THE NEED FOR FORECLOSURE PROCESS UNIFORMITY
Revisiting The Uniform Nonjudicial Foreclosure Act
The current law in the United States, with respect to foreclosures, can hardly be described as uniform. Some state laws require lengthy judicial proceedings, while others merely require expeditious non-judicial steps. These procedural differences are further exacerbated by various state post sale laws which may include requirements for ratification or confirmation as well as other provisions permitting redemption or disallowing deficiency judgments. One would think that such a dichotomy would not exist today as a result of the adoption of the Fannie Mae/Freddie Mac Uniform Loan Instruments as well as the adoption of various national uniform disclosure laws that apply during origination. Because of this dichotomy, the National Conference on Uniform State Laws, drafted the Uniform Non-judicial Foreclosure Act (UNFA), which attempts to create uniformity for lenders and services handling national loan pools. The UNFA balances the need for prompt and efficient non-judicial sales of property securing loans, while also affording various safeguards for borrowers. The UNFA was approved by the American Bar Association on February 10, 2003. Because, many States will not adopt the UNFA, Congress should consider its enactment.
As background, approximately forty percent of states utilize a judicial foreclosure process. Judicial foreclosures entail lengthy procedures, including the filing of a Complaint with the appropriate court, service of process, a hearing and the entry of a decree or judgment. Thereafter an auction is generally handled by a Sheriff. This process is almost synonymous with additional expense to lenders and redeeming borrowers as well as delay.
The remaining states, including Maryland, constituting a majority, utilize “power of sale” foreclosure provisions contained in loans documents. After notice is provided, a foreclosure occurs without any or only minimal court involvement at a public sale held by a Sheriff or trustee. Less court involvement translates into a more efficient process, which can be completed in a fraction of the time that a costly judicial foreclosure entails. A review of the Freddie Mac guidelines for servicers, clearly demonstrates the time savings found in non-judicial states, such as Georgia, Virginia, or Texas. Reduced time reduces cost to both borrowers and lenders.
Maryland requires the filing of an Order to Docket and other pleadings, but minimizes the need for Court hearings and service of process. Instead, notice must be given to reasonably ascertainable parties as established in Island Financial v. Ballman, 607 A.2d 76 (1992) and later adopted by statute. This has sometimes been called a quasi-judicial proceeding, the purpose of which is to balance the competing interests of the parties.
Once the foreclosure sale occurs, almost half the states have additional procedures. Statutory redemption, which exists in many states, allows a mortgagor and junior lien-holders up to a year or longer to regain title after foreclosure. The lien-holder regains title by paying the sales price, plus interest and various expenses. This concept exists in both judicial and non-judicial states. Typically, the defaulting mortgagor can remain in a property during this period, which consumer protectionists applaud, as it provides a mechanism for the mortgagors “last chance” to refinance and save their property. That said, an argument can also be advanced that the right of redemption suppresses bidding and lowers prices since the bidder must wait for the redemption period to expire or alternatively to pay additional monies to the mortgagor in an attempt to obtain their waiver of this period. Maryland does not permit redemption, but instead requires court ratification of a sale after a short period during which the mortgagor can assert arguments as to legal deficiencies in the specific action
The treatment of mortgagor personal liability resulting from post foreclosure deficiency judgments is another large difference found in various state laws. California bars the pursuit of deficiency judgments, while other states, including Maryland permit such judgments. About half of the states, require a creditor to obtain a judgment for the amount of the mortgage first, before pursuing sale of a property, and an attempt must be made to collect against other assets. Other states adopt an election of remedies theory, under which only one legal action can be chosen. Some states also limit the deficiency judgment to the difference between the mortgage debt and the fair value of the foreclosed real estate as opposed to the difference between the debt amount and foreclosure sale price. It can be argued that limitations on deficiency judgments, increase the cost of loans held in large securitized mortgage pools, which others are paying as a result of increased interest rates.
Several attempts at uniformity have been considered. The National Conference on Uniform State Laws promulgated several acts, starting in 1927 with the Uniform Real Estate Mortgage Act, and in 1940 with the Model Power of Sale Foreclosure Act. No states adopted these Acts. In 1985, the Conference promulgated the Uniform Land Security Interest Act. This Act also failed to be adopted by a single state even though it was intended to become the equivalent of the Uniform Commercial Code (UCC) for the mortgage industry. The Act contained provisions for power of sale proceedings, restricted deficiency judgments to non-residential borrowers and redemption procedures were abolished.
In 1997 the American Law Institute created the Restatement (Third) of Property: Mortgages, in another attempt to achieve the same goal. This was met with somewhat greater success, in that several state courts adopted various provisions. Adoption of its provisions is dependant on individual litigation on each of the issues in each of the states in order to obtain national unity. That process is fraught with extensive delay and no assurance of universal adoption.
In an attempt to create uniformity, Fannie Mae and Freddie Mac, published many note and mortgage forms. Although the uniform document contains language specific to each applicable state, it incorporates numerous uniform provisions. These documents, through contract, have achieved some consistency with casualty insurance issues.
