6th Cir. Questions Bank’s Contractual Limit on Liability for Fraudulent Checks

The U.S. Court of Appeals for the Sixth Circuit recently reversed the dismissal of a class action lawsuit filed by a bank account holder who asserted that the bank violated the Uniform Commercial Code 4-401 and 4-103(a), dealing with liability for fraudulent checks.

The account holder experienced check fraud and the bank refused liability because the master services agreement for the account contained a liability waiver for failure to purchase fraud protection products, which the account holder had not done.

A copy of the opinion in Majestic Building Maintenance, Inc. v. Huntington Bancshares Inc. is available at:  Link to Opinion.

The bank account holder, a commercial cleaning business, opened a business checking account with the bank subject to a master services agreement that contained a liability waiver.

The liability stated that if the account holder elected not to avail itself of the bank’s products to discover and prevent unauthorized transactions, the bank would have no liability for any unauthorized transactions and no duty to re-credit the account for any losses.

The account holder did not avail itself of the bank’s anti-fraud products, and instead ordered hologram checks from a third party as protective measure to avoid fraudulent account activity.

The account holder discovered four unauthorized, non-hologrammed checks debited from the account totaling $3,973.96 that had the same check numbers as previously used hologram checks. The account holder contacted the bank within 24 hours to request reimbursement and the bank responded via letter stating that “reasonable care was not used in declining to use our [fraud prevention] services, which substantially contributed to the making of the forged item(s),” and that “[a]s a result, we will not reimburse you for these unauthorized/forged item(s).”

The account holder’s attorney sent a letter to the bank and filed complaints with the Federal Reserve and the FDIC, which resulted in the OCC contacting the bank about the complaints. The bank again responded to the account holder that the bank would not have any liability for the fraudulent transactions because the account holder had not used the bank’s anti-fraud products. The OCC sent the account holder a letter that it would not intervene in a private party dispute involving the interpretation and enforcement of a contract.

The account holder filed a putative class action complaint alleging that the bank had breached its obligations under U.C.C. § 4-401 when it paid the four fraudulent checks, and violated U.C.C. § 4-103(a) when it unreasonably shifted all liability to the account holder and improperly disclaimed its responsibility to act in good faith and exercise ordinary care by incorporating a liability waiver into the master services agreement.

The bank moved to dismiss the complaint for failure to state a claim.  The trial court granted the motion holding that the account holder had not stated a claim that the bank violated § 4-401 or § 4-103. The trial court concluded that the master services agreement was not manifestly unreasonable and did not absolve the bank of its duties to act in good faith and exercise ordinary care because several provisions “plainly reaffirm [the bank’s] duties to act in good faith and exercise ordinary care” and thus was not liable for the account holder’s loss. The account holder appealed.

The Sixth Circuit found that the provision in the master services agreement at issue “might improperly disclaim [the bank’s] basic responsibility to act in good faith and exercise ordinary care” such that the complaint sufficiently stated a claim to survive the motion to dismiss.

The Court noted that under U.C.C. § 4-401, cmt. 1, “[a]n item containing a forged drawer’s signature or forged indorsement is not properly payable.” As you may recall, this rule may be varied by the parties’ agreement but the agreement cannot disclaim a bank’s responsibility for its lack of good faith or failure to exercise ordinary care and cannot limit the measure of damages for that failure.  See U.C.C. § 4-103(a). The agreement may state reasonable standards for measuring the bank’s responsibility.  See U.C.C. § 4-103(a).

The Sixth Circuit explained that this means the bank could not use the master services agreement to remove its statutory duty to act in good faith and exercise ordinary care toward the account holder and that doing so could be considered “manifestly unreasonable.”

The Court found that the account holder had plausibly alleged that the provision at issue violated § 4-103(a) because it allegedly unreasonably disclaimed the bank’s basic duties of ordinary care and good faith. The Sixth Circuit pointed out that the factual record would need to be developed regarding whether the bank charged the account holder additional fees for what it was supposed to do at no additional cost, which was to exercise its ordinary duty of care.

The Sixth Circuit further explained that the trial court erred by concluding that because the master services agreement contained other provisions that reaffirmed the bank’s duties to act in good faith and exercise ordinary care, the provision at issue did not violate § 4-103(a). The Court held that the account holder properly challenged a specific provision, and the other provisions did not change that.

Accordingly, the trial court’s order dismissing the putative class action complaint was reversed, and the case was remanded with instructions to allow the account holder to amend the complaint as needed and conduct discovery.

Fla. App. Court (1st DCA) Holds Third-Refiled Foreclosure Action Not Barred by Res Judicata or SOL

The District Court of Appeal of the State of Florida, First District, recently affirmed the trial court’s entry of a final judgment of foreclosure, holding that because the complaint included at least some installment payments within five years of the filing of the complaint, the action was not barred by res judicata or the statute of limitations.

A copy of the opinion in Forero v. Green Tree Servicing, LLC  is available at: Link to Opinion.

Husband and wife borrowers defaulted on their mortgage loan in December 2008. The mortgagee filed a foreclosure action in February 2010, but voluntarily dismissed the case in December 2011.

The mortgagee filed a second foreclosure action in February 2013 based on the same default date of December 2008, but again voluntarily dismissed the case in April 2013.

The note and mortgage were sold and assigned in September 2013 and the new servicer sent an acceleration letter to the borrowers. The new servicer then filed a third foreclosure action in April 2014, again based on the same default date of December 2008.

The borrowers raised the defense of res judicata by operation of Rule 1.420, which provides that a second voluntary dismissal “operates as an adjudication on the merits … based on or including the same claim.” The borrowers also raised the defense that Florida’s five-year statute of limitations for foreclosures contained in section 95.11(2)(c), Florida Statutes, barred the third foreclosure action.

The third foreclosure action went to trial and the court entered judgment in the plaintiff mortgagee’s favor, but refused to award interest, late fees and “other sums” because the plaintiff mortgagee failed “to prove amounts for these items.” The borrowers appealed.

On appeal, the borrowers argued that the third foreclosure action resulting in the final judgment of foreclosure was barred by Rule 1.420(a)(1) and the statute of limitations.

The Appellate Court began by discussing Rule 1.420’s “two dismissal rule[,]” but noted that under the Fourth District Court of Appeal’s decision in Olympia Mortgage Corp. v. Pugh, the rule “itself does not actually preclude subsequent actions” because “it is the doctrine of res judicata which bars subsequent suits on the same cause of action.”

The Court then cited the Florida Supreme Court’s 2004 decision in Singleton v. Greymar Associates, which held that “the doctrine of res judicata does not necessarily bar successive foreclosure suits, regardless of whether or not the mortgagee sought to accelerate payments on the note in the first suit. … [T]he subsequent and separate alleged default created a new and independent right in the mortgagee to accelerate payment on the note in a subsequent foreclosure action.”

Relying on Olympia Mortgage and Singleton, the Appellate Court reasoned that because there was no dispute that the borrowers stopped paying in December 2008 and also that no payments were made thereafter, the third foreclosure action “was not barred as res judicata, even in light of rule 1.420(a), because the open-ended series of defaults included different missed payments at issue in each suit.”

The Appellate Court also rejected the borrowers’ argument that the third foreclosure action was barred by the statute of limitations based on the Florida Supreme Court’s recent 2016 decision in Bartram v. U.S. Bank, which held that its analysis in Singleton applied equally to the statute of limitations, and “with each subsequent default, the statute of limitations runs from the date of each new default providing the mortgagee with the right, but not the obligation, to accelerate all sums then due under the note and mortgage.”

