CFPB Proposes Amendments to RESPA and TILA

In a highly anticipated pair of proposed rules issued on July 9, the Consumer Financial Protection Bureau has called for amendments to key provisions of Regulation Z and Regulation X, with an initial comment deadline for both Notices of Proposed Rulemaking set for September 7, 2012, and a subsequent deadline of November 6, 2012, for the integrated disclosure form aspects of the proposals.

Watch your inbox tomorrow for alerts from our Mortgage Banking Group summarizing the CFPB’s hefty releases (one is nearly 300 pages, the other nearly 1,100 pages) and offering some immediate analysis of the impact these rules will have if adopted.

Defects in Chain of Title Must Be Raised Prior to Foreclosure

Borrowers alleging defects in a foreclosing lender’s chain of title must raise the issue prior to the conduct of the foreclosure sale, Maryland’s highest court has ruled.

In Thomas v. Nadel, the Maryland Court of Appeals held that a borrower is barred from raising purported irregularities in the lender’s ownership of the mortgage debt by way of post-sale exceptions.

Instead, the court held, allegations concerning the lender’s ownership of the promissory note must be raised prior to the foreclosure sale. Post-sale exceptions to sale are generally limited to irregularities in the conduct of the sale itself, and are not the proper vehicle to challenge the validity of the lender’s title, the court ruled.

In Thomas, the borrowers filed post-sale exceptions to a foreclosure sale based on a purported gap in the chain of ownership of the promissory note secured by the borrowers’ mortgage. The borrowers claimed that the note was transferred to an entity that did not exist at the time of the transfer, and therefore a subsequent transfer to the foreclosing lender was ineffective.

The court rejected the argument, noting that foreclosing trustees had possession of the original promissory note endorsed in blank, which was all that was required under Maryland law to establish the lender’s right to foreclose. Further, the court noted that there was no dispute as to the authenticity of the note.

The court left open the possibility that a mortgage that was the product of fraud could be challenged by way of post-sale exceptions, but ruled that purported gaps in the chain of title of the note did not constitute fraud.

The decision is good news for mortgage lenders and servicers in that it limits the procedural avenues for borrowers to challenge a lender’s ownership of a mortgage.

Robert A. Scott

Borrower May Sue Over Lender’s Failure To Contact Prior to Foreclosure, California Appellate Court Rules

A residential lender’s failure to contact a borrower prior to initiating nonjudicial foreclosure proceedings triggers a private right of action under California law, the California Court of Appeal has ruled.

In its July 3, 2012, opinion in Skov v. U.S. Bank National Association, the California Court of Appeal, Sixth District, held that a borrower could assert a cause of action against a residential lender under California Civil Code Section 2923.5 for failure to contact the borrower prior to recording a notice of default.

Section 2923.5 provides that a residential lender must contact a borrower “in person or by telephone in order to assess the borrower’s financial situation and explore options for the borrower to avoid foreclosure” or satisfy due diligence requirements before a notice of default is recorded. The remedy for failing to comply with Section 2923.5 is postponement of the foreclosure sale.

The borrower in Skov defaulted on her home loan, prompting the lender to initiate nonjudicial foreclosure proceedings by the recording of a notice of default. The notice of default contained a declaration of compliance with Section 2923.5.

The borrower filed suit to prevent the foreclosure from going forward. Among other things, the borrower alleged that the lender did not comply with Section 2923.5 because the lender did not contact the borrower until after it recorded the notice of default. The trial court dismissed the action and the borrower appealed.

In reversing the dismissal, the appellate court held that the question of whether the lender properly complied with Section 2923.5 was an issue of fact that could not be resolved at the pleading stage. The appellate court further held, relying on an earlier California appellate decision, that Section 2923.5 necessarily confers an individual right of action because the statute’s purpose is to force the lender and borrower to communicate about the specific borrower’s situation and the specific borrower’s options to avoid foreclosure.

