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Lender’s Non-Liability for a Servicer’s RESPA Violation

In a first, a federal circuit court rules a lender cannot be held liable for a servicer’s RESPA violation.

A borrower who took out a home equity loan from Bank of America alleged the Bank is vicariously liable for the failure of its loan servicer to comply with the Real Estate Settlement Procedures Act (RESPA), particularly 12 C. F. R. § 1024.41(c)(1). That regulation imposes duties on servicers who receive a complete loss mitigation application more than 37 days before a foreclosure sale to–within 30 days of receipt–evaluate the borrower for all loss mitigation options available to the borrower and provide the borrower with a notice stating which options, if any, it will offer the borrower.

The Fifth Circuit, which is apparently the first circuit to address the issue, held banks cannot be held vicariously liable for the alleged RESPA violations of servicers. Christiana Trust v. Riddle, — F. 3d — (2018) (2018 WL 6715882, 12/21/18). The Court had three related reasons.

First, “[b]y its plain terms the regulation at issue here imposes duties only on servicers” as it states a “servicer shall.” 12 C. F. R. § 1024.41(c)(1)

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Finding the Unicorn in Lender Liability Litigation

Investors frequently talk in terms of trying to find the next unicorn, that small start-up company that is going to turn into a billion dollar valuation.  Lawyers are like that as well, always looking for that new decision where a court opens a crack in the door of some long held legal theory. Something like this occurred in the 1980’s when the courts in California held that a party could bring a tort action for the breach of the obligation of good faith. The courts were expanding a doctrine that then existed only in the area of insurance contracts. The expansion of this theory to noninsurance contracts generated universal criticism by other courts and scholars across the US and after a ten year experiment the California Supreme Court reversed its earlier decision for the following reasons: (1) the different objectives underlying the remedies for tort or contract breach, (2) the importance of predictability in assuring commercial stability in contractual dealings, (3) the potential for converting every contract breach into a tort, with accompanying punitive damage recovery, and (4) the preference for legislative action in affording appropriate remedies. [See: Blanchard, Lender Liability: Law, Practice and Prevention, Chapter 4, Bad Faith Tort Claims]

When a party enters into a loan agreement or a promissory note, one understands what the consequences of a breach might be. If a lender is found to have improperly failed to fund under a line of credit it knows that it may have to pay compensatory damages to the borrower. Likewise, guarantors understand that if the borrower fails to pay the underlying obligation the guarantor must step in and pay the obligation.  Our commercial banking industry is built on this understanding that parties will need to put the nonbreaching party into as good of condition as they would have been if there had been no breach. Damages for breach are therefore predictable.

The unicorn for borrowers counsel today is to tag a lender with punitive damages. This has traditionally been a difficult endeavor. Courts almost uniformly dismiss breach of fiduciary duty claims because absent some unusual set of facts, the normal lender/borrower relationship is not a fiduciary one. Lenders owe no special duty to borrowers or guarantors to advise them on whether a particular business transaction for which the borrower is obtaining funds is a “good” one or not. Fraud claims are a bit easier for a borrower to keep from being dismissed but such claims are subject to heightened pleading standards and require specificity in making the claim, a general claim of “fraud” without more will be dismissed.

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Before You Comment on My Haircut, Think Again

Back in 2008 and 2009 Eddie Liles lent around $102,000 to his brother Dallas to purchase rental properties at 554 South Shore Drive and 540 South Shore Drive in Greenup County, Kentucky, as well as a 2008 Ford 4×4 truck.  The brothers signed a Loan Agreement that provided the loan would be interest free and that the loan for 554 South Shore Drive to be repaid first, followed by the loan for the truck, and finally the loan for the 540 South Shore Drive. The Loan Agreement called for Dallas to make payments of “ [a] minimum of $600.00 per year,” which it specified could be “multi-payments or one payment of $600.00.” It was also clear that Dallas could pay more than $600 per year towards the indebtedness, if he so desired.

