Ohio Practical Business Law : Columbus Ohio Business Lawyer & Attorney : Teri Rasmussen : Plunkett Cooney Law Firm : Commercial Law, Creditors, Business Formation : Columbus, Central Ohio

And now, a cautionary tale about the importance of actually paying attention to what a promissory note and mortgage say.  In the recent case of National City Mortgage  Co., v, Richards. 182 Ohio App.3d 534, 2009-Ohio-2556 (10th App. Dist.), the Bank found out that failing to comply with the relatively simple provisions  in a note and mortgage concerning notice to be given a delinquent borrower was a costly mistake. 

REALLY COSTLY >>>>>> as in DISMISSAL of a FORECLOSURE

FACTS.  The facts here are numbingly similar to those in any number of other cases.  Ms. Richards, the borrower had a loan from the Bank secured by a mortgage on her property in Columbus - presumably her residence, although the decision doesn't really say.  Anyway, when Richards defaulted, the Bank apparently sent her a notice of default by certified mail only; no notice was sent by regular mail.  The certified mail receipt came back "unclaimed".

In December 2005, the Bank initiated a foreclosure action.  Richards, acting pro se, filed an answer in January 2006 indicating that she had made a payment of $3,329,70 consisting of the January payment, the past-due amount and other fees totaling, all as indicated by her December 2005 statement, and therefore was not in default.  The Bank responded by sending Richards a letter stating that, not counting the payments already made by Richards it would take payment of $6,838.09 -which included payment of attorneys' fees - to reinstate her loan.

Richards filed a second response to the foreclosure Complaint indicating she had sent additional funds exclusive of the attorney fees to the Bank to bring her account current and had sought a payment plan for the attorney fees.  The Bank then returned all of the payments sent by Richards since the commencement of the foreclosure.and sought summary judgment on its foreclosure complaint.  Several months later, while the case was still pending, the Bank [for some inexplicable reason as far as I can see] sent a "demand/acceleration letter" to the property address; the case doesn't say whether the letter was sent by regular or certified mail and it doesn't appear to have figured in the decision.

Richards alleged among other arguments that the Bank had failed to provide proper notice of default and opportunity for cure, thereby failing to satisfy a condition precedent to acceleration of the note and foreclosure of the mortgage securing the note.  The trial court eventually granted summary judgment in favor of the Bank.  The Court of Appeals REVERSED.... 

>>>>>>   Here's where everyone needs to pay attention!   >>>>>>

THE NOTICE PROVISIONS.  The promissory note had a relatively ordinary notice of default provision providing for a thirty day cure period:

If I am in default, the Note Holder may send me a written notice telling me that if I do not pay the overdue amount by a certain date, the Note Holder may require me to pay immediately the full amount of Principal which has not been paid and all the interest that i owe on that amount.  That date must be at least 30 days after the date on which the notice is mailed to me or delivered by other means,

In addition, both the promissory note and mortgage had explicit provisions requiring notice to be given by first class mail.  The note said:

[A]ny notice that must be given to me under this Note will be given by delivering it or mailing it by first class mail to me at the Property Address above or at a different address if i give the Note Holder a notice of my different address.  

Similarly, the mortgage provided:

All notices given by Borrower or Lender in connection with this Security Instrument must be in writing.  Any notice to Borrower in connection with this Security Instrument shall be deemed to have been given to Borrower when mailed by first class mail or when actually delivered to Borrower's notice address if sent by other means.

LESSON TO BE LEARNED >>>>  Most lenders have realized by now that in the current economic environment, courts are not exactly tending to be sympathetic to lenders failing to cross all their "t"s and dot ail their "i"s.  This is yet another reminder that ESPECIALLY  where it is easy to comply, it is most certainly in the lender's best interests to do so .... to the letter. 

It is easy enough to send a demand letter by both regular mail and certified mail; even if the certified mail comes back "unclaimed", the lender will get the benefit of the "mailbox' rule that the regular mail got through.  Fed. Natl. Mtge. Assn. v. Doyle, (Oct. 9, 1998), 6th Dist. No. L-98-1010, 1998 WL 700663. 

And if your documents say first class mail, then make sure it at least gets done that way.  By the same token, if your documents provide for a cure period, make sure your demand letter incorporates the time period provided.

IN SHORT, READ YOUR LOAN DOCUMENTS BEFORE YOU START THE FORECLOSURE AND DO WHAT THEY SAY.   

For those particularly "in" to this issue, the decision also provides several helpful drafting pointers about ways the Bank's attorneys could have put together a tighter better drafted Complaint that might have helped their cause somewhat with respect to certain procedural issues.

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Are we there yet?  Anyone who has ever been involved in a transactional deal of any complexity has udoubtedly at least thought, if not uttered, this well worn phrase in frustration as yet another obstacle arises to the successful completion of the contemplated transaction.   

Even sophisticated clients are sometimes frustrated by how long it seems to take lawyers to "close" and complete a transaction.  Clients with less experience can become positively apoletic about the fact that it takes more than a week or so for the lawyers to declare the deal done and finished.  Frankly, as one of the lawyers at the center of these trabsactions, I too am occasionally surprised how long it can take in certain situations to successfully complete the transactions.

So why does it take so long, and perhaps more importantly, how can everyone in the deal know how close we are to being able to answer yes to the perennial question "are we there yet?  One of the best tools to understand both what's involved in getting a particular transaction completed AND, on a real time basis what's left to do is a CLOSING LIST.  Every transactional attorney uses some variation of a Closing List to keep track of which tasks and items have been completed, which are still in process, and which issues and tasks still need to be addressed. 

A Closing List for a loan transaction  (Click here and  here  and here for examples) necessarily differs somewhat from a Closing list for a purchase/sale of a business or other transaction (click here and here for examples), both share the same basic elements and utility.  When I do my Closing List, I always start by putting the contact information for all the parties and their attorneys and other important agents and representatives at the top of the first page.  This way I'm never searching for a phone number or e-mail at a crucial point in negotiations.  

The rest of the Closing List is generally in the format of a table.  My tables have visible grid  lines so I can easily see each discrete item or task.  I usually have five columns: 

• Item Number (for quick reference and efficient organization of various folders pertaining to the deal)
• Name of Item or Task (for obvious reasons)
• Responsibility (i.e. which party is primarily responsible for preparing the documentation or completing the task) 
• Status (entries in this column are constantly changing as progress occurs)
• Comment (for additional useful information such as actual or potential obstacles to be resolved, other contact people, etc,)  

Because every deal is different, most closing lists are organic instruments which begin with certain basic items and tasks common to that sort of particular transaction and then initally grow longer as the unique aspects of the deal at hand become fleshed out.  Like other transactional attorneys, building out the Closing List helps me organize what needs to be done and the order in which tasks and items should be attacked.

I usually wait to give clients a copy of the Closing List until I am fairly certain it is a reasonably complete reflection of what will be entailed to make the contemplated transaction a reality in a manner that properly protects my client.  After circulating the intial Closing List, I try to provide updated revised Closing Lists on a regular basis which show where progress has been made and where we may have run into a roadblock or detour that may delay completion of the transaction. 

My hope and intention is that sharing these updated Closing Lists will allow clients to have as close to the same understanding as I do about "where we are" as far as getting the deal done and why we're not there yet.   Thus, if your attorney gives you something of this nature, don't just put it aside and assume it has no purpose relevant to you.  It's your best guide to what's been done so far to bring the deal to fruition and what still remians to make it a reality.   

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I'm finishing up my recent series of posts on cognovit notes and judgments with a summary of the key things to know about cognovit notes and judgments in Ohio.   

     1.  Shortcut to Judgment.  Cognovit notes provide a shortcut to judgment, allowing a creditor to take a judgment immediately (and I mean within MINUTES) of the filing of the Complaint.  No advance notice to the debtor required.  For more information on how this works, visit my Cognovit Promissory Notes Explained post.

     2.   Few States Allow.  Ohio is one of only a handful of states permitting cognovit judgmentsnat all. In fact, as far as I know, they are only enforceable in OHIO, Pennsylvaina, Maryland, Virginia and Delaware.  Visit An Examination of Confession of Judgment Statutes in the Mid-Atlantic States  for a very concise and specific summary of what is required in each of these states for a valid cognovit note.  In Indiana, it's even a Class B misdemeanor (punishable by a $1,000 fine or 180 days imprisonment)  to include cognovit language in a promissory note or to try to enforce a cog taken somewhere else like, say, Ohio. Indiana Code 34-54-4-1  

     3.  Commercial Deals ONLY.  Cognovit notes are valid ONLY in commercial transactions involving businesses and are not enforceable with respect to consumer obligations.   Ohio Rev. Code 2323(E).  

>>>>>>      The rest of these points pertain ONLY with respect to Ohio cogs.  

     4.   Follow the Statute.   DO NOT VARY IN ANY WAY WHATSOEVER THE LANGUAGE OF THE STATUTORY COGNOVIT WARNING.  The cognovit warning  should appear IMMEDIATELY (and I mean WITHOUT ANYTHING IN BETWEEN)  above(preferably) or below the signature line and should look EXACTLY like this for best results:

WARNING – BY SIGNING THIS PAPER YOU GIVE UP YOUR RIGHT TO NOTICE AND COURT TRIAL.  IF YOU DO NOT PAY ON TIME, A COURT JUDGMENT MAY BE TAKEN AGAINST YOU WITHOUT YOUR PRIOR KNOWLEDGE AND THE POWERS OF A COURT CAN BE USED TO COLLECT FROM YOU RGARDLESS OF ANY CLAIMS YOU MAY HAVE AGAINST THE CREDITOR WHETHER FOR RETURNED GOODS, FAULTY GOODS, FAILURE ON HIS PART TO COMPLY WITH THE AGREEMENT, OR ANY OTHER CAUSE.   

     5.  Confession of Judgment Must Also Be included.  Do not forget to include the enabling language authorizing confession of judgment within the body of the promissory note, guaranty or other instrument.  If the enabling language is not included, the instrument will still be enforceable but will not be any good for taking a cognovit judgment.  Klosterman v. Turnkey-Ohio, L.L.C., 2009-Ohio-2508 (10th App. Dist.).   The statute does not specify the exact language to be used, but over time certain language has customarily come to be used in virtually every Ohio commercial note or guaranty.

      6.  Enforceable Where Signed or Where Maker Located. Cognovit judgments must be taken in (A) the County in which the cognovit note was signed; OR (B) the County in which the individual resides or the business has its principal office.  Ohio Rev. Code 2323.13(A)

     7.   Not Required to Use Business Courts.  At least for now, the existence of commercial law dockets/business courts does not require cognovit judgments to be taken by a judge of that docket  GLIC Real Estate Holding, L.L.C. v. 2014 Baltimore-Reynoldsburg Road, L.L.C., 906 N.E.2d 517, 2009-Ohio-2129 (Common Pleas-Franklin Cty)

     8.  Signing Cog Doesn't Create Attorney-Client Relationship.  No attorney client relationship is established when an Ohio attorney signs a cognovit answer on behalf of a defendant.  It is simply a ministerial act and does not subject the attorney signing the answer to any claim of unethcialconduct..  Opinion 93-3 Ohio Supreme Court Board of Commisioners on Greivancxes and Discipline,  Dibenetto v. Miller, 180 Ohio App.3d 69, 2008-Ohio-6506 (1st App. Dist.).

     9. Copies May Do.  While many Ohio courts may require or at least expect the original promissory note containing the cognovit provision to be produced, the statute does permit use of a copy.  Ohio Rev. Code 2323.13(A).  Good luck with that one - call me when you're able to get the judgment without showing the original of the note to  the judge.

       10.    Getting a Do-Over.  It does not take as much to open up a cognovit judgment thorugh a Rule 60(B) motion as it does with rexpect to other judgments.  However, you have to at least show that a meritorious defense exists, at least in theory.  Visit my previous post What It Takes to Open Up a Cog Judgment to find out more details.