Finally, the appellate court held that the National Bank Act—which “vests national banks … with authority to exercise ‘all such incidental powers as shall be necessary to carry on the business of banking’”—does not preempt Section 2923.5.

– Alan S. Petlak

CFPB Adopts Privilege Waiver Rule As Originally Proposed

The Consumer Financial Protection Bureau has promulgated a final rule on non-waiver of attorney-client privilege and work product protection for information voluntarily or involuntarily submitted by a regulated entity to the CFPB in situations where it subsequently shares that information with another federal or state agency.

The rule, Confidential Treatment of Privileged Information, was adopted on June 28, 2012, exactly as originally proposed and previously described on our blog, CFPB Monitor. The final rule’s privilege preservation regime applies only to waivers for information finding its way into the hands of third parties—such as other federal or state agencies, including state attorneys general—and does not purport to preserve the privilege vis-à-vis the CFPB.

The final rule builds upon ground staked out by the agency early in January in its Bulletin 12-01, which figures prominently in the CFPB’s explanation of the final rule. Both claim unfettered access to the records of regulated entities and assert that the information so obtained would not be subject to waiver of attorney-client privilege (other than vis-à-vis the CFPB).

Whereas Bulletin 12-01 took more of a “carrot and stick” approach—hinting at enforcement action against recalcitrant banks while articulating a positive tone relating to preservation of privilege for their confidential documents—the discussion accompanying the final rule eschews saber-rattling in favor of matter-of-fact statements that the CFPB, like the bank regulators, has inherent power to gain access to privileged documents.

By its terms, Bulletin 12-01 applied only to depository institutions subject to the CFPB’s jurisdiction (those with more than $10 billion in assets). It asserted that, notwithstanding the regulated entity’s waiver of attorney-client privilege as regards the CFPB, banks should be comfortable turning over privileged information to CFPB examiners because the privilege would not be waived as to any other federal or state regulatory or law enforcement agency (including state attorneys general) with which the Bureau might share the privileged information.

The final rule applies more broadly and encompasses all nonbank entities subject to CFPB authority. In addition, the CFPB takes the position that, to the extent that depository institutions with less than $10 billion in assets submit privileged information (coerced or voluntarily) to the CFPB in the course of its supervisory or regulatory processes, the rule applies likewise to them and shields the information produced from privilege waiver.

According to the CFPB, the purpose of the rule is to “provide maximum assurances of confidentiality to the entities subject to its supervisory or regulatory authority” and to forestall “any claim, in Federal or State court, that a person has waived any applicable privilege, including the privilege for attorney work product, by providing such information to the Bureau in the exercise of its supervisory or regulatory processes.”

In the final rule, the CFPB also notes that compliance with federal consumer financial law is served by policies that “do not discourage those subject to its supervisory or regulatory authority from seeking the advice of counsel.” Thus the release underscores the CFPB’s policy of seeking privileged information “only when it determines that such information is material to its supervisory objectives and that it cannot practicably obtain the same information from non-privileged sources.”

Moreover, the CFPB will, as also noted in the Bulletin, “give due consideration to supervised institutions’ requests to limit the form and scope of any supervisory request for privileged information.”

– Keith R. Fisher

MERS Wins Florida Fee Case

The Clerk of the Circuit Court of Duval County, Florida, cannot maintain a class action against MERS for “millions of dollars in unpaid recording fees,” the U.S. District Court for the Middle District of Florida has ruled. The plaintiff, Jim Fuller, sought to represent his interests and the interests of 67 other Florida Circuit Court clerks.

In its June 27, 2012, decision in Fuller v. Mortgage Electronic Registrations Systems, Inc., the court held that because the statute creating Florida’s public recording system does not provide a private right of action, Fuller could not bring common law claims premised upon the statute. The statute “simply outlines Fuller’s authority to accept, maintain and make available to the public records,” the court said. Fuller had argued his common law claims for a Writ of Quo Warranto, civil conspiracy, unjust enrichment, and fraudulent and negligent misrepresentation were independent of the statute, but conceded the statute was the only source of his authority over Duval County’s public records.

