On June 17, New York Gov. Andrew Cuomo signed one of the most far-reaching COVID-19 mortgage assistance state programs yet into law. Affected servicers and lenders will soon need to decide whether they should find a way to comply, or bring a constitutional challenge.
The new law mandates that New York-regulated banking organizations and mortgage servicers take several steps to assist borrowers suffering COVID-19 related hardships as to non-federally backed mortgage loans (i.e., loans not covered by the CARES Act). Specifically, the law requires that the lenders and servicers:
- Make applications for forbearance “widely available” to any “qualified mortgagor” (defined broadly to include most any borrower whose primary residence is a house, condominium or co-op interest in New York) who demonstrates financial hardship as a result of COVID-19 and who is “in arrears or on a trial period plan, or who has applied for loss mitigation;”
- Grant up to 180 days of forbearance of all monthly payments to any qualified mortgagor, with the mortgagor having the option to extend the forbearance for up to an additional 180 days if he or she demonstrates continued financial hardship;
- Allow a mortgagor three options for paying back the amount in arrears due to forbearance: (1) extend the term of the loan for the length of forbearance period, without “additional” late fees or penalties on the forborne payments; (2) pay back the arrears accumulated during forbearance (without late fees or penalties) in monthly payments for the remaining term of the loan; or (3) negotiate a loan modification or other option for repayment;
- If the lender and the borrower are unable to “reasonably agree” on a loan modification (and presumably any of the other options listed above), then the lender shall offer to defer the accumulated arrearage as a non-interest-bearing balloon obligation due at the maturity of the loan.
- Not furnish negative credit reporting information to any credit bureau regarding the borrower’s option for the amount in arrears due to forbearance.
A lender’s compliance with all of these provisions is a condition precedent to pursuing foreclosure, and the borrower can raise non-compliance as a defense to the foreclosure. No guidance is provided on how a lender can establish compliance with the law.
Earlier drafts of the bills in the New York Legislature required lenders to waive note-rate interest accrued during the forbearance period. The final version signed into law omitted that draconian (and likely unconstitutional) provision, now only barring lenders from assessing “additional” late fees and interest.
Even with that amendment, the new law creates some significant burdens for regulated lenders and servicers. The bar on the collection of “all monthly payments” during the forbearance period suggests that servicers may not be permitted to collect escrow funds from borrowers in forbearance. If so, servicers will likely be forced to advance taxes and insurance payments for the borrower during the period of forbearance.
The law also gives borrowers the right to extend the duration of their loan obligation by up to a year (i.e., the potential 360-day forbearance period). Or a borrower might elect to repay the forbearance arrearage over the remaining duration of the loan – an approach that will likely pose tremendous burdens for a servicing platform. The new law is silent on whether a borrower may be required to sign such extensions or extended repayment agreements.
If regulated lenders and servicers decide these burdens are too great, they may opt to bring a constitutional challenge to the law under the Contracts Clause. Article I, Section X, Clause I of the U.S. Constitution states that “No State shall . . . pass any . . . Law impairing the Obligation of Contracts.” Known as the “Contracts Clause,” this provision limits the power of the states to impair the obligations of private parties under contracts. Under the current standard, the courts apply a two-step balancing test in considering a Contracts Clause challenge to a law. First, the court asks if the state law “operates as a substantial impairment of a contractual relationship” (Sveen v. Melin, 138 S. Ct. 1815, 1821-22 (2018)). If the law does impose a significant impairment on contracts, then it addresses the second question under the test: whether the state law is drawn in an “appropriate” and “reasonable” way to advance “a significant and legitimate public purpose” (quoting Energy Reserves Group, Inc. v. Kansas Power & Light Co., 459 U.S. 400, 411-12 (1983)).
Applying that test, the federal courts have determined that states have broad powers to affect private contracts, but those powers are not unlimited. For example, while the U.S. Supreme Court has recognized the states’ ability to pass laws for the general welfare that may have incidental effects on private parties’ contracts – such as by temporarily restricting the right of foreclosure or other enforcement procedures (see Home Building & Loan Ass’n v. Blaisdell, 290 U.S. 398, 445 (1934)) – courts have stated that a state law that “thwarts performance of an essential term . . . defeats the expectations of the parties . . . or alters a financial term” constitutes a substantial impairment on a private contract that is not permitted (see e.g., HRPT Properties Trust v. Lingle, 715 F. Supp. 2d 1115, 1136 (D. Hawai’i 2010), holding that state rent control law substantially impaired pre-existing contracts and violated the Contracts Clause).
Here, a regulated lender or servicer bringing a Contracts Clause challenge to the law would likely focus on the borrower’s option to choose how to repay the amount in forbearance. The duration of a mortgage loan is a major variable, and the lender, the servicer, and any other parties involved in making the loan relied on the duration for valuing the asset. Giving the borrower the power to choose to extend the duration by a full year arguably defeats the reasonable expectations of those parties.
The law’s ambiguous language regarding the possibility of a loan modification also creates a basis for a Contracts Clause challenge. A lender can only default to requiring repayment as a balloon obligation if the lender and borrower are unable to “reasonably agree” on a loan modification. Inserting the word “reasonably” suggests that there is objective criteria governing whether the borrower should receive a loan modification – in other words, there are circumstances where the borrower can argue that he or she has a statutory right to a certain type of loan modification. That upsets long-settled principles of both basic contract law (that a court cannot impose a contract on unwilling parties) and loan modifications in particular (that no borrower has a right to receive a specific loan modification option).
The Contracts Clause arguments are not the only potential constitutional issues with the law. Mandating that regulated lenders and servicers not provide negative credit reporting information regarding how consumers repaid amounts accrued during forbearance is a direct regulation of commercial speech. While commercial speech does not enjoy the same level of protection as noncommercial speech, it is nonetheless protected by the First Amendment.
With this new law, New York-regulated mortgage lenders and servicers face a tough decision: Do they try to find a way to comply and bear the costs and losses associated with compliance as best they can, or do they decide to litigate the law’s constitutionality in court? Neither option seems appealing, but if they do decide to litigate they will have some good arguments to make.