Compliance Bulletin

Summary of New State Foreclosure Moratorium
February 23, 2009

The State of California enacted a foreclosure moratorium on residential real property that will take effect May 21, 2009. The bill, ABX2 7 [1], which sunsets on January 1, 2011, applies to loans that are secured by deeds of trust which were recorded between January 1, 2003 to January 1, 2008 and that constitute a first priority mortgage or deed of trust on property that the borrower occupied as his or her principal residence at the time the loan became delinquent [2].

New Civil Code Section 2923.52 prohibits a mortgagee, trustee, or other person authorized to conduct a private sale of covered residential property from recording a notice of sale (which follows recording of a notice of default) until at least an additional 90 days has lapsed beyond the existing statutory three month period following the filing of a notice of default. A conforming amendment is made to Section 2924(a)(3). The stated purpose of the delay is to allow the parties to pursue a loan modification to prevent foreclosure.

The bill does not prescribe any criteria for conducting a loan modification if the lender either fails to maintain, or does not apply for, an exemption from the extended period (discussed below). Nor does it indicate any consequences if the parties fail to attempt a loan modification, for example, if the borrower refuses to negotiate or the lender determines no modification is feasible. Moreover lenders and servicers are still subject to the provisions of Civil Code Section 2923.5 enacted last year as SB 1137 which requires workout measures also to be pursued prior to the recording of the notice of default.

One of the underlying purposes of the bill is to encourage mortgage loan servicers (hereafter, simply “lender”) [3] to implement a “comprehensive loan modification program” by exempting them from the extra 90-day period if they establish such a program that is approved by a regulator. For state chartered banks, an exemption can be obtained by application to the Commissioner of the Department of Financial Institutions. National banks and federal savings institutions that seek to obtain an exemption are supposed to apply to the Department of Corporations [4]. A discussion of preemption issues raised is included at the end of this Bulletin.

A comprehensive loan modification program is required to have the following features:

  • It is intended to keep covered borrowers in their homes where the anticipated recovery under the workout exceeds the anticipated recovery through foreclosure on a “net present value basis.” The bill offers no guidance on how to make this calculation.
  • It targets a housing-related debt-to-income ratio [5] of no more than 38 percent on an aggregate basis in the program. (It is not required that each loan exhibit this ratio).
  • It includes some combination of interest rate reductions (for a fixed term of at least five years), extension of the amortization period to up to 40 years from the original date of the loan, deferral of principal until maturity, reduction of principal, compliance with any federally mandated loan modification program, and any other factors that the commissioner deems appropriate [6].
  • In each instance of a modification, the lender seeks to achieve “long-term sustainability” for the borrower. This term is not defined.

Application process

When the initial exemption application is submitted, the commissioner is required to “immediately” notify the applicant of the date of receipt of the application and issue a temporary order effective from that date of receipt. The temporary order remains effective pending a final order. The relevant commissioner is given 30 days of receipt of an initial or revised application to determine the sufficiency of the application. The commissioner must then either issue a final exemption order or deny the application, in which instance the temporary order remains in effect for 30 days after the date of denial. The lender is permitted to submit a revised application following denial.

The commissioner may also revoke a final order if the lender submitted a “materially false or misleading” application or if the approved program is subsequently materially altered. A revocation cannot be retroactive and is subject to a reasonable notice and an opportunity to be heard.

If a modification (whether under an approved modification program or not) is not successful and the lender proceeds to file a notice of sale, the notice must include a declaration stating whether or not the lender has obtained a valid final or temporary exemption order and whether the 90 day period does not apply (e.g., because the lender is exempt, the borrower has surrendered the keys, etc., as discussed below).

Regulations

The bill requires the various commissioners to adopt emergency and final regulations regarding the moratorium and the application process. Regulation must be adopted no later than 10 days after the date the law takes effect, and the moratorium itself is to become operative 14 days thereafter [7]. It remains to be seen whether the industry will have an opportunity to offer comments to the regulations to be issued under the bill, as is normally required of executive branch agency regulatory proposals. The commissioners and the Secretary of Business, Transportation and Housing have additional data collection, reporting, and publication duties under the bill [8].

Enforcement

The bill does not specifically create a separate right of action for a violation. However it specifies that a violation of the moratorium is considered a violation of the person’s “license law” as it relates to these provisions. Presumably this creates an additional basis for criticism against a bank by the DFI in the case of state chartered banks. CBA was able to include a provision clarifying that failure to comply with the law does not invalidate any sale that would otherwise be valid under Section 2924f. This suggests that, while a bank may be subject to sanction by the DFI, a violation will not necessary cloud title after a sale.

Nevertheless, this provision is to be read in conjunction with Section 7 of the bill, which amends Section 2924(a)(3) by incorporating the extra 90 day period into the law that specifies the timing requirement for giving a notice of sale after a notice of default is filed. The amendment essentially turns the three month period between filing a notice of default and notice of sale into an approximately six month period for loans covered by the bill. Except for the provision discussed above, this amendment to 2924(a)(3) would make the extended period an inherent requirement for a valid notice of sale. There is also some question whether the foreclosing lender that violates the statute would be liable for wrongful foreclosure (to the borrower) or for liability under Business and Professions Code Section 17200 et seq.