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When I hear the word "indulgences", my mind immediately goes to something "sinful" and well, probably fun.  In this case, however, I'm talking about  that ubiquitous provision found in loan documents designed to allow lenders to continue to hold borrowers and gurantors liabile notwithstanding the lender's failure or inability to abide by the letter of the loan documents or to exercise all or some subset of its rights upon default in a manner saitsfactory (usually with the benefit of 20-20 hindsight) to the borrower and/or gurantor.  Does this stuff really worK?   

Suppose you have this deliquent borrower -  let's call him "B"  -- on a promissory note (though it could be any obligation) and collateral not worth enough to pay you off in full.  But then you also have this guarantor -- let's call him "G".  Somewhere along the line one of your folks messed up in that "commercial reasonable sale" thing that's supposed to happen when you repossess and liquidate collateral.  Or maybe you let a financial covenant default here and there pass for the time being.  Or perhaps you just extended the maturity date or went interest only for B for a while.  Question is whether you're still OK because you can hold G - who does have assets - liable for the obligation.

Most, if not all, bankers and their counsel would say "yes" because both the UCC and our loan docs say we can.  Which is why  Huntington National Bank v. Wallace, 2009 WL 2023891 (N.D. Ohio 2009) -- now on appeal to the Sixth Circuit and the subject of my last post -- is an important case to watch. 

In a nutshell, the Bank had allowed advances to the Borrower to fund draws on letters of credit in excess of a  "maximum amount" specified in the loan documents and the Bank was pursuing one of the guarantors,  Bank took cognovit judgment and guarantor sought relief from judgment   Federal district court held that the indulgence clause was not sufficient to preclude relief from judgment.

Initially, as a lender-oriented attorney, the case concerned me. It seemed to suggest that lenders permitting any sort of modification -- other than the most vanilla extension of time sort --would now be accepting a substantially greater risk that such forbearance would relieve any guarantor not explicitly consenting from liability. In addition, the manner in which it brushed aside the waivers contained in the “indulgence” clause as inapplicable sent a cold shiver down my spine.   And the logic of the ruling would be applicable not just to cognovit notes, but really any sort of obligation.  So, taken as a whole, if upheld by the Sixth Circuit, the decision seemed likely to convince many lenders that it simply was not in their best interests to work with delinquent borrowers.

As I've thought about it more, however, I've begun to think this decision makes more sense and is less alarming than I had first surmised.  The decision in fact makes an important distinction between the nature and extent of the obligation intended by the parties to be guaranteed on the one hand and mistakes and errors made by the lender in enforcing the guaranty on the other.  In this particular case, the guaranty was never intended to be unlimited - there was a clearly stated unambiguous cap on the amount of credit to be extended to the borrower at particular times.  In continuing to permit advances to fund letter of credit draws, the Bank exceeded this previously agreed limitation on the amount for which the guarantor had accepted responsibility for seeing was paid.

When read closely, the language itself – and certainly the concept originally underlying inclusion of such a clause – is about the consequences of the Bank’s inaction or failure to take appropriate steps to ensure the obligation guaranteed could be satisfied from sources other than the guarantor. When viewed from this perspective, the decision leaves largely intact a lender’s ability to rely on indulgence clauses with respect to events and actions occurring during the course of a workout situation.  It is only a lender’s decision to continue extending credit to the borrower beyond an explicitly agreed–upon point that becomes a problem.

Granted, the ruling is still worrisome.  In asset-based lending, a lender may unknowingly extend credit beyond the “availability” permitted pursuant to a borrowing base calculation formula.  And in the Wallace case, the Bank was obligated to honor letters of credit previously issued and really did not have the ability to refuse to make further advances.

What also makes things a bit problematic for me in this case is that the “cap” in question was only for a very short, almost temporary, period of time and was substantially less than it was at other times.  Had the events occurred but a couple of months earlier or later, the cap would not have come into play.

For me, the take-away lessons for now from this case are:

•  If at all possible, obtain guarantor consent to any modifications or waivers at the time the modifications are made or waivers given.  I already do this anyway, but now it will be even more important.
•  If a lender wants the guaranty to truly be unlimited and/or cover over-advances, the guaranty should say so very explicitly.
• Problems arising due to lack of perfection, release of collateral or other obligors, or other events and circumstances connected with an aspect of the lending relationship that do not pertain to the amount advanced are probably still within the protection of indulgence clauses.   

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How would Peanuts’ Linus manage without his trusty security blanket? Depending on the result, the Sixth Circuit reaches in a recently appealed cognovit judgment case, financial institutions such as banks and others relying on cognovit notes, and perhaps ordinary promissory notes as well, may well have to face a similar question.

Every guaranty I’ve seen has some variation of what is sometimes called an “indulgence” clause. These provisions essentially say that a guaranty remains in effect even if the Bank waives a default by the primary obligor or errs in its collection efforts. Now a federal district court, applying Ohio law, has snatched this security blanket away, saying that such a clause does not allow the lender to ignore the credit terms of a loan with impunity. 

In Huntington National Bank v. Wallace, 2009 WL 2023891 (N.D. Ohio 2009) (Case No.09CV408, Carr, J.), decided August 19, 2009, the defendant guarantor alleged he had a meritorious defense justifying vacation of the cognovit judgment taken against him. His argument was that because the Bank made a “material alteration” to the terms of his guaranty by continuing to allow advances even though the amount outstanding exceeded the prescribed “maximum amount”, his guaranty obligation was rendered invalid. 

The Bank has now appealed the case to the Sixth Circuit (Case No. 09-4172).  If upheld, the decision may have far reaching consequences beyond cognovit notes.  The district court decision suggests that the ONLY modification to an obligation that a lender may comfortably do is an extension of time unless the guarantor agrees.  It could also be taken as meaning that even if the guarntor consents, such modifications would release the guarantor of all liability

Factual Background

The underlying fact scenario is a common one. In August 2007, a company known as Bellepointe entered into a First Amended and Restated Loan and Security Agreement “Loan Agreement”) with the Bank. The Loan Agreement governed three separate obligations – a term note, a line of credit, and a “Guidance Line” involving draws on letters of credit. Michael Wallace (“Wallace”), the father of the company’s owner, executed a guaranty of Bellepointe’s indebtedness to the Bank; the son also executed a guaranty, but the case pertains only to the father’s guaranty.

The guaranty excluded any liability for the term loan indebtedness and also capped the maximum amount of liability with respect to the Line of Credit. The crux of the case focused on the proper interpretation of certain language found in the Loan Agreement and the Guidance Line cognovit note, to wit: 

Notwithstanding anything to the contrary contained herein, the maximum amount available under the Guidance Line shall be as follows:

from the date hereof through and including 11/30/07 - $865,000

12/1/07 through and including 12/31/07 - $250,000

1/1/08 and thereafter - $550,000      

These provisions obviously required a substantial reduction in the amount outstanding as of December 1, 2007. It is not altogether uncommon for lines of credit to require a substantial reduction in the amount outstanding at least once a year. 

Procedural History

Procedurally, the case is a bit complicated. Apparently there was some discussion back and forth between Wallace and the Bank concerning his liability prior to any lawsuit being filed. When those talks broke down, Wallace filed a declaratory judgment action in the Southern District of Ohio federal district court against the Bank on February 11, 2009. Two days later, the Bank took a cognovit judgment against Wallace in Lucas County Common Pleas Court. The Bank said it had no knowledge of the declaratory judgment action when it took the cognovit judgment. 

Wallace promptly removed the state court cognovit judgment action to federal district court for the Northern District of Ohio, apparently on diversity grounds that he was a resident of Florida, and sought relief from judgment. After the Northern District federal court granted the motion to vacate the cognovit judgment, the Bank appealed to the Sixth Circuit where the case is now pending. It appears likely that the Southern District declaratory judgment action will be consolidated with the pending Northern District cognovit action.

The Decision 

Wallace alleged that the Bank continued to make advances on the Guidance Line in December 2007 even though Bellepointe had failed to reduce the amount outstanding as required.  Consequently, he contended that the Bank’s actions caused a “material alteration” in the nature of his guaranty obligation, thereby relieving him of liability under his guaranty. The Bank did not dispute that the advannces exceeded the "maximum amount."  However,it countered by pointing out that its loan documents had one of those “indulgence clauses” which stated:

Guarantor hereby promises that if one or more of the Obligations are not paid promptly when due, he will pay the Obligations to Bank, irrespective of any action or lack of action on the Bank's part in connection with the acquisition, perfection, possession, enforcement or disposition of any or all Obligations....   Guarantor agrees that no extension of time, whether one or more, nor any other indulgence granted to [sic] Bank by [sic] Debtor, or to any other gurantor, or any of them, and no omission or delay on Bank's part in exercising the right against, or in taking any action to collect from or pursue Bank's remedies against Debtor or any other guarantor, or any of them, will release, discharge or modify the duties of guarantor hereunder.

In addition, the Bank insisted that it was obligated to pay the draws on outstanding letters of credit in any event and that the definition of “advances” used in the line of credit differed from the definition of “maximum amount available” for precisely this reason. It also argued that the “indulgence” provisions in Wallace’s guaranty allowed it to ignore Bellepointe’s default in any event.  

So what happened? The federal district court agreed that the provisions of the loan documents did allow the Bank to continue making advances in December 2007. However, the court also noted that “Wallace’s burden is only to allege a meritorious defense, not to prove that he will prevail.” It went on to say:

Even if Wallace had initially failed to allege sufficient facts to support his defense, he has subsequently submitted an affidavit describing the above referenced facts, Wallace alleged sufficient facts for this court to evaluate whether his defense is meritorious.

And the reason? The Court cited Toland v. Key Bank of Wyoming, 847 P.2d 540 (1993) and Frost National Bank v. Burge, 29 S.W.3d 580 (Tex. App. 2000) for the proposition that “’indulgence’ is limited to extensions of time for payment and contract terms permitting indulgences do not waive suretyship defenses.” That’s it!  Really isn’t any further analysis or discussion. 

What IS interesting and informative are the briefs of the parties filed in the federal distriuct court case.  Leaving out exhibits, but including affidavits,here they are:

• Wallace's Motion to Vacate
• Bank's Responsive Memo in Opposition
• Wallace's Reply
• Bank's Sur-reply

Now I think the district court got this wrong and I’d really have appreciated a little further analysis of the pertinent provisions in the loan documents so I could fully understand the Court’s reasoning.  However, I also think the Sixth Circuit proceedings will be rather interesting to follow in the months ahead for lender attorneys everywhere. I’ll share my thoughts about the decision in more detail in my next post. 

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Creditors love cognovit notes because of the shortcut to judgment they offer upon the default of a borrower.  However, all is not entirely lost for unfortunate judgment debtors.  Recently, a case involving a cognovit note executed in connection with an asset purchase of a business discussed in more detail what a judgment debtor must demonstrate to obtain relief from a cognovit judgment.  See Baker Motors, Inc. v. Baker Motors Towing, Inc., 2009-Ohio-3294  (8th App. Dist.).  

Standard for Vacating a Cog

It is well accepted that the 60(B) standard for relief from judgment  is not as stringent with respect to opening up a cognovit judgment as it is for other judgments in that only a meritorious defense timely asserted need be shown.  Lykins Oil Company v.  Pritchard,169 Ohio App.3d 194 (2006).; it is not necessary to demonstrate that the defense would prevail. 

To successfully assert the existence of a meritorious defense to a cognovit judgment, the judgment debtor must demonstrate it "goes to the integrity  and validity of the creation of the debt or note, the state of the underlying debt at the time of confession of judgment; or the procedure utilized in the confession of judgment on the note"  First Nat'l Bank of Pandora v.Freed,  2004-Ohio-3554 (3rd App. Dist.); First Merit Bank N.A. v. NEBS Financial Servs., Inc., 2006-Ohio-5260  (8th App. Dist.)(emphasis supplied)   (For more on this standard, visit my previous post on American College of Cognovit Lawyers Ohio Case Roundup.)

