Can Mortgage Servicers Legally Offer the GSEs’ COVID-19 Payment Deferral Options?

Can Mortgage Servicers Legally Offer the GSEs’ COVID-19 Payment Deferral Options?On Wednesday, May 13, 2020, Fannie Mae and Freddie Mac unveiled new retention workout options that were jointly developed and “specifically designed to help borrowers impacted by a hardship related to COVID-19 return their mortgage to a current status.” The government-sponsored enterprises’ (GSEs) highly anticipated new COVID-19 payment deferral will allow servicers to defer up to 12 months of delinquent mortgage payments to the end of the loan term as a non-interest-bearing balance. Although the GSEs’ intentions behind the COVID-19 payment deferral are admirable, there are some questions about whether servicers can legally offer the deferral without violating the anti-evasion clause in Regulation X and, therefore, being exposed to risk.

As a refresher, the anti-evasion clause in Regulation X generally prohibits mortgage servicers from offering a loss mitigation option based upon an evaluation of an incomplete loss mitigation application. Instead, the CFPB’s mortgage servicing rules are designed to encourage servicers to collect complete loss mitigation applications and evaluate borrowers for all loss mitigation options that may be available. While servicers are always allowed to make blind offers of loss mitigation, they also are permitted to evaluate incomplete applications when the resulting offer constitutes either a short-term forbearance program or short-term repayment plan.

To make the new option simple and efficient for both servicers and borrowers, the GSEs both establish that servicers “must not require a complete Borrower Response Package (BRP) to evaluate the borrower for a COVID-19 payment deferral if the eligibility criteria are satisfied.” Instead, quality right party contact (QRPC) must be established with the borrower to gauge if (1) the borrower’s hardship has been resolved, (2) the borrower is able to make the contractual monthly payment going forward, and (3) the borrower is able to reinstate the mortgage loan or afford a repayment plan to cure the delinquency.

At the time of these interactions, servicers will likely already have an incomplete loss mitigation application open if the borrower previously requested a forbearance pursuant to the CARES Act or another COVID-19 related program. Even if, for whatever reason, that doesn’t apply in some circumstances and an application isn’t open, when the servicer makes contact with the borrower and begins discussing what is required to evaluate the borrower for the COVID-19 payment deferral, the conversation will inevitably constitute a loss mitigation application under Regulation X. The borrower will have to express an interest in loss mitigation and will have to provide information that the servicer will evaluate to make its decision. The servicer’s only option at that point under Regulation X will be to offer something that qualifies as a short-term forbearance or short-term repayment plan.

For purposes of the loss mitigation rules in Regulation X, a short-term forbearance is when a servicer allows a borrower to forgo making up to six months of payments, regardless of how long the borrower has to make up the missing payments. Given that borrowers will likely be coming off of forbearances when they are considered for a deferral and the deferral is designed to address already past due payments, it seems highly unlikely that a deferral would be considered a form of forbearance, which is traditionally considered to be a prospective option. Furthermore, the GSEs contemplate that servicers should be able to address up to 12 months of delinquent payments, which clearly does not fit within the short-term forbearance parameters in Regulation X that only permit servicers to forbear up to six months of payments. Therefore, the GSEs’ COVID-19 payment deferral will likely not meet the definition of a short-term forbearance program.

A short-term repayment plan, on the other hand, is when a borrower is allowed to repay up to three months of past due payments over a period lasting no more than six months. While a deferral could be considered a repayment plan because borrowers are agreeing to repay the arrearage over a significant period of time, the GSEs are allowing the COVID-19 deferral program to address up to 12 months of missed payments, which precludes the arrangement from being considered “short-term.” Additionally, under Regulation X, to be considered short-term, a repayment plan must address the arrearage within six months. Under a deferral, borrowers will repay the arrearage at maturity or loan payoff, which will almost always take place more than six months in the future. Either way you look at it, a COVID-19 payment deferral will also not meet the definition of a short-term repayment plan.

Given that the QRPC conversations will constitute loss mitigation applications and the COVID-19 payment deferral option will not fit into the parameters of a short-term forbearance or repayment plan, servicers may actually be required to collect a complete loss mitigation application before being able to evaluate the borrower for the new option – a reality contrary to the GSEs’ expectations and burdensome for servicers and borrowers. With that said, a servicer may be able to argue that, upon QRPC and once it determines the borrower is eligible for the COVID-19 deferral program, it actually has a complete loss mitigation application at that point. The argument would be that, following the conversation, the servicer has everything it needs to evaluate the borrower for all available loss mitigation options pursuant to the GSEs’ COVID-19 evaluation hierarchy. The strength of this argument is a bit unclear at this point and, nevertheless, it does not seem consistent with the GSEs’ expectations, as the GSEs make it very clear that the servicer must not collect a complete application and their form COVID-19 deferral offer notice does not contemplate that the offer is based upon a complete application (i.e., does not include any loan modification denial reasons, an appeal period, etc.).

While the CFPB previously announced that it will be lenient in its expectations when it comes to technical compliance with certain aspects of the mortgage servicing rules during the pandemic, its commitment has centered around future supervisory and enforcement activity. However, the CFPB has not indicated that it would provide any flexibility in terms of the anti-evasion clause in Regulation X. Furthermore, the loss mitigation rules in Regulation X are subject to private enforcement by individual borrowers, and the CFPB has not yet taken any steps to alleviate that risk. Therefore, servicers who follow the process laid out by the GSEs for the evaluation , and offering of, a COVID-19 payment deferral may be exposed to risk of potential future supervisory, enforcement, and litigation activity. These same risks apply – perhaps even more so – to servicers that elect to apply the GSE approach to their portfolio and private investor loans. In such cases, the servicer is even less likely to be able to point to the GSE guidance for potential cover.