The court also ruled that Fuller’s claims would all fail on their merits. Fuller argued that MERS attempted to usurp his function as the recorder of public instruments and sought a Writ of Quo Warranto, which is typically used to challenge a public officer’s attempt to improperly exercise a power or right derived from the State. However, as MERS successfully argued, there is no law requiring payment of a recording fee when a mortgage is assigned but not recorded. Moreover, the public does not use MERS’ private recording system to determine the status of mortgages. As a consequence, the court held MERS is not usurping Fuller’s authority.

Fuller could not establish a conspiracy because MERS has not committed an unlawful act or a lawful act by unlawful means. The court correctly opined that recording mortgages is “at the complete discretion of the party wishing to record the document.” Accordingly, MERS is under no legal obligation to record assignments or pay the associated recording fees and cannot be liable for “actions that are neither required nor prohibited under the law.”

Fuller’s unjust enrichment claim was rejected because, as noted above, MERS has no duty to record, so Fuller could not establish that he had conferred any benefit on MERS. Further, MERS had not failed to pay any recording fees, and Fuller had not conferred a benefit on MERS by complying with his statutory obligations.

Fuller’s fraudulent and negligent misrepresentation claims were premised on the notion that MERS falsely designated itself as the “mortgagee” on recorded instruments. The court rejected this position, finding that like most courts around the country, “Florida courts have consistently affirmed the use of MERS as the designated mortgagee of record and the principle that MERS may serve as the mortgagee or as nominee for the lender and the lenders successors and assigns.”

In summing up, the court wisely observed that it was “confronted with an old problem: the difficulty of reconciling new technology with old law, thus raising the centuries old separation of powers controversy.” The system for recording mortgages in Florida, as elsewhere, is a creature of statute, and the relief Fuller sought resides with the Florida legislature, not the courts.

Anthony C. Kaye

Federal Regulators Issue Interagency Guidance Addressing Practice Involving Military

On  June 21, 2012, five federal agencies issued an Interagency Guidance on Mortgage Servicing Practices Concerning Military Homeowners with Permanent Change of Station (PCS) Orders. The guidance was issued by the Federal Reserve Board, the Consumer Financial Protection Bureau, the Federal Deposit Insurance Corporation, the National Credit Union Administration, and the Office of the Comptroller of the Currency.

The guidance addressed risks associated with service members who have received permanent change of station orders. Most military members are subject to PCS moves every two to three years. The orders are generally non-negotiable and normally are issued anywhere from three to six months before the move would occur. However, in some cases, depending on the nature of the orders, the move could be more immediate.

The guidance pointed out that despite these military requirements, service member homeowners are still obligated to pay their mortgages, and in today’s market many of them are struggling to sell their homes at high enough prices to pay off their mortgages. In many cases, service members have to continue payments after relocating. The guidance set forth a number of practices that federal regulators find the most troubling. They include:

  • Failing to provide readily understandable information about the options available to service members who have received PCS orders
  • Asking service members to waive their SCRA rights in order to obtain information or assistance
  • Advising service members who are current on their loans to skip payments to create the appearance of financial hardship
  • Failing to provide reasonable means to obtain information on the status of assistance requests
  • Failing to communicate in a timely manner decisions regarding assistance requests or failing to explain denials

The guidance goes on to state that servicers need to adequately train their employees on the options that are available to service members with PCS orders and maintain appropriate policies and procedures to do so. Lastly, the guidance indicates that any servicer that engages in unfair acts and practices will be subject to all appropriate supervisory and enforcement actions.

In connection with the guidance, the Federal Housing Finance Agency announced changes to its short-sale policies in connection with Fannie Mae- and Freddie Mac-owned loans. The FHFA announced that military homeowners who receive PCS orders will be eligible to sell their homes in a short sale, even if they are current on their loans. Additionally, under the new policy, Fannie and Freddie will not pursue a deficiency judgment or any cash contribution from the service member for any property that the service member purchased on or before June 30, 2012.

