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Valuable Lesson from Overturned Foreclosure

New York case demonstrates importance of accurate records and good faith

December 4, 2009

Patton Boggs LLP

An overturned foreclosure case in New York offers some valuable insight for mortgage firms that want to avoid the same fate.

Lenders know that when judicially foreclosing defaulted residential mortgage loans, they must, among other things, prove ownership of the promissory notes; make sure loan records accurately reflect the outstanding principal, interest and other amounts due from the borrowers; and, depending on the state, be prepared for settlement conferences with the borrower before the judge, e.g. as mandated under New York's Foreclosure Prevention and Responsible Lending Act.

Sometimes in a foreclosure matter the lender makes a mistake, such as pleading the wrong interest amount due or losing a promissory note. Not infrequently, when the court believes the lender and its counsel are acting appropriately and are not in disregard of the law or the court, the court will allow the lender a limited period to fix the erroneous amount and find the missing note (or submit a lost note affidavit).

But what can happen when the foreclosing lender disregards the court's settlement efforts, cannot provide suitable and accurate evidence of amounts due from the borrower and declines a settlement?

Perhaps we now know.

A state court, upset with the conduct of a lender in an action foreclosing an underwater residential mortgage loan, ordered that the promissory loan note is "canceled, voided, avoided, nullified, set aside and is of no further force and effect."

In this case, the lender made a $292,500 loan in August 2004 and commenced foreclosure in July 2005. A judgment of foreclosure and sale was entered on Jan. 12, 2009.

In post-judgment mandatory settlement conferences -- including five continuances of the conference -- for subprime high-cost residential mortgages (held under CPLR § 3408), the court found the lender "uncooperative" and complained of the lender's "continuing failure and refusal to cooperate, both with the court and with defendant's multiple and reasonable requests."

The court described the lender's bungled attempt at a forbearance agreement, refusal of a short sale, refusal of a modification with no principal forgiveness and equivocation over the borrower's offer to provide a deed in lieu.

Most of all, the court described in great detail the lender's multiple inconsistencies in sworn and submitted testimony in more than seven court appearances over what amounts were due under the loan. The court noted that it "certainly is no secret that Suffolk County is in the yawning abyss of a deep mortgage and housing crisis with foreclosure filings at a record high rate and a corresponding paucity of emergency housing."

Finally, the court described the lender's poor credibility and its representative's "opprobrious demeanor and condescending attitude." toward a resolution of the defaulted loan, while noting the good faith and obvious physical difficulties of the home owner and her husband, both of whom attended the multiple court appearances over several years with their daughter.

The relief granted to the borrower by the court was extraordinary, and may be appealed.

Unfortunately, elements of this decision resulting from conduct of lenders are reported all too frequently in other loan collection or foreclosure cases. So lenders, do not send your attorney to court without evidence of promissory note ownership, ensure that your attorney has access to accurate records of amounts due and payments made under the loan and do not sign sworn affidavits, whether submitted to a foreclosure referee or to the court, regarding those amounts due without adequate proof of the records' accuracy.

It seems reasonable that in a foreclosure action's mandatory settlement conference regarding a foreclosure of an underwater subprime/high-cost residential mortgage loan with sympathetic borrowers living in an area adversely affected by the housing crises, and where the lender's numbers are embarrassingly inconsistent, that a lender should consider a settlement.

A court may review certain cumulative conduct of a lender in what is arguably part of an equitable proceeding (foreclosure). In this instance, the court found the lender's conduct to be "inequitable, unconscionable, vexatious and opprobrious." The court stated that it "is constrained, solely as a result of plaintiff's affirmative acts, to conclude that plaintiff's conduct is wholly unsupportable at law or in equity, greatly egregious and so completely devoid of good faith that equity cannot be permitted to intervene on its behalf."

IndyMac Bank F.S.B. vs. Dian Yano-Horoski, Wells Fargo Bank Minnesota National Association as Trustee for Soundview Home Equity Loan Trust 2001-1 and Kimberly Horoski.
Nov. 19, 2009 (Supreme Court, Suffolk County, State of New York).

This article originally appeared in Mortgage Banking Update from Patton Boggs LLP.

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Jerry Phelps is Of Counsel with the Washington, D.C.-based law firm of Patton Boggs LLP. Jerry assists clients on a full scope of business and corporate finance matters and represents investors, servicers and originators in securitized consumer and commercial loan matters including workouts. e-mail Jerry at [email protected].

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