The Loan Agreement also provided that if Dallas died, any outstanding balance would be forgiven. If, however, Dallas survived Eddie and the loan remained unsatisfied, the property would revert to Eddie. If both men died at the same time, and before satisfaction of the loan, the property was to pass to John B. Liles, II, or his estate. Eddie filed the Loan Agreement for record with the Greenup County Clerk and Dallas began making payments. As of early 2011 when the brothers had a falling out, Dallas had reduced the indebtedness to $89,400.

According to an affidavit filed by Dallas, the impetus for the falling out was an argument the two had in January of 2011 about a haircut. The argument was bad enough that the two were no longer communicated except for filing legal pleadings. Eddie refused to accept any more installment payments from Dallas and demand payment in full. Dallas refused but continued to make installment payments into an escrow account. Eddie filed suit and later sought summary judgment on the basis that he had full rights to demand payment in full. The circuit court determined that the loan was not a demand obligation and Eddie appealed.

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California Court Rejects “Sham Guarantee” Defense

Bryan Cave LLP recently served as counsel for amicus curiae California Bankers Association (“CBA”) and helped score a victory in an important California appellate case of great interest to the banking industry,  LSREF2 Clover Property 4 LLC v. Festival Retail Fund 1 357 N. Beverly Drive LP (Second District, California Court of Appeal case number B259937).

The trial court had ruled that the guarantor of a commercial loan was excused from performance on the grounds that the guaranty was a “sham,” structured by the lender to circumvent California’s anti-deficiency laws.  The guarantor essentially argued that there was no legal separation between it and the borrower because it was the borrower’s “alter ego,” and as support they identified evidence that the two entities failed to observe basic corporate formalities.  According to the guarantor, it should be excused from its obligations because it was essentially the same as the borrower, and thus protected by California’s anti-deficiency laws.

In its amicus brief, the CBA raised two principal arguments, both of which were adopted by the court of appeal in its published opinion reversing the trial court’s judgment in favor of the guarantor Festival Fund.

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Agreeing to Lower an Interest Rate is Fraudulent?

When is a loan modification that reduces the borrower’s interest rate fraudulent and not “benevolent” under the UCC?  Maybe when the lender extends the loan repayment period or procures a guaranty from HUD, according to one federal district court.

A husband and wife took out a mortgage. After their divorce, the ex-wife agreed with the lender to modify the mortgage to lower the interest rate by 2%, allegedly without the knowledge or consent of her ex-husband. The lender considered the husband obligated to make the modified mortgage payments and reported him to credit reporting agencies when payments were missed.

The ex-husband brought claims against the bank for breach of contract, violation of the Fair Credit and Reporting Act and defamation. He asserted he was discharged from the mortgage due to the loan modification.

The lender moved to dismiss the case at the outset by arguing that as a matter of law the refinancing was not a material alteration of the loan agreement and therefore the credit report was accurate. The district court denied the motion, thus allowing all the claims to proceed to discovery and a future factual resolution, based in large part on its interpretation of UCC § 3-407.

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Lenders and Collectors Beware: Missouri Expands Coverage of Consumer Protection Act

In companion opinions issued on August 19, 2014, the Supreme Court of Missouri held that unfair practices associated with residential foreclosures occur “in connection with” the original sale of a mortgage loan and therefore fall within the scope of the Missouri Merchandising Practices Act (“MMPA”).  See Conway v. CitiMortgage, Inc., — S.W.3d —-, No. SC 93951, 2014 WL 4086671 (Mo. banc Aug. 19, 2014); Watson v. Wells Fargo Home Mortg., Inc., — S.W.3d —-, No. SC 93769, 2014 WL 4086486 (Mo. banc Aug. 19, 2014).  In Watson, however, the court also held that unfair practices associated with loan modification negotiations between a lender and borrower do not occur “in connection with” the original sale and cannot form the basis for an MMPA claim.

The MMPA is a consumer fraud statute that provides both the Missouri Attorney General and consumers the right to bring actions against individuals who engage in unfair or deceptive practices “in connection with” the sale or advertisement of merchandise.  See R.S. Mo. § 407.010, et seq.  The statute permits consumers to recover damages for “ascertainable losses,” as well as punitive damages and attorneys’ fees.