– Emily G. Miller

Pennsylvania Passes Law To Resolve Foreclosure Jurisdiction Problems Caused By Superior Court Decision

On June 21, 2012, Pennsylvania Governor Tom Corbett signed the Homeowner Assistance Settlement Act, which remedies a host of problems created by the Pennsylvania Superior Court's January 2012 decision in Beneficial Consumer Discount Co. v. Vukmam, 37 A.3d 596 (Pa. Super. Ct. 2012).

The Superior Court in Vukmam found that Act 91, a pre-foreclosure notice requirement created by the Pennsylvania Housing Finance Agency and used prior to September 6, 2008, was defective because it entitled the borrower to a face-to-face meeting with either a credit counselor or the mortgagee, but the notice advised the borrower only of her right to have a face-to-face meeting with a credit counselor.

Because Act 91 is jurisdictional and the notice is required prior to initiating a foreclosure in Pennsylvania on all non-FHA, owner-occupied properties, the decision rendered all cases found to have defective notices potentially void. It also obligated plaintiffs with pending foreclosures subject to the "defective" notice to withdraw their claims.

Apparently recognizing the enormous problem the Vukmam decision would cause borrowers, lenders, servicers, and bona fide purchasers, the General Assembly of the Commonwealth of Pennsylvania relatively swiftly approved the Homeowner Assistance Settlement Act, which, among other things, took the teeth out of the Vukmam decision.

Specifically, the Act provides—retroactive to June 5, 1999—that (1) noncompliance with the portions of Act 91 at issue in Vukmam does not deprive a court of jurisdiction, (2) individuals or entities affected by a purportedly deficient Act 91 notice must raise the issue "in a legal action before the earlier of delivery of a sheriff's or marshal's deed in the foreclosure action or delivery of a deed by the mortgagor," (3) if such an issue is "properly raised in a legal action" the court has discretion as to how to remedy the alleged deficiency, and (4) noncompliance "shall not impair the conveyance or other transfer of land and the title of property subject to a mortgage obligation covered under the Housing Finance Agency Law."

Daniel J.T. McKenna

Purchase Price and Post-Closing Adjustments
Guest column from members of our Mergers and Acquisitions/Private Equity Group

Purchase Price

In an M&A transaction, the purchase price is the consideration that the seller receives from the buyer in connection with the purchase and sale of the target business. The purchase price may be paid in cash, securities (typically capital stock of the buyer), or a combination of cash and securities. Furthermore, the purchase price may be paid in full at closing or partly at closing with the remainder being paid over a specified period of time following the closing, pursuant to a promissory note made payable to the seller by the buyer. Such a promissory note is typically secured by certain assets of the buyer (including the assets of the target business) and/or guaranteed by one or more affiliates of the buyer. The cash portion of the purchase price is generally paid by the buyer to the seller at the closing via a wire transfer of immediately available funds to one or more bank accounts specified by the seller.

Post-Closing Adjustments 

According to a recent study performed by the American Bar Association, 82 percent of purchase agreements executed in 2010 contained a post-closing purchase price adjustment. Post-closing purchase price adjustments can vary greatly from transaction to transaction. For example, post-closing purchase price adjustments may be based on the target business’s net working capital, net worth, net assets, or another financial measure agreed to by the parties.  Post-closing purchase price adjustments also can include adjustments that are contingent on the occurrence of future events, such as the performance of the target business after closing (i.e., an “earn-out”) and/or obtaining certain regulatory approval for one or more products of the target business, such as FDA approval of a drug or 510K clearance for a medical device (i.e., a “milestone payment”). Earn-outs and milestone payments will be the subject of a separate article in a subsequent edition of this publication. However, the most common type of post-closing purchase price adjustment is based on net working capital, which is the subject of the remainder of this article.

