By Alan Steven Wolf of The Wolf Firm (Network News, March/April 1998)
Using pre-negotiating agreements
By Alan Steven Wolf of The Wolf Firm Today, the buzzword in loan servicing is "loss
mitigation." After years of pushing their servicers to foreclose, investors awoke one
day to discover that foreclosure is expensive. Indeed, the major investors found that the
average foreclosure results in literally tens of thousands of dollars in losses, and
extrapolated over entire portfolios, these losses translated into billions of dollars.
THERE ARE RISKS
Alarmed by these findings, and almost in unison, investors and
governmental agencies jumped on the loss mitigation bandwagon, pushing, pulling,
threatening and enticing the servicing community to develop loss mitigation departments
and to pursue alternatives to foreclosure, including forbearance plans, loan
modifications, short sales and deeds-in-lieu of foreclosure. The cause has taken on
religious undertones. You can not go to a mortgage industry conference, read a trade
journal or talk about servicing and escape the words "loss mitigation." It is
now an integral part of every servicing operation. And it has worked. The losses suffered
today are minute in comparison to the losses suffered just five years ago. Loss mitigation
is good, very good.
Unfortunately, the tremendous strides made in loss mitigation are not
without risks, and residential loan servicers seem to have forgotten the hard-learned
lessons of their commercial/multifamily brethren. Faced with similar problems in the late
80's and early 90's, commercial/multifamily investors and servicers pursued loss
mitigation with a fervor. In many ways, they perfected the techniques we use today on the
residential side. But a funny thing happened on the way to the mitigated losses, and it's
called litigation. Trying to reach a loss mitigation workout while simultaneously pursuing
foreclosure led to claims of deceptive practices and lender liability.
The case of Richter v. Bank of America,939 F.2d 1176 (5th Cir. 1991)
puts this problem into perspective. In Richter, the lender entered into negotiations with
the borrower for a workout of a loan and made a series of representations to the borrower
during the workout phase including statements that it "wanted to do a deal" with
the borrower, that it was "optimistic that [it] could reach an agreement,"
"we're heading in the right direction" and that "there were no
deal-breakers and they were going to bridge the gap pretty soon." The Borrower
claimed to have relied upon these statements despite the bank's repeated statements that
it could not "make any promises."
After the Bank foreclosed, the borrower sued, claiming in part, that
the lender had breached its duty of good faith and fair dealing by misleading the borrower
into believing that a workout could be achieved. The court awarded damages in excess of $3
million against the Lender finding that it had breached its duty to negotiate in good
faith toward a reasonable restructure of the loan and that it had committed fraud and
negligent misrepresentation by pursuing foreclosure while it taunted the borrower with a
prospective workout.
Does this mean servicers should cease all loss mitigation efforts? Of
course not. But servicers do need to be aware of the risks and should take steps to
protect their interests. Fortunately, those steps are relatively simply and effective.
The best and simplest advice is to "not speak with forked
tongue." Saying or suggesting that you will be pursuing loss mitigation in lieu of
foreclosure is just plain dumb. What has to be made clear is that you will be proceeding
with foreclosure without hesitation, and you will foreclose unless you have a writing
executed by both parties which sets forth an agreed loss mitigation alternative. You
should document that the borrower is not to rely on any possible loss mitigation result
and should take all steps to try to reinstate or pay you off. In short, you need to make
it clear that absent written evidence of an agreement to stop the foreclosure, the
foreclosure will proceed as scheduled.
CONSIDER THIS DOCUMENT
This understanding is crucial to the loss mitigation process and is an
important element missing from the residential side. After the numerous cases finding
lender liability when the lender "confused" the borrower by both foreclosing and
trying to do a workout, it became common for commercial and multifamily servicers to seek
this understanding prior to entering into negotiations with any borrower. The written
memorialization of this understanding became known as the "prenegotiation
agreement." Today, most commercial/multifamily lenders would not consider entering
into loss mitigation discussions without a signed prenegotiation agreement.
