Archive for the 'Defending Foreclosures' Category

Predatory Lending Defense"'> Predatory Lending Defense

The concept of “predatory lending” has been around for some time, not as a foreclosure defense unto itself but as an umbrella term for defenses sounding in things like unconscionability, unclean hands and equitable estoppel. The Connecticut Appellate Court seems to have changed that in its 2016 decision in Bank of America, N.A. v. Aubut. Our courts now recognize predatory lending as a defense that precludes foreclosure if the original lender knew or should have known that the loan was destined to fail.

Courts used to excuse banks for knowingly making bad loans

Before 2007 there was a huge demand for mortgage backed securities. Since mortgages are the primary ingredient of mortgage backed securities, the huge demand for the securities meant a huge demand for mortgages. That, in turn, meant a decline in the quality of the mortgages. In other words, mortgage originators made loans to people who could not afford them. The originators didn’t care whether the borrowers could afford the loans because the originators sold the loans into securitizations, making them somebody else’s problem. See The Big Short.

But the “lender, you should have known better” foreclosure defense never got any traction, mainly because the courts had refused to impose on lenders a duty to make sound lending decisions.

Connecticut Appellate Court changes the philosophy

The Appellate Court in Aubut seems to have changed that philosophy. The borrowers alleged a special, or affirmative, defense that the plaintiff could not foreclose because “the loan which was originated by [the original plaintiff] was unaffordable.” The court considered whether this unaffordability defense – which the borrowers had captioned “predatory lending” – was legally viable. It noted that there is no legal authority that coherently defines a predatory lending defense. The defendants argued that “their predatory lending allegations should be considered within the context of the recognized equitable defenses of fraud, unclean hands, unconscionability, and equitable estoppel.” The court agreed, noting that it did not really matter what the defendants called the defense as long as it provided the plaintiff with sufficient notice of the facts claimed and the issues to be tried. And, the borrowers had alleged a litany of facts, which, if true, supported a claim that the original lender knew or should have known that they could not afford the loan.

The court then set about fashioning a new defense. It noted that since foreclosure is an equitable remedy, a court can withhold it on equitable grounds. The predatory lending defense implicated the recognized equitable defenses of fraud and unconscionability, unclean hands, and equitable estoppel. These principles can be combined to plead a single special defense of predatory lending asserting that because the original lender knew or should have known that the loan was “destined to fail from [its] inception,” the plaintiff should not be permitted to enforce the mortgage.

Though the court did not expressly impose a duty on lenders to determine whether the borrower can afford a prospective loan, it seems to have implied one because the notion that the lender “knew or should have known” suggests foreseeability, which in turn suggests a duty. For example, negligence law imposes a duty to prevent foreseeable harm to others. Foreseeability in the negligence context is determined by whether the actor knew or should have known that the act would cause the harm. In the foreclosure defense context, the harm is a loan that failed.

Now Connecticut has a predatory lending foreclosure defense

In short, under Aubut, a residential mortgage borrower can avoid foreclosure if the loan was predatory when made. A loan is predatory if the originator knew or should have known that it would be just a matter of time before the borrower defaulted. Given this definition of predatory, mortgage originators may well have a duty to make an affordability determination before making a mortgage loan.

Mortgage Securitizations May Help Borrowers

Endorsements in blank and Pooling and Servicing Agreements may make it impossible for banks to prove they have the right to foreclose. I explained endorsements in blank in Produce the Note, An Alternate View, Part 3 and the right to foreclose, or standing, in Produce the Note, An Alternate View, Part 1. The Pooling and Servicing Agreement (PSA) is the heart of a mortgage securitization. It requires a “depositor” or “transferor” to transfer all of the mortgage loans being securitized to a trustee who “holds” them for the benefit of the investors who buy the mortgage back securities.

The mortgage notes transferred to the trustee pursuant to the PSA must be endorsed in blank. But, under UCC 3-301, transferring possession of a bearer note transfers only the right to enforce the note. It does not transfer ownership of the note and ownership, I have argued, determines who has the right to foreclose. UCC 3-301 affords a non-owner of the note, or even a thief, the right to enforce the note.