It is also worth noting that proposed follow-up legislation to the CARES Act, which is titled the Health and Economic Recovery Omnibus Emergency Solutions Act (HEROES Act), contains provisions that may pave a path for the GSEs’ COVID-19 payment deferral program to work and, at least theoretically, not violate the existing restrictions in Regulation X. However, that proposed legislation is not final and there appears to be substantial disagreement in the Senate over the existing proposal. Meanwhile, servicers of GSE loans will be required by Fannie Mae and Freddie Mac to follow their guidance in the coming weeks.

Servicers of Fannie Mae and Freddie Mac loans currently will be required to evaluate borrowers for the COVID-19 payment deferral beginning on July 1, 2020. We are hopeful that additional guidance will be released before that time.

Federal Law Preempts Connecticut’s Student Loan Servicer Licensing Law, According to Federal Court

Federal Law Preempts Connecticut’s Student Loan Servicer Licensing Law, According to Federal CourtSeveral states have recently ramped up their regulation of the student lending industry by passing laws requiring student loan servicers to be licensed in the state in order to operate there. Many of these state licensing laws are creating conflicts for servicers in an industry already dominated by federal law. Now a U.S. District Court in Connecticut has decided in Pennsylvania Higher Education Assistance Agency v. Perez that federal law preempts portions of Connecticut’s student loan servicer licensing statute, a decision that may limit the scope of other states’ licensing laws.

In 2017, Connecticut’s licensing statute placed student loan servicer Pennsylvania Higher Education Assistance Agency (PHEAA) in an impossible situation. The Connecticut Department of Banking, pursuant to Connecticut’s student loan servicer licensing statute, demanded PHEAA’s records and information related to the federal Public Service Loan Forgiveness Program. However, the Department of Education, which contracted with PHEAA for the servicing of certain federal Direct Loans in the Public Service Loan Forgiveness Program, instructed PHEAA to not disclose any data or documentation related to the Public Service Loan Forgiveness Program. The U.S. Department of Education took the position that PHEAA was prohibited from releasing the Public Service Loan Forgiveness Program’s records under the federal Privacy Act and declined to provide the records to the Connecticut Department of Banking.

Even though PHEAA informed the Connecticut Department of Banking that it could not respond to the request due to the U.S. Department of Education’s directive, the Connecticut Department of Banking threatened administrative action and suspension of PHEAA’s state license if it failed to comply with the records request. Ultimately, neither the Connecticut Department of Banking nor the U.S. Department of Education was willing to budge from their respective positions, leaving PHEAA’s state license hanging in the balance.

PHEAA sought a declaratory judgment from the federal district court as to whether federal law preempts the portions of Connecticut’s licensing statute relied on by the Connecticut Department of Banking in making its document requests. On summary judgment, the court examined the dispute under principles of conflict preemption, ultimately finding that federal law preempted the provisions of Connecticut’s licensing statute that required PHEAA to provide documents related to its servicing of federal student loans.

The court first noted that Connecticut’s “licensing requirements for student loan servicers overlap with [the U.S. Department of] Education’s own criteria for selecting its servicing contractors,” and accordingly interfere with the U.S. Department of Education’s selection process for its own contractors. This, the court held, violated the U.S. Supreme Court’s precedent set in Leslie Miller, Inc. v. State of Ark., in which the Supreme Court struck down a state licensing statute that virtually gave the state power of review over a federal contractor determination.

The court also held that “impossibility preemption bars the portions of [the Connecticut Department of Banking’s] demands that sought documents and information protected by the Privacy Act, since ‘compliance with both federal and state regulations [wa]s a physical impossibility’ for PHEAA.” The court noted that the U.S. Department of Education has “substantial discretion” in whether to release documents under the Privacy Act and has ownership of the documents themselves. PHEAA thus had no power on its own to provide the documents to the Connecticut Department of Banking, and impossibility preemption applied.

Notably, the court did not hold that Connecticut’s general licensing requirement was preempted, but rather limited preemption application to just those portions of Connecticut’s licensing statute that covered state investigations and record-keeping requirements for federal student loan servicers. Also, the opinion appears to restrict preemption to the servicing of federal student loans rather than privately held student loans. Lastly, while the court declined to reach the issue of whether field preemption applies, the court noted that there was some authority suggesting field preemption would not be appropriate as it relates to the relationship between state licensing laws and federal law.

This decision limits the reach of Connecticut’s licensing statute because it strips some potent tools from the Connecticut Department of Banking — investigatory powers and informational demands. While the decision likely will not slow the growing trend of state licensing laws aimed at the student lending industry, it may take the teeth out of some of the provisions.

CFPB Signals Renewed Enforcement of Tribal Lending

CFPB Signals Renewed Enforcement of Tribal LendingIn recent years, the CFPB has sent different messages regarding its approach to regulating tribal lending. Under the bureau’s first director, Richard Cordray, the CFPB pursued an aggressive enforcement agenda that included tribal lending. After Acting Director Mulvaney took over, the CFPB’s 2018 five-year plan indicated that the CFPB had no intention of “pushing the envelope” by “trampling upon the liberties of our citizens, or interfering with sovereignty or autonomy of the states or Indian tribes.” Now, a recent decision by Director Kraninger signals a return to a more aggressive posture towards tribal lending related to enforcing federal consumer financial laws.

