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

This morning I went down to the weekly Franklin County Sheriff's Sale to bid on a property for a client.  I don't get down there for this sort of thing that much anymore - paralegals and clients themselves tend to take the duty - but it was interesting to see both what was the same and what had changed from when I was the designated attendee years ago.

In the "old days", i.e. more than 20 years ago, sheriff's sales in foreclosures really did happen on the courthouse steps in some places.  Here in Franklin County, Ohio, sheriff's sales in foreclosures were done in the lobby of the Common Pleas Courthouse by a burly looking guy standing behind an enormous wooden podium (which is actually still there) and wielding a gavel.  It was noisy and necessarily a tad uncomfortable because it was strictly a standing only event with no seats.  And there really was a bit of a sense of drama as folks milled around waiting for the sale to begin.  And the actual fall of the gavel was a nice touch too.

Today, Franklin County sheriff's sales in foreclosure cases take place in a large nice quiet carpeted auditorium/room on the first floor of the courthouse with plenty of seats for everyone.  Three women - substantially less intimidating than I remember the guy doing it years ago - run the sales from a podium on a stage raised about 6 feet at the front of the room.  Then there are about a dozen table desks, well spaced in 3 rows, for the "regulars" who attend the event every week and may be bidding on multiple properties.  And for the rest of us, a couple of rows of reasonably comfortable chairs set up behind the special desks.  It is obviously a far more sensible arrangement, but at least to me, it somehow just doesn't quite seem as "official"  -- although of course it is.

Promptly at 9 AM every Friday (the time and day for sheriff's sales vary from county to county), the foreclosure sales begin.  First, all of the properties being withdrawn from sale, mostly because of bankruptcy filings but also possibly because they have been brought current or for some other reason, are read in alphabetical order by debtor.  Then each property is called in turn, again alphabetically by the principal defendant owner.  (Other counties may use a different order.)  Since my case involved a debtor defendant whose name started with "W", I was there for quite a while... and began to really appreciate the progress represented by the provision of those chairs.

So what happens, exactly?  Each sale is announced in the same way:

• Big Bank v. Jones at 123 Columbus Street,
• [Case  No.] 08-XXXX,
• Attorney Rasmussen,
• Appraised $XXX,XXX,
• Deposit $XX,XXX [in Franklin County and many other  Ohio counties, this is at least 10% of the appraised value, although the plaintiff lender can require more], 
• Parcel No. XXX-XXX-XXXX

And then, a brief description mentioning the subdivision or other identifying information is mentioned, followed by the words: 

Commonly known as 123 Columbus Street.  I need an Opening Bid of $XXX,XXX [here in Ohio this would be two-thirds of the Appraised Amount]    

At this juncture, bidding is open to everyone in attendance.    Sheriff's sales are open to the public.  It is not necessary to be an attorney, or even a paralegal, to bid.  Nor do you even have to be a resident of Ohio.  You do not have to register in advance, or even on the day of the sale,  to attend or bid.  You do, however, have to be there in person.  Eventually, sheriff's sales may carch up with technology, but for now there's no bidding by telephone or on-line and no streaming video of the sales as they happen. 

For most properties, there's not much interest.  Sometimes even the foreclosing plaintiff lender doesn't bid.  In these cases, the words "No Bid, No Sale "are intoned and the property will be reappraised at a lower value and offered for sale some subsequent Friday.   If, as often happens, the plaintiff lender makes the opening bid at the required minimum amount (and ocasionally for a bit more) and everyone else sits on their hands, the representative of the Sheriff's office simply says "Sold to the Plaintiff for $XX".

In the relatively rare situation in which there actually is some interest in the property being offered at foreclosure sale, bidding begins at the minimum bid amount, frequently kicked of by the plaintiff lender, and it goes from there.  There is no "auctioneer" in the sense of someone rattling on trying to coax higher bids as you might see in an ordinary auction.  Rather interested bidders simply speak up and the Sheriff's representative repeats the amount and pauses to see if anyone else wishes to place a higher bid.    If bidding gets bogged down, certain minimum increments may be imposed, but for the most part, bidding increases in the amounts desired by those bidding.  When it appears that no one wishes to place a higher bid, the iconic words "Going once, going twice, sold to... " are spoken, bringing the sale to an end.

At this point , the successful bidder must bring his properly completed Real Estate Judicial Sale Purchaser information Form and a Cashier's Check (no personal or company checks permitted except for lienholders) in the amount of the required deposit to the front of the room and hand it to the Sheriff's representative.  THIS MUST HAPPEN IMMEDIATELY - there is no waiting for the successful bidder to "go out to their car"  or over to the nearest bank branch to get the check - IMMEDIATE means NOW and if the deposit check isn't forthcoming or the paperwork is otherwise not in order for some reason, the property will be immediately resold right then and there!  (That actually happened once today although I don't know exactly what was wrong.) 

And then it's over.  No gavel now...  they just move on to the next property.  It's then up to the plaintiff lender's attorney to prepare a Confirmation Order within 3O days naming the successful bidder and specifying how the proceeds of sale are to be distributed in accordance with the applicable priority of the various lienholders.  The sheriff's deed conveying the real estate to the successful bidder and new owner must be prepared within 7 days after entry of the Confirmation Order and submitted to the Sheriff's office.  Sometimes it can then take quite a while after that before the deed actually gets recorded.  Once the Confirmation Order is entered by the Common Pleas Court, there is NO EQUITY OF REDEMPTION allowing the defendant to regain possession of the real property and the sale is final.

For more information about how Sheriff's sales are conducted here in Franklin County, Ohio, visit  the Franklin County Sheriff's website and click the "Civil Real Estate Sales" button on the left hand side of the page.   You can also find lists of properties to be sold at upcoming foreclosure sales, as well as the results of recently completed sales here - the results from today's sale were up by lunchtime.  Because Ohio's foreclosure law has recently changed, it may also be worthwhile to review the informational WHAT YOU NEED TO KNOW AS A POTENTIAL THIRD PARTY PURCHASER material made available there.

All in all, a fairly interesting Friday morning.

For another person's account of the experience, visit A Trip to the Franklin County Sheriff's Weekly Real Estate Auction.

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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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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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