Because PSAs routinely required notes in the pool to be endorsed in blank, parties in the secondary mortgage market often endorsed notes in blank well before the PSA depositor or transferor would come into possession. So, if the foreclosing party produces the PSA as proof of its ownership on a motion to dismiss for lack of standing, the borrower will want to know who transferred possession to the foreclosing party and to see proof of that transferee’s ownership. This process should be pursued for every link in the chain all the way back to the party that endorsed the note in blank. The foreclosing party normally has the burden of proof on standing and it likely will be difficult, if not impossible, for the foreclosing party to prove ownership for every transferee in the chain. The longer the chain, the harder it will be. If proof of ownership is lacking at any link, it follows that the foreclosing party has not established the right to foreclose and the foreclosure action should be dismissed.

Forensic Mortgage Audits are of Limited Utility

A forensic mortgage audit is an analysis of the loan from the application, to the closing and through the default. The primary goal is determine whether there are violations of the Truth in Lending Act (TILA) or the Real Estate Settlement Procedures Act (RESPA). A secondary goal is to determine whether loan payments were properly applied and all loan charges are consistent with the loan documents. Forensic auditors maintain that this information can give a borrower leverage in mortgage modification negotiations. I’m not so sure.

TILA and RESPA violations, or improper payment applications and loan charges, are claims that the borrower must prove in court. Merely presenting a forensic mortgage audit report that concludes the bank engaged in wrongdoing does not mean that the bank engaged in wrongdoing. The bank is entitled to have the borrower’s claims follow the normal litigation process. This means pleadings, documents discovery, depositions, experts, dispositive motions and possibly a trial. The bank can subject the audit report, and the person that prepared it, to close scrutiny. The bank will have its own competing audit report. This is all time consuming and expensive for the borrower. The banks, of course, know this. They also know that a borrower in mortgage default is not likely to have the financial resources to pay a lawyer to fight the fight. It’s true that this type of litigation is also expensive for the bank, but the bank may just want to see how far into the litigation the borrower’s resources will take him. Think of it like a game of litigation chicken. The bank is in a better position to win that game.

MERS Mortgages May Be Invalid

A mortgage loan has at least two parts: a note and a mortgage instrument. The note evidences the debt and the mortgage instrument provides an interest in real property as collateral for repayment of the debt. In a non-MERS mortgage loan transaction, the borrower signs a note payable to the lender and a mortgage instrument giving the lender an interest in the property. In a MERS mortgage loan transaction, the borrower signs a note payable to the lender but the mortgage instrument gives the mortgage interest to MERS instead of the lender. This splitting of the note and mortgage may make the mortgage interest invalid, which would make the mortgage loan an unsecured debt.

To see why, it’s helpful to consider a non-MERS loan where the original lender attempts to assign, or sell, only the mortgage interest and not the underlying debt. The original lender in a non-MERS loan owns the debt and has the mortgage interest in the property. It is a fairly universal principle that where a party tries to assign only the mortgage interest, without the underlying debt, the transaction is a nullity. It can’t be done. The putative assignee gets no mortgage interest in the property and acquires no right to foreclose. Logic suggests that if the original lender can’t transfer a mortgage interest to a party that does not have the debt, neither can the borrower. MERS does not make, buy or sell loans. Its sole function is to receive the mortgage interest. Thus, in a MERS mortgage transaction, the mortgage interest is purportedly created in a party that does not also have the underlying debt. This, as we’ve seen, cannot be done.

Of course, MERS and the bank will claim that MERS takes the mortgage interest only as the lender’s “nominee,” whatever that means; MERS mortgages do not define “nominee.” They do, however, usually say things like “MERS is the mortgagee under this security instrument” and “MERS holds only legal title to the interests granted herein.” They also usually purport to give MERS the right to foreclose. This gives the borrower a good argument that the mortgage instrument certainly purports to vest the mortgage interest in MERS. At worst, MERS mortgages are ambiguous on the point, which under the well-known contra proferentem rule, requires the mortgage to be interpreted against the party claiming the mortgage interest.

The Connecticut Supreme Court will be considering this argument regarding the invalidity of MERS mortgages in a case most likely to be heard in the Fall 2011.

What is MERS?