The protection afforded from lender liability alone makes the
prenegotiation agreement worthy of consideration. But the prenegotiation agreement has
evolved into much more. In addition to clearly defining the foreclosure/loss mitigation
dichotomy, the prenegotiation agreement is used as a tool to cure other, even unknown
potential problems; the agreement contains language waiving all of the possible defenses
to foreclosure. Thus, a typical prenegotiation agreement might contain the following
acknowledgments:
1. Loan balance, accrued interest and other charges and expenses
2. Validity, extent, enforceability and perfection of liens;
3. Identification of defaults
4. Acceleration of the debt
5. Demand for payment of outstanding indebtedness
6. Absence of any waiver, estoppel or release
7. Agreement that there have been no breaches of state and or federal regulatory
compliance and/or licensing laws
8. Agreement that there is no equity in the property for the benefit of the borrower
In short, the prenegotiation agreement attempts to make clear that if a loss mitigation
result cannot be achieved, there is no defense to the foreclosure. If possible a general
waiver of all claims, known and unknown should be inserted.
GET WHEN YOU GIVE
The key negotiation process is that default creates leverage. The loan
documents require that the borrower make payments, and if those payments are not made the
documents provide for relief through foreclosure. The loan documents do not require, nor
does the law impose a duty upon lenders do a workout. A workout is a voluntary act.
Don't give without getting! Don't negotiate a term less than immediate
foreclosure without getting something in return. And the return ought to be the protection
from litigation for all the potential issues that might be raised in defense of the loan,
including the issues described above. Why give the loss mitigation result without getting
this protection from the borrower? Put another way, why even enter negotiations where the
borrower's intent is to delay the foreclosure by claiming some defense to the instruments?
With a executed prenegotiation agreement, a lender can foreclose and
negotiate at the same time with little risk of lender liability issues and with little
risk that the borrower can raise defenses to the foreclosure action. Most borrowers,
desperate to work out a deal, will sign these documents without question. And even where a
borrower refuses to sign the prenegotiation agreement, the lender has benefited because it
is forewarned that the resolution of the loan is likely to be a problem case.
SERVICING BEARS THE COST
Given this analysis, a lender might wonder why prenegotiation agreements have not been
required by the major investors. The answer may lie in a simple exercise of business
judgment; that the risks of the borrower asserting lender liability damages or of the
borrower asserting foreclosure defenses, are far outweighed by the savings gained when
these cases resolve through typical loss mitigation techniques. In short, investors want
to mitigate their losses and are willing to take the risk that the process may sometimes
result in liability on their part. And they are probably correct in their analysis. After
all, it takes a relatively sophisticated borrower to raise these issues, and on the
residential side, the borrowers are much less sophisticated than those found in the
commercial/multifamily realm.
Nonetheless, when lender liability and foreclosure defense issues are
raised, it is generally the servicing that gets stuck with the costs. These costs include
the litigation fees, advances to the pool and administrative time involved in fighting
these cases. Servicers should consider protecting themselves from these actions by using
their leverage and seeking the prenegotiation agreements. When a borrower signs the
agreement, it almost assures a smooth path to foreclosure should the workout negotiations
end in failure. And when the borrower refuses to sign, the servicer knows it is in for a
fight, and it can take heightened action to protect itself and its asset.
For further information please contact:
The Wolf Firm, A Law Corporation, is an "AV" rated law firm which concentrates on providing superior legal services to the mortgage banking industry. The firm's national clientele includes many of the largest mortgage bankers in the country, as well as a variety of savings banks, commercial banks, commercial finance companies, credit unions, and the Resolution Trust Corporation. With a staff of approximately forty individuals, including attorneys, certified paralegals, legal secretaries, administrators, clerical personnel, and a full time computer systems analyst, the firm represents its clients on a wide range of matters including all aspects of both residential and commercial/multifamily mortgage loan origination and servicing, securitization, regulatory compliance, bankruptcy, and litigation related to the foregoing in both federal and state courts throughout California. For more routine matters, such as residential bankruptcies, evictions and receiverships, The Wolf Firm has developed extremely cost-effective and efficient programs using specially trained paralegals and computer technology to assist its attorneys in handling these matters at rates that are the most competitive in the State of California and, through its membership in the USFN, the Firm is able to arrange similar services in virtually every state in the nation.
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