Finally, Congress has proposed and enacted many other substantial pieces of legislation. One attempt occurred with the Federal Mortgage Foreclosure Act which was a part of the Housing Act of 1973. This Act was intended to apply to any mortgage made, owned, insured or guaranteed by any federal instrumentality and would have invalidated state statutory redemption rights. Congressional approval, however, was not obtained. Congress, however, was successful with the Truth-in-Lending Act of 1968 (TILA) and the Real Estate Settlement and Procedures Act of 1974 (RESPA). These Acts provided uniform disclosure requirements, regulated amounts held in mortgage escrow accounts, and restricted the payment of fees in connection with settlement services. Congress also successfully enacted the Depository Institutions Deregulation and Monetary Control Act which preempted state usury laws for all federally regulated loans. It also enacted the Garn-St. Germain Depository Institutions Act of 1982, rendering enforceable the due on sale clause and the Alternative Mortgage Transactions Parity Act of 1982 which authorized among other items, adjustable rate and reverse annuity mortgages. Finally, Congress successfully enacted the Multifamily Mortgage Foreclosure Act of 1981 and the Single Family Mortgage Foreclosure Act of 1994. These bills provided procedures for non-judicial forecloses for federally insured and other mortgages secured by property other than one to four family dwellings held by the Secretary of HUD and for HUD held mortgages on one-to-four family residences. They also preempted state anti-deficiency and statutory redemption provisions. The procedures contained in these Acts are substantially similar to those procedures utilized by Maryland with the exception of notice requirements to junior lien-holders.
The Foreclosure Sale
In an attempt to create uniform procedures, the UNFA proposes maintaining non judicial foreclosure auctions as the method of choice but creates two additional methods of sale. That is, foreclosure by negotiated sale and foreclosure by appraisal. The fundamental premise of this Act is that, in the great majority of foreclosures actions, judicial involvement is unnecessary since there is no dispute between the debtor and creditor. Neither the documents nor the amount of debt or payment history is in contest. Of course there are cases in which a defense exists and deserves to be heard, but it makes little sense to force all foreclosures into court because a small fraction of them involve disputes of law or fact. It was felt that using courts to conduct routine foreclosures is often a misallocation of public funds as well as a waste of resources. This seems to be the same reasoning Maryland utilized.
The drafters also felt that the delays and inefficiency associated with judicial foreclosures are costly in many other ways too. They increase the risks of vandalism, fire loss, depreciation, damage, and waste. The resulting costs raise the prices of private mortgages and erode the economic value of government subsidy programs. They also increase the amount of real estate owned (REO) properties and the problems such property cause. The availability of a uniform, less expensive, and more expeditious foreclosure procedures also serves to facilitate the secondary market sale and resale of real estate loans.
Non-judicial foreclosure auctions offer the advantage of efficiency and simplicity. They are an effective method of transferring a property to a lender at minimal expense. That said, auctions do not typically result in obtaining maximum market values because information about a property is lacking and prospective bidders are typically not able to inspect a property before purchasing. Bidders are also not purchasing subject to financing contingencies, financing availability and settlement incentives typically available in general market processes. Shorter marketing times also limit potential buyers to those who actively review legal advertisements and are also in the market on the auction date. Substantial deposits are given at the time of auction and the balance must be satisfied within a short period. Preparation is required and without assurance that a bidder in fact will be successful, discouragement of non professional or knowledgeable purchasers is inherent.
Arguments can also be advanced that the auction system causes mortgagors to relinquish claims to their equity. From the mortgagor’s prospective, unless the property has a value of at least twenty (20%) percent or more above the debt amount, the mortgagor has no reasonable expectation of receiving any surplus funds. Auction purchasers are generally unwilling to bid any higher amount. Since most lenders do not pursue deficiencies in the event of a short fall, consumer complaints have not been sizable. On the other hand, arguments can also be advanced that where there are special circumstances such as marital problems, illness or a slow real estate market, the interests of the home owner are not served by a quick foreclosure process.
In an attempt to improve the non-judicial auction system, the UNFA sets forth a twofold alternative approach. First, it provides that additional title and other specific property information should be provided to all prospective bidders. This reduces expense duplication for bidders as well as provides potential purchasers with knowledge concerning the property. The drafting committee did not want to name specific information to be provided. The idea was to leave the decision to lenders without creating any new requirements for additional documents.
The second improvement contained in the UNFA deals with inspections. A major limitation of an auction is the buyer’s lack of access to the property prior to the sale. As a result, bidders determine their maximum bids based on a worst case analysis. Requiring inspections, as a practical matter, is difficult as it conflicts with the “lien theory”, that is the property belongs to the mortgagor until it is conveyed voluntarily or involuntarily. The UNFA proposes to achieve inspections by encouraging mortgagors to permit access to their property by eliminating deficiency judgment liability when the mortgagor acts in good faith. Acting in good faith includes providing reasonable access to a home prior to auction. The mortgagor is informed of this beneficial provision in the notice of foreclosure.