Applying Singleton, the Appellate Court concluded that the voluntary dismissal of the first two foreclosure actions did not bar a third foreclosure action “because the causes of action are not identical. The additional payments missed by the time the third action was filed, which were not bases for the previous actions because they had not yet occurred, constitute separate defaults upon which the third foreclosure action may be based. Additionally, acceleration of the note occurred at a different time.”

Because Singleton clarified that “enforcement of the note via a foreclosure action is not barred by res judicata for the defaults occurring after” dismissal of the second foreclosure action in April 2013, and the third foreclosure action “was not barred by the statute of limitations” since “each missed payment constituted a new default[,]” restarting the five-year statute of limitations on that default, the final judgment of foreclosure was affirmed.

9th Cir. Rules Mortgage Underwriters Not Exempt Under FLSA

The U.S. Court of Appeals for the Ninth Circuit recently held that mortgage underwriters were not exempt under the federal Fair Labor Standards Act (FLSA) and were therefore entitled to overtime compensation for hours worked in excess of 40 per week.

After analyzing the specific details of the underwriters’ responsibilities, the Ninth Circuit panel concluded that, because the underwriters’ primary job duty did not relate to their employer bank’s management or general business operations, the administrative employee exemption to the FLSA’s overtime requirements did not apply.

Recognizing that there was a split between the Second Circuit and Sixth Circuit as to whether the underwriters are exempt, the Ninth Circuit adopted the Second Circuit’s conclusion that “the job of underwriter falls under the category of production rather than administrative work,” and, thus, the administrative exemption under the FLSA does not apply.

A copy of the opinion in McKeen-Chaplin v. Provident Savings Bank is available at:  Link to Opinion.

The plaintiff and the other members of the class were mortgage underwriters for the defendant bank.  The bank sold mortgage loans to consumers seeking to purchase or refinance homes, and then the bank would resell the funded loans on the secondary market.

The mortgage loan application process was streamlined.  A loan officer or broker worked with a borrower to select a particular loan product. A loan processor then ran a credit check, gathered further documentation, assembled the file for the underwriter, and ran the loan through an automated underwriting system. The automated system then applied certain guidelines based on the information input and then returned a preliminary decision.

From there, the file went to a mortgage underwriter, who verified the information put into the automated system and compared the borrower’s information against the applicable guidelines, which are specific to each loan product.  The underwriters were responsible for thoroughly analyzing complex customer loan applications and determining borrower creditworthiness in order to ultimately decide whether the bank will accept the requested loan. The underwriters could impose conditions on a loan application and refuse to approve the loan until the borrower satisfied those conditions.

The decision as to whether to impose conditions is ordinarily controlled by the applicable guidelines, but the underwriters could include additional conditions. They could also suggest a “counteroffer” — which would be communicated through the loan officer — in cases where a borrower did not qualify for the loan product selected, but might qualify for a different loan.

Underwriters could also request that the bank make exceptions in certain cases by approving a loan that did not satisfy the guidelines.  After an underwriter approved a loan, it was sent to other bank employees who finalized the loan funding. According to the underwriters, whether a loan was funded ultimately depended on factors beyond their control. Another group of bank employees then sold the funded loans in the secondary market.

Initially, the trial court denied cross motions for summary judgment and set the case for trial. But later, on the parties’ joint motion for reconsideration, the trial court concluded that the underwriters qualified for the administrative exemption under the FLSA, based on the finding that their primary duty included “quality control” or similar activities directly related to the bank’s general business operations.  Thus, the trial court granted summary judgment in favor of the bank. The plaintiff appealed.

As you may recall, the FLSA requires employers to compensate its employees time and a half of their regular pay for all hours worked over 40 in a week.  Under the FLSA, certain employees “employed in a bona fide executive, administrative, or professional capacity” are exempt from the overtime requirements. See 29 U.S.C. § 213(a)(1).

The Ninth Circuit recognized that the exemptions under the FLSA are to be narrowly construed, and the employer bears the burden of establishing they apply.  According to the Court, the FLSA “is to be liberally construed to apply to the furthest reaches consistent with Congressional direction,” and the exemptions “are to be withheld except as to persons plainly and unmistakably within their terms and spirit.”

In assessing whether the administrative exemption applied, the Court relied on the Department of Labor’s regulations interpreting the FLSA. In order for the administrative exemption to apply, the employee must (1) be compensated not less than $455 per week; (2) perform as her primary duty “office or non-manual work related to the management or general business operations of the employer or the employer’s customers;” and (3) have as her primary duty “the exercise of discretion and independent judgment with respect to matters of significance.” 29 C.F.R. § 541.200(a). An employee’s primary duty is “the principal, main, major or most important duty that the employee performs.” 29 C.F.R. § 541.700(a).

At issue in this case was the second requirement.  In order to satisfy that requirement, an employee’s primary duty must involve office or “non-manual work directly related to the management policies or general business operations” of the bank or the bank’s customers. See 29 C.F.R. § 541.200. “An employee must perform work directly related to assisting with the running or servicing of the business, as distinguished, for example, from working on a manufacturing production line or selling a product in a retail or service establishment.” 29 C.F.R. § 541.201(a).

This has commonly been referred to as the “administrative-production dichotomy.” Its purpose is “to distinguish ‘between work related to the goods and services which constitute the business’ marketplace offerings and work which contributes to ‘running the business itself.’” DOL Wage & Hour Div. Op. Ltr., 2010 DOLWH LEXIS 1, 2010 WL 1822423, *3 (Mar. 24, 2010).  According to the Ninth Circuit, “[t]his requirement is met if the employee engages in ‘running the business itself or determining its overall course or policies,’ not just in the day-to-day carrying out of the business’ affairs.”

The Court observed that the Second Circuit and Sixth Circuit had reached conflicting rulings on whether the administrative exemption applied to mortgage underwriters.  According the Second Circuit, “the job of underwriter . . . falls under the category of production rather than of administrative work.”  Davis v. J.P. Morgan Chase & Co., 587 F.3d 529, 535 (2d Cir. 2009).

On the other hand, the Sixth Circuit concluded that mortgage underwriters are exempt administrators, explaining that they “perform work that services the Bank’s business, something ancillary to [the bank’s] principal production activity.” Lutz v. Huntington Bancshares, Inc., 815 F.3d 988, 995 (6th Cir. 2016).  The Sixth Court determined mortgage underwriters performed “administrative work because they assist in the running and servicing of the Bank’s business by making decisions about when [the bank] should take on certain kinds of credit risk, something that is ancillary to the Bank’s principal production activity of selling loans.” Id. at 993.

Turning to the facts of this case, the Ninth Circuit agreed with the reasoning of the Second Circuit, and concluded that the underwriters “did not decide if the Bank should take on risk, but instead assess whether, given the guidelines provided to them from above, the particular loan at issue falls within the range of risk the Bank has determined it is willing to take.”

The Court continued, “assessing the loan’s riskiness according to relevant guidelines is quite distinct from assessing or determining the Bank’s business interests. Mortgage underwriters are told what is in the Bank’s best interest, and then asked to ensure that the product being sold fits within criteria set by others.”

