May Day! May Day! – Foreclosure Rules Kick In

As the seasons change (is rainy a season?) so too do banking laws and regulations continue to change and evolve. What follows are some important Winter/Spring developments:

May Day! May Day! – Foreclosure Rules Kick In

On February 22, 2013, the Illinois Supreme Court announced new mortgage foreclosure rules designed to help those who face loss of their homes via foreclosure. These rules went into effect on May 1, 2013 and are now in play. There are three (3) new Supreme Court rules, as follows:

• Rule 99.1 – This rule establishes requirements for mortgage foreclosure mediation programs set up in any judicial circuit in Illinois. At present, the Illinois Eighth Judicial Circuit (which covers Adams, Brown, Calhoun, Cass, Mason, Menard, Pike and Schuyler Counties) does not have a mortgage foreclosure mediation program in place nor are there any plans to put such a program in place. Therefore, this rule has no applicability to banks within that area.
• Rule 113 – This rule deals with practices and procedures in mortgage foreclosure cases by:
  • establishing requirements for prove up affidavits, notices of default and entry of judgments of foreclosure
  • prescribing the form of notice to be given and the motion to be filed when there are “surplus funds” from a foreclosure sale.
  Because of the restriction on disclosing older disciplinary records, school officials should develop procedures to ensure that the records are not released inadvertently. This might involve segregating them within the employment file or sorting them otherwise. Another helpful practice is to only release the file to the employee and let the employee provide the records to any third parties.

Rule 113 – APPLIES ONLY TO CASES FILED AFTER MAY 1.

• Rule 114 – This rule requires that before a Bank can obtain a judgment of foreclosure, it must comply with the requirements of any loss mitigation programs applicable to the subject mortgage loan. An affidavit must be filed which states what type of loss mitigation applies to the mortgage, what steps were taken to offer that type of loss mitigation and the results of those mitigation efforts. The affidavit must also identify any “in-house” loss mitigation processes regularly offered by the bank for a mortgage loan of that particular type. What’s key is that banks must understand what loss mitigation programs apply to particular types of loans when they go into default and must take the steps necessary to meet the obligations of those programs. This is a prerequisite to going forward with the foreclosure.

Rule 114 – APPLIES TO ALL CASES PENDING ON OR FILED AFTER MAY 1 IF A FORECLOSURE JUDGMENT WAS NOT YET ENTERED BY MAY 1.

BOTTOM LINE: Accurate, understandable and producible records of mortgage payments and knowledge of, and compliance with, applicable loss mitigation programs are a must under these new rules.

Student Loans – Is Water Starting to Leak Through The Non-Dischargeability Dam?

The bankruptcy code provides that student loans are exempt from discharge (are not excused) unless the continued obligation would “impose an undue hardship on the debtor and the debtor’s dependents”. In such case, the debt is discharged. What constitutes “undue hardship” then becomes crucial in determining whether or not a student loan is discharged or remains an enforceable obligation. In general, “undue hardship” is shown if three (3) conditions are met: (1) debtor cannot maintain, based on current income and expenses, a minimal standard of living if required to repay the loan; (2) the debtor’s state of affairs is likely to persist for a significant period of time; and (3) the debtor made good faith efforts to repay the loans. The last factor is key and often times cases come down to whether or not the inability to pay was due to factors within or beyond the debtor’s control. In other words, if, through no fault of the debtor, he was not able, or did not have the ability, to pay, i.e. due say to disability, infirmity or medical conditions, the good faith test was met. Normally, a student loan is not discharged if the person is healthy, able bodied and able to work. This may be changing.

The issue of whether or not the good faith test was met was the heart of the case in Krieger vs. Educational Credit Management Corporation decided by the United States Court of Appeals for the Seventh Circuit on April 10, 2013. Here, Susan Krieger incurred student loans to obtain training as a paralegal. She lived with her mother in a rural community where few jobs were available; received only a few hundred dollars every month from government programs; and was too poor to move to, or search for, better employment prospects elsewhere. She also had an old car that needed repairs and lacked internet access which hampered her search for work. The case came down to whether or not Krieger made a good faith effort to repay the loan. The bankruptcy court concluded that she had made a thorough (good faith) effort evidenced by her sending out over 200 applications for jobs over 10 years. The district court disagreed finding that Krieger could have searched harder for work and could have looked for employment in a field other than her stated profession, i.e. as a paralegal. On appeal, the Seventh Circuit concluded that Krieger, then age 53, and unemployed since 1986, had made a reasonable good faith effort to pay the student loan and that, therefore, the student loan was dischargeable.

The concern raised by the case is that the court discharged a student loan for a woman who was middle age (53), was in good health and had a solid education, i.e. paralegal training, for reasons that appear to be within her control, namely moving to an area where there were more job opportunities and/or taking a job outside her chosen profession. What is troubling is that Ms. Krieger’s situation is not unique. The Chicago Tribune recently reported that banks wrote off three million dollars of student loans in the first two (2) months of 2013 up six percent (6%) from 2012. Moreover, with over a trillion dollars of student loans outstanding and many young adults with college degrees struggling to find jobs in their chosen field, the implications of this case are profound. Will this case offer an excuse to avoid student loan obligations simply because one cannot find a job in his major/chosen profession within a small town where the young adult grew up or now lives? Is applying for 20 jobs a year good faith or borderline lazy? If a person gets a college degree, sits at home, makes some effort to get a job (2 job applications filed a month as Ms. Krieger did) and cannot find a job in his or her major (or chosen profession), can his student loan be excused and discharged? This case suggests that that is a possibility. Will the bankruptcy code’s protection against student loans being non-dischargeable start to break down as Krieger like cases trickle through the system? Time will tell.

