CFPB Eliminated Dual Tracking

The CFPB eliminated dual tracking, which occurs when the bank simultaneously considers a modification application and moves ahead with foreclosure. These things plainly are inconsistent with one another, especially if the borrower loses the property before the bank makes a decision on the modification application.

Dual or double tracking was particularly problematic for borrowers because they often misunderstood that they were being, or could be, double tracked. They often failed to respond to foreclosure notices because the bank told them it would not conduct a foreclosure sale until it decided the modification application. To borrowers, this meant that they didn’t have to worry about the notices the bank sent, or any summons and complaint. The problem for these borrowers is that foreclosure is a process that ends with a foreclosure sale but starts with something else (the “something else” varies by jurisdiction). There are often actions that the borrower could undertake to delay the foreclosure sale but they have to take them at the appropriate time or they’re lost forever. Borrowers were lulled into inaction and then prejudiced by their inaction.

CFPB Amended RESPA Regulations to Stop Dual Tracking

The RESPA rules are contained in Regulation X, which the CFPB amended effective January 10, 2014. The amendments impacting foreclosure defense are in Subpart C, 12 CFR 1024.30 et seq. Section 1024.41 governs the loan servicer’s obligations in evaluating and responding to modification applications and contains the provisions aimed at eradicating double tracking.

Subsection (f) restricts the servicer from commencing a foreclosure unless “[a] borrower’s mortgage loan obligation is more than 120 days delinquent.” This 120-day timeframe is the “pre-foreclosure review period.” If a borrower submits a “complete loss mitigation application” during the pre-foreclosure review period, the servicer cannot commence a foreclosure process unless: (i) The servicer notified the borrower that the borrower is not eligible for any loss mitigation option and any succeeding appeal process has terminated; (ii) The borrower rejects all loss mitigation options offered by the servicer; or (iii) The borrower fails to perform under an agreement on a loss mitigation option. This is particularly significant in non-judicial foreclosure states where commencement of a foreclosure is effectively synonymous, or nearly synonymous, with completion of a foreclosure.

Subsection (g) is more significant in judicial foreclosure states because it requires the servicer to decide a modification application before taking the dispositive step in a foreclosure. It provides that if a borrower submits a complete loss mitigation application after the servicer has taken the first step in any foreclosure process but more than 37 days before a foreclosure sale, the servicer shall not move for foreclosure judgment or order of sale, or conduct a foreclosure sale, unless: (1) There is no pending modification application or appeal of any denial of any modification application; (2) The borrower rejects all loss mitigation options offered by the servicer; or (3) The borrower fails to perform under an agreement on a loss mitigation option.



Predatory Lending is a Defense, Not a Claim

Predatory lending is a defense to foreclosure; it is not an affirmative claim that would entitle a borrower to damages from the lender.

Difference between foreclosure defenses and claims for damages

As discussed in my last post, in the Aubut case the Connecticut Appellate Court recognized that predatory lending is a defense to foreclosure. The defense depends on what the lender new or should have known at the time it made the loan. Though predatory lending might give rise to a claim for money damages against the lender that made the loan, the foreclosing plaintiff is rarely that. Most often, because of the prevalence of mortgage securitizations, the foreclosing plaintiff is an assignee of the loan. The question thus becomes whether you can hold a mortgage loan assignee liable for damages for what the original lender knew or should have known. The Aubut court answered “no.” The foreclosing plaintiff in that case was the ultimate assignee of the loan. The court noted that an assignee takes the loan subject to all defenses that might have been asserted against the assignor. But the assignee does not take the loan subject to the assignor’s liabilities unless the assignee expressly assumes those liabilities. Since the plaintiff had not assumed any liabilities, predatory lending could be a defense to foreclosure but not a counterclaim for damages.

Distinction is good for borrowers

This is a significant distinction. If it were a counterclaim instead of a defense, the courts likely would offset the damages the bank would have to pay against the amount the borrower owed on the loan. But that just reduces the debt. Since most large lenders do not pursue the borrowers for deficiencies between the amount owed and the property value in any event, the offset would be a Pyrrhic victory at best for the borrower. What borrowers really want is to save the property. A counterclaim can’t do that; this predatory lending defense can.

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.

Treasury’s Servicer Ratings for Modifications are Eye Opening

The Treasury Department recently issued The Making Home Affordable Program Performance Report Through April 2011 which reviews mortgage servicers in their administration of President Obama’s Making Home Affordable program. Bank of America, J.P. Morgan Chase Bank and Wells Fargo Bank did so poorly that the government will withhold the financial incentives it pays for mortgage modifications made through the program until these servicers show improvement.

The Report includes a number of metrics for the servicers reviewed but the one I found most interesting was the “Income Calculation Error %.” The borrower’s income is critical to a determination of whether the borrower qualifies for a Making Home Affordable modification. The Making Home Affordable-Compliance unit (MHA-C) did its own income calculation for certain applicants and compared it to the servicer’s income calculation. Differences of 5% or more between MHA-C’s and the servicer’s calculation were included in the “Income Calculation Error %.” Treasury set a benchmark of less than 5% meaning that Treasury believes that MHA-C’s and the servicer’s calculations should be within 5% of each other 95% of the time. None of the ten servicers reviewed met the benchmark. The results ranged from 6% for GMAC Mortgage and Litton Loan Servicing to 33% for Ocwen Loan Servicing. J.P. Morgan Chase was 31%, Bank of America was 22% and Wells Fargo was 27%.