While defenses available to a maker of a cognovit note are "extremely limited", there are some meritorious defenses which would justify granting relief from jugment according to the Court of Appeals in Baker:

 The "defense of 'non-default' is certainly one. Other asserted defenses found meritorious include improper conduct in obtaining the debtor's signature  on the note; deviation  from proper procedures in confessing judgment on the note  at the time of confession of judgment.

Standard Applied 

In the Baker case, successor liability was imposed on the purchaser for certain workers compensation obligations to the State of Ohio.  The purchaser consequently stopped making payments on the cognovit note given the seller for the balance of the purchase price.  Predictably the seller then took a cognovit judgment against the purchaser who immediately moved to have the judgment vacated.  The purchaser alleged the following defenses:

• its obligations under the note were excused by the seller's breach of its warranty that the assets were free and clear of liens and adverse claims.
• it had a right to set off the workers' compensation liabilities against its liabilities under the note
• its payment obligations were suspended when it notified the seller of the liability being asserted against it 

In analyzing the case before it , the Court of Appeals first noted that a "counterclaim or setoff is not a meritorious defense to a cognovit judgment."  Why? Because, according to the Court,  it "is, in effect, a claim that would reduce or satisfy the amount due on the note."  Now to me that sounds like a meritorious defense, but then I'm not on the Court of Appeals.  And from a lender's counsel perspective, I'm sure it was the correct interpretation; it is at least consistent with similar law in replevin actions.  With this perspective, the Court of Appeals held that neither the seller's breach of its warranty of title that the assets being sold were unencumbered  nor its alleged setoff claim would qualify as a meritorious defense permiting relief from judgment on the cognovit note. 

This, however, did not mean that the plaintiff seller won.  In what I would consider a victory for a lawyer's penchant for essentially dealing with the same issue in multiple places in a document, the Court of Appeals found a meritorious defense in other remedies given the purchaser in the event of the seller's default of its obligations under the asset purchase agreement.  Tucked within the Asset Purchase Agreement was a provision which allowed the purchaser to suspend payment on the cognovit note upon giving notice to the seller of assertion of workers compensation claim against the purchaser. 

The Asset Purchase Agreement apparently gave the seller one hundred eighty days to resolve the problem with the workers compensation claims and authorized the suspension of payments  on the cognovit note during that time.  What the decision doesn't explain is whether the Asset Purchase Agreement had any provision for what would happen if the seller failed to resolve the workers compensation liability.  Nevertheless this provision was sufficient for the Court of Appeals to overturn the cognovit judgment and send it back down to the lower court.

Practical Pointer

Perhaps the best take-away from this is that it is not always duplicative to address important issues in multiple sections of documentation of transaction.   The line between setoff, counterclaim, and defense, is often very thin. So providing multiple sorts of remedies for breach may well be a good idea.

>>> For more on the basics of cognovit notes, visit my Cognovit Promissory Notes Explained post. 

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So does it make a difference if someone messes up and forgets to attach the exact legal description to a mortgage which then gets recorded?  It may depend on how specific the mortgage is in describing the parcel of real property. 

Now I thought this seemed like an easy question, but apparently we needed a Sixth Circuit opinion recently issued (and recommended for full publication) to tell us that as long as the property is identified with sufficient precision that you could actually locate it  in real life, the mortgage works as a valid lien on the property.  Thanks to Amy Bower (who represented the winner),  my Managing Partner here in the Columbus office of Plunkett Cooney for sharing this decision with me.  

In Argent Mortgage Company, LLC v. Drown, Case No. 08-4508 (6th Cir. August 25, 2009), the Court addressed the question of

whether a recorded mortgage that contains the street address of residential property - but not the legal description - is sufficient to preclude the setting aside of an other-wise mortgage in bankruptcy court.

Judge Hoffman originally ruled that the Chapter 7 Trustee could avoid the mortgage pursuant to section 544(a)(3) of the Bankruptcy Code, relying heavily upon Stubbins v. American General Financial Services, Inc. (In re Easter), 367 B.R. 608 (Bankr. S.D.Ohio 2007), a decision by Judge Preston.  and caselaw discussed in that opinion, Judge Hoffman reasoned:

Under the circumstances of this case, the Court agrees with the Trustee that something more than the street address and permanent parcel number is necessary to provide constructive notice of the Mortgage to a hypothetical good-faith purchaser for value.  This is so because even if a third party had record notice of the existence of this Mortgage, neither the parcel number nor the street address , nor both together, would lead that third party to discover precisely what property is covered by the Mortgage.  Both a street address and a permanent parcel number may refer to a geographic area that contains more or less than what the morgagor intended to encumber.

The district court reversed and the Sixth Circuit upheld the district court's decision.  I agree with the Sixth Circuit in this situation when it notes

Mortgaging part rather than all of a single-dwelling residential subdivision property  is far enough outside the ordinary course of business that a reasonable prospective purchaser should assume that an ambiguous mortgage likely intended to encompass the entire residential lot at issue  

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Years ago, back in the day (my grandfather used to talk this way and since I'll be hitting the BIG 5-0 in a few weeks, I figure I might as well too), when I was a young associate at another large firm, we used to joke about being members of the prestigious and elite American College of Cognovit Lawyers.  Its primary membership qualification was/is that you take cognovit judgments on a regular basis.   Of course, there is no such organization in real life, but there should be.  If there was, it would certainly issue case updates for its members from time to time, so here we go.....

>>>>>  Onda, LaBuhn, Rankin & Boggs Co., LPA, 2008-Ohio-7017 (4th App. Dist.): When a creditor takes a cognovit judgment in combination with other claims such as a foreclosure count, can the debtor appeal or seek relief from the cognovit judgment?  ANSWER:: No, becuase unless it has the magic word "no just cause for delay", it's not a final order.

Appeal by debtor dismissed because cognovit judgment deemed not a "final order".

Because Appellants'  [sic] complaint contains multiple claims, Civ. R. 54(B) applies.  Because the trial court's judgment entry only addresses the first claim regarding the cognovit note and not the foreclosure claim, it does not completely dispose of Appellants' [sic] claims against Appellees. [sic]  Under Civ. R. 54(B), a trial court can only enter a final judgment as to fewer than all of a party's claims only upon an express determination that there is no just reason for delay.

>>>>> Export-Import Bank v. Advanced Polymer Sciences, 2009 WL 688921 (N.D. Ohio): What does it take to get relief from a cognovit  judgment under Ohio law?  It must be a meritorious defense that goes to the very basis of the bargain

 The United States District Court for the Northern District of Ohio begins with a fairly extensive discussion of the nature and purpose of requiring the demonstration of a "meritorious defense" to obtain relief from cognovit judgments"

The meritorious defense requirement exists because "a litigant, as a precondition to relief under Rule 60(b), must give the trial court reason to believe that vacating the judgment will not be an empty exercise....  If after vacation of the judgment the court would rule against a defendant on the legal merits of his defenses, even though all his factual allegations were proven true, then vacation of the judgment would still be an empty exercise....

[In the context of relief from judgment on a cognovit instrument, quoting First Natl. Bank of Pandora v. Freed, 2004-Ohio-3554 (3d App. Dist) with approval] a meritorious defense is one that goes to the integrity and validity of the creation of the debt or note, the state of the underlying debt at the time of confession of judgment, or the procedure utlized in the confession of judgment on the note.   A judgment on a conovit note will generally not be vacated for reasons which do not encompass such matters of integrity and validity....

Examples of meritorious defenses to a cognovit judgment are "improper conduct in obtaining the debtor's signature on the note; deviation from proper procedures in confessing judgment on the note; and miscalculation of the amount remaining due on the note at the time of judgment.

The defenses of res judicata and laches... do not fit into any of these categories of meritorious defenses.  Neither defense involves the integrity or validity of the Guarantees they signed, whether the debt had already been satisfied, or whether the procedure utilized in confession of judgment comported with the statutory procedures set forth in Ohio Revised Code 2323.13. 

PREVIOUS POSTS ON COGNOVIT JUDGMENTS:

Cognovit Promissory Notes Explained

Cognovit Promissory Notes - Still Enforceable, But...? 

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Last week, in a relatively unheralded decision (which didn't even rate an "official" summary by the Court's Public Information Office), the Ohio Supreme Court served notice that there's more than one way to look at certain aspects of the deepening foreclosure crisis.  In Wilborn v. Bank One Corp., 2009-Ohio-306 (hat tip to Justin Ristau for his summary in a Bricker & Eckler Creditor Rights & Bankruptcy E-Alert which called my attention to the case), the Court arguably departed a bit from established precedent to uphold an attorney fee shifting provision in the context of a residential mortgage reinstatement following the commencement of foreclosure proceedings.  Why?  Because the stability of the market demanded it.  But I'm getting ahead of myself here.

In my last post, I explained that generally speaking, everyone pays their own attorney fees in the United States, regardless of whether they wind up on the winning or losing side.  I also mentioned that one exception to this general rule was when the parties agreed between themselves that a particular party or parties was entitled to recover their attorney fees from the other side in the event they ultimately prevailed.  But that this sort of provision only really worked where both sides had relatively equal bargaining power.

Nearly all commercial loan documentation contain provisions obligating the borrower to pay the lender's attorney fees incurred in connection with the lender's enforcement of its rights under those documents.  Many consumer mortgage documents also contain such a provision.  However, in Ohio, up to now there have been several cases involving the enforceability of such provisions in the context of the enforcement of a debt -- and in foreclosure proceedings in particular -- which have generally found them to be against public policy and thus not enforceable.

What Wilborn Held.  What make Wilborn interesting is that, particularly in the current foreclosure crisis and overall difficult financial situation, it would have been VERY EASY for the Court to strike down the attorney fee shifting provisions.  While addressing a fairly unique fact pattern, the Court's naked capitalist reasoning and what it may portend for subsequent attorney fee shifting cases are worth examining. 

In Wilborn, the Ohio Supreme Court's syllabus states:

A provision in a residential mortgage contract requiring a defaulting borrower to pay a lender's reasonable attorney fees as a condition of terminating pending lender-initiated foreclosure proceedings on a defaulted loan and reinstating the loan is not contrary to Ohio statutory or decisonal law or against Ohio public policy 

Wilborn  Facts and Procedural History.  The case involved an appeal by 11 different plaintiffs in a class action (apparently a declaratory judgment action) challenging the enforceability of an attorney fee provision in a standarized residential mortgage.  After the lender had initiated foreclosure proceedings (but prior to the entry of a foreclosure judgment decrees), the plaintiffs had all entered into some sort of reinstatement of their defaulted mortgage.  In addition to bringing the defaulted mortgage current, the lender required the plaintiff borrowers to reimburse the lender for its attorneys fees and other collection costs.  The trial court dismissed the case on the grounds that payment of attorney fees as a condition for reinstatement was permissible.  The Court of Appeals affirmed.

The Reasoning.  The Ohio Supreme Court acknowleged that two very ancient cases - namely Leavans v. Ohio Natl. Bank, 50 Ohio St. 591 (1893) and Miller v. Kyle, 85 Ohio St. 186 (1911) - had long stood for the proposition that attorney fee provisions in connection with the enforcement of a debt obligation, particularly in foreclosure situations, were not enforceable.  It also recognized the holdings of Nottingdale Homeowners' Assn v. Darby, 33 Ohio St3d 32 (1987) and Worth v. Aetna Cas. & Sur. Co., 32 Ohio St3d 238 (1987)  to the effect that such provisons had to be the product of bargaining between parties of equal strength.