Background

On February 18, 2020, Director Kraninger issued an order denying the request of lending entities owned by the Habematolel Pomo of Upper Lake Indian Tribe to set aside certain CFPB civil investigative demands (CIDs). The CIDs in question were issued in October 2019 to Golden Valley Lending, Inc., Majestic Lake Financial, Inc., Mountain Summit Financial, Inc., Silver Cloud Financial, Inc., and Upper Lake Processing Services, Inc. (the “petitioners”), seeking information related to the petitioners’ alleged violation of the Consumer Financial Protection Act (CFPA) “by collecting amounts that consumers did not owe or by making false or misleading representations to consumers in the course of servicing loans and collecting debts.” The petitioners challenged the CIDs on five grounds – including sovereign immunity – which Director Kraninger rejected.

Prior to issuing the CIDs, the CFPB filed suit against all petitioners, except for Upper Lake Processing Services, Inc., in the U.S. District Court for Kansas. Like the CIDs, the CFPB alleged that the petitioners engaged in unfair, deceptive, and abusive acts prohibited by the CFPB.  Additionally, the CFPB alleged violations of the Truth in Lending Act by not disclosing the annual percentage rate on their loans. In January 2018, the CFPB voluntarily dismissed the action against the petitioners without prejudice. Accordingly, it is surprising to see this second move by the CFPB of a CID against the petitioners.

Denial to Set Aside the CIDs

Director Kraninger addressed each of the five arguments raised by the petitioners in the decision rejecting the request to set aside the CIDs:

  1. CFPB’s Lack of Authority to Investigate Tribe – According to Kraninger, the Ninth Circuit’s decision in CFPB v. Great Plains Lending “expressly rejected” all of the arguments raised by the petitioners as to the CFPB’s lack of investigative and enforcement authority. Specifically, as to sovereign immunity, the director concluded that “whether Congress has abrogated tribal immunity is irrelevant because Indian tribes do not enjoy sovereign immunity from suits brought by the federal government.”
  2. Protective Order Issued by Tribe Regulator – In reliance on a protective order issued by the Tribe’s Tribal Consumer Financial Services Regulatory Commissions, the petitioners argued that they are instructed “to file with the Commission—rather than with the CFPB—the information responsive to the CIDs.” Rejecting this argument, Kraninger concluded that “nothing in the CFPA requires the Bureau to coordinate with any state or tribe before issuing a CID or otherwise carrying out its authority and responsibility to investigate potential violations of federal consumer financial law.” Additionally, the director noted that “nothing in the CFPA (or any other law) permits any state or tribe to countermand the Bureau’s investigative demands.”
  3. The CIDs’ Purpose – The petitioners claimed that the CIDs lack a proper purpose because the CIDs “make an ‘end-run’ around the discovery process and the statute of limitations that would have applied” to the CFPB’s 2017 litigation. Kraninger claims that because the CFPB dismissed the 2017 action without prejudice, it is not precluded from refiling the action against the petitioners. Additionally, the director takes the position that the CFPB is permitted to request information outside the statute of limitations, “because such conduct can bear on conduct within the limitations period.”
  4. Overbroad and Unduly Burdensome – According to Kraninger, the petitioners failed to meaningfully engage in a meet-and-confer process required under the CFPB’s rules, and even if the petitioners had preserved this argument, the petitioners relied on “conclusory” arguments as to why the CIDs were overbroad and burdensome. The director, however, did not foreclose further discussion as to scope.
  5. Seila Law – Finally, Kraninger rejected a request for a stay based on Seila Law because “the administrative process set out in the Bureau’s statute and regulations for petitioning to modify or set aside a CID is not the proper forum for raising and adjudicating challenges to the constitutionality of the Bureau’s statute.”

Takeaway

The CFPB’s issuance and defense of the CIDs appears to signal a shift at the CFPB back towards a more aggressive enforcement approach to tribal lending. Indeed, while the pandemic crisis persists, CFPB’s enforcement activity in general has not shown signs of slowing. This is true even as the Seila Law constitutional challenge to the CFPB is pending. Tribal lending entities should be tuning up their compliance management programs for compliance with federal consumer lending laws, including audits, to ensure they are ready for federal regulatory review.

A Good Day for Lenders: Texas Supreme Court Rules that Lenders Still Entitled to Equitable Subrogation for Non-compliant Home Equity Loans

A Good Day for Lenders: Texas Supreme Court Rules that Lenders Still Entitled to Equitable Subrogation for Non-compliant Home Equity LoansOn April 24, 2020, the Texas Supreme Court upheld a lender’s right to equitable subrogation for non-compliant home equity loans, ruling that lenders who fail to cure within the statutorily mandated 60-day period may recoup funds paid to satisfy prior liens. The court’s opinion in Federal Home Loan Mortgage Corp. v. Zepeda answered a certified question from the United States Fifth Circuit Court of Appeals, and gives some relief to home equity lenders in a notoriously complicated environment.

Texas has a long history of protecting the family homestead from foreclosure by limiting the types of liens that can be placed upon homestead property, being the last state to permit home equity loans by virtue of a constitutional amendment in 1997. These loans allow homeowners to use the equity in their home as collateral to refinance a prior debt and secure additional funds at rates that are typically lower than other types of consumer loans. Home equity loans are strictly regulated by article XIV, section 50(a)(6) of the Texas Constitution, which promulgates a large and often confusing number of rules and regulations regarding loan origination that frequently leads to subsequent consumer litigation. This same section also sets out a framework by which lenders are to be notified of alleged errors and cure any noncompliance (usually by correcting the error and paying a penalty). In the event a lender fails to cure the noncompliance within 60 days of being put on notice by the borrower, it forfeits all principal and interest on the loan in an eventual foreclosure action.

This decision comes against the backdrop of two recent decisions in which the Texas Supreme Court held that no statute of limitations applied to quiet title claims stemming from noncompliant home equity loans, a striking victory for borrowers. By way of example, a properly noticed noncompliance demand letter pursuant to Section 50(a)(6) can be sent at any time after closing, even in the 29th year of a loan.