MERS, or Mortgage Electronic Registration System, Inc., is a company formed by the residential mortgage lending industry to avoid paying government mortgage recording fees and to make it simpler to buy and sell residential mortgage loans. It is easier to understand what MERS is if you first understand why it was created. A mortgage loan has two parts: a promissory note and a mortgage instrument (mortgage deed or deed of trust). The mortgage instrument must be recorded with a governmental office. In most states, the governmental recording office is the County Clerk or County Recorder. In other states, like Connecticut, the governmental office is the Town Clerk. The governmental office charges a fee to record the mortgage instrument. Recording helps potential new creditors evaluate whether to accept the mortgaged property as collateral for a loan because it determines the order in which the creditors are paid if the property is sold. Recording also identifies the parties claiming interests in the property. This information can be necessary to foreclosure proceedings. It is also important to know where to direct questions about the claimed interest.

The mortgage securitization industry is in the business of buying, selling and pooling mortgage loans and then selling rights to receive a fraction of the payments on the mortgages in the pool. Every time a mortgage loan is sold, an “assignment of mortgage” or “mortgage assignment” is supposed to be filed with the government recording office. The assignment must specifically describe the individual mortgage being assigned and must be signed by the assignor. The recording office charges a fee for recording the assignment. Since securitizations involve hundreds or thousands of mortgage loans, it is burdensome to prepare and sign an assignment for each individual loan. It is also difficult and expensive to identify the proper recording office and to pay the recording fee for each assignment.

The mortgage industry formed MERS to avoid the burdens and costs associated with recording mortgage assignments. Think of MERS as a club, with membership open to mortgage loan originators, buyers and sellers. The mortgage loan originator who is a MERS member has the borrower sign a note payable to the originator and a mortgage instrument in favor of MERS. The borrower is charged the recording fee as a closing cost. The closing agent for the loan sees to it that the mortgage instrument is recorded in MERS’ name in the proper recording office. The member-originator can sell the loan to another MERS member without having to record a mortgage assignment. The buyer-member can also turn around and sell the loan without having to record an assignment. The members are supposed to report mortgage loan sales to MERS so that MERS can keep track of who owns which debt. If MERS receives an inquiry about a mortgage interest, or is named in a foreclosure proceeding, MERS notifies the member who owns the associated debt.

The industry’s theory is that MERS is merely a placeholder in the recording office for the owner of the debt. As we will see in future posts, however, there is an argument that giving the note to one party and the mortgage interest to another voids the mortgage interest such that the loan is unsecured.

Motion to Dismiss for Lack of Standing

Produce the Note, An Alternate View, Parts 1, 2 and 3 explained why borrowers might be better off asking the foreclosing party to prove ownership of the debt rather than asking it to produce the note. But how and when does the borrower go about asking the lender to do either of these things? In my view, the best way to do it is by a formal motion to dismiss for lack of standing. Part 1 of the Produce the Note series explained that standing is an aspect of subject matter jurisdiction and that if the foreclosing party lacks standing, the court lacks subject matter jurisdiction. If the court lacks subject matter jurisdiction, the case must be dismissed. When a borrower asks the foreclosing party to prove ownership of the debt (or to produce the note if the borrower goes that route), the borrower is really asking the court to dismiss the case because the foreclosing party can’t prove ownership of the debt (or produce the note). Whether the borrower does this informally, by making the request at a court appearance for example, or formally, by filing a written request with the court, the borrower’s request is a motion to dismiss for lack of subject matter jurisdiction. If the borrower chooses to ask the foreclosing party to prove it owns the debt, the borrower should make a formal written motion. The mortgage industry wants to prove standing merely by producing the note and that is all the courts have been requiring. The borrower needs to why producing the note is not sufficient and that requires a written explanation.

One of the best features of the lack of subject matter jurisdiction is that in some jurisdictions, like Connecticut, it cannot be waived or conferred by consent. This means that the borrower can raise it at any time. Other jurisdictions may require the borrower to do something, like raise it as a defense in the pleadings, to preserve the right to move to dismiss later. Assuming the borrower has properly preserved it, or doesn’t have to, the question of when to move to dismiss for lack of subject matter jurisdiction is really a question of strategy in a particular case. It may not be beneficial to do it early in the case when, for example, the borrower is participating in the Foreclosure Mediation Program (CT) or the Foreclosure Settlement Conference Program (NY). The goal of these programs is to modify the mortgage to keep the borrower in the property. They are essentially “court-annexed” programs, which means that if there is no case pending against the borrower, the borrower cannot participate in the program. A successful motion to dismiss will take the borrower out of the program because it results in there being no case. On the other hand, it may be beneficial to do it early in the case when no court-annexed program is available to the borrower as in the case of an investment property. In those circumstances, the borrower might get some leverage in negotiating a workout or modification if the foreclosing party is facing dismissal.