The Ninth Circuit also cited to the DOL’s regulations to support its conclusion.  “The financial-services industry example also includes descriptors that do not correspond with the underwriters’ primary duty, which aims more at producing a reliable loan than at ‘advising’ customers or ‘promoting’ the Bank’s financial products.” See 29 C.F.R. § 541.203(b).  The Court emphasized that underwriters do not “advis[e] customers at all, nor do they market[], servic[e] or promot[e] the employer’s financial products.”

The Court then summarized its ruling as follows:

“We conclude that where a bank sells mortgage loans and resells the funded loans on the secondary market as a primary font of business, mortgage underwriters who implement guidelines designed by corporate management, and who must ask permission when deviating from protocol, are most accurately considered employees responsible for production, not administrators who manage, guide, and administer the business.”

The trial court had granted the bank’s motion for summary judgment on the basis that the underwriters performed work related to “quality control.”  The Ninth Circuit, however, concluded that the record evidence did not support such a conclusion.

The Court concluded that the underwriters’ primary duty did not go to the heart of the bank’s internal operations, but instead went to the marketplace offerings and were related to the production side of the bank’s business.

Accordingly, the Ninth Circuit reversed the trial court’s granting of summary judgment in favor of the bank and remanded with instructions to enter summary judgment in favor of the plaintiff class.

7th Cir. Divided Panel Holds Debt Collector Liable Under FDCPA Despite Changes in Underlying Law at Issue

In a deeply divided opinion, the U.S. Court of Appeals for the Seventh Circuit, in an en banc review, reversed its previous opinion, Oliva v. Blatt, Hasenmiller, Leibsker & Moore, LLC, 825 F.3d 788, 791 (7th Cir. 2016), holding this time that a debt collector that relied upon circuit precedent interpreting the federal Fair Debt Collection Practices Act (FDCPA) venue provision was not protected by the bona fide error defense.

In so ruling, the Court also held that for purposes of compliance with the FDCPA, reliance on court precedent is permitted, but only if there can be no doubt whatsoever as to the accuracy of the prior court’s interpretation of the law.

A link to the opinion is available at:  Link to Opinion.

As you may recall, the FDCPA requires that a debt collector who sues to collect a consumer debt must sue in the “judicial district or similar legal entity” where the debtor lives or signed the contract in question. 15 U.S.C. § 1692i.  In 1996, the Seventh Circuit interpreted “judicial district” to mean a county court, such that when debt collectors were filing suit in Cook County, they could file suit in any of the county’s six municipal districts as long as the debtor resided in Cook County or had signed the underlying contract there. Newsom v. Friedman, 76 F.3d 813, 819 (7th Cir. 1996).

In 2013, relying on Newsom, a debt collection law firm filed suit against a debtor in the First Municipal District of Cook County in downtown Chicago. The debtor did not reside in that district at the time the lawsuit was filed, although he had been a student there when he opened the account and had worked in downtown Chicago.

While the lawsuit was pending, the Seventh Circuit issued a new ruling in Suesz v. Med-1 Solutions, LLC, 757 F.3d 636, 638 (7th Cir. 2014) (en banc), in which it held that the “judicial district or similar legal entity” in § 1692i is “the smallest geographic area that is relevant for determining venue in the court system in which the suit is filed,” which can be smaller than a county if the court system there uses smaller districts. The Suesz Court explained that § 1692i “should prevent debt collectors from choosing venues that are inconvenient for the debtor and/or particularly friendly to the debt collector,” and noted that the “venue provision applies even where the debt collector’s venue selection is permissible as a matter of state law.”  The Suesz Court further explained that “§ 1692i must be understood not as a venue rule but as a penalty on debt collectors who use state venue rules in a way that Congress considers unfair or abusive.”

Thus, Suesz overruled NewsomEight days later the debt collector dismissed the pending lawsuit against the debtor.

The debtor then sued the debt collector under the FDCPA alleging that the debt collector had violated the venue provision in  § 1692i. The parties filed cross-motions for summary judgment and the trial court ruled in favor of the debt collector reasoning that it had shown that its violation of the venue provision was the result of a bona fide error in relying on incorrect circuit precedent. The trial court rejected the debtor’s argument that Suesz should apply retroactively.

The debtor appealed and the Seventh Circuit affirmed, concluding that the safe harbor of the bona fide error defense prevented retroactive application of Suesz. That original holding by the Seventh Circuit would have overruled a string of trial court cases in the U.S. District Court for the Northern District of Illinois in which Suesz was held to retroactively apply to venue under § 1692i. The debtor requested an en banc review asserting that the ruling conflicted with Suesz and the Supreme Court’s ruling in Jerman v. Carlisle, McNellie, Rini, Kramer & Ulrich LPA, 559 U.S. 573, 576 (2010), which held that the bona fide error defense does not apply to mistakes of law.

The debt collector argued that the FDCPA’s bona fide error defense protected it from liability when it relied in good faith on Newsom in choosing the venue for the collection lawsuit. In addressing that argument, the appellate court read Jerman to mean that a debt collector’s own mistaken interpretation of the law prevented application of the bona fide error defense. The panel, however, read Jerman more broadly, concluding that the bona fide error defense does not apply where a debt collector relies in good faith on a court’s reasonable but mistaken interpretation of the law.

The Seventh Circuit panel explained that Jerman offered no indication that some mistakes of law were protected and others were not. In doing so, the panel removed the Jerman holding from its context and applied it more broadly to decide that the bona fide error defense does not apply where a debt collector relies in good faith on reasonable court precedent where the precedent is later overruled.  The panel adopted the reasoning in Jerman that because there can be different interpretations of the FDCPA, a “broad exception for good-faith legal errors…would allow debt collectors to resolve all legal uncertainty in their own favor…” which runs against the purpose of the FDCPA. The panel concluded that the FDCPA puts “the risk of legal uncertainty on debt collectors, giving them incentives to stay well within legal boundaries.”

The panel further justified its holding by explaining that, although court precedent may be considered “the law,” the statute itself is the controlling law even where judges mistakenly interpret it, which is why an overruling of precedent can be retroactive. The panel explained that Suesz was applied retroactively because, while civil rulings are permitted to have a prospective-only effect “to avoid injustice or hardship to civil litigants who have justifiably relied on prior law,” it was not persuaded to give Suesz a prospective-only effect because doing so “would be impermissible unless the law had been so well settled before the overruling that it had been unquestionably prudent for the community to rely on the previous legal understanding.”

Essentially, the Seventh Circuit reasoned that reliance on court precedent is permitted but only if there can be no doubt whatsoever as to the accuracy of the court’s interpretation of the law.

The debt collector also argued that the debtor had signed the underlying contract in the First District such that venue there was proper, but the trial court did not address that argument in its ruling, and therefore the appellate court did not address it either.

The Seventh Circuit panel attempted to mitigate the harsh consequences of its ruling by pointing out that the FDCPA permits a court, when determining damages, to consider the extent to which the non-compliance was intentional. 15 U.S.C. § 1692(b)(1).

Accordingly, the trial court’s judgment in favor of the debt collector was vacated and the case was remanded for further proceedings.

The dissent vehemently disagreed, pointing out that the panel majority’s ruling had created “an unprecedented new rule—one that punishes debt collectors for doing exactly what the controlling law explicitly authorizes them to do at the time they do it.”

