The homeowner bill of rights movement represents the building blocks of a major shift, shaking up the landscape of real estate lending and enforcement of an investor’s rights when a borrower stops paying a mortgage.
This movement is a powerful conflux of the progressive political movement, widely publicized foreclosure process errors by large servicers and the commonly accepted cultural narrative that the financial industry caused the Great Recession.
The rallying cry of the HBR movement is to protect homeowners by granting them rights against their foreclosing lenders. The movement receives significant positive press coverage for championing the abused homeowner, though it extracts distinctly different consequences on the financial markets.
To date, the HBR movement has succeeded in significantly changing nonjudicial foreclosure statutes in California, Massachusetts, Hawaii, Nevada and the District of Columbia, with the largest jewel in the HBR movement’s crown the mortgage servicing regulations adopted by the Consumer Financial Protection Bureau. CFPB servicing regulations, which are scheduled to take effect in January 2014, impose some of the HBR movement’s goals.
The Golden State, with its California Homeowner Bill of Rights, leads the HBR movement, with Massachusetts a close second. The law of these two states will be used as the primary examples of this statutory structure.
THE FOUR STATUTORY PILLARS
The four pillars of HBR foreclosure reduction legislation are:
- The removal of the nonjudicial foreclosure process from contract law;
- The granting to the borrower of loan modification due process;
- “Miranda-izing” the nonjudicial foreclosure process; and
- “Gideon-izing” the nonjudicial foreclosure process.
These pillars drastically alter the legal landscape of the nonjudicial foreclosure process. To explain this changing landscape, the California and Massachusetts statutes will serve as the models.
PILLAR I: Removal from contract law
This is particularly critical in the case of nonjudicial foreclosure process, where the entire process is viewed as outside of state control and is entirely contractual.
Prior to the HBR movement, the agreement between a secured lender and the borrower was viewed legally as a contract: The creditor lends money to the borrower on agreed terms. As long as the borrower makes the agreed payments, he or she keeps the collateral. When the borrower breaches the agreement by missing payments or not protecting the collateral (such as not paying property taxes or insuring it against loss), the creditor had the right to involuntarily take title and possession of the collateral and dispose of it.
The law of contracts exists to enforce lawful agreements made between parties. Basically, contract law allows parties to write their own agreed “law” as to how their relationship is to work. The courts will then enforce that private law so long as it is legal. This law has developed over centuries and contains several bedrock principles, including a provision that no party in breach of a contract can sue the other for damages arising out of that contract.
For the HBR movement to succeed, it has to accomplish the following:
Make the borrower’s default irrelevant to lender liability ;
Grant the borrower rights that do not exist in the contract; and
Impose penalties for violating those extra-contractual rights.
As an historical aside, the original HBR movement can be traced back to the 1780s when state legislatures passed similar laws to relieve borrowers from their obligations to debtors. After all, a lot more debtors vote than lenders. The U.S. Constitution addressed this issue in Section 10, which states: “No state shall … pass any … law impairing the obligation of contracts…” Without explaining the evolution of constitutional law interpretation, the present and second HBR movement has exactly the same problem as the first.
In the world created by the HBR movement, the borrower’s default is the trigger that gives rise to the rights and the borrower’s nonpayment then becomes completely irrelevant; once the default occurs and the nonjudicial foreclosure process is commenced, the lender’s rights under the contract fade into oblivion.
PILLAR II: Mandatory loan modification
The second pillar is mandatory loan modification due process. The rationale for loan modification is very appealing. It is in everyone’s best interest to keep the borrower in the home: The investor gets a better return than through foreclosure; the community property values are protected from distressed sales; and the borrower gets to keep the home. As long as done voluntarily, this concept works. When loan modification due process becomes mandatory, a culturally toxic moral hazard is created. Unfortunately, in common culture, the phrase moral hazard loses all meaning. Most readers simply pass this phrase off as another moral argument similar to abortion or gender roles. The industry needs much stronger words to describe the problem created when the law, in essence, rewrites a contract after it has been entered and makes a house payment discretionary. That concept is “willingness to pay,” which will be the subject of another article in this series.
In addition to creating a culturally toxic moral hazard, the granting of loan modification due process rights adds a layer of legal complexity. In law, there are two forms of due process: procedural due process and substantive due process. Procedural due process deals only with the procedural requirements; substantive due process deals with the content of those processes so as to assure the intent behind the process is honored.