Purchase agreement provisions regarding a post-closing purchase price adjustment based on net working capital (a “Net Working Capital Adjustment”) are some of the most complicated terms in a purchase agreement, requiring extensive negotiations by the parties. These provisions require thoughtful and precise drafting in order to accomplish the objectives of the buyer and the seller and to avoid future disputes. This article highlights some of the essential elements of a well-drafted Net Working Capital Adjustment.

Net Working Capital Adjustment

The rationale for a Net Working Capital Adjustment is that the target business needs a minimum amount of net working capital in order for its operations to be continued by the buyer in the ordinary course after the closing. The minimum amount of net working capital, which is usually a specific dollar amount typically referred to as the “target amount,” is a negotiated amount agreed to by the parties that is often based on the historical operation of the target business. If, at the closing, the actual amount of net working capital of the target business is less than the target amount, the buyer will have to contribute more cash  to operate the business in the ordinary course, thereby effectively increasing the purchase price that the buyer paid for the target business. However, if the actual amount of net working capital at closing exceeds the target amount, the buyer will have effectively underpaid for the target business as the seller transferred more net working capital than contemplated by the parties.

Depending on the objectives of the parties, a Net Working Capital Adjustment can either be upward-adjusting or downward-adjusting (i.e., a “one-way adjustment”), or can adjust both upward or downward (i.e., a “two-way adjustment”). It can also be dollar-for-dollar or subject to a deductible or cap. Purchase agreements usually call for an adjustment to the purchase price within 60 to 90 days after the closing since the accounting information needed to accurately calculate the actual amount of net working capital will most likely neither be available nor subject to verification by the parties on the closing date.

For example, in a two-way adjustment that is dollar-for-dollar, if the parties have agreed on a target amount of $1 million and, as of the closing date, it is determined that the actual net working capital is $800,000, the seller would be required to pay the buyer $200,000. However, if the actual net working capital as of the closing date is $1.2 million, the buyer would be required to pay the seller $200,000. If the actual net working capital at closing was $1 million, neither party would be required to make a payment as the actual amount of net working capital equals the target amount.

Aside from the target amount and whether the Net Working Capital Adjustment will be a one-way or two-way adjustment, the most important aspects of a Net Working Capital Adjustment provision are (1) the definition of “net working capital,” (2) the standards of accounting to be used in calculating net working capital, (3) which party initially determines the actual amount of net working capital as of the closing date and the access to relevant books and records by the non-preparing party, and (4) the dispute resolution process.

Definition of “Net Working Capital”
The purchase agreement should be as specific as possible regarding the accounts or financial line items that will be used to calculate net working capital. Attaching a list of the specific accounts or financial line items or a sample calculation as a schedule to the purchase agreement are ways to narrow the risk of a later misunderstanding. The calculation of the actual net working capital as of the closing should be consistent with the methodology used in setting the target amount so that any comparison to the target amount is not distorted and is on an “apples to apples” basis.

Standards of Accounting
Both the buyer and seller should specify precisely the standard of accounting that will be used in determining the actual amount of net working capital as of the closing. The two most common standards for calculating a Net Working Capital Adjustment are generally accepted accounting principles (GAAP) or GAAP applied consistently with historical financial statements of the target business. Even when GAAP is the selected standard of calculation for the Net Working Capital Adjustment, the parties must be careful to account for interpretations allowed within GAAP. This can require careful attention to the accounting methods underlying the target company’s financial statements and a separate schedule of acceptable accounting principles or assumptions attached to the purchase agreement. If GAAP applied consistently with historical financial statements of the target business is the selected standard of accounting, any modifications to such standards should be explicitly set forth in the purchase agreement in order to avoid any ambiguity.