The dissent accused the majority panel of repeatedly misreading the Supreme Court’s and the Seventh Circuit’s prior rulings on multiple issues, including its interpretation and application of Suesz and Jerman, pointing out that the debt collector’s choice of venue was lawful when made based on Newsom. The dissent continued that the debt collector met each of the three elements of the bona fide error defense — its violation was unintentional despite its maintenance of reasonable procedures to avoid the error and resulted from its good faith mistake of complying with the controlling law of Newsom. The dissent noted that while retroactive application of Suesz may have created a cause of action for retroactive violations, it did not “retroactively proscribe the application of the bona fide error defense.”

The dissent further disagreed with the panel majority on its interpretation of Jerman, pointing out that the Jerman Court held that the bona fide error defense does not apply only where a debt collector incorrectly interprets the FDCPA, not where the debt collector follows established precedent interpreting the statute. The dissent reasoned that a court’s mistaken interpretation of the FDCPA cannot be attributed to the debt collector who follows it.

The dissent neatly summed up the panel majority’s dissonant ruling: the debt collector “correctly interpreted (and did not violate) Newsom’s controlling determination of the legal requirements of § 1692i, but incorrectly interpreted (and violated) § 1692i itself,” which doesn’t make any sense and should not prevent the application of the bona fide error defense.

3rd Cir. Holds Single Unsolicited Automated Call Enough to Confer Standing

The U.S. Court of Appeals for the Third Circuit recently held that a consumer satisfied the concreteness requirement for constitutional standing and asserted a valid cause of action under the federal Telephone Consumer Protection Act (TCPA), where she alleged she received one unsolicited prerecorded phone call to her cell phone.

Accordingly, the Third Circuit reversed the order of the trial court granting the defendant’s motion to dismiss.

A copy of the opinion in Susinno v. Work Out World Inc. is available at:  Link to Opinion.

The plaintiff consumer alleged that she received an unsolicited call on her cell phone from the defendant fitness company.  The consumer did not answer the call, but the company left a prerecorded promotional offer that lasted one minute on her voicemail.  The consumer alleged the phone call and message violated the TCPA’s prohibition on nonconsensual prerecorded calls to cellular telephones.

The company filed a motion to dismiss, which was granted by the trial court.  In so ruling, the trial court found that: (1) a single solicitation was not “the type of case that Congress was trying to protect people against,” and (2) the consumer’s receipt of the call and voicemail caused her no concrete injury.

The consumer appealed.

On appeal, the Third Circuit first noted two questions were presented: (1) does the TCPA prohibit the conduct alleged by the consumer, and (2) if it does, is the harm alleged sufficiently concrete for Article III standing.

As to the first question, the company argued that the TCPA does not prohibit a single prerecorded call to a cell phone if the phone’s owner was not charged for the call.

As you may recall, the TCPA provides that it shall be unlawful for any person “to make a call . . . using any automatic telephone dialing system or an artificial or prerecorded voice . . . to any telephone number assigned to a . . . cellular telephone service, . . . or any service for which the called party is charged for the call . . .” 47 U.S.C. § 227(b)(1).

The company argued that the structure of this provision limits the scope of “cellular telephone service” to cell phone services where “the called party is charged for the call.”  The company further asserted that when Congress passed the TCPA, it was primarily concerned with the costs of those calls.

The Third Circuit disagreed, noting that the company’s “reading of section 227(b)(1) is strained.”

Quoting the Eleventh Circuit, the Third Circuit stated: “[t]he rule of the last antecedent requires the phrase ‘for which the called party is charged for the call,’ [in § 227(b)(1)], to be applied to the words or phrase immediately extending to or including others more remote.”  Osorio v. State Farm Bank, F.S.B., 746 F.3d 1242, 1257 (11th Cir. 2014).

The Third Circuit also found support in section 227(b)(2)(C), which provides that the Federal Communications Commission “may . . . exempt from the requirements of paragraph (1)(A)(iii) of this subsection calls to a telephone number assigned to a cellular telephone service that are not charged to the called party.”  The Third Circuit noted that if “cell phone calls not charged to the recipient were not covered by the general prohibition, there would have been no need for Congress to grant the FCC discretion to exempt some of those calls.”

The Court therefore held that “the TCPA provides [the consumer] a cause of action for the conduct she alleged.”

With respect to the question of whether the consumer alleged a sufficiently concrete injury to establish constitutional standing to sue, the Third Circuit first noted the issue implicates the Supreme Court’s decision in Spokeo, Inc. v. Robins, 136 S. Ct. 1540 (2016).

In discussing the Spokeo decision generally, the Third Circuit found it significant that the Supreme Court “noted that ‘intangible injuries can nevertheless be concrete.’”  The Third Circuit further referred to its own ruling in In re Horizon Healthcare Services Inc. Data Breach Litigation, 846 F.3d 635 (3d Cir. 2017) wherein it applied Spokeo to a claim for inadequate protection of personal information in violation of the Fair Credit Reporting Act.

In summarizing the rule from Horizon, the Third Circuit stated: “When one sues under a statute alleging ‘the very injury [the statute] is intended to prevent,’ and the injury ‘has a close relationship to a harm . . . traditionally . . . providing a basis for a lawsuit in English or American courts,’ a concrete injury has been pleaded.  We do not, and need not, conclude that intangible injuries falling short of this standard are never concrete.  Rather, we simply observe that all intangible injuries that meet this standard are concrete.”  (Internal citations omitted).

Applying this standard to the facts of the case, the Third Circuit determined that “Congress squarely identified [the] injury” at issue because the “nuisance and invasion of privacy” resulting from a single prerecorded telephone call is the type of harm Congress sought to prevent in enacting the TCPA.

The Third Circuit then turned to the historical inquiry, and determined that the consumer satisfied that test as well.  In so ruling, the Third Circuit noted that the Ninth Circuit “has opined that TCPA claims closely relate to traditional claims for invasion of privacy, intrusion upon seclusion, and nuisance,” which have long been valid claims in American courts.

The Third Circuit then determined that intrusion upon seclusion best fit the circumstances of the case, because the consumer’s privacy is invaded by the phone calls.  The Court noted that although two or three calls would not traditionally be actionable under an intrusion upon seclusion claim, Congress intended the TCPA to elevate a harm that, while “previously inadequate in law,” was of the same character of previously existing “legal cognizable injuries.”

Accordingly, the Third Circuit held “that [the consumer] alleged a concrete, albeit intangible, harm. . .”  The Court further held “that the TPCA provides [the consumer] with a cause of action, and that her injury satisfies the concreteness requirement for constitutional standing.”

Illinois Fed. Court Holds No ‘Bad Faith Denial Of Coverage’ Against Title Insurers in Illinois

The U.S. District Court for the Northern District of Illinois recently held that a title insurer may exclude coverage under the exception for defects “created, suffered, assumed, or agreed to by the insured claimant” without intentional or wrongful conduct by the insured.

In so ruling, the Court also held that the Illinois statute for bad faith denial of coverage by insurers did not apply to title insurers.

A copy of the opinion in Bank of America, NA v. Chicago Title Insurance Company is available at:  Link to Opinion.

In 2007, a developer sought to purchase real estate in Yorkville, Illinois, to build a shopping center.  The lending bank and the developer entered into a construction loan agreement, which was secured by a construction mortgage, security agreement, assignment of rights and leases and fixture filing on the property.

As part of the project, the developer sold land to an anchor tenant pursuant to a purchase agreement.  Under that purchase agreement, the developer agreed to reimburse the tenant for a portion of a special tax imposed on the property by Yorkville.  The purchase agreement also provided lien rights to the tenant should the developer fail to timely pay the reimbursement, and stated that the developer’s obligation shall be a covenant running with the land and binding the developer’s successors and assigns.