Now in the current economic climate, the plaintiffs-borrowers probably expected - and I certainly would not have been surprised  - the Ohio Supreme Court to apply these precedents easily and strike down the attorney fee provisons forcing poor defenseless folks on the verge of losing their homes to pay big bad banks for their legal costs in enforcing a mortgage that might even have been unfairly foisted upon the homeowner in the first place.  But that's not what happened. 

Not Against Public Policy

Instead, the Ohio Supreme Court first drew a distinction between foreclosure proceedings to enforce a mortgage and reinstatement.  It held that "reinstatement is not the enforcement of a debt obligation" and that consequently the public policy considerations of the ancient cases concenring "imposition of a penalty' were simply not relevant.  The Court explained:

A defaulting borrower is not entitled by law to have a mortgage loan reinstated.  Upon a borrower's default, a lender is entitled to initiate  foreclosure proceedings, to be paid in full, and to sever its relationship with the defaulting borrower.  A defaulting borrrower's right to reinstate the mortgage loan arises solely from the terms of the residential mortgage agreement between the parties.  Reinstatement occurs only when the defaulting borrower chooses reinstatement and consequently, chooses in the existing foreclosure proceeding to forgo those statutory protections arising from the foreclosure process.  The defaulting borrower's agreement to pay the lender's attorney fees incurred in connection with the foreclosure proceedings is a reasonable exchange for the right to require the lender to reinstate the defaulted mortgage loan and to forbear the lender's legal rights to foreclose, be presently paid in full, and sever the relationship with the defaulted borrower.

Thus, a mortgage reinstatement provison in a residential mortgage agreement creates no obligation on a defaulting borrower to pay a lender's attorney fees until the borrower exercises his or her choice to reinstate.  Thus the borrower's obligations to pay such fees does not arise solely as a consequence of the lender-initated foreclosure action.  instead, the obligation arises only upon the defaulting borrower's voluntary exercise of the contractual right to reinstate the mortgage loan, a right gained in exchange for the lender's surrender of the present right to foreclose.  

No Negative Implication of ORC 1301.21

The Ohio Supreme Court also found unpersuasive the borrowers' argument that the negative implication of Ohio Rev. Code 1301.21 - which is relatvely recent  (in the sense that it has become law during the course of my legal careeer)  and DOES allow attorney fee shifting provisons in larger commercial loans - was that the General Assembly did not intend to all such provisons in the consumer mortgage context.  Frankly, I thought this was a pretty good argument. but the Court simply put blinders on and said, well that's not what is says. 

No Contract of Adhesion - Equal Bargaining Power Exists

Perhaps even more surprising was the Ohio Supreme Court's choice to go "big picture" when considering the relative bargaining strength of the parties to a residential mortgage.  Instead of focusing on the obvious vast chasm in bargaining power between the individual homeowner and the lender, the Ohio Supreme Court instead chose to consider the entire business and commercial context in which the terms of the standarized mortgages were determined, launching into an extensive recitial of how Fannie Mae and Freddie Mac came to have standardized forms at all.  Thus, according to the Ohio Supreme Court:

although none of the Borrowers or Lenders in this case were involved, those who did participate in the process that created the uniform mortgage forms were virtual proxies for the consumers and lenders who would eventually use the product.  That process brought together many sophisticated parties with competing interests and significant bargaining power.  The reinstatement provison, including the payment of attorney fees incurred by the lender as a condition of reinstatement, was thus agreed to in a representative process of free and understanding negotiation between parties with equal bargaining power. 

Public Policy In Fact Demands Upholding Attorney Fee Shifting Provisions

In what must have seemed to the borrower-plaintiffs like adding insult to injury, the Ohio Supreme Court went on to conclude that not only did public policy not preclude enforcement of the attorney fee provisions- it in fact DEMANDED enforcement of such provisions.  As the Ohio Supreme Court saw it, weighing in the balance was nothing less than the stability of Ohio's mortgage business itself:

public policy strongly favors the use of these uniform mortgage forms to further Congress's stated purpose and to permit the trading of Ohio's conventional mortgages on the secondary market.  To declare some part of these forms unenforceable would make Ohio less competitive in the secondary mortgage market, thwarting the objectives of the Fannie Mae and Freddie Mac enabling legislation, denying lenders liquidity for their investment portfolios, and decreasing the capital available to borrowers for mortgages.  in light of the economic difficulties afflicting the national economy as of late, and particularly in the housing sector, our decision today also serves the public policy of this state by avoiding further destabilization,  

Bone to the Borrower

Almost as an afterthought, the Ohio Supreme Court threw borrowers a bone in a footnote to the effect that of course the amount of attorneys fees must still be "fair, just and reasonable as determined by the trial court upon full consideration of all the circumstances of the case." 

Some Thoughts and Implications.  While the gulf in bargaining power between consumer advocates and lenders is not nearly so wide as that between lender and consumer borrower, I'm not altogether convinced that characterizing the parties involved in hammering out the standardized mortgage forms as being of equal bargaining strength is all that accurate. 

In addition, while I "get" the distinction between foreclosure as a debt enforcement procedure and the "privilege" of reinstatement, I'm not convinced that such a distinction necessarily matters when it comes to public policy.  Personally, I've always felt that with consumer obligations such as auto loans or home mortgages, a slight presumption towards the consumer was not necessarily a bad thing.  My rationale is that, unlike business and commercial loans, in which someone has voluntarily decided to enter the business world in the hopes of making considerable money (and therefore needs to be willing to accept the risks of failure), home and auto loans are part of the fabric of everyday existence in America and are essentially unavoidable obligations.  As such, it is more appropriate for there to be protections for the borrower. 

Perhaps one of the ironic outcomes of this decision is that small commercial enterprises involved in commercial transactions with larger more powerful business partners may now actually have greater protection against an attorneys fee provision than the average consumer mortgage borrower.

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In my last post, I highlighted a post by Mark Edwards at the Concurring Opinions blog focused on the plight of perhaps "blameless" tenants being evicted from property being foreclosed upon.  Although I think Mark has overstated the problem somewhat, I also believe he raises an excellent point of general application reminding us that there is a "human" consequence entailed in foreclosure that shouldn't just be ignored.

Keith Mullen of the Tough Times for Lenders blog who brought my attention to Mark's post has followed up with a post entitled "Foreclosure and the Residential Tenant: Some Helpful Hints".  In this post, Keith explains that commercial lenders should be more concerned about this topic because"the time will come when evicting a small business owner, or evicting families who occupy abandoned property (or a model home), or evicting laid-off workers occupying an abandoned warehouse ofr factory will gain the attention of the local media."  His suggestions, aimed at getting the property back "while managing media coverage":

• Realize that a broader spectrum of people and entities may need to be notified, i.e get the lender's community/governmental relations group involved so that they can "rach out to local community organizations and governmental agencies".
• As soon as you have the legal right to do so COMMUNICATE directly with the occupant(s) about the process and options available to them (e.g. local community and governmental resources)
• Consider entering into short-term leases both as a bridge to finding a replacement tenant and to allow occupants to find other housing
• Examine title records to determine any restrictions burdening the property.

Commercial lenders DO need to be concerned about the likely increasing complications involved in regaining possession of real property, but Keith's list seems to me to miss the point, both from the lender perspective of wanting the shortest least complicated route to clean possession and resale of the property and from the perspective of addressing the true underlying problem.  The challenge presented by the presence of perhaps unwanted occupants in foreclosed property is not as simple as just shoving the problem off to another division of the lender, but neither does it have to be a circus.   

Foreclosure, at least in Ohio, is not an especially swift process (click here and here for previous posts describing the procedures in Ohio). The best way to deal with the problem of squatters and/or other potentially unwanted occupants is to obtain the appointment of a receiver to manage the operation of the property and to sort out the occupancy issues during the pendency of the case.  Properly handled, any "media' issues should be able to be dealt with incrementally.  In addition, Keith's idea of utilizing short term leases to ameliorate any harshness entailed as a result of the forclosure process also seems like a useful approach.

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In my last post, I made some overall observations about Ohio's required judicial foreclosure procedures and explained the initial steps necessary to begin the foreclosure process.  In this post, I will explain what is involved, once the Complaint has been properly filed, in getting the property being foreclosed upon to sheriff's sale

One other caveat about this explanation is that it relates to foreclosures filed in STATE court as opposed to FEDERAL court.  While foreclosures are generally filed in state court, especially when receivership is involved, if diversity jursidiction can be met, foreclosures are now being filed somewhat more often in federal court.  in Ohio, this seems to happen most often in Cuyahoga County where the federal court route is perceived as a faster track option.

STEP THREE - Receivership Detour.  (Less than one day to several weeks after Complaint is filed.)  When commercial investment property is involved such as an office building, apartment complex, or multi-family property, the real property is generating revenues in the form of rental payments from tenants.  Lenders wanting to protect that stream of income and apply it to the defaulted loan will often seek appointment of a receiver to manage the property.  In addition, property securing defaulted loans has often been the subject of deferred maintenance and lenders are frequently concerned about deteriorating value of the property as a result.

Virtually all commercial loan mortgages securing a loan of any size have explicit provisions in them pursuant to which the mortgagor consents in advance to the appointment of a receiver in advance.  The following is a very typical such provision:

If an Event of Default has occurred and is continuing, regardless of the adequacy of Lender’s security, without regard to Borrower’s solvency and without the necessity of giving prior notice (oral or written) to Borrower, Lender may apply to any court having jurisdiction for the appointment of receiver for the Mortgaged Property to take any or all the actions set forth in the preceding sentence. If Lender elects to seek the appointment of a receiver for the Mortgaged Property at any time after an Event of Default has occurred and is continuing, Borrower, by its execution of this instrument, expressly consents to the appointment of such receiver, including the appointment of a receiver ex parte if permitted by applicable law.

Thus, commercial borrowers have by contract usually agreed to the appointment of a receiver in the event of a default. 

If for some reason, the mortgage lacks the requisite language consenting to appointment of a receiver,  Ohio Rev. Code 2735.01 permits appointment of a receiver when:

 A receiver may be appointed by ... the court of common pleas or a judge thereof in his county … in the following cases:            …

(B) In an action by a mortgagee, for the foreclosure of his mortgage and sale of the mortgaged property, when it appears that the mortgaged property is in danger of being lost, removed, or materially injured, or that the condition of the mortgage has not been performed, and the property is probably insufficient to discharge the mortgage debt;

…

(F) In all other cases in which receivers have been appointed by the usages of equity.

Appointment of a receiver is also permissible under common law whenever it will prevent a wasting of assets. 

To expedite appointment of a receiver, a motion seeking appointment of a receiver is usually filed at the same time as the Complaint.  Technically, the identity of a receiver and the terms of his/her appointment are up to the Court, but generally (although this varies considerably from county to county and from judge to judge) the Court will follow the suggestion of the foreclosing creditor.  Once appointed, the party appointed as receiver will have to post a bond in an amount set by the Court.

While appointment of a receiver often makes sense with respect to income producing property, lenders must weigh those benefits against the additional costs associated with receivership such as the premium for a receiver's bond, fees and expenses of the receiver, and additional attorneys' fees.  

STEP FOUR - Obtaining Decree in Foreclosure.  (No less than 6 weeks, generally 16-24 weeks, sometimes much longer.)  Once the Complaint, and any applicable motion for a receiver, is filed, service of process must be obtained upon the defendants just as in any other lawsuit.  Generally, service is first sought by way of certified mail, then by regular ordinary first class U.S. mail, and then, if necessary, by appointment of a special process server or by advertising.  Obtaining good service on all defendants may take as little as a week or several months; generally this process only takes about a week or two.

Twenty-eight (28) days after being served, a defendant must file an answer to the Complaint.  If no answer ot other responsive pleading is filed, a default judgment will be entered against the defendant.  If a senior lienholder fails to answer, their lien can be eliminated without. any payment to the lienholder so it is important not to ignore a foreclosure initiated by another creditor.  If the foreclosure has been commenced by another creditor, a creditor has the option of  either (A) "crossclaiming" by setting forth its own foreclosure claims which can continue even if the first creditor resolves its differences with the delinquent borrower; or (B) simply filing an answer setting forth its interest in the property being foreclosed.