Preparation of Actual Net Working Capital Amount
The parties must determine who will prepare the initial draft of the net working capital statement (the “Closing Statement”) showing the calculation of the actual amount of net working capital as of the closing so it can be compared to the target amount. Most commonly, the buyer prepares the initial draft of the Closing Statement since the buyer has possession of the books and records of the target business after the closing. However, the target may advocate that its accountants are best situated to prepare the Closing Statement due to their familiarity with the financial statements of the target business. Another aspect of Net Working Capital Adjustments that can be easily overlooked is timely access to books and records after the closing. Access to the relevant information is critical to reviewing and/or disputing the Net Working Capital Adjustment.

Dispute Resolution
Following the preparation of the Closing Statement, the non-preparing party and its advisors should have the opportunity to review it in detail. In the event of a dispute, the purchase agreement typically requires the buyer and the seller to work together for a short period of time using good faith efforts to resolve any disputes prior to engaging an independent accountant.

In addition to mathematical mistakes, disputes related to purchase price adjustments may arise when the financial components of an adjustment are not properly defined, creating questions as to whether certain transactions should be included in the amount of net working capital at closing. It is customary that disputes related to Net Working Capital Adjustments be resolved by an independent accountant rather than a court, since these disputes relate to the proper interpretation of GAAP and its application to financial information.

The purchase agreement should (1) describe the process for appointing an independent accountant to resolve disputes, (2) define the scope of the independent accountant’s review, (3) allocate the independent accountant’s fees between the parties, and (4) state that the determination by the independent accountant shall be binding and conclusive on the parties absent manifest error or fraud.

The purchase agreement also should clearly state that a party may not recover for a matter both through the purchase price adjustment and the indemnification provisions in the purchase agreement (i.e., no “double dipping”).

Net Working Capital Adjustment provisions can be a minefield of problems for drafters who fail to appreciate the complexity and nuances involved in such adjustments. Through careful and thoughtful drafting, Net Working Capital Adjustments can be drafted to avoid disputes and, if disputes do arise, provide for their resolution in an independent manner by a qualified expert.

Ballard Spahr’s Mergers and Acquisitions/Private Equity Group has extensive experience drafting and negotiating purchase agreements on behalf of its clients, who represent both buyers and sellers. For further information, please contact Craig Circosta at 215.864.8520 or

North Carolina Amends Annual Fee Requirements for Mortgage Companies

North Carolina recently amended its statute regarding the annual licensing fees required for mortgage bankers, mortgage brokers, and mortgage servicers. Instead of charging a set renewal fee of $625 for licensed companies and $300 for branches, the North Carolina Office of the Commissioner of Banks (OCOB) will charge an annual assessment based on loan volume. The annual assessment will include a base amount of $2,000, plus an additional amount calculated for loan volumes over $1.5 million. Companies with both a lending and servicing volume will have those volumes added together for the purpose of the calculation. The new provisions also permit the OCOB to charge additional amounts for examinations or investigations that include “extraordinary review, investigation, or special examination” expenses. The amended provisions are effective on October 1, 2012.

Texas Issues, then Postpones Enforcement of, New Disclosure Requirements for Mortgage Banker Registrants, Mortgage Company Licensees, and Mortgage Loan Originator Licensees

The Texas Department of Savings and Mortgage Lending (SML) recently adopted new regulations that, in part, changed the disclosures required for Mortgage Company Licensees, Mortgage Banker Registrants, and Mortgage Loan Originators. Although the new disclosure requirements became effective July 5, 2012, the SML recently announced that due to practical implementation concerns, it would not enforce violations of the new requirements during examinations for using outdated disclosures until September 1, 2012. The SML further announced that the updated disclosure forms would be available on its website by July 9, 2012. We will discuss these changes in more depth in a future Mortgage Banking Update.

Correction: The Did You Know? section of our previous Mortgage Banking Update referenced an exemption in New York applicable to mortgage loan originators. The referenced exemption actually applies to mortgage bankers.

Reid F. Herlihy

Copyright © 2012 by Ballard Spahr LLP.
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This alert is a periodic publication of Ballard Spahr LLP and is intended to notify recipients of new developments in the law. It should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own attorney concerning your situation and specific legal questions you have.