The purchase agreement, development agreement, and the mortgage were recorded in that order.  A title insurer provided title insurance to the bank for the transaction.

The developer defaulted under the construction loan agreement and the bank sued for foreclosure in state court.  With respect to the tenant, the foreclosure complaint alleged that the tenant’s rights were subordinate and inferior to the lien and interest of the bank.  The tenant counterclaimed for a declaration of its rights under the agreements that ran with the land and were binding on the developer’s successors and assigns.  The parties filed cross motions for summary judgment.

The state court in the foreclosure held that the bank’s mortgage had priority, the tenant’s tax reimbursement and lien rights were personal between the developer and tenant, did not run with the property, and would be foreclosed and terminated upon entry of final order of foreclosure.

The state appellate court affirmed in part and reversed in part, agreeing that the bank’s mortgage had priority over any lien of the tenant, but concluded that the tenant’s tax reimbursement and lien rights were covenants that ran with the land binding on the bank and its successors, and were not extinguished, because the bank had actual knowledge of the tax reimbursement and lien rights before the bank recorded the mortgage, and because the mortgage was recorded after the memorandum of agreement and memorandum of development agreement.

As a result of the state appellate court ruling, the bank filed a complaint in federal court against the title insurer.  The bank alleged that due to the state appellate court ruling, it sold the mortgaged property for $1,780,000 less than what it would have sold without the tax obligation.  The title insurer, which represented the bank in the state court action against the tenant, denied coverage and refused to indemnify the bank because it claimed that the bank’s loss was excluded from the policy.

The bank’s complaint asserted a claim for breach of contract (Count I) and a claim titled “bad faith” (Count II).  The title insurer answered Count I, moved to dismiss Count II, and raised a number of affirmative defenses, and filed a counterclaim for declaratory judgment and/or “reformation of the policy to reflect the bargained for coverage.”

The bank moved to strike and/or dismiss the title insurer’s counterclaim and first affirmative, both of which asserted that the underlying policy excluded the bank’s claims.

The title insurer’s motion to dismiss argued that § 155 of the Illinois Insurance Code, which provides a cause of action against insurers for bad faith denial of coverage, did not apply because the Insurance Code specifically exempted title insurance companies.  See 215 ILCS 5/451.  Moreover, the title insurer argued that Illinois law does not provide an independent tort claim for breach of good faith and fair dealing.  See Voyles v. Sandia Mortgage Corp., 196 Ill.2d 288, 297-98 (2001).

The Court granted the title insurer’s motion and dismissed Count II.

Next, the bank’s motion to strike and dismiss the counterclaim and first affirmative defense, argued that: (1) the counterclaim should be stricken because it was duplicative of the title insurer’s first two affirmative defenses, and (2) neither the first affirmative defense nor Count I of the counterclaim, both of which sought to avoid coverage based on an exclusion for encumbrances, stated a cause of action because the title insurer did not allege that the bank’s intentional misconduct or inequitable behavior created the tax encumbrances at issue.  The Court rejected both arguments.

First, the Court determined that the bank suffered no prejudice by having to respond to the counterclaim, even if the counterclaim was duplicative of the title insurer’s first two affirmative defenses.  The issue of whether the exclusion applied was the key issue in this case.  The Court held that striking the counterclaim as redundant will not remove the issue, and would not save the plaintiff any time or money.

Second, the Court held that the title insurance policy excluded from coverage “defects, liens, encumbrances, adverse claims or other matters (a) created, suffered, assumed, or agreed to by the insured claimant.”   The title insurer’s affirmative defense and counterclaim alleged that the bank was aware: (1) of the documents creating the tax encumbrance; (2) that the documents provided for the encumbrance to run with the land; and (3) the documents that created the encumbrance were intended to be and were recorded prior to the bank’s mortgage.

Because the tax encumbrance was recorded before the mortgage, the Court held that the foreclosure could not extinguish it.

The Court also held that the exclusion could be applied without intentional or wrongful conduct by the bank to create the encumbrance.  By agreeing to the order of recordation, the Court found that the bank implicitly agreed that the encumbrance for tax reimbursements would survive a foreclosure.

Accordingly, the Court granted the bank’s motion to dismiss Count I and denied its motion to strike and dismiss the title insurer’s counterclaim and first affirmative defense.

Fla. App. Court (2nd DCA) Holds Trial Court Erred in Applying Texas Law to Foreclosure Deficiency Claim

The District Court of Appeal of the State of Florida, Second District, recently held that where loan documents provided that Florida law applied to foreclosure claims, the trial court erred in applying Texas law because the deficiency claim in the case was part of the Florida foreclosure process.

A copy of the opinion in Bonita Real Estate Partners, LLC v. SLF IV Lending, L.P. is available at:  Link to Opinion.

Two limited liability companies and their principals borrowed $6.1 million to develop real estate, signing a promissory note, mortgage and personal guarantees. The loan documents provided that they would be governed by Texas law, except that in case of foreclosure, Florida law would apply as the state where the property was located.

The borrowers defaulted and the lender sued the borrowers and guarantors in Florida state court. The complaint contained claims for foreclosure, promissory note and guaranty.

The trial court entered a final judgment of foreclosure in May 2012, reserving jurisdiction to enter a deficiency judgment. A foreclosure sale took place in June 2012 and the mortgagee was the successful bidder.

The mortgagee then filed a motion for deficiency judgment pursuant to section 702.06, Florida Statutes, alleging that the fair market value of the mortgaged property on the sale date was less than the debt owed under the foreclosure judgment.

The defendants claimed in their amended answer that the property value exceeded the indebtedness.

Shortly before the case went to trial on the promissory note and guaranty claims, the mortgagee argued for the first time that Texas law applied to these claims for damages, and that the defendants had “waived their right under Texas law to have the fair market value of the property considered when determining the amount of deficiency.”

On the other hand, if Florida law applied to the deficiency claims, “the borrowers and guarantors had not waived such right and could present evidence concerning the property’s fair market value.”

The trial court held that Texas law applied “to the lender’s claims for damages based on the language of the documents and that while Florida law appl[ied] to the foreclosure, Texas law appl[ied] to the deficiency claim.”

The defendants moved for reconsideration on whether Texas law applied to the deficiency claim, but the trial court denied the motion.  The trial judge then granted the defendant’s motion to disqualify her and a replacement judge was assigned. The successor judge denied the motion for reconsideration after hearing.

The mortgagee later moved for partial summary judgment, and the trial court granted the motion, ruling that under Texas law, “the deficiency would be calculated as the difference between the amount of the judgment of foreclosure and the bid price, with the difference being $6,892,125.”

After a trial on the issue of whether certain events occurred that would trigger a default, the trial court entered judgment in the mortgagee’s favor for the deficiency amount plus approximately $1.1 million in interest, for a total just under $8.1 million. The borrowers and guarantors appealed.

The Appellate Court agreed with the borrowers’ and guarantors’ argument that “the trial court erred in applying Texas law to the lender’s claim for deficiency because the loan documents provide for the application of Florida law to foreclosure and a claim for deficiency is a continuation of a claim for foreclosure.”

The Court first addressed whether “the final judgment entered is a deficiency judgment.” It reasoned that because under Florida law a lender “has the right to pursue both a claim for foreclosure of the mortgage and a claim for damages on the note” and “a deficiency does not exist without a foreclosure judgment and sale[,] … the final judgment on the note … must be treated as a deficiency determination.”