If one or more defendants answer, then a motion for summary judgment must be filed before a decree in  foreclosure can be obtained.  If factual issues exist, a full-blown trial may even be necessary. 

Unless and until a receiver has been appointed, the delinquent mortgagor may remain in possession of the real property throught the pendency of the foreclosure proceeding.

STEP FIVE - Setting a Date for Sheriff's Sale.  (No less than 6 weeks and often much longer.)  After the Court has entered the Decree in Foreclosure, whether by default judgment, grant of a summary judgment motion, or following trial on the merits, a separate Order of Sale must be entered directing the Sheriff to sell the subject property at auction,  Once the Decree in Foreclosure has been obtained, the Order of Sale is a formality and serves as the operational document to put the mechanics of the foreclosure sale procedure in motion.

Pursuant to Ohio Rev. Code 2329.17 and Ohio Rev, Code 2329.18, the Sheriff must obtain an appraisal of the property from three (3) appraisers and file a copy of the appraisals with the Court.  The Sheriff handles the appraisal process on his own without intervention, consultation, or assistance from the foreclosing creditor.  The average of the appraisals establishes a floor below which the property cannot be sold; pursuant to Ohio Rev. Code 2329.20, the required MINIMUM BID is TWO-THIRDS of the APPRAISED VALUE based on the appraisal filed with the Court. 

Before the real property can be sold, Ohio Rev. Code 2329.26  requires that a notice of sale, showing time and place of sale, address of the property,and certain other required information,  must be published in a newspaper of general circulation within the county beginning at least thrity (30) days before the date of sale.  The notice must be published at least once a week, on the same day of the week, for at least three weeks.  All defendants (other than those who failed to respond to the Complaint) must be served with the notice of sale at least seven days before the sale. 

STEP SIX - Selling the Property at Sheriff's Sale.  Once the date of sale has been obtained and proper notice has been sent out, there is little for anyone to do but wait.   While Ohio Rev. Code 2339.272 permits the Sheriff to hold an "open house" at which prospective purchasers may view the property being foreclosed upon, in my experience, that rarely, if ever, happens.  Commercial investment property has typically remained open to the public thoroughout  the foreclosure proceedings so in these cases, perhaps the need for an "open house" is relatively small.  However, in residential foreclosures, the borrower may have moved out and the actual condition of the property may not be readily apparent.   In both cases, the doctrine of caveat emptor, i.e."buyer beware" has never been more applicable.  There are NO warranties about the condition of the property being sold at foreclosure sale, the successful purchaser is buying "AS IS, with all faults". 

And, no, the foreclosing lender will not make arrangements for prospective bidders to get inside to see the property so don't bother even asking!

On the appointed date of sale, the Sheriff holds an auction sale of the property, often quite literally on the steps of the County Courthouse, with bidding beginning at two-thirds of the appraised value as determined by the Sheriff. Thus, if the real property has been appraised at $150,000, it cannot be sold at sheriff's sale for less than $100,000.   If no one is willing to purchase at the required minimum bid, the property will be re-appraised and re-noticed for sale. 

The highest bidder becomes the succcessful purchaser of the property and is awarded ownership of the property free and clear of all liens belonging to defendants named in the forecosure action.   Typically, the successful bidder is required to make an immediate down payment to the Sheriff of at least ten percent of the winning bid with the balance due within a specified time thereafter, usually 15-30 days.  The foreclosing creditor is permitted to bid at the sale and if it is the successful high bidder, it need only pay the amount, if any, by which its successful "credit bid" exceeds the amount owed to te foreclosing creditor.  In addition the successful bidder is permitted to assign its bid to another party on whatever terms are agreeable between it and its assignee upon the filing of approriate pleading to the effect with the Court.

For the sake of comparison, it may be helpful to visit a post on the Calculated Risk blog entitled "Foreclosure Sales and REO for UberNerds" (which contains a further useful link to a website purporting to contain summaries of foreclosure procedures in all 50 states) to see how the Ohio foreclosure sale process differs in several significant ways from that in several other states.

STEP SEVEN - Completing the Foreclosure Sale Process.  (Approximately 4-6 weeks).  Following completion of the foreclosure sale and payment in full of the purchase price by the successful bidder (or bid assignee), a Confirmation Order approving the sale and ordering delivery of the deed to the successful bidder must then be entered by the Court of Common Pleas.

Once the Confirmation Order is entered by the Court, the delinquent mortgagor has no further right of redemption.   Ohio Rev. Code 2923.31 and Ohio Rev. Code 2329.33.  This differs from many other states.  Prior to entry of the Confirmation Order, the mortgagor can redeem the property and in  essence undo the foreclosure sale by paying the amount of the judgment, plus interest on the purchase price at the rate of 8% per annum from the date of deposit.

Again, every foreclosure is different and has its own timetable.  Local procedures vary considerably from county to county in Ohio and from judge to judge.  In addition, unique issues may arise which complicate the process.  However, in general, this is how a typical Ohio foreclosure unfolds when filed in state court.

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Now that the calender has rolled over to 2009, everyone should also be aware that the permissible rate of interest on judgments obtained in Ohio has changed as well.  For new judgments obtained in Ohio courts in 2009 for tort claims or with respect to contracts (including promissory notes and trade accounts) that do not otherwise specify an interest rate, the new rate of interest is ONLY 5%.  This is the lowest it's been since 2005 and quite a drop from the 8% applicable in 2007 and 2008.  For a more detailed explanation of how this number is determined and calculated, visit my previous post "Determining Interest on Ohio Judgments".

Judgments obtained prior to 2009 can continue to accrue interest at the rate specified in the applicable judgment entry.  However, new judgments obtained in 2009 will only accrue interest at 5% even if the permissible rate goes back up in subsequent years.      

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When you're part of the Ohio outpost of a Michigan-based law firm, you get asked questions about Ohio law that you're so used to knowing, it sorta surprises you initially... until you stop and realize there's a whole heckuva lot about Michigan law that you don't know.  Anyway, recently I was asked about foreclosure procedure in Ohio and it occurred to me that in the current economic climate, this might be useful information for lots of folks. 

So, here's a two part post laying out a roadmap for a typical Ohio foreclosure.  Part One covers getting from declaring default to bringing foreclosure proceedings into full swing.  Part Two deals with obtaining the judgment decree in foreclosure once the case is filed, selling the property at sheriff's sale, and the adminstrative details involved in completing the process.  

And of course, my disclaimer: Every foreclosure is unique and presents its own problems and challenges so the following description of the process should be seen only as the most general outline and not relied upon as a detailed explanation of how every forclosure will proceed.  

Whether involved in a foreclosure from the creditor side or as the delinquent mortgagor, everyone always wants to know how long it will take.  And the short answer is longer than you might think.  The length of foreclosure proceedings in Ohio varies considerably from one county to the next and of course every case has its own pace,  However, in my experience, Ohio foreclosures rarely, if ever, take any less than at least six months and often take much longer, not infrequently more than a year.

Initial Observations.  In Ohio, foreclosure proceedings work much the same way regardless of whether the property involved is residential, i.e. someone's home, or commercial/investment.  The most significant difference is that a receiver is often appointed in cases involving commercial investment property to protect the value of the property and the flow of income from occupants in the property.  Because my law practice here in Central Ohio primarily involves representation of creditors with liens on commercial or investment properties, this post will focus primarily on how the process works in those situations.  However, most of what is said is equally applicable to the resdential side as well.  

Ohio, unlike many other states, does not offer creditors the option of a nonjudicial foreclosure, strict foreclosure or deed of sale.  (Click here for a very brief explanation of the difference between judicial and nonjudicial foreclosure.)  If a creditor has a mortgage or judgment lien on real property in Ohio and wishes to convert that lien to cash to pay off the borrower's debt, a lawsuit MUST be filed; there is NO summary procedure or shortcut.  The only out of court alternative available is a "deed-in'lieu" situation in which the borrower voluntarily conveys the real property to the creditor in full or partial satisfaction of the outstanding obligation.  (This could and probably will be the subject of a separate post.)

Because Ohio does enforce cognovit promissory notes evidencing commercial obligations which permit creditors to obtain money judgment immediately upon filing a Complaint, creditors are allowed to pursue post-judgment collection actions with respect to a debtor and its personal property assets during the pendency of the foreclosure proceeding if they have taken a cognovit judgment on the underlying monetary obligation.  Perhaps the most important point here is that a creditor can both take a cognovit judgment and pursue foreclosure simultaneously.

The fact that the titled owner of the real property may be a guarantor rather than a borrower does not affect foreclosure proceedings in any meaningful way.  Nor does the fact that the loan agreement, note, or mortgage is a "hypothecated" obligation or contains "exculpatory" provisions, both of which relieve the signatory of liability in excess of the value of the property pledged, change any aspect of the foreclosure proceedings other than eliminate any attempt to obtain money judgment.

While statutes and court rules governing foreclosure are uniform throughout Ohio, several counties have additional supplementary local rules, many of which fall in the "unwritten" variety, that must be followed by the foreclosing creditor.  Several counties, including Cuyahoga (think Cleveland) and Hamilton (think Cincinnati), use magistrates for foreclosure proceedings.  This can add time to the process because Magistrate Decisions must be adopted by Common Pleas judges before becoming effective.

STEP ONE - Establishing the Event of Default.    (Generally 1 -3 weeks, occasionally 4-5 weeks.) Obviously, an event of default, whether monetary or nonmonetary, must first occur before the foreclosure remedy is appropriate.  Typically, upon default, a demand letter of some sort will be sent to the borrower and any guarantors setting out the amount owed and referencing the occurrence of the default.  Nonmonetary default can include many things, a number of which will likely be spelled out in the applicable loan documents, and can include such things as default on obligations to other creditors, decrease or deterioration in the value of the real property, failure to maintain insurance, or filing of a mechanics' lien upon the real property. 

Before commencing a foreclosure action, lenders must take care to comply with any applicable cure period which allows the borrower to bring the obligation current or otherwise correct the default.  Loans guaranteed by the Small Business Administration, or in which the Veterans' Administration or the Federal Housing Administration is involved may have specific notice periods and guidelines that must be observed before foreclosure should be initiated.   

STEP TWO - Preparing and Filing Foreclosure Complaint.  (Typically 1- 3 weeks, depending on the complexity of the title work required; process can occur contemporaneously with STEP ONE.)  To ensure that all creditors with liens on the real property --  including junior or senior mortgageholders, judgment lien holders, mechanics' lien holders, and taxing authorities -- are properly included as defendants in the foreclosure action, a title report must be ordered from a title company.  It is important to include all such lienholders because if omitted, the lien will remain an encumbrance on the real property even following foreclosure sale, and depending on its priority, might even be entitled to recover proceeds from the foreclsoure sale from other recipients. 

Purusant to Ohio Rev Code 2329.191, the title report or preliminary judicial report (sometimes called PJR, for short), must be filed with the Complaint in the Common Pleas Court in the Ohio county in which the real property is located.  The key is WHERE the property is located; it does not matter if the debtor is a  foreign corporation headquartered in, say Delaware, or if the loan documents were all signed in Michigan, or even if the principal place of business of the debtor is in another county or state. 

