Foreclosures: Beware Unexpected Violations

Field v. Bank of America, N.A. (In re Gibbs), 522 B.R. 282 (Bankr. D. Hawaii 2014) –

A bankruptcy trustee sued a mortgage lender to recover for defects in a prepetition non-judicial foreclosure sale. The lender brought a motion to dismiss for failure to state a claim.  The primary focus of the court was on claims under the state Unfair and Deceptive Acts or Trade Practices (UDAP) law.

The alleged defects in the foreclosure sale included the following:

  • The published and recorded foreclosure notice announced that the sale would be held in the courtyard of the court building. It also said the sale could be postponed by public announcement. However: (1) Shortly before the sale the state court stopped allowing sales on the premises. So the lender made an oral announcement postponing the sale on a public sidewalk at the bottom of the steps to the entrance of the courthouse. (2) A person standing in the courtyard where the sale was supposed to take place could not see or hear the announcement. No notice of the new date and location was published.
  • According to the published terms of the sale: (1) the lender would only give a quit claim deed, (2) the buyer had to pay at least 10% of the bid price at the close of the auction, (3) a cashier’s check for the balance of the bid was due within 21 days, and (4) the buyer had to close within 30 days or forfeit the 10% down payment. However, the winning bidder (who had purchased other properties at sales conducted by the lender’s attorney) received a limited warranty deed and closed the sale nine months after the auction without losing its 10% down payment.
  • The winning bid was ~$112,000 (subject to the first mortgage). This was substantially less than market value. The buyer resold the house two years later for $535,000.

The trustee asserted three claims: (1) the lender violated UDAP by engaging in “unfair” and “deceptive” foreclosure practices; (2) it engaged in an unfair method of competition by deterring potential bidders; (3) it engaged in wrongful foreclosure by failing to comply with the foreclosure statute and the power of sale in the mortgage, and by violating its duty “to act reasonably and in good faith to get the best possible price when it sold the house.”

Turning to the statute, the court noted that a practice is unfair “when it offends established public policy and when the practice is immoral, unethical, oppressive, unscrupulous or substantially injurious to consumers.” A deceptive practice is “(1) a representation, omission, or practice that (2) is likely to mislead consumers acting reasonably under the circumstances where (3) the representation, omission, or practice is material.”

To support his claim the trustee argued that advertising sale conditions that were not true killed the bidding and resulted in a lower price. In response, the lender argued that the UDAP claims failed because they were not based on any breach of duty.  However, the court rejected the premise that there must be a duty independent of the statute to support a claim.  The statute itself imposed a duty to refrain from unfair or deceptive acts or practices.

The lender also argued that it owed no duty to maximize the price. The court was unwilling to grant a motion to dismiss on this basis:

Taken to its logical extreme, [the lender’s] argument against any duty leads to an absurd result.  Suppose that a lender had a $500,000 mortgage in default and that the lender found someone who was willing to buy the property for $700,000.  If [the lender] is right and the lender owes no duty regarding price to the borrower, the hypothetical lender could make a credit bid of $1.00 at the auction, make a profit of $699,999 (less expenses) on the resale, and recover a deficiency judgment of $499,000 (less expenses) against the debtor.

The court did not believe the state law would permit this result, so there must be some duty. In fact, old case state law recognized a duty to “‘[use] every effort to sell to the best advantage’ and to ‘use all fair and reasonable means in obtaining the best prices for the property on sale…’”

In contrast, there was a Federal district court decision holding that there was no duty to maximize price, which the lender urged the bankruptcy court to follow. However, the bankruptcy court disagreed with the district court’s analysis and declined to do so.

Similarly the lender relied on a district court decision holding that UDAP does not impose duties on foreclosing lenders beyond those imposed under the foreclosure statute. Once again the bankruptcy court disagreed with the district court, instead concluding that (1) UDAP imposed obligations beyond those in the foreclosure statute, and (2) foreclosing lenders are not exempt from UDAP.

With respect to the proper remedy, the lender argued that the only remedy for a defective foreclosure sale was to invalidate the sale. The court disagreed, holding that a damage claim was available.  The lender next argued that damages were not sufficiently pled.  However, the court compared this case to a 9th Circuit case where “‘merely stat[ing]’ that the plaintiff ‘suffered ‘considerable hardship’ due to spending ‘almost two years’’ attempting to modify her mortgage and ending in foreclosure was sufficient to survive a motion to dismiss.”  Given that the trustee alleged far more specific harm, the court once again rejected the lender’s arguments.

Consequently the lender’s motion to dismiss was denied.

This case highlights an interesting procedural point. As discussed in a footnote, there is a split in authority as to whether bankruptcy judges are bound by district court opinions.  According to this court, the majority view is that stare decisis does not apply.  However, that is not the end of the story.  As the judge commented: “Even if I am not bound, I’m still reluctant to disagree with my colleagues on the district court bench because they are very good judges who are usually right.”  Another aspect of the relationship that was not expressed in the footnote is that a bankruptcy court’s decisions are subject to being reversed by the district court regardless.  So, a district court decision will always carry weight, but a bankruptcy judge might be persuaded to go a different direction if it is not viewed as binding.

Vicki R. Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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