Produce the Note, An Alternate View, Part 3

Parts 1 and 2 in this series explained that the produce the note defense is based on UCC 3-301 which provides a “holder” with the right to enforce the note. UCC 1-201(21)(A) defines “holder” as “the person in possession of a negotiable instrument that is payable either to bearer or to an identified person that is the person in possession.” The reason that producing the note makes it easy for the foreclosing party to prove standing to foreclose stems from the principle that the possessor of a note payable to bearer has a right to enforce the note. UCC 3-205 tells us that a note becomes payable to bearer through an endorsement in blank, which occurs when the person to whom the note is payable writes on it “pay to the order of”, leaves a blank space and then signs below the blank space. The endorsement can be on the note itself or on a page attached to the note called an “allonge.” Endorsing the note in blank makes the note “bearer paper” which means that whoever “bears,” or possesses, it has the right to enforce it.

Calling for production of the note plays right into the foreclosing party’s hand. If the note is endorsed in blank, and virtually all notes that were part of mortgage securitizations were endorsed in blank, all the foreclosing party needs to do is produce the note to show possession (together with evidence that it possessed the note at the time it started the foreclosure lawsuit). But it does not even have to do that. UCC 3-309 provides that a person who does not have possession of the note can nonetheless enforce the note as long as it can prove that it once had possession and had a right to enforce the note when it had possession. Foreclosing parties do this with a “lost note affidavit.”

For these reasons, borrowers would be better served by taking the position that the foreclosing party has to own the debt to have the right to foreclose and merely producing the note does not establish ownership (see Parts 1 and 2 of this series). It is far more difficult for a foreclosing party to produce compelling evidence of ownership than it is for that party to produce a bearer note or a lost note affidavit. In fact, I have raised this argument many times and have yet to see a single foreclosing party produce any credible evidence of ownership. That’s not to say that all the cases where I have raised the argument have been dismissed. The trial courts have been grappling with the owner-holder distinction. The Connecticut Supreme Court has agreed to resolve the issue in one of my cases and I expect the case to be heard in the Fall of 2011. In the same case, the Supreme Court will consider the validity of MERS mortgages, which I will make the subject of future posts.

Produce the Note, An Alternate View, Part 2

Picking up where I left off in Produce the Note, An Alternate View, Part 1, UCC 3-301 is entitled “Person Entitled to Enforce Instrument.” It provides in relevant part that the “Person entitled to enforce” an “instrument” is the holder of the “instrument.” UCC 3-104 defines “instrument” as “an unconditional promise or order to pay a fixed amount of money.” In other words, as far as the UCC is concerned, an instrument is a promissory note. Instruments under the UCC do not include mortgage deeds or deeds of trust. This is the main problem with the produce the note defense. By the express terms of UCC 3-301, the party that can produce the note has nothing more than the right to enforce the note. But, the foreclosing party is not trying to enforce the note. The foreclosing party is trying to enforce the mortgage deed or deed of trust because it’s the mortgage deed or deed of trust, not the note, that describes the lender’s rights to the property and how to exercise those rights.

Not only is UCC 3-301 expressly limited to the enforcement of notes, no court can expand its reach to mortgage deeds or deeds of trust. The statute provides that “[a] person may be a person entitled to enforce the instrument even though the person is not the owner of the instrument or is in wrongful possession of the instrument.” We saw in Part 1 that at common law the owner of the debt is directly injured by its non-payment (“common law” is judge made law as opposed to legislature made law). UCC 3-301 does not require any injury. It gives the right to enforce the note to a nonowner or even a thief, i.e., a person “in wrongful possession of the instrument.” Because the statute provides a right to sue without requiring an injury, it is “in derogation of the common law” or, more simply, changes common law. It is a fairly universal principal that statutes in derogation of the common law must be “strictly construed.” That’s just a complicated way of saying that a judge can’t expand a statute that changes the common law; the statute means only what it says and nothing more. Under this principle, a judge can’t expand UCC 3-301 to apply to the enforcement of mortgage deeds or deeds of trust.