Defendants named in the complaint MUST include the follwing:

• Original mortgagor (i.e. party granting the mortgage) - note that this may or may not be the principal borrower and that if not, the principal borrower is not required to be named a defendant
• Current owner of the property, if different from the original mortgagor
• Junior or senior lienholders, including mortgage holders, judgment lien holders, statutory lien holders such as mechanics' liens and others
• Spouse of individual debtor (to eliminate dower rights)
• Current tenants and other occupants, whether there pursuant to written lease or not
• Holders of other interests such as easements, if wish to eliminate them

The Complaint may seek only foreclosure or may also include other counts for such causes of action as money judgments against the borrower(s) and guarantor(s), replevin (i.e.personal property foreclosure - yes, this too will likely eventually be the subject of a separate post), or other related claim.  If a lender has determined appointment of a receiver is warranted, the Complaint will also include a count seeking appointment of a receiver and the lender should have selected a preferred receiver appointee before filing the Complaint.

So this is how a typical Ohio foreclosure generally begins.  In my next post, I'll explain what happens once the foreclosure action is filed and how the process culminates in a sheriff's sale conveying good title to the real estate being foreclosed to another party and providing the source of funds to payall or part of the delinquent debt.

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The other day, one of my attorney friends called to see if I could "sign a cog" for him, by which he meant confess judgment for the defendants by signing an Answer to the Complaint on their behalf.  Since this function is considered merely a ministerial act in Ohio and gives rise to no actual attorney-client relationship with the unfortunate defendants, I said sure and we made a date for lunch when I'll sign the pleadings. 

I've previously posted on the enforceability of cognovit promisory notes, but I thought it might be useful to step back for a moment and explain in more detail what they really are.  Ohio is one of only a handful of states that still allow the enforcement of cognovits in commercial transactions.  To the best of my knowledge, it has been decades since any jursidiction permitted cognovit provisions to be enforced in consumer transactions.  While cognovit provisions are most commonly used in promissory notes, they can also be used in guaranties, litigation settlement agreements and even contracts involving the payment of money.   

As long as the debtor does not default, there is really no practical difference between a cognovit promissory note and any other promissory note.  However, when  things go bad, they head south much faster for the borrower who signed a cognovit note.   

Language.  Cognovit notes are simply a special kind of promissory note -- with the addition of certain statutorily required language.  That extra verbage gives creditors an unusually rapid path to judgment and collection activities in the event of a default by the borrower.  In Ohio, cognovit provisions are effective ONLY if they have the language required by Ohio Rev. Code 2323.13.  Thus, the following warning - IN EXACTLY THIS LANGUAGE - must appear "in such type size or distinctive marking that it appears more clearly and conspicuously than anything else in the document" immediately above or below (customarily it will be just above) the signature of the debtor:

WARNING

 

BY SIGNING THIS PAPER, YOU GIVE UP YOUR RIGHT TO NOTICE AND COURT TRIAL.  IF YOU DO NOT PAY ON TIME, A COURT JUDGMENT MAY BE TAKEN AGAINST YOU WITHOUT YOUR PRIOR KNOWLEDGE, AND THE POWERS OF A COURT CAN BE USED TO COLLECT FROM YOU REGARDLESS OF ANY CLAIMS YOU MAY HAVE AGAINST THE CREDITOR WHETHER FOR RETURNED GOODS, FAULTY GOODS, FAILURE ON HIS PART TO COMPLY WITH THE AGREEMENT, OR ANY OTHER CAUSE.

To ensure compliance with the statute, this language is typically in a larger boldfaced typeface and often boxed.

In addition, an authorization to take a cognovit judgment must be contained somewhere in the body of the promissory note or other instrument of indebtedness,   Thus, generally near the end of the document, the following language (or something fairly similar) must appear:

WARRANT OF ATTORNEY

Each of the undersigned authorize any attorney at law to appear in any Court of Record in the State of Ohio or in any other state or territory of the United States after the above indebtedness becomes due, whether by acceleration or otherwise, to waive the issuing and service of process, and to confess judgment against any one or more of the undersigned in favor of the Bank for the amount then appearing due together with costs of suit, and thereupon to waive all errors and all rights of appeal and stays of execution.  No such judgment or judgments against less than all of the undersigned shall be a bar to a subsequent judgment or judgments against any one or more of the undersigned against whom judgment has not been obtained hereon; this being a joint and several warrant of attorney to confess judgment.

Execution.  To be valid, a cognovit promissory note must either be signed in Ohio or the borrower executing the cognovit must reside in Ohio at the time judgment is taken.  To ensure enforceability, virtually all creditors will require execution in Ohio, even if that means the borrower must make a plane trip.

Enforcement.  The primary value of cognovit provisions is that they provide a shortcut to judgment for the creditor.  If the debtor defaults, the creditor can file a complaint, as well as an answer on behalf of the delinquent debtor, and obtain judgment within minutes of filing the action rather than having to wait a month or more to obtain a default judgment.  Within minutes after that, bank account or wage garnishments or other post judgment action can be instituted against the now judgment debtor.  Thus it is entirely possible that the defaulting borrower's bank account will be cleaned out by the creditor before the debtor even knows judgment has been taken.  The only requirement is that the ORIGINAL of the note or other document with cognovit provisions must be produced and shown to the judge before judgment is entered. 

Traditionally, the job of taking cognovit judgments falls to the youngest lawyer in the office.  In urban populated areas like Columbus and Franklin County where I practice, taking a cog is really no big deal from the standpoint of difficulty.  You simply call one of your attorney friends and take them to lunch in exchange for their signature on the purported answer of the debtor and then head down to court with the pleadings and the original note.  Once there, you file the Complaint and then find your way to the "Duty Judge" who checks to make sure you have the original promissory note or other instrument with the cognovit provision, signs the judgment entry, and gives it back to you to be filed downstairs with the Clerk.  If you want to hit some bank accounts belonging to the defendant, you can then do that too, although I usually let the court runner take care of that in his next run because there's lots of copies involved and it takes too long.  The whole thing takes maybe an hour at most, but it does have to be a real lawyer who does the deed - no paralegals or laypeople allowed.

In more rural counties, taking a cog can sometimes be an adventure.  Often there is only one judge for the county and if he or she is in trial, well then you just have to wait for a break in the action.  In addition, I have strong and not so pleasant  memories of one judge in particular cross-examing me at length about whether our "Warning" was distinctive enough.  For a while, I was seriously concerned that he would refuse to sign my judgment entry and began wondering just how I was going to be able to spin this one and explain coming home without the judgment.  Fortunately for me, the judge did eventually sign the entry and my membership in the mythical American College of Cognovit Lawyers remained secure.         

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A while back, I promised to try to explain how this whole securitization thing works, especially in the context of the subprime mortgage melt-down and the various problems being experienced by the current Wall Street lenders-assignees in accomplishing foreclosure. So here goes.....

Let's start with how the whole thing is structured. Securitization creates subparts in what was initially a simple transaction. While its most well known application is with respect to residential mortgages, equipment leases and virtually any kind of cash flow producing asset can be securitized. In many respects, securitization is simply an extremely sophisticated means of "factoring" a receivable and is just a very advanced form of asset-based lending. The Cleveland Complaint filed in the Cleveland "public nuisance" suit against a number of Wall Street lenders (which I've covered in this previous post) contains a good diagram of the process and does a fairly good job of succinctly describing it as follows:

Mortgage-backed securities essentially are bonds secured by real estate loans. They comprise a collection of mortgages that lenders sell to the issuer of the securities. The issuer uses the sums received from the borrowers in repaying their loans to fund disbursements made to investors.

Using a few more words, but still doing an excellent job of contrasting the securitization process of today with the way it used to be, a recent issue of the Federal Reserve Bank of Chicago's Chicago Fed Letter explains:

Thirty years ago, if you got a mortgage from a bank, it was very likely that the bank would keep the loan on its balance sheet until the loan was repaid. That is no longer true. Today, the party you deal with in order to get the loan (the originator) is highly likely to sell the loan to a third party. The third party can be Ginnae Mae, a government agency; Fannie Mae or Freddie Mac, which are government-sponsored entities (GSEs); or a private sector financial institution. The third party often then packages your mortgage with others and sells the payment rights to investors. This can continue for additional steps. In effect, the eventual buyers of the mortgage - the parties that provide the funding - can be many steps removed from the originator of the mortgage.

 

The process by which most mortgage loans are sold to investors is referred to as securitization.... The MBS origination process typically begins when the issuer purchases a collection of mortgage loans from the originators. As payments are made on the mortgages, they are passed through the trust to bondholders.

The initial steps in securitization are fairly easy to follow. Everyone understands Level 1 - Borrower (often, but not necessarily a residential homeowner) borrows money from Hometown Bank to purchase real estate and gives Hometown Bank a mortgage to secure repayment. So far, so good.

Initial Assignment. Level 1½ might be an ordinary assignment of the promissory note and mortgage from Hometown Bank to a larger financial institution we can call National Bank. This might even be repeated more than once. If it is, this will add to the complexity of the entire transaction and increase the likelihood of a missing or incomplete assignment being involved.

The problem the lenders face in the much publicized recent foreclosure dismissals is that getting the appropriate assignment after the fact, if a discrepancy has occurred, is not a simple matter. In some cases, either Hometown Bank or National Bank, or any of the other financial institutions along the pre-securitization assignment route, may now have merged into other banks or financial institutions without clear assignments of the notes and mortgages having been made. In part, this could simply be a function of reliance upon basic corporate law that a necessary consequence of the merger of two corporations is that the surviving corporation automatically becomes the owner of the assets of the other corporation - which in the case of a bank would include all outstanding loans and all of the notes, mortgages, and other loan documents evidencing the outstanding obligations of borrowers. No specific assignment of individual assets (including notes and mortgages) is necessary. There is also the possibility of basic human error of incorrect assignments having been made along the way.

These are "fixable" problems, although potentially costly and time-consuming to remedy at this point; had these matters been addressed at the time of the original transaction, the cost would have been much less. However, what seems to have been overlooked by many jumping on the bandwagon for a beatdown of the greedy subprime lenders is that these sorts of issues can and do occur totally apart from whether a mortgage has become part of a securitization vehicle.

Why Securitization Is Attractive. Level 2 is where the basic securitization vehicle is created. For National Bank (or even for Hometown Bank if no further assignment is made), the underlying assigned promissory note and mortgage is primarily an income-producing asset. The real property connected to the mortgage is only secondarily important as a means of guaranteeing that the loan will be repaid, i.e. the value of the asset is protected. Before securitization became popular in the 1990's, Hometown Bank made a profit through the spread between (A) the interest rate on its cost of funds from money it obtained through deposits from other bank customers, or otherwise and (B) the interest rate charged to Borrower. Hometown Bank might decide to accept a discounted return by assigning the note and mortgage to National Bank and receiving an immediate lump sum payment in return. National Bank made money by buying the promissory note and mortgage for less than their full amount and being willing to wait for Borrower to pay the full face amount over time.

Securitization provides a new way to unlock the income producing potential of the mortgage and promissory note and to leverage the associated cash flow. This can result in greater returns to the owners of that financial institution or simply give National Bank more funds so it can make more loans to other borrowers.

Nature of Securitization. At Level 2, a new "bankruptcy remote" "special purpose entity", known colloquially as an SPE, is created, often as a "trust" entity in which the originator National Bank holds the sole beneficial interest. This is where things become a bit more complicated. The concept is that the SPE will have no other purpose than as a holding vehicle for the notes and mortgage which are assigned to it. In addition, because the SPE is a separate entity from National Bank, any insolvency or financial difficulties experienced by National Bank will not affect the SPE or cause any of the SPE's assets to be distributed to creditors of National Bank. Consequently, any investment vehicle connected with the SPE becomes more attractive to investors.

The SPE "buys" the underlying promissory note and mortgage and there is an "absolute" assignment of promissory notes and related mortgages from the "originator" Hometown Bank or National Bank to the SPE. To fund this "purchase", the SPE (to which mortgages and promissory notes have been assigned) issues securities usually referred to as mortgage-backed securities, or MBSs, representing the right to receive the cash flow from the SPE's entire portfolio of mortgages and promissory notes.

