Compliance Bulletin

Partial Victory in SB 1137 Case
June 7, 2010

A California Court of Appeals rendered a decision in one of a rash of law suits filed against lenders and loan processors under Civil Code section 2923.5, which was codified by SB1137 in 2008. SB1137 was enacted in response to the significant rise in residential mortgage foreclosures due to the financial crisis. 

The primary purpose of the statute was to require mortgagees, trustees, beneficiaries, or their authorized agents (hereafter, “lenders”) to explore alternatives to foreclosure with their borrowers before filing a notice of default. The primary mechanism established was the requirement by the lender to wait 30 days after contacting the borrower (or 30 days after satisfying specified due diligence requirements) before filing the NOD. Among other things, the lender is required to contact borrowers, assess their financial situation, and explore alternatives to foreclosure. In addition, the lender must include with the NOD a declaration that it has complied with the contact requirements or that the borrower has surrendered the property.

The borrowers in this case, who seek to act on behalf of a class of similar plaintiffs, sued Aurora Loan Services to prevent foreclosure on the grounds that it did not comply with Section 2923.5. In particular, the borrowers alleged that Aurora failed to describe specifically how it attempted to contact them (Aurora used generic language indicating compliance with Section 2923.5) and failed to certify that the declaration was made under penalty of perjury. The trial court granted a motion for a preliminary injunction based on the allegation that Aurora did not contact the borrowers as required (the facts are in dispute), but later ruled that the suit was preempted by federal law (Aurora is a subsidiary of a federal savings association), and that plaintiffs were required to tender the full amount of the deficiency as a prerequisite to bringing an action under Section 2923.5.

CBA filed an amicus curiae brief on behalf of Aurora on the issues of private right of action, specificity of specificity, and the alleged penalty of perjury requirement. Last week, the Appellate Court rendered its decision. The following is a summary of that decision.

Private right of action. Section 2923.5 does not provide that a private right of action to enforce the statute is either allowed or disallowed. In finding that plaintiffs may sue to enforce compliance with Section 2923.5, the Court relied on the disputed precedents that a private right of action may inhere within a statute when such a right is necessary to achieve the statute’s policy objectives. It noted that the 2923.5 is imbedded within a series of statutes (from Section 2924, together with Sections 2924a through 2924l) in connection with rules involving foreclosure. Section 2924g(c)(1)(A) sets forth the grounds for postponement of foreclosure sales, and includes the possibility that a court may issue an order postponing sale. Reading the two statutes together, the Court held that Section 2923.5 allows a remedy of postponement of foreclosure. As the right conferred by Section 2923.5 is for the borrower to be contacted to assess and explore alternatives to foreclosure, it would defeat the purpose of the statute to require the borrower to tender payment as a condition of enforcement. Therefore, no tender is required.

The Court did not adopt authority supporting the proposition that if a defaulting borrower requests a court to exercise its equitable powers to stop or set aside foreclosure proceedings, the borrower must first “do equity” by tendering the entire loan amount prior to the sale. The Court also did not respond to the argument that, even if there was a violation, borrowers could not demonstrate what harm is caused.

However, the Court did hold that an action may not be brought under Section 2923.5 as a class action because the question of the adequacy of the attempted or actual contacts is fact-specific. That is, they differ from one member of the class to the next. Thus, it would be nearly impossible to determine whether a lender complied with the contact requirement in any specific instance without an examination of individual claims separately. This is an important holding, as it removes much of the incentives and leverage that plaintiffs attorneys need in order to bring these suits.

Preemption. The Appellate Court rejected Aurora’s argument that Section 2923.5 is federally preempted as to a subsidiary of a federal savings association. As the statute is narrowly drawn, the industry did not discuss preemption when the bill was negotiated in the Legislature. Real property law has traditionally been the exclusive domain of the states, and the Appellate Court did not find any specific provision in the Home Owners’ Loan Act that indicated a legislative intent that the federal law of thrifts preempts state laws on foreclosure procedures.

The Court arrived at this conclusion in the face of OTS regulations that could easily be construed to preempt Section 2923.5. 12 CFR Section 560.2 lists numerous categories of state laws that are preempted. Included in the list are state laws purporting to impose requirements regarding:

“(4) The terms of credit, including amortization of loans and the deferral and capitalization of interest and adjustments to the interest rate, balance, payments due, or term to maturity of the loan, including the circumstances under which a loan may be called due and payable upon the passage of time or a specified event external to the loan; [and]

(10) Processing, origination, servicing, sale or purchase of, or investment or participation in, mortgages.”

The Court reasoned weakly that 2923.5 did not require lenders to engage in any of these activities, only that they contact borrowers, assess their condition, and explore other options.

However, the Court suggested that an action brought under 2923.5 could be deemed preempted to the extent that expansive remedies are sought beyond simply “assessing” and “exploring” alternatives to foreclosure. For example, the Court considered an action under 2923.5 not to survive a preemption challenge if the borrower sought to compel the lender to consider a new loan application or provide loan counseling, as those are preempted servicing and origination activities.

Specificity of declaration. The Appellate Court agreed with CBA’s argument that the mandatory declaration need only track the language of Section 2923.5(b) and need not delineate precisely how any particular means of contacting the borrower was attempted. From a practical standpoint, the Court recognized that different, multiple persons may be involved in contacting borrowers and preparing declarations, making it unlikely that the Legislature intended that each declaration is required to be custom drafted.

Penalty of perjury. The Court also agreed with CBA that the statement is not required to be prepared under penalty of perjury. If the Legislature intended that, it could have stated it explicitly, as it has in other statutes, such as Section 2941.7(b) (declaration supporting a statutory reconveyance when mortgagee cannot be located). As the statute is silent on the subject, the Court found no reason to infer a requirement.

Effect on title. Importantly, the decision states that noncompliance with Section 2923.5 does not cloud title after sale. The statute does not require such an outcome, and the only remedy is a postponement of the sale. A decision to the contrary would have been disastrous as the legal uncertainty would depress sales even further.

The upshot is that, because an action under Section 2923.5 may not be brought as a class action, and the only remedy is a delay of foreclosure until the contact and other requirements are satisfied, plaintiffs counsel will have less incentive to bring these actions in the future.

This is the text of Aurora’s statement: “The Beneficiary or its designated agent declares that it has contacted the borrower, tried with due diligence to contact the borrower as required by California Civil Code section 2923.5, or the borrower has surrendered the property to the beneficiary or authorized agent, or is otherwise exempt from the requirements of section 2923.5.”
The information contained in this CBA Regulatory Compliance Bulletin is not intended to constitute, and should not be received as, legal advice. Please consult with your counsel for more detailed information applicable to your institution.

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