However, the Appellate Court held, because the “language of the note and the mortgage provide[d] that Florida law governs the foreclosure of the lien created by the mortgage, and we conclude that this includes the lender’s claim for deficiency[,] … the trial court erred in applying Texas law to the deficiency determination….”

Thus, the portion of the final judgment that determined the amount of the deficiency was reversed and the case was remanded so the parties could “address how a new determination on the issue of deficiency under Florida law affects the lender’s claims on the guarantees.”

The trial court’s judgment was affirmed in part, reversed in part and the case was remanded for further proceedings consistent with the Appellate Court’s opinion.

4th Cir. Holds SCRA Does Not Apply to Mortgage Loan Incurred During Service, Even If Borrower Re-Enlists

The U.S. Court of Appeals for the Fourth Circuit recently held that the federal Servicemembers Civil Relief Act (SCRA) does not apply to a mortgage loan obligation incurred while a borrower is a member of the military, even where he subsequently leaves and then later re-enlists in the military prior to a foreclosure sale.

A copy of the opinion in Sibert v. Wells Fargo Bank, NA is available at:  Link to Opinion.

The borrower obtained a mortgage loan to purchase his home from the lender while he was serving in the U.S. Navy.  After his discharge from the Navy, the borrower defaulted on his mortgage loan, and the current loan owner (“mortgagee”) began foreclosure proceedings.

During the foreclosure proceedings, but before the sale was held, the borrower enlisted in the U.S. Army.  The owner continued the foreclosure action and sold the property at a foreclosure sale while the borrower was an active member of the Army.

After the sale, the borrower also executed a “Servicemembers’ Civil Relief Act Addendum and Move Out Agreement,” in which he stated that he was “affirmatively waiv[ing] any rights and protections provided by [50 U.S.C. § 953] with respect to the May 15, 2008 Deed of Trust . . . and the May 13, 2009 foreclosure sale.”

More than five years after the foreclosure sale, the borrower filed a lawsuit against the mortgagee alleging the foreclosure sale was invalid under the SCRA.

As you may recall, the SCRA requires a lender to obtain a court order before foreclosing on or selling property owned by a current or recent servicemember where the mortgage obligation “originated before the period of the servicemember’s military service.”  50 U.S.C. § 3953(a), (c).

The parties filed cross-motions for summary judgment, and the trial court granted summary judgment to the mortgagee, ruling that because the borrower obtained his mortgage loan during his service in the Navy, the loan was not subject to SCRA protection.  The trial court found that the resolution of the case “turn[ed] on the interpretation of the phrase ‘originated before the period of the servicemember’s military service,’” which the trial court noted was an issue of first impression where the borrower had multiple periods of military service.

The trial court noted that, on its own, “the language . . . is unclear on whether it contemplates multiple periods of military service,” but “the specific context of the language indicates that the statute does not apply to obligations incurred while one is in the military, because the underlying concern is the impact military service may have on a servicemember’s income and status, uncontemplated at the time when they incurred the obligation.”

The trial court accordingly concluded that “[b]ecause it is undisputed that [the borrower’s] mortgage originated while he was in the military, that obligation does not qualify under [§ 3953(a)]” and, “[ a]s a result, the borrower cannot claim the remedy provided in [§ 3953(c)].”

Because of its ruling, the trial court did not reach the mortgagee’s alternative argument that the borrower had waived his rights under the SCRA by executing the addendum to his move-out agreement.

The borrower appealed.

On appeal, the borrower argued that because he incurred his mortgage loan obligation during his service in the Navy, the SCRA applied.

The Fourth Circuit disagreed.  In reaching its conclusion, the Fourth Circuit agreed with the trial court’s interpretation of the SCRA, that it was “designed to ensure that servicemembers do not suffer financial or other disadvantages as a result of entering the service,” and that the SCRA accomplishes this goal “by shielding servicemembers whose income changes as a result of their being called to active duty, and who therefore can no longer keep up with obligations negotiated on the basis of prior levels of income.  Such a change in income and lifestyle was not a factor in [the borrower’s] case, as the mortgage at issue here originated while he was already in the service.”

The Fourth Circuit further held that the SCRA “explicitly creates two classes of obligations — those protected and those not.  It provides protection to only those obligations that originate before the servicemember enters the military service.  It thus grants protection to obligations incurred outside of military service, while denying protection to obligations originating during the servicemember’s military service.”

Because the borrower’s obligation originated when he was in the Navy, it “was not in the class of obligations protected by the statute.”

The borrower further argued that even though his mortgage loan was not a protected obligation at the time he incurred it, he obtained retroactive protection when he later entered the Army because the obligation was incurred before he entered the Army.

The Fourth Circuit disagreed, noting that such an interpretation of the SCRA “reads the singular word ‘before’ myopically,” and that “[i]t would lead to inconsistent treatment of substantially identical obligations and would introduce arbitrariness into Congress’ distinction between protected and unprotected obligations.”

The Court therefore held that “because [the borrower’s] mortgage obligation originated when he was in the Navy, it was not a protected obligation under § 3953(a), and his later enlistment in the Army did not change that status to afford protection retroactively.  Accordingly, we affirm the district court’s judgment.”

Because of the ruling, the Fourth Circuit did not determine whether, in the alternative, the borrower executed a valid waiver of his rights under the SCRA.

Third Circuit Serves Up Double Fault in FDCPA, TCPA Decision

A recent decision from the Third Circuit Court of Appeals examines both the provision of consent under the federal Telephone Consumer Protection Act (TCPA) and the bona fide error defense for debt collectors under the federal Fair Debt Collection Practices Act (FDCPA).

The decision has dire implications for debt collectors, creditors and any commercial enterprise using telephone technology and QR codes in communicating with customers.

A copy of the decision in Daubert v. NRA Group, LLC is available at: Link to Opinion.

First up is the TCPA. The trial court ruled that the collection agency violated the TCPA when it used an automated dialing system to call the consumer to collect a medical debt without prior consent because the defendant’s deposition witness previously testified that “the dialer does the dialing.”

In an attempt to fix this error, the collector later submitted an affidavit stating that the telephone dialing system used “human intervention” to make the calls. The trial court labeled this a “sham affidavit” and would not consider it. Worse, even though the consumer appears to have provided his cell phone number to the hospital where he incurred the medical debt, the Third Circuit ruled “more is required” than the simple provision of the cell phone number to an intermediary hospital that was not a creditor.

Distinguishing decisions from the Sixth and Eleventh Circuits (Baisden and Mais, respectively), the Third Circuit pointed out that in those cases the hospital intake forms gave permission to release the consumer’s information for payment purposes. Here, there was no evidence that the consumer released his information to be used for payment purposes. The court affirmed an award to the consumer of $34,000 for 69 telephone calls.

Now for the FDCPA ruling — a debt collector cannot rely on a trial court decision to escape FDCPA liability. That’s tough because as new theories develop, companies will often adjust their practices to align with applicable decisions.

In this case, the debt collector had made operational changes to use Quick Response codes in its mail communications to consumers. It did so relying on two trial court decisions that found that the use of QR codes visible on the face of envelopes did not violate the FDCPA. When the debt collector was later sued for using such QR codes, the trial court here found that it did violate the FDCPA, but the debt collector was exempt from liability under the FDCPA’s bona fide error exception because it relied on the earlier trial court decisions.