The third improvement suggested was a minor amendment to expand the advertising and marketing of a property. The UNFA requires that an advertisement run once a week for the three weeks prior to the auction, a requirement already required in some states, including Maryland. It also provides, that the advertisement “may” contain any other information about the collateral and that a sign be posted on the property, although this may embarrass homeowners who eventually cure their arrearage. Finally, the drafters provided a comment stating that the foreclosing creditor may post information about the sale on an internet site that provides information about foreclosures, whether the site is operated by a private party or by an entity of state or local government.
The fourth and final improvement provided for in the UNFA was the elimination of statutory redemptions, which currently exist in approximately half of the states. Since it is impossible for bidders to know whether they will ultimately be successful after tendering a bid because of the right of redemption, little effort is made to improve a property until the period expires. This leads to neighborhood blight and waste. The theory of redemption was developed as a pro-debtor provision to allow former owners one “last chance” to save the property. It was also thought that bid prices would increase and as a result the former homeowner would be less likely to exercise their right of redemption. In actuality, because of the uncertainty of ultimately winning the bid, potential buyers tend to bid less. As a result the drafters felt that the right of redemption should be eliminated.
Other alternatives to foreclosure were also provided by the UNFA. The first alternative is the negotiated sale. Under a foreclosure by negotiated sale, the foreclosing creditor can list a property with a real estate broker and advertise it in magazines and newspapers. The contract would be contingent on the homeowner failing to redeem by the auction date. When the lender is in receipt of a contract, the borrower is notified of the terms and the amount that would be credited to the debt. The credit can be 15% less than the contract price in order to compensate realtors as well as to cover marketing and holding expenses. A borrower once notified of the proposed sale has the right to accept or reject it. If the borrower accepts the offer or takes no action, the sale will take place. If the borrower objects to the sale within seven days before the sale date, then the sale is cancelled and the auction foreclosure method is utilized. Junior lien-holders are also provided notice and they too have the right to object. If they object, the foreclosing creditor may either pay off their balance or notify them that their lien will be preserved rather than extinguished by the foreclosure.
The second new method of foreclosure proposed by the UNFA is foreclosure by appraisal. This permits the lender to obtain an appraisal and provide a copy to the borrower along with an offer of a proposed net amount that the lender agrees to allow in return for taking title to the property. This method is useful for those properties that are either in poor physical condition or where a negotiated sale has been consummated under the first alternative. Similarly, junior lien-holders would be given notice and a right to object. If they object, the lender can either satisfy the recorded judgment or alternatively, proceed to auction.
In addition to an exemption from deficiency liability for residential borrowers who have acted in good faith, the UNFA proposes other protections for mortgagors. The act proposes a “meeting to object to foreclosure”. This allows the debtor to present his case to a reviewer and affords due process. The borrower must request such hearing in writing. The hearing does not have to be held in person, but can be held telephonically. The UNFA also requires creditors to make a “reasonable effort” to find a correct address for notification purposes. If a creditor learns that a notice was returned unclaimed or with a note that the address is no longer valid additional procedures must be undertaken to find the correct address. The comment suggests that reasonable effort would include using the forwarding address provided by the U.S. Postal Service, the use of a telephone directory and at least one internet search database. Notice of default and a 30 day right to cure is also maintained. The UNFA also requires that notice of foreclosure must be given to junior lien-holders and other interested parties. If notice is not given the foreclosure is valid but the lien remains.
The UNFA also deals with post foreclosure matters. With respect to surplus funds, that is sometimes left over when a home sells for more than its debt, the liens and other interests that previously attached to the real estate now attach to the surplus in the order of priority that they enjoyed prior to the auction. The UNFA does not provide guidance regarding whether surplus funds should be paid to all junior interests, including tenants and easement holders without the necessity of these types of interest holders filing additional pleadings. However, this provision is not substantially different from what is already required in many states, including Maryland.
The UNFA additionally, adopts a “Fair Value” limitation on deficiencies. First, if a foreclosing creditor chooses to foreclose under the UNFA, on a residential mortgagor who is in good faith, no deficiency judgment is available. If the UNFA foreclosure is against some other debtor, a deficiency judgment is available but it is subject to a 90 percent of fair market value limitation. That is if the foreclosure amount is less than 90 percent of the fair market value of the home at the time of the auction, the court will substitute 90 percent of the fair market value of the foreclosure amount in determining the deficiency. This serves to significantly reduce deficiency liability and brings its provision into closer parity with various other states. In any event, the UNFA is contrary to California’s anti deficiency statutes and the deficiency bars for purchase money mortgages found in other jurisdictions and its adoption would cause these states to change their body of law.
UNFA clearly represents a new way of unifying and simplifying the disjointed laws that currently exist across this nation. The mortgage industry clearly has a substantial impact on the national economy. In an era of national pools and securitizations, unification would be beneficial. The UNFA proposes an innovative, flexible, efficient and simple foreclosure system, which is deserving of review. It balances the interests of lenders while providing fairness and protection to borrowers. Because of the differing philosophies in various States, the chance for its eventual enactment by each state is not great. That said, given the growth of the secondary market for mortgages, a compelling case can be made for its adoption by Congress.