In Conway and Watson, the Supreme Court of Missouri considered whether mortgage lenders may violate the MMPA by virtue of either: (1) their foreclosure-related practices, or (2) their loan modification negotiations with borrowers.  In Conway, the court concluded that, with respect to mortgage loans, the original “sale” continues throughout the life of the loan by virtue of the long-term relationship between the parties and the duties imposed upon each party by the loan documents.  As a result, the court held that any unfair practices associated with residential foreclosures occur “in connection with” the original sale even when the foreclosure occurs years afterward.  Furthermore, the court held that third parties who did not originate the loan, but only acquired the loan years later, could still be held liable under the MMPA.

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Third Party Communications can Lead to Lender Liability

When a lender underwrites a loan application it examines the borrower’s business and makes a decision about whether the business model is acceptable to it, whether cash flows are adequate and whether sufficient collateral exists to secure the loan. If the borrower is expanding its business operations the lender may decide whether the new operations make sense to it. Likewise, if a borrower is purchasing a major piece of equipment the lender might indicate that it does not finance certain items or it might say that it only finances such equipment on certain terms. The point is that the terms of what the lender finds acceptable will be contained in a commitment letter setting out all of the terms of the loan or in the actual loan documentation.  As part of that process the lender may be a part of conversations the borrower has with various vendors such as ones selling major pieces of equipment or building major projects.

What happens if the lender decides that it wants to communicate directly with the vendor to ask questions about the product being sold? What if they have objections about the contract itself, can they express those directly to the vendor as opposed to dealing directly with the borrower? Can they request that changes be made to the contract without consulting with the borrower? Even if they can do it from a pure legal standpoint, is it a good idea?  A recent case (Velocity Press v. Key Bank, N.A., 2014 WL 2959460 (CA10 2014)) would suggest that engaging in such behavior is problematic.

The lender agreed to provide a line of credit to a company in order to purchase a custom printing press from the manufacturer for $1,797,229.  Under its arrangement with the manufacturer the borrower was scheduled to make several progress payments: 30% down, 30% halfway through manufacturing, 35% when the press was completed and operating on the manufacturer’s floor  and the final 5% when installation of the press was finished at the borrower’s plant.

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Major Loan Participation Decision Affecting FDIC Successor Rights

One of the very powerful rights that the FDIC possesses in any receivership is a provision added by FIRREA which states that the FDIC may enforce any contract entered into by the depository institution notwithstanding any provision of the contract providing for termination, default, acceleration, or exercise of rights upon, or solely by reason of, insolvency or the appointment of or the exercise of rights or powers by a conservator or receiver (i.e., “ipso-facto” clauses). Many typical vendor contracts will oftentimes contain just such a clause providing that one party to the contract can terminate the contract at will if the other party files for relief under the Bankruptcy Code or is taken over by the government. The logic is pretty compelling, a party wants to be able to decide if it is comfortable dealing with an entity that is insolvent or attempting to reorganize.

​A recent Georgia Court of Appeals decision raises interesting issues about how this specific FDIC power can be used in the context of a loan participation. In CRE Venture 2011-1, LLC v. First Citizens Bank of Georgia, First Citizens found itself the surviving bank of a group of four banks that had been involved in a loan participation. The lead bank and two others had been placed into receivership and the FDIC had sold the lead position to CRE Venture 2011-1, LLC. As is oftentimes the case in such situations, the local bank objected to the manner in which the lead was handling the credit, specifically, the proposed foreclosure of the real property securing the participated loan. First Citizens sought equitable relief based on its argument that if the foreclosure went forward, First Citizens would lose most of its interest in the loan and would be forced to account for the sale in a manner that would do it serious and irreparable harm to its finances and business prospects. First Citizens pointed out that unlike the two other loss-share banks that had succeeded to the other failed banks shares in the loan, it had not entered into a loss-sharing agreement with the federal government. Moreover, First Citizens argued that CRE Venture purchased the Loan at a significant discount and would not suffer the same loss, and might even profit from a quick sale of the property.