In Part 3, I will discuss how producing the note actually makes it easier for a “lender” to overcome challenges to its standing.

Produce the Note, An Alternate View, Part 1

“Produce the note” has been a popular mortgage foreclosure defense since the revelation that lenders often do not have the “paperwork” necessary to foreclose.  This is the first post in a series that will explain why the defense may be a misstatement of the law and actually may make it easier for a lender to overcome what might otherwise be an insurmountable problem.

The produce the note defense is rooted in the requirement of standing, which is an aspect of subject matter jurisdiction.  If the foreclosing party lacks standing, the court lacks subject matter jurisdiction and the foreclosure action must be dismissed.  This does not mean that the debt or mortgage is unenforceable.  It means that the wrong party commenced the foreclosure action.  The right party can try again but make no mistake — a dismissal is a fantastic result for a borrower.

To have standing, the foreclosing party must have a direct injury or be authorized by statute to foreclose.  The purpose of a foreclosure action is to remedy the injury resulting from the non-payment of the debt.  The party who is owed the debt is the one that is injured by non-payment.  The owner of the debt is the party who is owed the debt.  In short, the owner of the debt has a direct injury from the borrower’s failure to pay and thus has standing to foreclose.

In my experience, foreclosing parties do not try to establish standing by direct injury.  Instead, they claim statutory authority to foreclose.  More specifically, they rely on section 3-301 of the Uniform Commercial Code (commonly called the “UCC”).  Section 3-301 provides the “holder” of the note with the right to enforce the note.  For our purposes, “holder” under the UCC means the person in possession of a note.

The produce the note defense is based on theory that a party who cannot produce the note does not possess the note and so does not have the right to enforce it.  The flaw in the defense, as we’ll see in future posts in the series,  is that the right to enforce the note, without more, is irrelevant to the right to foreclose the associated mortgage.

Foreclosure is Not Neccessarily Flipping a Switch

When you took your mortgage loan, you signed a mortgage instrument, which gave the lender an interest in your real estate as collateral for repayment of the mortgage loan. The mortgage instrument normally is called a “mortgage deed” or “deed of trust” depending on the state where the property is located. The mortgage instrument provides that if you do not pay the loan, you are in default. This activates the lender’s right to take the collateral. “Foreclosure” is the process by which the lender takes the collateral.

The steps in the foreclosure process are determined by the state where the property is located. Some states, like Connecticut and New York, are “judicial” foreclosure states. This means that the lender must start a lawsuit against you in order to foreclose. The lender’s goal is a foreclosure judgment. The lawsuit is, for the most part, like any other lawsuit, which is to say that it can take considerable time for the lender to obtain the foreclosure judgment. The borrower has rights that it can exercise as part of the foreclosure lawsuit that can delay the foreclosure judgment or, in some circumstances, stop the lawsuit entirely. This is “foreclosure defense.” So, in Connecticut and New York (and possibly any other judicial foreclosure state) a lender does not foreclose merely by flipping a switch. With proper assistance, the property owner can often retain the property for an extended period.

I frequently use a train analogy to describe the foreclosure lawsuit process. The first stop on the train is the summons and complaint, which starts the lawsuit. The foreclosure judgment is the last stop. There are a number of stops between the summons and complaint and foreclosure judgment. Foreclosure defense is trying to make sure the lender moves as slowly as possible between stops and attempting to insure that the lender makes every stop. Sometimes a borrower can derail the train, which means that the lender has to start the process all over again.

Connecticut and New York have programs associated with foreclosure lawsuits that are designed to help homeowners and lenders achieve a mortgage modification. The programs, in addition to helping with modification, slow the foreclosure lawsuit process. Connecticut’s program is called “Foreclosure Mediation” and New York’s is the “Foreclosure Settlement Conference Program.” Borrowers are admitted to these programs when the foreclosure lawsuit starts.

The foreclosure process is closer to flipping a switch in nonjudicial foreclosure states because the lender does not need to involve the courts. Instead, it follows the procedure set forth in the mortgage instrument, which ordinarily provides the lender the right to sell the property at an auction on a specified number of days notice to the borrower.

Some states provide for both judicial and nonjudicial foreclosures. Click here for RealtyTrac’s state-by-state listing of foreclosure procedures. I don’t know how RealtyTrac calculated the “Process Period” but my experience in Connecticut and New York has been different.