Up until recently, lenders availed themselves of the doctrine of equitable subrogation to help ease the pain of failing to cure a noncompliant loan, which was expressly blessed by the Texas Supreme Court in the LaSalle Bank National Association v. White. Per LaSalle Bank (and consistent with long-standing general Texas commercial law), a lender who discharges a valid lien on the property of another can step into the prior lienholder’s shoes and assume that lienholder’s security interest in the property, even though the lender cannot foreclose on its own lien. Thus, though a lender is not made entirely whole, it is afforded some relief. The unaddressed issue in LaSalle Bank was whether a lender had clean hands if that lender failed to respond to a borrower’s notice of non-compliance, an argument that seemed to have some support.

Thus, the stage was set for Zepeda. The case, arising in the Southern District of Texas, involved a defective acknowledgement of fair market value, and the borrower brought suit against Freddie Mac to quiet title. The borrower raised claims for both contractual and equitable subrogation. The district court found in favor of the borrower, holding that Freddie could not avail itself of contractual subrogation due to the defective loan documents. The district court also rejected any claim for equitable subrogation because Freddie had supposedly been “negligent” in failing to cure the defective loan documents after being properly noticed of its noncompliance.

On appeal, the Fifth Circuit affirmed the district court’s holding on contractual subrogation. When it turned to the issue of equitable subrogation, however, the court was unable to find any Texas Supreme Court cases directly dealing with instances of constitutional defects that were solely the fault of the lender. Therefore, the Fifth Circuit issued a certified question to the Texas Supreme Court to clarify the issue.

The Texas Supreme Court found in favor of the lender’s right to equitable subrogation, and in reaching its decision, reviewed a century-long history of decisions addressing equitable subrogation in conjunction with the development of Section 50 of the Constitution. As reasoned by the court, because Section 50(a)(6) does not expressly displace the equitable remedy, such language should not be read into the Constitution.

While the Texas Supreme Court’s opinion affords relief to home equity lenders, the pitfalls that gave rise to this issue in the first place still exist. Home equity lending is complicated and the failure to comply can have drastic consequences. Further, equitable subrogation is truly a remedy of last resort as a lender can find itself severely under-secured and many times the cost to cure can be excessive. Given that many consumers will need to tap their equity in these times of the COVID-19 pandemic and high unemployment, lenders should expect Texas home equity loans to continue to be on the forefront of the Texas financial marketplace.

Individual Employs New Small Business Bankruptcy Law to Modify Mortgage

Individual Employs New Small Business Bankruptcy Law to Modify MortgageSmall businesses often struggle to reorganize in bankruptcy. To address this issue, Congress passed the Small Business Reorganization Act of 2019 (the SBRA). The SBRA took effect in February 2020 and makes small business bankruptcies faster and less expensive.

The recent case of In re Ventura, 2020 WL 1867898 (E.D.N.Y. Apr. 10, 2020) addresses many notable issues under the SBRA. In that matter, the debtor owned and operated a bed and breakfast out of a historic mansion, which was also her home. The debtor financed her purchase of the mansion with a $1 million loan. The debtor filed a Chapter 11 bankruptcy and proposed a plan to bifurcate the mortgage into secured and unsecured claims. The court ruled that the plan was not confirmable because applicable law at the time prohibited modifying a mortgage on a primary residence.

The SBRA went into effect during the debtor’s bankruptcy, and now allows modification of certain mortgages secured by a primary residence. The debtor took advantage of the change in the law, and amended her petition to designate herself as a small business debtor. The mortgage lender and U.S. trustee objected.

Amending a Prior Petition

As an initial matter, the SBRA is silent as to whether it applies to pending cases, or only cases filed after the effective date. In Ventura, the U.S. trustee acknowledged, and the court agreed, that there was no absolute bar to retroactively applying the SBRA to pending cases. At least two other bankruptcy court decisions allowed debtors to amend their petitions to take advantage of the SBRA.

Nonetheless, the trustee raised procedural concerns with allowing the debtor to amend her petition. The SBRA has strict deadlines for a status conference and plan filing. Since the debtor filed her case 15 months earlier, she missed these deadlines. The SBRA does allow an extension of the plan deadline “if the need for an extension is attributable to circumstances for which the Debtor should not be justly held accountable.” The court held that, since the SBRA did not yet exist at the time of filing, requiring the debtor to comply with the deadlines would be “the height of absurdity.”

The lender also argued that allowing the debtor to proceed under the SBRA would amount to a “taking” of its right to propose a competing bankruptcy plan. The court explained the relevant question was whether allowing the debtor to designate herself as a small business debtor impaired the lender’s rights as they existed prior to the SBRA. The debtor’s choice to amend her petition did not amount to a taking of property because the lender retained its right to recover the value of the mansion.

Designation as a “Small Business Debtor”

The Ventura court also analyzed whether the debtor qualified as a “small business debtor,” which is defined as a “person engaged in commercial or business activities” that has “aggregate, noncontingent, liquidated secured and unsecured debt of less than $2,725,625. . . not less than 50 percent of which arose from the commercial or business activities of the debtor” (11 U.S.C. § 101(51D)). In response to the COVID-19 pandemic, Congress raised this debt limit to $7.5 million for one year until March 26, 2021.

The mortgage lender argued that the relevant debts did not arise from the debtors “commercial or business activities,” because she previously filed bankruptcies where she categorized the same debts as consumer debts. The court disagreed. The real question was whether a specific debt was “incurred with an eye towards profit.” Fifty percent of the relevant debts arose from commercial activities because the debtor’s “primary purpose of purchasing the Property” was to operate the bed and breakfast.

