the credit union (June 23, 2017),the  insurance company had not yet made a draw request on the letter of credit.

 

The insurance company appealed.

 

On appeal, the insurance company presented three main arguments. First, the insurance company argued the NCUAB had no authority to repudiate the letter of credit under 12 U.S.C. § 1787(c)(1) because a letter of credit is not a "contract."  See 12 U.S.C. § 1787(c)(1) (authorizing the conservator to repudiate "any contract").

 

The Eighth Circuit disagreed, noting when Congress enacted § 1787, common law defined the word "contract" as "a promise or a set of promises for the breach of which the law gives a remedy, or the performance of which the law in some way recognizes as a duty."  Restatement (Second) of Contracts § 1 (Am. Law Inst. 1981). Here, the credit union promised to pay insurance company $385,000 upon receipt of insurance company's proper draft, and North Dakota's Uniform Commercial Code provides a remedy for the breach of that specific promise. Thus, the Eight Circuit held that this fits the common law definition of a contract, and therefore that the NCUAB could repudiate the letter of credit.

 

Next, insurance company argued that if the letter of credit is a contract, then it is entitled to damages for the NCUAB's repudiation under § 1787(c)(3).

 

The Eighth Circuit agreed, rejecting the trial court's adoption of the District of New Hampshire's rationale that "no damages would be due as long as the triggering event" -- the presentation of a sight draft -- "had not occurred prior to the date of the appointment of the conservator."  See Credit Life Ins. Co. v. FDIC, 870 F. Supp. 417, 425-26 (D.N.H. 1993). The Eighth Circuit reasoned that this argument which "requires letter-of-credit beneficiaries to be prescient of an impending conservatorship in order to recover damages." 

 

Instead, the Court held that the failure to present the issuer of a letter of credit with a draw request before appointment of a conservator does not necessarily preclude recovery of damages under § 1787(c)(3).

 

Lastly, Insurance company argued that § 1787(c) does not preempt the letter of credit provisions of North Dakota's Uniform Commercial Code because the two laws are not in conflict.  However, the Eighth Circuit concluded the issue of preemption was premature until it is clear that the insurance company's recovery under the letter of credit provisions of North Dakota's Uniform Commercial Code exceeds the limits of § 1787(c)(3).

 

Accordingly, the Eighth Circuit reversed the judgment of the trial court and remanded.

 

 

 

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   |   Massachusetts   |   New Jersey   |   New York   |   Ohio   |   Pennsylvania   |   Texas   |   Washington, DC

 

 

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.

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Financial Services Law Updates

 

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and

 

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