Cal Foreclosure Consultants Must Now Register & Post $100K Bond

As the mortgage crises began, I received a number of unsolicited inquiries from people who were interested in starting a business to help borrowers in distress by purchasing and leasing back their residence or negotiating a loan modification. I explained to these callers that they would be acting as "foreclosure consultants" and would be subject to statutes in the Civil Code that regulate foreclosure consultants. Invariably, the callers were not aware of these statutes and were not interested in paying a lawyer to advise them how to follow the law. Apparently budding foreclosure consultants fancy the idea of a new business with no start up costs.

As the mortgage crises became worse, there stories in the news about unscrupulous people who would take a fee up-front to negotiate a loan modification (this is illegal unless an exemption applies) and then do nothing for the fee. The California Legislature was apparently moved by these stories to amend Civil Code sections 2945, et seq. effective July 1, 2009 so that "foreclosure consultants" are now require to register with the State and post a $100,000 bond. To learn more about the changes to the laws governing "foreclosure consultants," and the consequences if the laws are violated, click here or here.

New Foreclosure Hurdles in California Helping Distressed Homeowners

Section 2923.5 of the California Civil Code went into effect on September 6, 2008. This statute, which applies only to owner-occupied, residential real property, was enacted to help distressed California homeowners. Section 2923.5 requires a lender seeking to foreclose to contact the borrower "in order to assess the borrower's financial situation and explore options for the borrower to avoid foreclosure." The statute applies to all loans made from January 1, 2003 through December 31, 2007.

Section 2923.5 is complicated and sets up a number of requirements that must be satisfied by the foreclosing party or its authorized agent. The contact requirements of section 2923.5 are very specific. The foreclosing party must contact the borrower, in person or by telephone, to assess the borrower's financial situation and explore options to avoid foreclosure. If contact is not made by phone or in person with the borrower, the foreclosing party must send a certified letter to the borrower with a return receipt requested. If the foreclosing party is unable to contact the borrower, it must fulfill certain due-diligence requirements outlined in section 2923.5. In addition, the statute imposes a 30‑day waiting period after the foreclosing party fulfills the contact or due-diligence requirements.

After the foreclosing party has met the requirements of section 2923.5, in order to ensure compliance, the foreclosing party must submit a declaration along with the recording of any notice of default or its notice of sale, if the foreclosure proceedings were initiated prior to September 6, 2008.

The foreclosing party does not have to meet the statutory requirements in certain limited situations: (1) if the borrower surrendered the property; (2) the borrower contracted with an organization, person or entity whose primary business is to advise people who have decided to leave their home and seek to extend the foreclosure process and avoid their contractual obligations; or (3) the borrower filed for bankruptcy and the proceeding has "not been finalized."

A foreclosing party must be well versed in the detailed requirements of section 2923.5 and follow them to the letter to avoid further delays in the foreclosure process. A distressed homeowner should also study the new statute to gain the benefits of its protection. In addition, a distressed homeowner should consult with a CPA about the tax consequences of a foreclosure or loan modification.

More changes in California's foreclosure laws are in the offing. Governor Schwarzenegger has proposed a 90 day foreclosure moratorium to pressure banks to modify loans. The California Legislature has not yet acted on the Governor's new proposals.

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HOME SWEET HOME --The Price of a Great Love Affair

On June 13, 2005, TIME magazine reminded us that Americans were at the height of a great love affair with residential real estate. On October 3, 2008, we learned that every American taxpayer, now and in the future, would share in the cost of mortgage defaults and the rescue plan through the Troubled Assets Relief Program (TARP). The recent federal "rescue" legislation and the government's takeover of Fannie Mae and Freddie Mac make the United States the largest mortgage company in the world.

Two maxims of California jurisprudence provide food for thought in assessing the fallout from the messy aftermath of the latest residential real estate binge: "He [or she] who takes the benefit must bear the burden"; and, "He [or she] who consents to an act is not wronged by it." California Civil Code sections 3521 & 3515.