Stripping Down a Mortgage Under the SBRA

The court then had to decide whether or not the debtor could modify, or “strip down,” the mortgage on her primary residence under 11 U.S.C. § 1190(3), a tool unavailable to individuals in a typical Chapter 11. Under this section, a debtor can modify a claim secured by a mortgage on a principal residence so long as the new value received in connection with the mortgage was (1) not used to primarily acquire the real property; and (2) used primarily in connection with the small business of the debtor.

The court chose to hold a future evidentiary hearing on these questions, but not before identifying five factors it planned to consider: (1) whether the mortgage proceeds were used in furthering the debtor’s business; (2) whether the property was an integral part of the business; (3) the degree to which the property was necessary to run the business; (4) whether customers must enter the property to use the business; and (5) whether the debtor uses employees and other businesses to run the operations.

The Evolution of Caselaw Under the SBRA

There is little doubt that the economic turmoil stemming from the outbreak of COVID-19 will drive the development of SBRA caselaw. With many small businesses temporarily shuttered, it is only a matter of time before courts see an increase in small business filings. Further, debtors with struggling Chapter 11 cases may take this opportunity to amend their petitions and designate themselves as small business debtors under the SBRA. Creditors should monitor the developing caselaw and be prepared to preserve their rights in these new small business cases.

Southern District of Texas Enters Temporary Restraining Order Extending PPP Loan Benefits to Debtor in Bankruptcy

Southern District of Texas Enters Temporary Restraining Order Extending PPP Loan Benefits to Debtor in BankruptcyIn a potentially ground-breaking decision, Judge David R. Jones of the United States Bankruptcy Court for the Southern District of Texas temporarily enjoined the Small Business Administration (SBA) from denying a Paycheck Protection Program (PPP) loan to Hidalgo County Emergency Service Foundation due solely to its status as a Chapter 11 debtor in bankruptcy. While the order will expire on May 8, 2020, and only applies to Hidalgo, the order could mark a significant change in the SBA’s administering of the PPP.

Congress passed the CARES Act in response to the coronavirus pandemic to provide financial relief to small businesses. The act provides substantial funding for the SBA’s 7(a) Loan Program under the Paycheck Protection Program. Qualified applicants can receive up to $10 million, with amounts spent on payroll and other covered expenses (subject to certain limitations) eligible for debt forgiveness. In furtherance of the act, the SBA promulgated a Borrower Application Form for small businesses to complete when applying for PPP loans. Question 1 of the Borrower Application Form requires the applicant to disclose if the applicant, or any owner of the applicant, is “presently involved in any bankruptcy.” The form further provides that if the answer to this question is “yes” then the loan will not be approved. Consequently, PPP loans have heretofore been unavailable to debtors involved in a bankruptcy case.

Enter Hidalgo, the primary 911 patient transfer provider for a large part of its service area in South Texas and a debtor in a Chapter 11 bankruptcy proceeding pending in the Southern District of Texas. Hidalgo applied for a PPP loan with a local bank on April 3, 2020, and disclosed that it was involved in a bankruptcy on the Borrower Application Form. On April 9, 2020, the bank denied Hidalgo’s request on the grounds that Hidalgo was not eligible due to its status as a debtor involved in a bankruptcy case. Hidalgo then filed an adversary proceeding seeking injunctive relief prohibiting the SBA from unlawfully prohibiting it from participating in the PPP based on its status as a debtor in bankruptcy. Among its legal arguments, the SBA contended that “[t]he prohibition on lending to companies in bankruptcy allows the Program to continue with shorter-than-normal due diligence periods.”

The court, however, disagreed. The court found that Hidalgo had shown a substantial likelihood that the SBA had (i) exceeded its statutory authority under the CARES Act by categorically prohibiting debtors in bankruptcy from qualifying for PPP loans and (ii) violated section 525(a) of the Bankruptcy Code, which prohibits governmental units from discriminating against parties applying for licenses, permits, charters, franchises or other similar grants who are or have been in bankruptcy. The court further found that Hidalgo would suffer significant harm if the SBA continued in its refusal to permit Hidalgo to apply for a PPP loan. In evaluating the public interest, the court also found that Hidalgo provides critical health services to South Texas and that the continued employment of Hidalgo’s 200+ workforce benefits the public interest.

Based on these findings, the court entered a temporary injunction in favor of Hidalgo enjoining and prohibiting the SBA from, among other things, summarily rejecting Hidalgo’s application for a PPP loan based on its involvement in a bankruptcy proceeding.

While Hidalgo is not the only debtor to be refused a PPP loan, Judge Jones’ order appears to be the first ruling, albeit limited and temporary, prohibiting the SBA from conditioning access to the PPP on a debtor’s involvement in a bankruptcy. The order may provide a path forward for debtors looking to participate in the expected second round of funding for PPP loans. The court will hold a hearing on whether to extend the temporary restraining order into a preliminary injunction on May 8, 2020.

FHFA Announces COVID-19 Forbearance Relief for Mortgage Servicers

FHFA Announces COVID-19 Forbearance Relief for Mortgage ServicersIn a statement released on April 21, 2020, the Federal Housing Finance Agency (FHFA) announced that mortgage servicers would only be required to advance four months of missed payments for Fannie Mae and Freddie Mac owned loans on CARES Act forbearance plans. After that four-month period, FHFA explained the servicers would be under “no further obligation to advance scheduled payments.” Importantly, this policy applies both to bank and nonbank servicers.

Servicers for Fannie Mae owned loans with a scheduled payment remittance generally must advance the principal and interest payment regardless of borrower payments. Freddie Mac servicers are only obligated to advance four months of missed borrower interest payments. FHFA’s announcement described the new limit for Fannie Mae loans as “consistent with the current policy at Freddie Mac.” The new limitation aligns with the opinion of Mark Calabria, director of FHFA, whose expectation is that “the overwhelming majority of people who take forbearance will be for two or three months and not 12 months.” Of course, the CARES Act permits borrowers with federally backed loans to forbear their payments up to 12 months with only an attestation as to financial distress caused in whole or part by COVID-19.