MORTGAGE LENDER vs. CONTRACTOR – WHO GETS THE FUNDS?

The issue is this: how are the proceeds of a foreclosure sale to be distributed between a construction lender/mortgagee and mechanic’s lien claimant when the mortgage predates the mechanic’s lien but the proceeds from a foreclosure sale are insufficient to fully pay all parties. In short, who wins if there is a shortfall of funds? In LaSalle Bank NA vs Cypress Creek, the Illinois Supreme Court held that the lender’s share of the foreclosure sale proceeds should be determined by adding together the value of the underlying unimproved land and the value of project improvements paid for by the loan proceeds. In other words, Cypress Creek held that the lender’s lien was superior to that of the mechanic’s lien holder on the improvements for which the construction loan proceeds were used to pay the contractors. As such, the lender stands in the shoes of mechanic’s lien claimants who have already been paid from the construction loan. This case was good news for lenders!

Unfortunately, Public Act 097-1165, effective February 13, 2013 overturns this decision. Under the new law, when the proceeds of a foreclosure sale are insufficient to satisfy the claims of both the lender and the mechanic’s lien claimants, the proceeds of the sale are to be distributed as follows:

• (1) The lender has priority only as to the portion of the proceeds attributable to the value of the land before any improvements were made; and
• (2) The unpaid mechanic’s lien holders have senior priority to the proceeds attributable to the value of all improvements made to the property regardless of whether some of those improvements have already been paid for by the lender.

In other words, once the lender receives payment for the value of the land, unpaid mechanic lien holders are paid in full next and the lender only thereafter.

This is bad news for lenders as it reverses the lien priorities on improvements made using the loan proceeds and thereby limits a bank’s ability to recoup on its loans when a project falls into trouble and a foreclosure ensues. To compensate for this increased risk, lenders have several options, including:

• increasing the interest rate charged on construction loans and/or charging up-front underwriting fees.
• tightening, from a risk management standpoint, underwriting standards for construction loans.
• requiring all contractors to file mechanic’s liens and to assign those to lenders each and every time loan proceeds are disbursed.
• utilizing other credit enhancement tools such as guarantees or letters of credit to support the loan.

CONSUMER FINANCIAL PROTECTION BUREAU UPDATES

• Credit Life Insurance Financing Prohibition/Delayed. On May 10, 2013, the CFPR announced a temporary (and indefinite) delay of the June 1, 2013 effective date on the prohibition against creditors financing credit life insurance premiums in connection with certain consumer credit transactions secured by a dwelling. The delay is to allow the CFPR time to clarify, before the provision takes effect, its applicability to transactions other than those in which a lump sum premium is added to the loan amount at closing.
• Final Appraisal Rules for Higher Risk Mortgages Issued. Dodd Frank added a new section to the Truth in Lending Act establishing appraisal requirements applicable to higher risk mortgages. Dodd Frank further required that final regulations implementing the property appraisal requirements for higher risk mortgage be issued by January 21, 2013. These regulations were issued by the CFPB on January 18, 2013. This final rule not only defines a “higher risk” mortgage, but also sets forth requirements for the appraisal obtained in connection with such a loan as well as exempting certain mortgage transactions therefrom. The regulation also impose certain additional requirements, including that the lender obtain and pay for a second appraisal, when the higher risk mortgage is obtained to buy a home that is a “flip”, i.e. where the Seller purchased the home at a lower price within six (6) months of selling the property to buyer at a higher price.
• Amendments to 2013 Escrow Final Rule under Reg. Z. On May 23, CFPB issued final amendments and clarifications to the rule it issued January 10, 2013, which, inter alia, lengthens the time for which a mandatory escrow account established for a higher price mortgage loan must be maintained. This rule, as well as the appraisal rule, establishes an exemption for certain creditors/lenders that predominately operate in “rural” or “underserved” areas.

INTERESTING FACTS

• The average credit card debt of those in debt was in:
  • 1993 - $4,500
  • 2003 - $6,500
  • 2013 - $16,000
• Number of U.S. companies in 1979 with a Moody AAA Credit Rating 61; number today 4.
• Realty Trac reports that it takes an average of 720 days to complete a foreclosure case in Illinois.

SCARY FACT

• U.S. government spends $435,000,000 per hour, 24/7, 365 days of the year.

FUNNY FACT – LOTTO LUCK!

• The Chicago Tribune reports on May 16, 2013 that a Chicago couple found a $4.38 Million lottery ticket in their cookie jar enabling them to pay off their home loan then in foreclosure. So much for getting caught with one’s hand in the cookie jar!

The foregoing is not intended to be legal advice, but rather, to provide accurate information regarding banking law and regulatory matters. For more information, please contact any member of our banking practice group: James A. Rapp ( jrapp@srnm.com ), William M. McCleery, Jr. ( wmccleery@srnm.com ), Michael A. Bickhaus ( mbickhaus@srnm.com ), Ted Niemann ( tniemann@srnm.com ), Alok Patel ( apatel@srnm.com ), or Joseph Ott ( jott@srnm.com ) at (217) 223-3030 or visit us on the web at www.srnm.com. We invite and welcome all questions and comments.