Procedural due process means mandated processes for accepting, processing and responding to loan modification requests. For example, California requires written response to a loan modification request within five days of receipt and provides mandatory minimum content for that response. It also requires that denials be in writing and have mandatory minimum content.
Substantive due process asks the question: Must a loan servicer properly process a loan modification request? Or may a servicer butcher the request so long as the procedural process is followed? For example, if a loan modification request is denied based on the net present value model, which takes into account the value of the home, does the borrower have the right to sue claiming the loan servicer used the wrong value? This is a significant issue as millions of dollars will turn on how this issue is decided.
The HBR movement to date has provided three answers to the issues of substantive due process:
Mandatory substantive due process. This approach was adopted in Massachusetts. Its HBR statute mandates that all loans to which it applies — virtually every pre-2007 RMBS pool — that a certain loan modification must be granted. Thus, in Massachusetts a defaulting borrower has an option. The borrower can honor the terms of the contract the borrower signed or the borrower can have the contract rewritten as mandated by the state legislature.
Substantive due process prohibited. The CFPB, which will set the floor for the loan modification process commencing in January 2014, specifically provides that its regulations do not impose substantive due process.
Ambiguous. The final approach is the ambiguous, which is the approach adopted by California. On one hand, the California HBR clearly does not mandate any certain outcome to the loan modification process. On the other, the California statute does not provide protection against the claim a loan servicer negligently denied a loan modification request. The question to imply substantive due process is compelling: Why grant the procedural right to a loan modification if a loan servicer can butcher the request and mistakenly deny a modification without any consequences?
The question of whether or not the California law imposes substantive due process on loan servicers will most likely take years to resolve as cases making this claim wend their way through the courts. Because the borrower has little to no risk in bringing such a claim, yet the lender still gets subjected to the burden of discovery and trial, it is likely allegations of negligent loan modification processing will become a regular part of any California HBR wrongful foreclosure lawsuit.
So how can so much money ride on the existence of substantive due process? The answer lies in the cost to defend claims of mistakenly denying a loan modification, which is discussed in pillar four.
PILLAR III: Miranda-izing the nonjudicial process
Almost every American knows the first phrase of a Miranda warning: “You have the right to remain silent.” It emerged out of the United States Supreme Court, which held that statements obtained by police prior to the defendant being informed of his or her constitutional rights were inadmissible in a court of law. A practical impact of the decision was to elevate the importance of process over substance. While a borrower defaulting on a loan is clearly not a criminal, the rule of Miranda is a clarifying example of placing process over substance. And, to succeed, the HBR movement had to elevate process over substance. To apply this concept to a nonjudicial foreclosure, imagine the case of a borrower claiming that an assignment of the mortgage/deed of trust was robo-signed. Obviously, who signed that assignment or the process by which it was signed had nothing to do with the borrower missing a house payment. In addition, the assignment could be 100% correct. Yet, under HBR legislation, the process for signing and recording that assignment is more important than making the house payment or whether the assignment is 100% true.
California is probably the best example of how drastic a shift the HBR brings to lending contract analysis. Prior to the HBR, California law completely rejected the concept of “process over substance” in nonjudicial foreclosures with the prejudice rule.
Under the prejudice rule, if a borrower claimed that the servicer made an error in signing a document or in the language used in a form, in order for that error to result in a claim against the loan servicer or the investor, the borrower would have to demonstrate that the alleged error caused the borrower to miss the house payment. For example, under pre-HBR case law, a borrower was prohibited from attacking the signing of a loan assignment for any reason unless the borrower could prove that this alleged improper signing caused the borrower to miss a house payment. Of course, that is impossible and in two appellate opinions (one in 2011 and another in 2012), the California courts threw out cases which attacked foreclosure sales based on allegedly robo-signed assignments.
The California HBR completely eviscerated the prejudice rule. The statute imposes liability for robo-signing of an assignment without regard to the impact on the borrower’s making or missing a house payment.
What matters is how and by what process the assignment was executed.
PILLAR IIII: Gideon-izing of the nonjudicial foreclosure process
As the previous three sections have demonstrated, the HBR rewrites the contract to create rights that arise upon default. The issue now becomes how are these rights to be enforced? There are four possible approaches:
Solely by a regulatory. This is the method chosen by the government’s Home Affordable Modification Program and by the national settlement against the nation’s large servicers led by the state attorneys general.
By express private right of action. Under this approach, the rights granted are protected by a borrower’s statutory right to sue. The power of this approach is that it allows the borrower to claim his or her rights were violated, without any regard for the failure to make the house payment. This was the approach used in the California statute.