Calabria explained, “[t]he four-month servicer advance obligation limit for loans in forbearance provides stability and clarity to the $5 trillion Enterprise-backed housing finance market” and “[m]ortgage servicers can now plan for exactly how long they will need to advance principal and interest payments on loans for which borrowers have not made their monthly payment.”

This relief from FHFA is critical as nearly three million homeowners (almost 6% of all home loans) have already sought forbearances, and the industry expects those numbers to continue to climb.

The Mortgage Bankers Association (MBA) commented that FHFA’s announcement “is an important step in reducing the maximum liquidity demands for servicers who are providing mortgage payment forbearance for borrowers who have a pandemic-related hardship, and we appreciate FHFA’s action.” The MBA reiterated, however, “the need for Treasury and the Federal Reserve to create a liquidity facility for those servicers who need it in order to continue to make payments to investors, municipalities, and insurers on behalf of borrowers who have been granted forbearance required” by the CARES Act.

Misrepresentation Claims Not Preempted: Eleventh Circuit Rules Against Preemption in Student Loan Case

Misrepresentation Claims Not Preempted: Eleventh Circuit Rules Against Preemption in Student Loan CaseAs we’ve been tracking for over a year now, courts across the country have addressed the significant question of whether the federal laws governing federally owned or guaranteed student loans preempt state laws placing burdens on servicers of those loans. Last week, the Eleventh Circuit became the latest court to weigh in, holding in Lawson-Ross v. Great Lakes Higher Ed. Corp. that the Higher Education Act’s (HEA) disclosure requirements do not preempt claims of affirmative misrepresentation by the loan servicer. Although court cases have come down on both sides of this dispute, this circuit-level decision marks a new chapter in the ongoing controversy.

Background

In Lawson-Ross, the court’s preemption analysis turned on the precise claims raised by the plaintiffs. The plaintiffs (who were borrowers whose student loans were serviced by Great Lakes) had asserted claims for affirmative misrepresentation, rather than an allegation of failure to disclose. Specifically, the plaintiffs alleged that Great Lakes representatives “told them they were eligible for forgiveness of their loans through the [Public Service Loan Forgiveness Program], and only later did they discover they were not eligible—after they had already made payments that could not then be counted toward the PSLF Program.” According to the plaintiffs, Great Lakes had informed them that they were eligible for the PSLF Program and would qualify for loan forgiveness after making 120 payments, when the majority of the loans for each borrower were not federal direct loans, and thus were not eligible. The plaintiffs claimed that they had been harmed by these misrepresentations because they lost the opportunity to seek to consolidate their student loans into a different sort of loan that may have been eligible for forgiveness and thus made payments that they may not have been required to make.

The plaintiffs filed a class action complaint, asserting claims for breach of fiduciary duty, negligence, unjust enrichment, breach of an implied contract, and violation of Florida’s Consumer Collection Practices Act, all premised on the allegation that they had spent years making payments they believed would qualify for the PSLF Program, only to be told otherwise later.

Great Lakes moved to dismiss the case, contending that the claims were expressly preempted by Section 1098g of the HEA, which preempts “any disclosure requirements of any State law.” According to Great Lakes, all the claims were preempted as nondisclosure claims based on the alleged failure to disclose information about the PSLF Program.

Notably, after Great Lakes filed their motion to dismiss, the Department of Education issued its notice on March 12, 2018, announcing that “Congress intended section 1098g to preempt any State law requiring lenders to reveal facts or information not required by Federal law” and that any state laws imposing “new prohibitions on misrepresentation or omission of material information” violated section 1098g’s express preemption provision. Great Lakes maintained the borrowers’ claims were only restyled non-disclosure claims. The federal district court in Florida agreed. In dismissing the case the district court construed the misrepresentations as a “failure to provide accurate information.” The plaintiffs appealed.

Eleventh Circuit – No Preemption

On appeal, the Eleventh Circuit saw things differently. Although section 1098g expressly preempts state laws that require additional disclosures, the court found it was not to be read so broadly and that “state law causes of action arising out of affirmative misrepresentations a servicer voluntarily made that did not concern the subject matter of required disclosures impose no disclosure requirements.” The court concluded there was no express preemption, conflict preemption, or field preemption for such claims.

The court focused on the required disclosures for repayment options under the HEA’s section 1083(e). It concluded that the affirmative misrepresentation-based claims were different in kind from the disclosure-based claims. The plaintiffs were not in default and were merely requesting information on loan forgiveness programs, the court reasoned. According to the allegations in the complaint, Great Lakes voluntarily provided the borrowers false information about their eligibility for the PSLF Program, thus giving rise to a non-preempted claim.

The court also distinguished and downplayed the similar Chae v. SLM case from the Ninth Circuit because the claims there challenged how the servicer communicated information the HEA required, whereas the present case involved claims not of required information being misleadingly communicated, but rather affirmative, voluntary misrepresentations.

The court’s finding of a clear distinction between the mandatory disclosures in Chae and the voluntary statements made by Great Lakes may be subject to further litigation. After all, a servicer of a federal student loan could hardly be expected to tell a borrower that the servicer can’t answer questions about the PLSF Program. While the Eleventh Circuit was considering an appeal from a dismissal (which required the allegations in the complaint to be accepted as true), that part of its holding could be challenged as the case progresses.