The bill also states that it does not require a lender to violate contractual agreements for investor-owned loans or to offer a modification to a borrower who is not willing or able to pay under the modification [9]. The no-violation provision may offer comfort to a lender in the context of a loan modification outside of an exempt program. It may have lesser application within a program, as a servicer presumably would not commit to a loan modification program that includes provisions requiring it to violate its own agreements.

Preemption

While on its face the bill applies to all covered loans without regard to the charter status of the lender, it provides no mechanism for national banks and federal savings association to secure exemptions through their own regulators, nor could it. However, the definition of “commissioner” as applied to the Commissioner of the Department of Corporations refers to “licensed residential mortgage lenders and servicers and licensed finance lenders and brokers servicing mortgage loans and any other entities servicing mortgage loans that are not described in subparagraph (B) or © [10].” [Emphasis added]. Generally, a state agency has no licensing authority over federally chartered financial institutions and may not exercise visitorial authority. But it remains to be seen whether preemption is implicated if an institution “voluntarily” seeks an exemption from the agency and thereby submits to the agency’s requirements, as authorized in the bill.

The bill states that the requirements of the bill do not confer on the commissioner (of the Department of Corporations) visitorial authority over federally chartered financial institutions. Furthermore, it states that “nothing in this subdivision is intended to affect the authority of the commissioner over a federally chartered financial institution pursuant to federal law or regulation.” The purpose of these provisions may be to assure federally chartered institutions that the Department of Corporations would not attempt to exercise jurisdiction over them other than to receive applications, approve or deny them, and conduct certain data gathering and reporting functions. The language may also be intended as a defense against a preemption claim, in other words, as an insulation against a claim that the Department of Corporation’s exercise of its duties under the bill amount to the exercise of illegal visitorial authority.

Exceptions

 

The moratorium does not apply if the borrower surrendered the property, as evidenced by a letter or return of the keys to the property; the borrower has contracted with an organization, person, or entity whose primary business is advising people who have decided to leave their homes regarding how to extend the foreclosure process and avoid their contractual obligations to mortgagees or beneficiaries; or if the borrower is in bankruptcy. As with a similar provision in SB 1137, this narrow definition of such an entity raises the question whether there are any persons or entities whose primary business is as defined. Also, the bill may create a disincentive for borrowers to surrender their keys when there is a built-in 90 day period under this legislation and an additional 45-60 days under SB 1137. If a cram down of mortgage loans becomes federally available, then careful timing by the borrower under California and federal laws could yield significant benefits.

As a transitional matter, the bill does not clarify whether a loan that is subject to a notice of default any time prior to January 1, 2011, when the legislation sunsets, is still subject to the moratorium after this date. CBA will seek clarification on this and other points. See bill.

Peter S. Munoz, a partner at Reed Smith LLP and member of the CBA Legal Affairs Committee, advised CBA on the bill and contributed to this Bulletin. Mr. Munoz can be reached at 415.659.5964.

  1. Two identical bills from both houses, ABX2 7 and SBX2 7, were signed. As ABX2 7 was signed last, it supersedes SBX2 7.
  2. The restriction does not apply to loans made, purchased, or serviced by, or that are collateral for securities purchased by, certain government housing agencies or authorities listed in Civil Code Section 2923.52(c). All code references are to the California Civil Code.
  3. “Mortgage loan servicer” is defined as a person or entity that receives or has the right to receive installment payments of principal, interest, or other amounts placed in escrow pursuant to the terms of a mortgage loan or deed of trust, and performs services related to that receipt or enforcement as the holder of the note or on behalf of the holder of the note evidencing that loan. Section 2923.53(k)(3). This definition would appear to include a lender servicing its own loans.
  4. The bill grants authority to the “commissioner” to determine the form and manner of the exemption application. Section 2923.53(b). As used in the bill, “commissioner” refers to the commissioner of either the Department of Corporations, Department of Real Estate, or the Department of Financial Institutions as to the respective licensees thereof. Section 2923.53(k)(1).
  5. “Housing-related debt” is defined as debt that includes loan principal, interest, property taxes, hazard insurance, flood insurance, mortgage insurance, and homeowner association fees. Section 2923.53(k)(2)
  6. The bill specifically provides that the Commissioner may consider efforts implemented in other jurisdictions that have resulted in a reduction in foreclosures. As of the time of this writing, the loan modification provisions of the Obama Administration’s program are not “mandated” as it contains a number of incentives for lenders but not requirements. Therefore, it is uncertain whether a lender has the option to comply with a federal program as a part of its compliance efforts with this bill.
  7. Sections 2923.52(d) and 2923.53(d).
  8. The Secretary of Business, Transportation and Housing, three months following the granting of any exemption, is required to submit a report to the Legislature regarding actions taken to implement the bill and the numbers of applications received and orders issued. An additional report is required six months later and every six months thereafter. The Secretary must also publish on a web site details of final exemption orders granted and provide a link describing the loan modification programs. Additionally, the commissioners are required to collect data regarding loan modifications accomplished pursuant to the bill and publish the data available on the Internet. Sections 2923.53(e) and (f).
  9. Section 2923.53(i).
  10. Section 2923.53(k)(1)(A).

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.

© This CBA Regulatory Compliance Bulletin is copyrighted by the California Bankers Association, and may not be reproduced or distributed without the prior written consent of CBA.

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