With that said, let us acknowledge the participants who benefited from and consented to the questionable transactions in the United States that have resulted in extraordinary actions by governments around the developed world:

Buyers who used "creative financing" while they were in denial about the consequences of a variable interest rate loan readjusting and the inevitable decline in housing prices;

Mortgage brokers and real estate brokers who did not adequately warn buyers about the credit risk of buying a home without a down payment or a fixed rate loan;

Appraisers who, in some cases, participated in the validation of inflated prices or worse; i.e., mortgage fraud;

Mortgage companies and banks who defied reality by making loans without following reasonable underwriting standards;

Investment bankers who "securitized" pools of loans ("mortgage backed securities") that were not properly underwritten or backed by capital in the event of widespread defaults;

Rating companies that bestowed their pedigrees on the mortgaged backed securities at they same time they were compensated by the investment bankers;

Hedge funds, insurance companies and investment bankers who wrote contracts ("credit default swaps") to pick up the losses on the mortgage backed securities without the financial ability to do so in the event of widespread defaults;

And the United States government which failed to warn, regulate and control the participants before it became the world's biggest mortgage company.

Agent for Home Equity Purchaser is No Longer Required to be Bonded

Even a well intentioned law may be declared void for vagueness if the reader is left in a fog. A recent case in point involves the bonding requirement in the Cal. Home Equity Sales Contract Act.

According to the Court of Appeal, "The Home Equity Sales Contract Act (Civ. Code, section 1695 et seq . . .) was enacted to protect homeowners faced with mortgage foreclosure proceedings from being victimized by person employing oral and written representations, intimidation, and other unreasonable commercial practices to induce homeowners to sell their homes for a fraction of their fair market value and lose the equity in their homes. (citations omitted)." Schweitzer v. Westminster Investments, Inc. (12/13/2007) 157 Cal. App. 4th 1195.

The Home Equity Sales Contract Act ("HESCA") contains a number of protections for sellers in foreclosure. As discussed in my February 20, 2007 post ["Buyers (and Agents) Beware If the Seller is Upside Down"): "There is another interesting protection for equity sellers. If an equity buyer is represented by an agent, the agent must have a bond from an admitted insurer in an amount equal to twice the fair market value of the property. But no insurer admitted in California offers such a bond, so agents should avoid representing equity buyers." The Court of Appeal has recently eliminated the requirement of a bond. The reason -- that bonding subsection of the law was so vague that a person of ordinary intelligence would have to guess what it requires.

In Schweitzer, the trial court held that a deed transferring the property to an equity purchaser was voidable because the purchaser's representative did not have the bond required by Civil Code section 1695.17. The code section requires proof that the purchaser's agent/representative is "bonded by an admitted surety in an amount equal to twice the fair market value of the real property which is the subject of the contract." The Court of Appeal reversed, holding that the requirement of a bond was void for vagueness and unenforceable.

That language, reasoned the Court of Appeal, ". . . provided no guidance on the amount, the obligee, the beneficiaries, the terms or conditions of the bond, the delivery and acceptance requirements, or the enforcement mechanisms of the required bond." However, the rest of the HESCA is enforceable because the statute had a "severability" provision specifying that if any provision of the Act is declared unconstitutional the remainder shall not be affected (section 1695.11) if it is "grammatically, functionally and volitionally separable." Under the remaining provisions, the equity purchase contract was enforceable.

Schweitzer v. Westminster teaches us 3 lessons: a statute, like a contract, should be complete and written so that a person of ordinary intelligence does not have to guess what it requires; the remainder of the HESCA survives intact, including the requirement that a purchaser's representative be licensed by the Department of Real Estate; and, "Buyers (and Agents) Should Still Beware If the Seller is Upside Down."

Real Estate Appraisers -- Decline in Home Prices Exposes Inflated Appraisals

In a surging real estate market, the "rising tide lifts all boats." The rapid appreciation of home prices makes it less likely that a buyer will complain about problems with his purchase that are discovered after the close of escrow. But for every high tide there is a low tide that exposes rocks below the surface and barnacles on grounded ships.

A down cycle in the real estate market also exposes a variety of reasons for the artificial inflation in prices: lax loan underwriting, fudged loan applications, rampant speculation, "creative" financing, a secondary market for sub prime loans, and inflated appraisals. The last of these problems is the subject of this post.

Since the savings and loan debacle in the 1980's, the federal government has regulated real estate appraisers who prepare appraisals for loans by federally insured institutions. For example, California established an apparatus for licensing real estate appraisers in 1989.

Appraisers can be liable for negligence or negligent misrepresentation to lenders or buyers who rely on inflated appraisals that have not been prepared in accordance with the standard of care. Based on anecdotal evidence in my litigation practice, the licensing of real estate appraisers appeared to result in the decline of lawsuits against appraisers after 1989. I handled a number of such cases for a mortgage company and a S&L before 1989, but none in the 1990's after licensing became mandatory.