While the majority of the opinion focused on express preemption, the court also addressed Great Lakes’s other preemption arguments. The court went on to conclude there was no conflict preemption because where Congress has explicitly addressed preemption there is implication that it did not intend to preempt other areas of state law. The court further found no conflict preemption because uniformity – as Great Lakes argued was a goal in the federal student loan program – was, in fact, not a goal of the HEA, despite the contrary view drawn from the Chae decision. Finally, the court dispatched Great Lakes’ argument of field preemption, calling it the “weakest of its preemption arguments” because the HEA does not occupy the field of debt collection practices and does not impliedly preempt state laws.

Conclusion – Misrepresentation-Based Claims May Not Be Preempted

This reversal of the district court’s dismissal of a class action provides a significant development in the ongoing preemption controversy, and servicers of federal student loans should pay particular attention to the decision when evaluating the preemption defense. Although this decision is only binding in the Eleventh Circuit (Alabama, Florida, and Georgia), courts in several other jurisdictions also have or will soon be addressing this preemption issue:

  • Oral argument took place on March 11, 2020, in Commonwealth of Pennsylvania v. Navient Corp, et al., where the Third Circuit Court of Appeals will decide whether the HEA preempts state claims that a servicer of federal student loans did not disclose details about federal student loans. The district court held that the HEA did not expressly or through conflict preemption foreclose the Commonwealth’s state law claims brought under the Pennsylvania Unfair Trade Practices and Consumer Protection Law.
  • The Seventh Circuit Court of Appeals reversed the district court’s decision in Nelson v. Great Lakes Educational Loan Services, Inc., holding the HEA did not preempt affirmative misrepresentation claims. The court noted that, “when a plaintiff alleges a defendant’s false affirmative misrepresentation, recasting the claim as imposing a ‘disclosure requirement’ is not necessary and may not even be appropriate,” which was similar reasoning to the Eleventh Circuit’s decision in Lawson-Ross.
  • In Minner v. Navient Corp., the United States District Court for the Western District of New York held that the HEA did not preempt state law claims that a student loan servicer’s statements to a borrower steered him into repayment options that allegedly harmed him financially.
  • A federal district court in the Central District of California held in Winebarger v. Pennsylvania Higher Education Assistance Agency that the HEA did preempt state law claims brought by a student loan borrower against a servicer alleging that the servicer failed to disclose information about the PSLF Program’s application related to the borrower’s loans. The district court reasoned that the borrowers’ state law claims rest “on an alleged misrepresentation – that [the servicers] provided an inaccurate qualifying payment count for [Public Service Loan Forgiveness Program] eligibility – and, thus, the Court concludes that these claims are preempted because the failure to provide accurate information is, in essence, nothing more than a disclosure claim.”

Stay tuned for updates on this significant issue for the student lending industry.

New Nevada Decisions Confirm Additional Ways to Satisfy HOA Superpriority Liens

New Nevada Decisions Confirm Additional Ways to Satisfy HOA Superpriority LiensThe Nevada Supreme Court again turned its attention to superpriority liens in the first quarter of 2020, issuing two opinions dealing with tenders, i.e. attempts or offers to pay. These decisions outline additional ways that the superpriority portion of an HOA’s lien can be satisfied, offering hope to lenders embroiled in litigation over the continuing validity of their deeds of trust.

In our most recent coverage of Nevada’s HOA superpriority lien litigation, we discussed the court’s decision in Bank of America v. SFR Investments Pool 1, which confirmed that a lender’s offer of payment with a check was a valid tender that discharged the superpriority portion of the lien. We also discussed a second decision, Bank of America v. Thomas Jessup, which held that the “excuse of tender” rule applied to HOA liens. If the HOA would have rejected a lender’s superpriority payment, the lender was “excused” from tendering payment to protect its deed of trust. Six months after that decision, the full en banc court decided to vacate the panel’s opinion.

Litigants have waited and wondered for several months what the ultimate outcome of the excuse of tender doctrine would be. Rather than announcing a final opinion in Jessup, the Nevada Supreme Court instead published an en banc opinion on the subject in another case: 7510 Perla Del Mar Ave Trust v. Bank of America. Perla Trust also concerned a situation where a lender extended an offer to pay the superpriority lien, but did not send a check to the HOA because it did not have a way to calculate the superpriority amount.

In this case, evidence established that the HOA’s collection agent had a policy and practice of rejecting Bank of America’s superpriority tenders. Under those facts, the court was satisfied that tendering a superpriority payment would have been “futile.” As a result, the court held that the excuse of tender rule applied: the obligation to tender payment was excused, and the superpriority portion of the HOA’s lien was extinguished. Under this rule, a rejected offer to pay has the same result as a tendered payment – it cures the default as to the superpriority portion of the HOA’s lien. If the HOA later forecloses on the remaining subpriority portion, the senior deed of trust remains intact.

A week later, the Supreme Court addressed whether a homeowner’s pre-foreclosure payments to an HOA can satisfy the superpriority portion of the HOA’s lien. In 9352 Cranesbill Trust v. Wells Fargo Bank, the HOA had initiated foreclosure proceedings after the homeowner became delinquent on assessments. After the recording of the lien, the homeowner had made several partial payments on her account. The sum of the payments exceeded the superpriority portion of the HOA’s lien. This fact led the district court to hold that the superpriority portion had been satisfied by the homeowner.

The Supreme Court reversed the decision, but did not adopt the HOA-sale purchaser’s argument that a homeowner is incapable as a matter of law from satisfying the superpriority portion. Instead, the court mandated a fact-specific inquiry: trial courts are required to determine how the payments were applied by the HOA. If the HOA applied the payments to the superpriority portion of the lien, then that portion would be satisfied, and the foreclosure sale would not threaten the senior deed of trust. The court explained that this inquiry encompasses “the actions and express or presumed intent of the debtor and creditor” as well as “the competing equities involved.”