The agreements assigning the mortgages and promissory notes to the SPE, as well as the Servicing Agreements which cover loan administration after the assignment, are extremely long and complicated and contain numerous provisions. For example, one of the keys to securitization is that the "originator" -- National Bank in our example -- needs to be able to remove the underlying promissory note and mortgage from its balance sheet. For this to occur, lawyers for National Bank will be asked to give "true sale" opinions of counsel to the effect that in fact actual ownership of the promissory note and mortgage has been conveyed to the SPE from National Bank. However, as a practical matter, National Bank may be forced to repurchase notes and mortgages assigned to the SPE if too many of them prove uncollectible.

Securitization Achieved. Level 3 is the point at which the connection between the cash flow tied to the mortgage and promissory note really becomes attenuated. This is where the securitization part actually happens. Just as the assets of an ordinary company might include accounts receivable, an SPE's assets are (theoretically) the underlying promissory notes and mortgages and the obligations of Borrower evidenced by these debt instruments. MSBs are issued by the SPE based on the value of these promissory notes and mortgages which in a perfect world would be based on the face amount still owing; when investors purchase MSBs, it is not unlike buying shares of stock in an ordinary company.

In reality, the MBSs are given a rating by an underwriter based upon the perceived likelihood of the collectibility of the underlying promissory notes and mortgages. They are then offered in the public market to investors, primarily sophisticated "institutional" investors; the better the "rating", the more attractive the MSBs are to "institutional" investors, including those seeking a "conservative" investment such as state pension plans.

An already complex set of relationships is further complicated by the fact that, typically, at Level 4, the SPE delegates the actual oversight over the mortgages and promissory notes, and the cash flow they produce, to a servicing agent. The servicing agent then may take action, including initiating collection activities and foreclosure, in its own name or in the name of others along the chain. Frequently, originator National Bank continues to act as the servicing agent and receives a fee from the SPE for performing these tasks.

Investor Cash Flow. As Borrower repays his or her loan, the cash flow generated - minus any servicing fee paid to National Bank or other servicing agent - flows through the SPE to the investors who purchased the MSBs. Sometimes, there will be various classes of investors, sometimes referred to as "tranches", so that certain investors will be paid sooner than others or receive a greater return on their investment.

And that, essentially is what securitizationis all about. For those wanting still more detail (including a very nice summary of the advantages and disadvantages to the various parties in the transaction other than the Borrower) or technical information, about securitization, I recommend visiting Wikipedia's entry on the subject.

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OK, so I thought the dismissals of foreclosures without prejudice by three federal judges a couple of months back were not that big a deal by themselves. Click here and here for my earlier postings on the decisions by Judge Boyko, Judge O'Malley, and Judge Rose. However, the recent "public nuisance" and "predatory lending" lawsuits by the City of Cleveland and the City of Baltimore, respectively - coupled with a number of other events I'll describe below - HAS gotten my attention.

I stand by my earlier postings about the importance of those particular decisions on their own, but the march of events since then clearly indicates that foreclosures - regardless of whether they are connected to the subprime mortgage business - and mortgage lending in general are destined for the national stage. For a quick round-up on what's been happening here in Ohio click here. For those wanting the most succinct description of recent legal filings in Cleveland and Baltimore, click here for the Wall Street Journal Law Blog's posting.

As might be expected, according to the Cleveland Plain Dealer, the rulings did affect the actual number of filings in federal court in Cleveland, resulting in drastically fewer filings. Click here for the Christmas Day story in the Cleveland Plain Dealer. However, the impact has been far more widespread. Like a lit match dropped on dry wood, these rulings have ignited a veritable forest fire not easily extinguished.

Summary of Recent Events. A brief review of some recent events is in order. This is by no means complete, even with respect to Ohio, but should give an idea of the burgeoning issue.

• In early December, Hamilton County Common Pleas Judge Steven E. Martin dismissed a Wells Fargo foreclosure with facts very similar to those in the federal cases. Although the bank was ultimately able after the case had been filed to demonstrate that it was the owner of the mortgage, Judge Martin nevertheless dismissed the action. In addition, the law firm handling the foreclosure was told that it could not file any more foreclosures unless it provided proof of the client's ownership of the mortgage at the time of the initial filing. Click here for news coverage on this by Cincinnati Enquirer.

• According to several news reports (including various ones I've linked to elsewhere in this post), the Consumer Protection Section of the Office of Ohio Attorney General Marc Dann is apparently waging a stealth campaign by filing motions in Hamilton County and elsewhere challenging whether the named plaintiff is the proper "party in interest". Interestingly, while some reports state that as many as 30 such motions have been filed, there is no press release on the Attorney General's website concerning these actions.

• On the Friday before Christmas, Ohio State Bar Association President Rob Ware sent an e-mail to OSBA members seeking volunteers to help assist people facing foreclosure and according to this story in the Cincinnati Enquirer, by the day after Christmas more than 200 attorneys had volunteered.

• In Clermont County, Common Pleas Judge Robert P. Ringland has sent a letter to local law firms asking that they participate in mediation in foreclosure cases. Click here for coverage by the Cincinnati Enquirer.

• Following on the heels of the recently released University of Iowa study Misbehavior and Mistake in Bankruptcy Mortgage Claims detailing widespread "shortcuts" and other less than stellar loan collection practices in Chapter 13 bankruptcies, came a New York Times article about how Countrywide Home Loan, Inc. was forced to admit it "recreated" certain letters used as evidence in a bankruptcy proceeding. Read the Countrywide Transcipt of the Status Conference in which this came out.

Enter City of Baltimore and City of Cleveland. Then, last week came the attention-commanding lawsuits by the City of Baltimore and the City of Cleveland:

• Last Tuesday, the City of Baltimore filed a Complaint infederal district court, Case No. L 08 CV 062,against Wells Fargo Bank, NA alleging that the bank engaged in a"reverse redlining"predatory lendingpractice by charging higher fees and interest rates in Baltimore's poorest neigborhoods, resulting in foreclosure rates twice the citywide average. Click here for the press release issued by the City of Baltimore about the lawsuit. Click here for news coverage by the New York Times. Click here and here for news coverage by the Baltimore Sun-Times and here for Baltimore Sun-Times coverage of reaction.

• A couple of days later on January 10, 2008, the City of Cleveland filed a "public nuisance" action in state court against Deutsche Bank Trust Company and twenty other lenders (including Wells Fargo & Company, but not including any Ohio home grown institutions such as National City Bank, KeyBank, Fifth Third Bank or the Huntington National Bank) in a suit on the docket of Cuyahoga Common Pleas Court captioned City of Cleveland v. Deutsche Bank Trust Company, Case No. CV 08 646970, Judge Corrigan presiding, Here is a copy of the filed Cleveland Complaint and a graphic showing the named defendants and their foreclosure activity in the Cleveland area. Click here for the City of Cleveland press release on the case.
  • For news coverage from Cleveland including a video of Cleveland Law Director Robert Triozzi discussing the lawsuit, click here and here. In the "notable quote" department, Cleveland Mayor Jackson told the Cleveland Plain Dealer reporters, "To me, this is no different than organized crime or drugs."
  • For Cleveland Plain Dealer coverage of reaction to the suit, click here
  • For the Cleveland Plain Dealer's Sunday editorial praising the filing of the lawsuit click here.
  • UPDATE: On January 16, 2008, defendant Lehman Brothers Holdings, Inc. got the case removed to federal court in the U.S. District Court for the Northern District of Ohio, Case No. 08-CV-00139-DCN, Judge Donald C. Nugent presiding. As might be expected, the City of Cleveland has responded by filing a Motion to Remand.

What the Boyko, O'Malley, and Rose decisions did was legitimize lingering questions and uncork pent-up forces long looking for an angle of attack. To some extent, an old problem has simply gotten new visibility. Click here for an ABC News story on a New Hampshire man engaged in a six year "predatory lending" battle and click here for a Wall Street Journal Law Blog posting about a Cleveland man ahead of the curve who made the "not the owner" argument years ago and is now appealing on that basis to the United States Sixth Circuit. Read his arguments in Davet Motion.

So, basically there's a lot to take in at this point. For one academic perspective on whether municipalities even have standing to file actions like the City of Baltimore action, see Cleveland State University Assistant Professor Kathleen Engel's 2005 paper, "Do Cities Have Standing? Redressing the Externalites of Predatory Lending", which discusses "public nuisance" as a possible basis for city claims against predatory lenders.

What's It All Mean? Anyone who reading the papers over the last month or so can see that the politicians from the federal government on down have recognized that foreclosures have started to be a enough of a real risk for a substantial enough Americans that they need to take notice. And there will undoubtedly be various plans offering "assistance" of one kind or another to "deserving" homeowners. It's still too early to know the form these will take or whether they will really help any significant number of people.

From a legal standpoint, residential foreclosures in Ohio may become more costly for lenders (and less easy for lenders' counsel to do on a "flat rate" per case basis as is often done) in the short run. Logically, the stricter standards may also carry over into commericial foreclosures although probably with less impact since commericial mortgages are less often commoditized into securitization vehicles.

Documenting Ownership. In the end, however, the "not the real owner" argument will merely force lenders to take more care in documenting transfers of mortgage loans. While this is certainly not a bad thing from an objective standpoint - although it may add to transaction costs ( which may ultimately be passed on to consumers), especially in the beginning as lenders retool - it is also not some sort of fatal blow to the mortgage lending industry or even to securitization. In addition, not every mortgage loan has been assigned away. This theory may buy some borrowers some time (and sometimes that IS very important), but with some exceptions, it's probably not going to change the outcome for most borrowers in default.

Public Nuisance. Although the "public nuisance" theory advanced by the City of Cleveland is certainly innovative and I'd be remiss if I didn't give kudos to a superfically appealing argument, I just don't see it as a winning argument ultimately. I haven't fully digested the lengthy Complaint yet and perhaps once I do, I'll have a better understanding. It strikes me as just another reincarnation of the "lender liability" arguments in vogue when I began practicing law - "you shouldn't have lent me the money because you knew I couldn't pay it back". At some point, there has to be some assumption of responsibility by borrowers for taking the loans in the first place. From my cursory review of the City of Cleveland Complaint, it seems to contend that lenders "should have known" about all sorts of trends and economic factors more easily understood by everyone in hindsight. While "lender liability" lawsuits did get some borrowers out of some loans and did complicate lenders' lives for a while, eventually the novelty wore off. I think the same thing may happen here.

Predatory Lending. Now this one MIGHT amount to something. If lenders did mislead borrowers about the terms of their loan, then they should have to reap the consequences. Perhaps due to all my years as bank counsel, however, I'm a bit skeptical here too. The truth of the matter is that NONE of us really listen to all of the terms of the loan; we just want the house and are happy we found a bank willing to give us the money we need to make it happen. So who's job is it to police the terms offered? Again I haven't fully analyzed the allegations of the City of Baltimore Complaint either so I'm not sure how strong that case is. So I will be interested to see how this one develops, both in Baltimore and elsewhere.

Why It Matters. Aside from the obvious reasons why we should all care about this issue both personally in terms of our own ability to access mortgage loans and more generally in terms of the plight of our fellow citizen, its effect on the credit markets is likely to extend beyond residential mortgages. Business owners may find that their ability and cost to obtain credit have changed.

It's hard to know for sure how the foreclosure "crisis" will play out over the next few months in Ohio and elsewhere. In the short run, however, "business as usual" for the foreclosing lender is over for a while.

UPDATE: What Might Be Next. For an interesting peek at what might be next in Cleveland and Baltimore, click here for the recent cover story in Business Week about "Bank Day" in a Buffalo courtroom in which lenders are being held accountable for various housing code violations on properties being foreclosed upon.

This post was accidentally deleted for a time, but fortunately I had kept a copy and was able to put the original post back up once I realized the problem.