Unfortunately, the recent decline in the housing market has again exposed problems caused inflated residential real estate appraisals. So two months ago, the California Legislature made it illegal to pressure an appraiser to reach a inflated opinion of value. And a new California law effective January 1, 2008 has substantially increased the educational requirements for certified appraisers.

How does "the market" pressure appraisers to inflate appraisals? Will the new laws have any effect on the appraisal industry? How widespread is the problem of inflated appraisals? A recent article in the Los Angeles Times tackles these questions. To read the article, click here.

U.S. Mortgage Relief Act

Until yesterday, debt that was forgiven in a foreclosure or as part of a loan workout was classed as income. For example, a homeowner who negotiated a short sale with her lender was required to recognize as income the amount of the loan that was forgiven.
That changed when President George W. Bush signed the Mortgage Forgiveness Debt Relief Act into law.

The measure will eliminate income taxes for many homeowners who must restructure their mortgages as they face foreclosure. The new law relieves a homeowner of the burden of paying additional income taxes if his lender has reduced the original loan amount to make it easier to continue making the mortgage payments. The law is a response to the rising waive of foreclosures and the re-setting of interest rates in 2008 on as many as 1.8 million mortgages.

BETWEEN A ROCK & A HARD PLACE -- Using A Short Sale to Avoid Foreclosure

In my December 28, 2006 post, I discussed some of the anticipated problems from the "boom" in subprime mortgages and other creative lending practices during recent years. I entitled the post, "'Creative' Financing -- The Slippery Slope in 2007."

It didn't take a crystal ball last December to predict the fall-out from adjustable rate home loans that facilitated the purchase of homes for unprecedented prices with lax underwriting and no money down. It was also apparent this would problem would create weighty issues in California real estate law during 2007 and beyond.

With the prices of homes declining in many areas, some borrowers are between a rock and a hard place. How does the owner of a home with no equity get out from under the loan without suffering a foreclosure and the resulting damage to his or her credit rating?

One strategy is a "short sale." A short sale requires the seller to first negotiate with the lender to reduce the balance of the loan subject to the sale of the property to a third party. For example, let's say the seller bought the house for $550,000 with a non-recourse loan of $500,000; the house is now worth $450,000; the seller persuades the lender to reduce the balance of the loan to $450,000 and sells the house for $454,000, with $450,000 going to the lender and the $4,000 used to pay a portion of the closing costs. The lender doesn't have to deal with the house as an "REO" (real estate owned by the lender); and the seller avoids the negative impact of a foreclosure and is no longer obligated to the lender after the sale is completed.

But there may be negative tax consequences to a short sale. Under the current tax law, the seller may have to recognize "phantom income" from the "cancellation of debt" in the amount of the loan reduction ($50,000). Any reader who wants to employ this strategy should consult with an accountant about the tax consequences of a short sale and to determine if an exemption from the payment of income tax on the cancellation of debt is available.

P.S. On August 31, 2007, President Bush proposed legislation to temporarily eliminate the recognition of income when the lender forgives a portion of the debt. Stay tuned! The Congress may move the boulder that is one of the impediments to short sale.

BUYERS (AND AGENTS) BEWARE IF THE SELLER IS UPSIDE DOWN

In the January 30th post, I discussed the California statutes that regulate "foreclosure consultants" who seek to "assist" buyers who are in danger of losing their homes to foreclosure. There is an another group of California statutes that may be a trap for the unwary buyer of a house in foreclosure.

When mortgage defaults and foreclosures increase, investors may actively seek out homes owned by a buyer is in default before foreclosure sale takes place. California Civil Code sections 1695-1695.17 were enacted to protect homeowners in that vulnerable situation. In brief, if an owner resides in the home (or up to 4 residential units) and has equity in the property, the owner is in a protected class as an "equity seller." Subject to specific exclusions, if an investor tries to acquire title from an equity seller and does not intend to reside in the property, the investor is an "equity buyer."

When an equity buyer tries to enter into a deal directly or through an agent with an equity seller, there are a number of special requirements. For example, the equity seller has five (5) days to cancel and the equity buyer cannot pay any money to the seller during that time period. Violations of Civil Code sections 1695, et seq. can result in criminal penalties and fines.

There is another interesting protection for equity sellers. If an equity buyer is represented by an agent, the agent must have a bond from an admitted insurer in an amount equal to twice the fair market value of the property. But no insurer admitted in California offers such a bond, so agents should avoid representing equity buyers.