The Third Circuit reversed, finding that a bona fide error cannot be premised on a mistaken legal interpretation of the FDCPA, even when it is premised on trial court decisions from within the same Circuit.

Fla. App. Court (4th DCA) Upholds Judgment for Borrower in Foreclosure Where Mortgagee Did Not File Allonge

The District Court of Appeal of the State of Florida, Fourth District, recently affirmed a final judgment in favor of a borrower because the foreclosing mortgagee failed to file the original allonge to the note, holding that as a result the mortgagee lacked standing to foreclose.

A copy of the opinion in U.S. Bank National Assoc., etc. v. Jean Kachik is available at:  Link to Opinion.

A mortgagee sued to foreclose the mortgage, attaching copies of the promissory note and an “Endorsement and Assignment of Note” to the complaint. The endorsement was “blank.”

At trial, the mortgagee offered the original note into evidence, but only a copy of the endorsement. After briefing, the trial court entered judgment in favor of the borrower and the mortgagee appealed.

On appeal, the mortgagee argued “that the endorsement and assignment was merely an assignment for which the original document was not required.” The Appellate Court rejected this argument and agreed with the borrower that “the subject document was an allonge and, as such, [the mortgagee] was required to file the original.”

The Appellate Court explained that “'[a] promissory note is a negotiable instrument …’ [and] [w]here a document is a negotiable instrument, the best evidence rule, as codified [in § 90.953(1), Florida Statutes] requires the production of the original.” Subsection 90.953(1) provides that “[a] duplicate is admissible to the same extent as an original, unless … [t]he document or writing is a negotiable instrument …. ‘Therefore, a party who seeks to foreclose on a mortgage must produce the original note.’”

The Appellate Court explained further that an allonge is “an addition to a negotiable instrument” that must be “so firmly affixed thereto as to become a part thereof. … Although Florida’s Uniform Commercial Code does not specifically mention an allonge, the Code provides that ‘[f]or the purpose of determining whether a signature is made on an instrument, a paper affixed to the instrument is a party of the instrument … [under § 673.2041(1), Florida Statutes].”

The Appellate Court then reasoned that when an allonge is blank or “does not identify a specific payee[,]” it is “payable to bearer.” “If an instrument is payable to bearer, it may be negotiated by transfer of possession alone” [pursuant to § 673.2011(2), Florida Statutes].”

The Appellate Court concluded that since ‘an allonge is part of the note, and an original note is required, it follows that an original allonge is required. … “or a satisfactory reason must be given for failure to do so.”

“Because [the mortgagee] failed to produce the original allonge and did not plead a lost instrument count,” the Appellate Court affirmed the trial court’s judgment in favor of the borrower.

Illinois App. Court (1st Dist) Holds Borrower Could Not Challenge Foreclosure Sale Notice as Unlawfully Discriminatory

The Illinois Court of Appeals, First District, recently determined that a borrower in a foreclosure matter did not have standing to challenge whether the mortgagee’s notice of sale was in violation of the Illinois Human Rights Act (IHRA).

Following the entry of a judgment of foreclosure, the plaintiff mortgagee published its notice of sale, in which the mortgagee required that anyone attending the sale possess a “photo identification issued by a government agency.”

The mortgagee purchased the property at the sale, and then moved for an order confirming the sale.  The borrower objected to the mortgagee’s motion, arguing that the language in the notice requiring government-issued identification violated the IHRA because it discriminated on the basis of national origin.

The Appellate Court concluded that the borrower did not have standing to assert the notice was discriminatory because he had not identified any individual, including himself, who went to the sale with adequate funds to purchase the property but was denied access because they did not have the required identification.

In the absence of such evidence, the Appellate Court held that the borrower failed to identify a distinct and palpable injury traceable to the language in the notice.  Accordingly, the Appellate Court affirmed the trial court’s confirmation of the order of sale.

A copy of the opinion in Deutsche Bank National Trust v. Peters is available at:  Link to Opinion.

The trial court entered a judgment of foreclosure and sale on the borrower’s property in favor of the mortgagee.  Following a judicial sale in which the mortgagee purchased the property, the mortgagee moved for any order confirming the sale pursuant to 735 ILCS 5/15-1508.

The borrower did not contest the judgment of foreclosure, but objected to the motion to confirm the sale, asserting that the published notice of sale was discriminatory and violated the IHRA.

The mortgagee’s notice of sale contained the following language: “You will need a photo identification issued by a government agency (driver’s license, passport, etc.) in order to gain entry into our building and the foreclosure sale room . . .” The borrower contended this language violated the IHRA and prevented the court from confirming the sale under section 15-508(b).

Following a hearing, the trial court entered an order approving the sale.  In its order, the trial court stated “the court makes a finding that [borrower] has not met [his] burden to show that the sale should not be approved.  Further, the court finds that [borrower] has not proven that the notice of sale violated the IHRA or that [borrower] has standing to raise that issue.”

The borrower filed a notice of appeal, challenging the confirmation of the sale.

On appeal, the Appellate Court observed that the borrower did not address at all the trial court’s finding that he did not have standing to challenge whether the notice of sale was discriminatory.

Instead, the Court noted, the borrower only challenged the notice as discriminatory, alleging that the notice discriminated on the basis of national origin.  In particular, the borrower argued that persons who had entered the country without proper documentation, particularly Mexican nationals, were prohibited from obtaining a government-issued identification and, thus, would be unable to participate in the judicial sale of the property.

The borrower therefore asserted that the terms of the sale were unconscionable and not commercially reasonable because the “universe of potential buyers” would be limited.

In response, the mortgagee argued that the borrower had forfeited any challenge to the trial court’s finding that he lacked standing to contest the notice because he did not address it in his appellate brief.  The mortgagee also argued that the notice did not violate the IHRA because (1) the language requiring a government-issued identification does not discriminate on the basis of national origin, and (2) the IHRA does not bar discrimination based on citizenship status.

The Appellate Court acknowledged that the borrower did not address the standing issue in his brief, but determined that forfeiture is a limit on the parties, not the court, and the Court could exercise its discretion to review an otherwise forfeited issue.

The Court first addressed the broad discretion given to trial courts under section 15-508 of the Illinois Code of Civil Procedure, which among other things states that the trial court shall confirm a foreclosure sale unless the trial court finds that (i) proper notice of the sale was not given, (ii) the terms of the sale were unconscionable, (iii) the sale was conducted fraudulently, or (iv) justice was otherwise not done.  Section 15-508 also provides that the trial court’s decision to confirm or reject a judicial sale will not be disturbed absent an abuse of the court’s discretion.

Addressing the standing issue, the Court established that “a plaintiff possesses standing to sue when the plaintiff has suffered an injury in fact to a legally cognizable interest.”  Noyola v. Board of Education of the City of Chicago, 227 Ill. App. 3d 429, 432 (1992).  The Court continued, “the claimed injury may be actual or threatened, and it must be (1) distinct and palpable, (2) fairly traceable to the defendant’s actions, and (3) substantially likely to be prevented or redressed by the grant of the requested relief.”  Glisson v. City of Marion, 188 Ill. 2d 211, 221 (1999).

