NEWS, EVENTS, PUBLICATIONS & EMERGING ISSUES

SW&M EMERGING ISSUE
July 6, 2010

“FILLING THE GAPS” IN S.B. 1137: THE MABRY CASE AND PROPOSED S.B. 1275

As our California clients know, the state legislature’s passage of SB 1137 (aka the “Foreclosure Reform Bill” or the “Perata Mortgage Relief Act”) in 2008 drastically altered the way mortgage lenders in California are required to interact with borrowers in the pre-foreclosure context. At the time, concerns about California’s rapidly declining real estate property values, accompanied by the state’s record-high foreclosure rates, led SB 1137 to be passed as “emergency legislation,” effective immediately upon the Governor’s signature.

Perhaps as a result, the legislation and the California Civil Code provisions it created are filled with ambiguities and unaddressed issues regarding compliance and enforcement. For example, SB 1137 does not prescribe model notices for the consumer due diligence requirements, or model language for the Notice of Default regarding due diligence, or specific remedies available to consumers if a creditor fails to materially comply with the requirements of the law.

Recently, both the state courts and the California legislature appear to be taking action to “fill the gaps” with respect to these unanswered questions regarding compliance and enforcement. Below, we briefly address (1) a recent Court of Appeals case regarding a lender’s failure to comply with the “contact” requirements in SB 1137, and (2) SB 1275, currently-proposed California legislation which may expand upon the obligations in SB 1137.

Mabry v. Superior Court : Failure to Provide Pre-Foreclosure Counseling Enforceable by Private Right of Action

The California Court of Appeal recently issued one of the first major court decisions addressing SB 1137, in Mabry v. Superior Court, ___ Cal. App. 4th ___ (2010).

Specifically, the Mabry court considered the pre-foreclosure counseling required by California Civil Code Section 2923.5. In the case, the plaintiff borrowers alleged that the lender of their home loan (Aurora Loan Services, which serviced the loan but was treated as the lender for the purposes of the case) violated Section 2923.5 by failing to contact them to discuss foreclosure-avoidance options prior to filing a notice of default. The lender defended the claim in part by arguing that Section 2923.5 did not provide for a private right of action, and also that it was preempted by federal law, which specifically delineates certain loan servicing issues as matters for federal (not state) regulation.

The California Court of Appeal disagreed with the lender on both points.

Although the legislative history of the statute was silent regarding individual enforcement, the Court held that such a right was necessary in order to make the provision meaningful, in light of what it called the “obvious goal” of the statute: “forcing parties to communicate.” It reasoned that by requiring lenders to contact borrowers “in person or by telephone” prior to filing a notice of default, the statute conferred not only obligations (upon the lender), but also corresponding rights (upon the borrowers) as well. As such, the court concluded that Section 2923.5 is enforceable by private right of action.

With respect to the preemption issue, the Court found that Civil Code Sections 2923.5 and 2923.6 do not require a lender to rewrite or modify a loan, and thus do not run afoul of federal law. In holding so, it narrowly interpreted the SB 1137 provisions and confirmed that “there is no right . . . to a loan modification” under the statute. Instead, it found that Section 2923.6 merely expressed the “hope that lenders will offer loan modifications on certain terms.” This holding is significant in that it should eliminate a number of mortgage litigation claims based on plaintiffs’ allegations that SB 1137 requires lenders and loan servicers to modify loans prior to foreclosure.

The Court also offered another “silver lining” to creditors. In narrowly construing the California Civil Code provisions, the Court made clear that relief under Section 2923.5 is limited to postponement of the sale until the lender has complied with the requirements. In other words, if the foreclosure has already taken place, there is no remedy, and a creditor’s non-compliance with the “contact” obligations will not permit a borrower to “unwind” a foreclosure or otherwise cause a cloud to title. Although this holding should offer some comfort to our clients concerned about the ability of borrowers to “unwind” foreclosures, we must note that this particular ruling may be superseded in the near future by proposed SB 1275, described in further detail below.

Beyond the above, the Mabry case also clarifies a number of other important issues relating to Civil Code Section 2923.5 that are optimistic for lenders:

• The requirements under Section 2923.5 to “assess the borrower’s financial situation” and “explore options” to avoid foreclosure are to be construed simply. That is, lenders can fulfill such requirements by asking borrowers why they are not able to make their payments, and by informing borrowers about the traditional ways to avoid foreclosure (e.g., deeds in lieu, workouts, or short sales). A lender need not obtain such detailed information from its borrowers that it is functionally taking a new loan application, or offer detailed loan counseling in any way.


• The declaration required by Section 2923.5 is not required to be made under oath or under penalty of perjury.


• Because Section 2923.5 “contemplates highly individuated facts” (e.g., how a lender contacts the borrower, what the lender says), in most instances, claims under this provision would not be suitable for class-action treatment.

Look Out for SB 1275: The “Homeowners’ Bill of Rights”

The California legislature seems ready to again increase lender and servicer obligations under a new bill, SB 1275. In drafting SB 1275, the legislature appears to be clarifying its original intent under SB 1137, by expanding the borrower contact requirements described above and prohibiting the commencement of foreclosure proceedings until borrowers have been given a final determination on their loan modification application. SB 1275 has been voted on and recommended for passage but is making a stop at the Assembly Appropriations Committee before heading to the Governor’s desk for signature.

Under SB 1275, prior to recording a notice of default, lenders and servicers are required to:

• Mail borrowers a specified notice informing them of their foreclosure-related rights and foreclosure avoidance options (i.e., loan modification, short sale, or deed in lieu of foreclosure);


• Mail borrowers a letter that includes, among other things, a clear description of loan modification options and a detailed list of the documents the borrower should collect for evaluation for a modification, or, a notice that the lender or servicer does not have a modification program or the borrower is not eligible to be evaluated for a loan modification;


• Evaluate a borrower’s written application for loan modification (or other foreclosure alternative); and


• Mail borrowers who are denied a loan modification (or other foreclosure alternative) a detailed explanation regarding the reasons for their denial.

Lenders and servicers will also be required to file a new document, called a “Declaration of Compliance,” concurrently with the notice of default, attesting to (among other things) compliance with the borrower contact requirements.

Importantly, a borrower may have grounds to void a foreclosure or recover specified damages from a lender or servicer, if the lender or servicer fails to record the Declaration of Compliance or fails to materially comply with the contact requirements. While the Mabry case casts a light on the challenges that lenders have faced in trying to comply with the requirements under SB 1137, under the provisions of SB 1275, lenders and servicers will have a new set of rules to follow that carry a large burden if not followed.

We note that the legislation, as drafted, does not appear to provide an exclusion for borrowers who are able to pay but elect to “walk away” from the property because it is underwater (“strategic defaulters”).

Finally, as a reminder to our clients, SB 1137 which shall sunset on January 1, 2013, unless otherwise extended, applies to mortgages or deeds of trust recorded between January 1, 2003 and December 31, 2007, secured by owner-occupied residential real property containing no more than 4 dwelling units. Provided that SB 1275 is signed into law, which we anticipate will be the case, SB 1275 will also extend the SB 1137 requirements to mortgages or deeds of trust recorded prior to January 1, 2009, on owner-occupied residential real property up to 4 dwelling units.

If your credit union has any questions regarding the Mabry case or the proposed SB 1275, please contact our office.

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