From our experience in these cases, homeowners rarely specified how their pre-foreclosure payments should be applied, and it was not always clear how an HOA applied payments to the specific portions of a homeowner’s delinquency. As a result, most homeowner-tender cases will turn on how the court decides the HOA should have applied the payments. Lenders must convince the court that the most equitable result comes from applying the homeowner’s payments to the lien’s superpriority portion such that the HOA’s subsequent foreclosure did not extinguish the senior deed of trust.

On the whole, lenders should be pleased by these new decisions from the Nevada Supreme Court. With the court’s endorsement of the excuse of tender doctrine and confirmation that homeowner tenders are capable of paying off the superpriority portion, lenders have two more arguments at their disposal to protect their deeds of trust.

Having Trouble with CARES Act Forbearances in Ch. 13 Bankruptcy? You’re Not Alone!

Having Trouble with CARES Act Forbearances in Ch. 13 Bankruptcy? You’re Not Alone!Guest Author: Karlene A. Archer of Karlene A. Archer Law P.L.L.C.

Consumers that have pending Chapter 13 bankruptcy cases undoubtedly suffered from financial hardship prior to the COVID-19 pandemic. For many of those consumers, the pandemic may have exacerbated that hardship. The CARES Act’s mortgage forbearance provisions allow some breathing room for consumers that anticipate a temporary inability to pay their mortgage. These provisions also apply to consumers in bankruptcy and in that sphere present unique difficulties.

Forbearance Overview

Section 4022 of the CARES Act allows consumers who have been financially affected by the COVID-19 pandemic and who have a federally backed mortgage to seek a forbearance of their mortgage payments for up to six months, with a possible extension of up to an additional six months. If the consumer seeks such a forbearance and attests to a hardship, the servicer is required to allow for this forbearance. During the forbearance time period, extra interest and fees will not accrue, and the suspension of payments under the forbearance will not impact the borrower’s credit rating. At the end of the forbearance, the payments will come due, provided the consumer and servicer do not reach another arrangement regarding those payments.

Bankruptcy Complications

For consumers outside of bankruptcy, the forbearance process is simple – the consumer contacts the servicer, attests to a COVID-19-related hardship, and receives the forbearance requested. For consumers in bankruptcy, requesting a forbearance due to COVID-19 may be just as simple, but complications arise for the consumer’s attorney, the servicer, and the Chapter 13 trustee. The consumer bankruptcy process requires that all interested parties have notice of the payments that are required during the bankruptcy case. While the consumer and servicer may be aware of the forbearance terms, they must provide such notice to the court and the Chapter 13 trustee as well. Unfortunately, this forbearance does not fit into the generally neat boxes defined by the Federal Rules of Bankruptcy Procedure or the CM/ECF process used to file bankruptcy pleadings and notices electronically.

Options

As of now, there has been no nationwide guidance on how servicers should notice forbearance agreements. On a recent webinar provided by the National Association of Chapter 13 Trustees, the panel provided several options that are currently being used. Here are those options with the benefits and difficulties of each:

  1. File a general notice on the docket indicating the terms of the forbearance.
    • This option provides transparency into the forbearance terms and provides flexibility for the servicer. It also allows for any later documents adjusting the terms to be linked.
    • The CM/ECF process may not permit a document like this to be filed without linking to another pleading.
    • This type of notice may be more difficult for Chapter 13 trustees to efficiently process, as their systems generally are more closely tied to the claims register.
  2. File a general notice on the claims register indicating the terms of the forbearance.
    • This option permits the servicer to attach the terms of the forbearance directly to the affected claim.
    • The CM/ECF process typically does not allow for a “general notice” on the claims register, so there is a risk that filing under an available option on the CM/ECF dropdown menu (such as Notice of Payment Change) may be rejected by the clerk of court as a deficient filing.
  3. Write a letter to the Chapter 13 trustee providing the terms of the forbearance.
    • This option eliminates CM/ECF issues.
    • Trustees may not have processes in place to implement these changes solely based on a letter. Additionally, this may not provide the transparency needed since there is no evidence in the docket.
  4. Another option would be to file a modified Notice of Payment Change on the claims register indicating the terms of the forbearance.
    • This option allows for servicers to use a notice function that already exists and is familiar to all parties, and servicers would not need to engage counsel to file these documents.
    • This is not a true payment change, as the forbearance payments are still “coming due.” Additionally, the forbearance will have occurred prior to the filing of the notice, giving rise to timing issues under the requirements of Rule 3002.1(b).

There is no “right answer” for this question. These options all have technical difficulties. We hope for additional guidance in the next few weeks, but for now servicers should work with local firms, be mindful of local practices, and choose the option best suited for them.

After Forbearance

The payments that were delayed due to the forbearance come due in a lump sum at the close of that term. However, this is unlikely to be feasible for consumers affected by COVID-19 and may be less feasible for those in bankruptcy. Servicers are therefore coming to agreements with borrowers to pay back those payments over a longer period of time. These post-forbearance agreements must also be noticed within the bankruptcy process. Absent other guidance, they fit more neatly into the Notice of Payment Change process, with the “new payment” being the original mortgage payment plus the portion of the forbearance mortgage payment. If, however, the post-forbearance arrangement involves a deferral of the payments or other loan modification, a motion to approve the loan modification or separate Chapter 13 trustee approval likely will be necessary, depending on the local rules and orders of the court.

A Final Note

During the forbearance time period, the time for a mortgage loan’s escrow analysis or interest rate change may come. Those payment changes still must be noticed in accordance with Rule 3002.1(b) even though the borrower is not making those payments. This permits the Chapter 13 trustee to keep track of the amount due during the forbearance period.

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