The Court determined that, at the trial court level, the borrower had not identified any person, including himself, who went to the judicial sale with the adequate funds to purchase the property but was denied access due to a lack of government-issued identification.  Indeed, citing I.C.S. Illinois, Inc. v. Waste Management of Illinois, 403 Ill. App. 3d 211, 225 (2010), the Appellate Court noted that the plaintiff could not establish standing to challenge the result of a bidding competition without establishing that he would have been successful “but for the defendant’s conduct.”

The Court also observed that the borrower did not present any evidence at the trial court level that any undocumented person was actually discouraged from bidding.  According to the Appellate Court, in the absence of such evidence the borrower’s claim is “purely speculative.”

As a result, the Court held, the borrower did not establish a distinct and palpable injury fairly traceable to the notice of sale.  Thus, the borrower failed to establish he had standing to assert a violation of the IHRA as a basis to challenge the sale.

Accordingly, the Appellate Court affirmed the judgment of the trial court.

9th Cir. Holds ‘Free and Clear’ Bankruptcy Sale Was Not Rejection of Unexpired Leases, Did Not Implicate 11 U.S.C. § 365(h)

The U.S. Court of Appeals for the Ninth Circuit recently held that a bankruptcy trustee was authorized to sell real estate free and clear of unexpired leases under 11 U.S.C. § 363(f), and the sale was not a rejection of the unexpired leases and therefore did not implicate 11 U.S.C. § 365(h).

In so ruling, the Ninth Circuit adopted the minority approach established in Precision Indus., Inc. v. Qualitech Steel SBQ, LLC, 327 F.3d 537 (7th Cir. 2003), which held that sections 363 and 365 may be given full effect without coming into conflict with one another.

By allowing the bankruptcy trustee to sell the property free and clear of the unexpired leases, in the Ninth Circuit’s view, the estate was able to fetch higher price for the property and maximized recovery for all creditors.

A copy of the opinion in Pinnacle Restaurant at Big Sky, LLC v. CH SP Acquisitions, LLC is available at:  Link to Opinion.

The developer of a 5,700-acre resort in Montana obtained a $130 million loan secured by a mortgage and assignment of rents from a lender, who later assigned the note and mortgage to a limited liability company.  A collection of interrelated entities owned the resort and managed its amenities, including a ski club, golf course, and residential and commercial real-estate sales and rentals.  At issue are two leases of commercial property at the resort.

The developer defaulted on loan payments and petitioned for bankruptcy protection.  The limited liability company had a claim of more than $122 million secured by the mortgage on the property, making it the largest creditor in the bankruptcy, and subsequently assigned its interest to an assignee (“creditor”).  The bankruptcy trustee and creditor agreed to a plan for liquidating “substantially” all of the developer’s real and personal property, and stated that the sale would be “free and clear of all liens.”

The trustee moved the bankruptcy court for an order authorizing and approving the sale free and clear of all liens except for certain specified encumbrances, and provided that other specified liens would be paid out of the proceeds of the sale or otherwise protected.

The two leases at issue were not mentioned in either the list of encumbrances that would survive the sale, or the list of liens for which protection would be provided.  The lessees objected and argued that 11 U.S.C. § 365 gave them the right to retain possession of the property notwithstanding the trustee’s sale.

After the bankruptcy court authorized the sale, the creditor won the auction with a bid of $26.1 million and argued that its bid was contingent on the property being free and clear of the leases.  The bankruptcy court approved the sale, and the order stated that the sale was free and clear of any “Interests,” a term defined to include any leases “(except any right a lessee may have under 11 U.S.C. § 365(h), with respect to a valid and enforceable lease, all as determined through a motion brought before the Court by proper procedure).”

The trustee then requested leave to reject the two leases because the subject property was no longer property of the estate.  Meanwhile, the creditor moved for a determination that the property was free and clear of the leases.  The lessees renewed their prior arguments as objections to the creditor’s motion.

At the evidentiary hearing, the bankruptcy court determined, among other things, that one of the leases was below fair market rental value, that the leases were junior to the creditor’s mortgage, and were not protected from foreclosure of the creditor’s mortgage by subordination or non-disturbance agreements.  Based on these findings, the bankruptcy court held that the sale was free and clear of the two commercial leases.  The lessees appealed to the district court, which affirmed, and this appeal followed.

The principal issue on appeal is whether the two leases survived the trustee’s sale of the property to the creditor.

As you may recall, 11 U.S.C. § 363 authorizes the trustee to sell property of the estate, both within the ordinary course of business and outside of bankruptcy.  See 11 U.S.C. § 363(b), (c).  Sales may be “free and clear of any interest in such property of an entity other than the estate,” only if:

(1) applicable nonbankruptcy law permits sale of such property free and clear of such interest;

(2) such entity consents;

(3) such interest is a lien and the price at which such property is to be sold is greater than the aggregate value of all liens on the property;

(4) such interest is in bona fide dispute; or

(5) such entity could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest.

11 U.S.C. § 363(f).

Meanwhile, 11 U.S.C. § 365 of the Code authorizes the trustee, “subject to the court’s approval,” to “assume or reject any executory contract or unexpired lease of the debtor.”  11 U.S.C. § 365(a).  The rejection of an unexpired lease leaves a lessee in possession with two options:  treat the lease as terminated (and make a claim against the estate for any breach), or retain any rights—including a right of continued possession—to the extent those rights are enforceable outside of bankruptcy.  11 U.S.C. § 365(h).

When the trustee sells property free and clear of encumbrances, and one of the encumbrances is an unexpired lease—federal courts have addressed the interplay between 11 U.S.C § 363 and 11 U.S.C. § 365 in different ways.

The majority of bankruptcy courts that have addressed this issue held that sections 363 and 365 conflict when they overlap because “each provision seems to provide an exclusive right that when invoked would override the interest of the other.”  In re Churchill Props., 197 B.R. 283, 286 (Bankr. N.D. Ill. 1996); see also In re Haskell, L.P., 321 B.R. 1, 8-9 (Bankr. D. Mass. 2005); In re Taylor, 198 B.R. 142, 164-66 (Bankr. D.S.C. 1996).  These courts held that section 365 trumps section 363 under the canon of statutory construction that the specific prevails over the general, and the legislative history regarding section 365 evinced a clear intent by Congress to protect a tenant’s estate when the landlord files bankruptcy.

However, in Precision Indus., Inc. v. Qualitech Steel SBQ, LLC, 327 F.3d 537 (7th Cir. 2003), the U.S. Court of Appeals for the Seventh Circuit held that sections 363 and 365 may be given full effect without coming into conflict with one another, because lessees are entitled to seek “adequate protection” under 11 U.S.C. § 363(e), and were not without recourse in the event of a sale free and clear of their interests.

The Ninth Circuit here followed the Seventh Circuit, and held that sections 363 and 365 did not conflict.  Section 363 governed the sale of estate property and section 365 governed the rejection of a lease, and according to the Ninth Circuit, where there was a sale but no rejection (or a rejection, but no sale), there was no conflict between the statutes.  Here, because the parties agreed that the two leases were not rejected prior to the sale, the Ninth Circuit ruled that section 365 was not triggered.

The Ninth Circuit noted that a limitation in the majority approach was that while it protected lessees, a property subject to a lease would presumably fetch a lower price and therefore reduce the value of the property of the estate.  Therefore, this approach is contrary to the goal of maximizing creditor recovery, which was a core purpose of the Bankruptcy Code.

Accordingly, the Ninth Circuit affirmed the lower court’s ruling that the bankruptcy trustee’s sale of the debtor’s property was free and clear of unexpired leases.