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Over the last couple of weeks, Judge Boyko and Judge O'Malley in Cleveland, as well as Judge Rose in Dayton, have dismissed numerous residential foreclosures brought by the trustees of mortgage-backed securitizations on the grounds that the financial institutions have failed to demonstrate adequately their ownership of the mortgages being foreclosed. Because of all the hype these federal court dismissals without prejudice seem to be getting, especially in the blogosphere (visit Iamfacingforeclosure.com if you don't know what I'm talking about), I thought it would be helpful to post some basic source documents in one place so that everyone could see what this is all about.

1. Judges' Opinions - there are three so far that I know about:

• Judge Boyko's decision, handed down October 31, 2007, dismissed 14 cases and has the most colorful language and juicy footnotes - click JudgeBoykoOrder to read.

• Judge O'Malley's decision, handed down November 14, 2007, dismissed 32 cases and is the most matter-of-fact decision - click Judge O'Malley Order to read.

• Judge Rose's decision, handed down November 15, 2007, dismissed 20 cases and chooses to focus on a perception that mortgage lenders are generally scofflaws by referencing a study by University of Iowa Associate Professor Katherine Porter (more about this below) - click JudgeRoseOrder to read.

2. Misbehavior and Mistake in Bankruptcy Mortgage Claims, a recently released study by University of Iowa Associate Professor Katherine Porter of 1700 Chapter 13 bankruptcy cases filed in April 2006 across 24 states which was quoted by Judge Rose as follows:

("[H]ome mortgage lenders often disobey the law and overreach in calculating the mortgage obligations of consumers.... Many of the overcharges and unreliable calculations... raise the spector of poor recordkeeping, failure to comply with consumer protection laws, and massive, consistent overcharging.")

I have not yet read this study with any thoroughness so I can't comment on it other than to say its conclusion certainly is that mortgage lenders have been permitted to be rather lax in providing appropriate documentation in at least consumer bankruptcy proceedings. From the limited vantage point of my own legal practice, I will say that I disagree with the conclusion as a sweeping generalization.

3. The Affidavits - Just so everyone understands what these Judges were looking at, I thought I would post examples from each Judge of an Affidavit being put forth. In most state courts in Ohio, no such affidavit is needed at the inception of the case. Yes, they are fairly conclusory.

• Affidavit in Boyko Case
• Affidavit in O'Malley Case
• Affidavit in Rose Case

4. The Complaints - again so we are all starting from the same information, here are examples of the Complaints that were filed in these cases, together with a notation of the named plaintiff and the named mortgagee in the document in each case:

• Complaint in Boyko case - Plaintiff is Deutsche Bank National Trust Company, as Trustee of Argent Mortgage Securties, Inc. Asset-Backed Pass-Through Certificates, Series 2006-W4 under the Pooling and Servicing Agreement dated April 1, 2006, assignee of Argent Mortgage Company, LLC. Mortgagee is Argent Mortgage Company, LLC
• Complaint in O'Malley case - Plaintiff is Deutsche Bank National Trust Company, as Trustee of Argent Mortgage Securties, Inc. Asset Backed Pass-Through Certificates, Series 2005-W5 under the Pooling and Servicing Agreement dated as of November 1, 2005 Without Recourse. Mortgagee is Argent Mortgage Company, LLC
• Complaint in Rose case - Plaintiff is Citibank, N.A., as trustee for First Franklin Mortgage Loan Trust, Mortgage Loan Asset-backed Certificates, Series 2005-FF12 c/o Home Loan Services, Inc. Mortgagee is First Franklin, a division on Nat. City Bank of In.

Rather than explaining the chain of title or alleging that the named plaintiff is an assignee of the original mortgagee, the Complaints simply allege that the named plaintiff is the "holder" of the mortgage, or perhaps the "owner and holder" of the mortgage. Had either the Complaint, or the Affidavit, in these cases added an extra sentence or two explaining the assignment, it would not have been nearly as easy a decision for the courts to dismiss these cases.

5. Securitization - What's it All About? - And finally for those who really are trying to understand the underlying factual and legal context in which these dismissals occurred, I offer the following links to resources explaining how securitization works. At some point soon, I hope to post on this as well [UPDATE-click here for post on this] , but for now visit either:

Chicago Federal Reserve November 2007 newsletter

Wikipedia's Securitization posting

In Ohio, foreclosures are most often brought in state, rather than federal, court. One reason these cases may have been filed in federal court was for the convenience of being able to assign a number of cases to a single attorney who would not have to travel from county to county. It will be interesting to see if Ohio state court judges (who are elected) follow the lead of the federal courts or this becomes a friendlier forum for financial institutions.

I continue to think that the most likely outcome in the long run will simply be more detailed form Complaints explaining the securitization process and alleging the plaintiff is an assignee. New securitizations may also involve a few more pieces of paper as individual assignments are executed for the notes and mortgages, or more likely there will simply be a schedule attached to a blanket assignment.

What is not going to happen is that securitization ceases to be a viable financing tool. Instead, those involved in these transactions will merely adapt. There may be some delays, or additional costs, in the short run, but ultimately securitization will continue.

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The Cleveland foreclosure cases recently dismissed by Judge Boyko and Judge O'Malley have been incorrectly heralded by some as a severe blow to lenders wishing to foreclose on delinquent loans. At most, the decisions are merely a warning to a certain class of lenders involved in "securitization" transactions that they will need to pay more attention to certain details in those transactions, particularly if they wish to avail themselves of the federal courts in Northern Ohio.

It may have started with this post from I am Facing Foreclosure.com, but it was the New York Times story by Gretchen Morgensen which increased the level of interest in the dismissals of more than thirty foreclosure cases by two federal judges in Cleveland, Ohio. This then produced a bevy of activity in the blogosphere as others rushed in to express how exciting this was for borrowers. Click here and here for a sample of the reaction.

Now that Judge Rose, another federal judge in Dayton, Ohio has dismissed fourteen other similar cases and this has now also been reported by Gretchen Morgensen in the New York Times, some pundits will undoubtedly become even more effusive about this "victory" for homeowners facing foreclosure. For a copy of Judge Rose's Order, click JudgeRoseOrder.

However, those believing that these federal trial court dismissals without prejudice have somehow signaled disaster for lenders everywhere and a debt holiday for borrowers are sadly mistaken. To be sure, there have been some responsible bloggers who have tried to stem the tide against premature celebration. For example Calculated Risk has made at least two reasoned and exceptionally well explained posts about what this is all really about. Click here and here to read these - and if you read nothing else about these cases, read this! In addition, John Waller of the Indiana Commercial Foreclosure Blog has rather succinctly summed up what these cases mean in reality for lenders:

The moral of the story is that the institution filing the foreclosure suit, if pressed by the Court or the defendant borrower, must have proof that it owned the note and held the mortgage on the date of the filing of the foreclosure complaint. As demonstrated by the Ohio ruling, with respect to mortgage security pools this seemingly simple requirement may be burdensome or perhaps even impossible under certain structuring.

Corrective action probably can be taken during the proceedings in most cases to ensure that the named plaintiff actually holds the mortgage and owns the note. For example, depending upon the circumstances, the pleadings can be amended to name the proper party or, on the other hand, assignments can be executed to place the note/mortgage into the hands of the plaintiff. Lenders/investors and their counsel should be advised of the Ohio ruling and prepare themselves accordingly.

At the outset, it is important to understand how limited the dismissal ruling really is. All of the cases were dismissed "without prejudice" which means that once the deficiencies noted by the Judges are corrected (which they probably can be), the lenders can, and almost certainly will, refile the foreclosure successfully. In addition, unlike most foreclosures that are typically filed in state court, these dismissals occurred in cases filed in federal courts and there is no way to know whether state courts would require the same proof of the ownership of notes and mortgages. Finally, these were decisions made by trial courts which leaves other trial courts free to make other decisions.

So why were the cases dismissed? Simply put, the lenders failed to take sufficient care in establishing the chain of ownership through the various assignments of the mortgage and promissory note from one financial institution to another. The nature of the "securitization" process as applied to the mortgages in question certainly contributed to this shortcoming by making it more cumbersome to obtain all of the proper assignments throught the chain of title.

However, as explained in the Calculated Risk postings, with some expenditure of time and money, the problem can be remedied in these cases and relatively minor changes in procedures can totally eliminate the issue. Moreover, in those cases where the promissory note and mortgage have only been assigned once or twice and are not part of a mortgage-backed securitization, the problem of demostrating ownership is unlikely to arise anyway.

Thus, while these developments certainly underscore the importance of attention to detail, they in no way indicate any collapse of the securitization market or an insurmouintable problem for lenders. For another bank attorney's similar conclusion focusing on the practical realities of the situation, read Kevin Funnell's "Tale of Two Judges" posting on his Bank Lawyer's Blog.

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Several recent Ohio Court of Appeals decisions have confirmed that while Ohio will remain among the minority of states that recognize and enforce cognovit provisions in promissory notes (see Ohio Rev. Code section 2323.13), getting back into court on a motion for relief from judgment may be becomining easier.  Over time, Ohio courts have been gradually lowering the threshold for obtaining relief from judgment when it comes to opening up a cognovit judgment.  However, the individual  facts of the case and the specificity of the judgment debtor's factual allegations supporting the purported meritorious defense remain important. 

 When a promissory note contains a cognovit provision, also known as "confession of judgment" provisions, a creditor can obtain judgment immediately following the filing of the Complaint without any notice to the erstwhile debtor or opportunity to be heard.  All that is necessary is that the creditor file a ministerial answer on behalf of the debtor and present the court with the original of the promissory note containing the appropriate "warrant of attorney" cognovit language and "clear and conspicuous" warning.  Creditors obviously appreciate this feature as it can give them a head start on such post-judgment collection activities as bank account garnishment.

 For many years, cognovit judgment debtors were required to demonstrate they in fact did have a "meritorious defense" just as any other party seeking relief form judgment was required to prove.  In addition, many courts held the view that the mere existence of cognovit provisions in a promissory note precluded any defense other than payment.  (see, e.g. Fifth Third Bank v. Jarrell,  2005 Ohio 1260 (Franklin Cty- 10th App. Dist.). 

While no less an authority than the United States Supreme Court has upheld the constitutionality of cognovit notes and specifically as used in Ohio (D. H. Overmyer Co., Inc. v. Frick Co., 405 U.S. 174 (1972)), Ohio courts have gradually become more uncomfortable about the lack of due process inherent in the enforcement of cognovit provisions in promissory notes.  Some courts have become more willing to entertain potential defenses to cognovit judgments beyond simply payment.  In addition, the threshold for obtaining relief from judgment on a cognivit judgment has been modifed so that the judgment debtor need only show that a meritorious defense can be asserted, and need not prove that he or she would prevail upon that defense.

However, while Ohio courts are becoming somewhat more receptive to relief from cognovit judgment, it is not entirely clear what that will mean in practice.  Just last week, in Gerold v. Bush,  2007 Ohio 5885, 2007 Ohio App. LEXIS 5171, the Erie County Court of Appeals for the Sixth Appellate District upheld a trial court's grant of relief from judgment where the debtor alleged accord and satisfaction and a failure of consideration without requiring much more from the judgment debtor.  Meanwhile, a little more than a month ago, the Knox County Fifth Appellate District Court of Appeals upheld the denial of relief from a cognovit judgment in World Tire Corp. v. Webb, 2007 Ohio 5135, 2007 Ohio App. LEXIS 4517 in which the debtor alleged fraudulent inducement to execute the note because the judgment debtor failed to provide sufficient "operative facts" in its affidavit.  Other Ohio Courts of Appeal also upheld denial of relief from cognovit judgments on the grounds that insufficient "operative facts" had been alleged.

Thus from the creditor's perspective, cognovit promissory notes will remain an important tool.  From the judgment debtor's perspective, taking care to be specific about the facts giving rise to a perceived defense seems likely to be particualry important.

UPDATE: To learn more about cognovit notes in Ohio, click here for my post on the basics.

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