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The Anti-Tying Rules: Recent Case Illustrates Problems for Banks

A loan negotiation generally follows the lines of each party setting out its “want” list and then using whatever leverage it brings to the table to accomplish its goals.  The lender typical wants to get paid back in a reasonable time frame and at a market rate while possibly generating other business income from things such as selling cash management services while the borrower wants to obtain favorable repayment terms that leave it with as much discretion to run their business as possible. The size of the loan, documentation costs, regulatory pressures and possible past dealings are all issues that affect the negotiation.

Sometimes the lender’s “want list” includes things such as the borrower providing guarantees or additional collateral or even retaining a consultant to advise the borrower on developing a better business plan. In preparing its request for such items, lenders must work within the strictures set out in the anti-tying provisions of the Bank Holding Company Act. The Act, with some exceptions,  generally prohibits a lender from conditioning an extension of credit other services on the requirement that the borrower purchase some other credit, property or services from the lender. (See generally, Blanchard, Lender Liability: Law., Practice and Prevention, Chapter 16, Anti-Tying Provisions.)

The typical loan covenants that lenders ask for such as financial reporting and financial ratios do not violate the anti-tying provisions. The requirements are fairly traditional and both generally understood by both the lender and borrower. Lenders get into trouble, however, when they begin asking for things from a borrower that don’t seem to have anything to do with maintaining the soundness of the borrower’s loan.

A recent example of this is found in the case of Halifax Center, LLC, et al. v. PBI Bank, a decision from the Western District of Kentucky. In this case an investor named David Chandler wanted to purchase a note and mortgage from HUD involving a 165 unit apartment complex in Chicago. The total purchase price was $9,145,020.06. The investor sought financing for $6 million of the purchase price from PBI Bank. In his lawsuit against PBI the investor alleged that PBI indicated that they were willing to extend the requested loan but only on the condition that he purchase some unrelated property located in Owensboro, Kentucky on which the Bank currently held a mortgage (the “Halifax Property”). The underlying loan was in default. The investor did not know the owner of the property and knew nothing about the property but agreed to purchase the property in order to obtain the sought after financing.

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Bank Has No Obligation to Inform Borrower of Bank’s Impending Failure

One of the ironic issues for failing banks has been the fact that banks that they have had to continue to deal with their borrowers and depositors in the ordinary course of business even though they are already in the queue for resolution by the FDIC. So for example, loans continue to get renewed and documents executed. What happens if you renew a loan shortly before the bank fails, do you have some sort of defense to enforcement of the loan when the successor bank or the FDIC makes demand on you? The Georgia Court of Appeals recently dealt with a set of facts like these in the case of CSS Real Estate Development I, LLC v. State Bank & Trust. CSS Real Estate had entered into a credit relationship with The Buckhead Community Bank d/b/a The Alpharetta Community Bank in February of 2007 to obtain funding to purchase land and construct a hotel.  There were three guarantors on the loan. In October of 2008 the borrower and the guarantors (the “obligors”) agreed to sell the project to Enville, Inc. but they all remained liable as guarantors. A year later the loan came up for renewal and the parties executed new guaranties two days before the bank failed. The FDIC was appointed receiver and sold the assets, including the loan in question, to State Bank & Trust. In July of 2011 that bank sent default letters after payments on the loan were not made and later filed suit to collect the loan.

The borrower and the guarantors responded by claiming that  The Buckhead Community Bank had engaged in fraud and breached a fiduciary duty by concealing the fact that it was about to fail. The trial court granted State Bank & Trust’s motion for summary judgment for judgment on the note and the guarantees. On appeal the obligors asserted that they had been fraudulently induced into renewing the loan and reaffirming the guarantees. They argued that they would have waited to negotiate directly with the FDIC or the successor bank and that their guarantees should be voided due to “bad acts” by The Buckhead Community Bank in failing to keep them informed about the impending receivership of the bank.

The court of appeals began its legal analysis by noting that once a bank has established the facts that a party signed what appears to be a valid guaranty, the guarantors must establish a defense to payment to avoid liability. Fraud is one of the types of defenses that would be sufficient if proven. Under Georgia law fraud requires that a party prove that the defendant knowingly made a false statement to cause the complaining party to act or refrain from acting. The party must also show that it was reasonably justified in relying upon the statement and that it suffered damages as a result. Each of the elements must be established.

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