By defense to an eviction. In this approach, the borrower can raise the failure in defense to a post-foreclosure eviction. This is the approach the Massachusetts HBR appears to have taken.
By judicial interpretation. The final method is by the judiciary allowing the violation of the rights to be the basis of any action under another theory, such as a deceptive and fraudulent business practice or under a state or federal racketeering statute, or under the state or federal fair debt collection acts.
As California has the most extensive and clearest private right of action, that HBR will be the focus of this section. There, the HBR movement succeeded in having a private right of action for the borrower to sue placed into the statute. But even this victory presents problems: What good does it do to grant the borrower the right to sue if the borrower cannot afford an attorney? Obviously, attorneys cost money and if the borrower had the money to retain an attorney, in all likelihood they would not have defaulted. Once again, the HBR movement turned to a ready, willing and available legal concept.
In Gideon v. Wainwright (1963), the U.S. Supreme Court held that state courts must provide attorneys to criminal defendants who cannot afford one. The legal reasoning is familiar: The right to assistance of counsel is a fundamental right, essential for a fair trial, and thus is necessary for due process of law under the 6th Amendment (as applied to the states through the 14th Amendment). The philosophical reasoning of the court in Gideon is also clear: Rights mean little if they cannot be meaningfully enforced, and complex rights can only be meaningfully enforced if the party possessing the rights is represented by an attorney.
The California HBR takes the same philosophical view as the court in Gideon. The problem is, Who is going to pay for the borrower’s attorney? The HBR solves this problem by seeking to shift the borrower’s legal fees to three parties: the investor, the loan servicer and the nonjudicial foreclosure trustee. Thus, like the court in Gideon, the California Legislature realized that without a way for delinquent borrowers to retain counsel, the HBR rights would mean little in practice because there was no good mechanism to enforce them. Rather than create public foreclosure defenders, as was the outcome of the Gideon case, the HBR instead was drafted to seek to have the targeted defendants pay the legal fees for the borrowers and, thus, attract more attorneys into the field of representing these borrowers. By making it more appealing for attorneys to represent defaulted borrowers, and by giving them an easy path to getting their legal fees paid, the HBR effectively does to nonjudicial foreclosures what Gideon did to criminal law. The main tool for attracting the attorneys is the “Harris Rule.”
To help attract attorneys into representing defaulted borrowers, the HBR includes an entirely one-sided legal fees provision, which the author has named the “Harris Rule,” after Kamala Harris, the California attorney general who pushed for the passage of the HBR. It has two components. Under the first, the HBR grants a one-sided attorneys fees clause in which only the borrower can get legal fees. However, its one-sided nature pales in comparison to the second component: A borrower who obtains an injunction to halt the nonjudicial foreclosure process is deemed the prevailing party and can be awarded his or her legal fees even if the borrower loses the lawsuit. This component is the most radical anti-foreclosure law in the nation. To belabor the point, here the borrower can bring a completely meritless claim alleging various violations of the HBR and ultimately lose, but can still end up with a substantial legal fee award.
The “heads I win, tails you lose” component of the Harris Rule only applies to actions brought prior to the recordation of the foreclosure deed under the HBR’s private right of action, and it does not apply to actions brought after the foreclosure deed records. And, the requirement of obtaining an injunction is not likely to be much of a gatekeeper. It should not be terribly difficult for borrowers’ counsel to obtain an injunction in the vast majority of cases. In addition, the legal fees involved may very well be quite large, because the amount is controlled by the borrower’s attorney. To demonstrate just how serious the HBR movement is about the recruitment of attorneys to sue lenders using the California nonjudicial foreclosure, the California attorney general just gave a grant out of the state settlement funds to pro-consumer groups. This was for two reasons: to hold seminars to teach attorneys how to sue lenders using nonjudicial foreclosure process and to create websites and pleadings banks to aid that counsel.
HBR’S BATTLE CRY
The HBR movement is riding high in parts of the United States. Its battle cry is that large financial institutions have wrongfully foreclosed on America’s defaulting homeowners, seeking to give them rights and using media coverage to push through radical change in the laws relating to foreclosure, particularly nonjudicial foreclosure process. The changes sought in the structure of the law is most clearly understood in grasping the four pillars of the HBR statutory structure. The changes made in state law by the HBR movement — particularly in Washington, D.C., California and Massachusetts — obliterate at least 200 years of legal tradition. Here, I have simply presented the structure of that change. The next article in this series will discuss the financial impact the HBR movement imposes on the housing market.