This data means that many borrowers did not get mortgage modifications because the servicer miscalculated their income. We can applaud the Treasury for taking steps to correct the servicers’ miscalculations for future applications. But what’s being done for those who lost a modification opportunity because of an income miscalculation?

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.

New York’s Foreclosure Settlement Conference Program

New York’s Foreclosure Settlement Conference program provides court oversight to the mortgage modification process. The goal is to insure that the borrower timely submits the necessary information for the bank to make a modification determination. More importantly for the borrower, the program gives the bank some accountability for receiving the necessary information and for making a timely decision.

Only borrowers who are defendants in a foreclosure lawsuit are eligible for the program. After the bank serves the borrower with the summons and complaint, the bank is obliged to file with the court a form that notifies the court’s clerk to send the parties notice of the first conference. The conference takes place at the courthouse but not in a courtroom, although the borrower may be waiting in a courtroom for the borrower’s case to be called. When the case is called, the borrower will be escorted into a private room. The borrower, the borrower’s lawyer (if the borrower has one), the bank’s lawyer and a state employee who is not a judge are the only people in the room. There is no court reporter or clerk. The bank’s lawyer will give the state employee some basic information about the loan like the type of loan (fixed or adjustable rate, etc.), when the last payment was made and the outstanding principal balance. The state employee will then discuss with the borrower the reasons for the default and whether the borrower wants to retain the property. Assuming the borrower wants to remain in the property, the bank’s lawyer will provide the borrower with some forms to complete and a list of documents to submit. The forms ask for the borrower’s income, expenses, and assets. The documents normally include bank statements, pay stubs, tax returns and a current utility bill. The borrower will also have to submit a hardship affidavit explaining the financial hardship that caused the borrower to default. The hardship affidavit is often one of the forms for the borrower to complete but sometimes the borrower must provide it separately.

The next conference is normally scheduled at the conclusion of the first conference. The borrower should submit the forms and documents before the next conference. The subsequent conferences will address any requests the bank has for additional information or any questions about the information submitted. The length of the process normally requires the borrower to periodically submit updated paystubs and bank statements.

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.

Deed in Lieu of Foreclosure

The “deed in lieu of foreclosure” is the foreclosure alternative in which the property owner turns over the property to the lender and avoids the formal foreclosure process. As in a true short sale, the borrower’s goal in a “deed in lieu” resolution is to avoid liability for the deficiency that results if the property is worth less than what the borrower owes on the debt. The general idea is that the borrower saves the lender the expense of foreclosing by giving the lender the deed to property. In exchange the lender waives the deficiency.

Most lenders in the states where I practice law, Connecticut and New York, require the borrower to list the property for sale for a certain time period (usually at least 90 days) before they will consider a taking a deed in lieu of foreclosing. Whether the lender actually accepts the deed, or waives the deficiency, after the time period expires is an open question. I have not been involved with any deed in lieu transaction in Connecticut or New York nor have I heard of any completed deed in lieu transaction in Connecticut or New York. I think this is largely for three reasons. First, the bank would much prefer that the borrower sell the property rather than the bank have to add the property to its inventory of unsold, “bank-owned” properties. The bank has carrying costs on the properties it owns and there is no reason to increase those costs in a terrible real estate market. Plus, real estate agents will tell you that it is generally easier to sell a property that is occupied than it is to sell a property that is vacant. If the bank takes the deed, the property will be vacant.

Second, Connecticut and New York are judicial foreclosure states. By the time the borrower starts considering a deed in lieu in transaction, the bank has already commenced the foreclosure lawsuit. For residential foreclosures, the parties will spend time in Connecticut’s Foreclosure Mediation program or New York’s Foreclosure Settlement Conference program trying to agree to a mortgage modification. If the programs fail to achieve a modification, most banks believe completing the foreclosure is a foregone conclusion. The bank has less incentive to consider a deed in lieu because it has already initiated and, in its view, can expeditiously complete, the foreclosure without having to waive the deficiency. Contrast this with a nonjudicial foreclosure state where a deed in lieu can avoid commencement of the foreclosure process.

Finally, banks don’t like to waive deficiencies. In a judicial foreclosure state, where the foreclosure lawsuit has already commenced, the borrower gets no real benefit from a deed in lieu if the bank will not waive the deficiency. This is essentially the flip-side of the bank’s viewpoint discussed above: the bank has little incentive to consider a deed in lieu when the foreclosure action is pending and neither does the borrower.

That being said, if a borrower is resigned to losing the property, it cannot hurt to explore the deed in lieu possibility with the bank. At the least, it might provide the borrower with some flexibility in vacating the property.

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.