January 2008

FRAUD

Home Loan Corp. v. Texas American Title Insurance Company, C.A. No. 14-03-01131-CV

On June 1, 2007, the Texas Supreme Court denied the petitions for review filed by Home Loan Corporation (Home Loan) and Texas American Title Insurance Company (TATCO) appealing the decision from the Houston Fourteenth court of appeals styled Home Loan Corp. v. Texas American Title Insurance Company, C.A. No. 14-03-01131-CV. TATCO filed a motion for rehearing in the Texas Supreme Court, but the court denied that motion as well. Consequently, the TATCO case is now the law in Texas.

From the title insurance industry's perspective, the TATCO opinion creates a disturbing precedent for current and future lender litigation for losses arising from real estate closings. In TATCO, the transaction was fraudulent, though no proof established that the escrow officer knew of the fraud. Instead, Home Loan relied on evidence that the escrow officer requested, post-closing, to divert half of the net sale proceeds to the mortgage broker. In accordance with the seller's instructions, TATCO wired the funds to the owner of the mortgage broker company, but failed to notify Home Loan of the disbursement. Instead, the HUD-1 merely indicated that net sale proceeds were to be paid to the seller. In suing TATCO, Home Loan argued TATCO had a duty to disclose the re-direction of sale proceeds due to its fiduciary relationship to the lender. Home Loan claimed that, had it known of the request for transfer of sale proceeds to the mortgage broker, it never would have funded the loan. Significantly, Home Loan already had funded the loan when the seller made the request to send sale proceeds to the mortgage broker. The appellate court apparently did not find this fact important in its decision.

In holding that TATCO owed an unfettered fiduciary duty to the lender, the Houston court of appeals found that TATCO was obligated to disclose all facts material to the lender's decision to loan money to the buyer. While TATCO was not in the best position to determine the materiality of information to Home Loan, the court applied a reasonable lender standard to materiality. Since Home Loan presented evidence that information about the requested transfer of sale proceeds was material to its lending decision, the court found that TATCO should have disclosed this information to the lender. As such, its failure to disclose the information constituted a breach of fiduciary duty and subjected TATCO to liability for Home Loan's losses.

Given the current state of the law based on the TATCO opinion, closers should be aware of this important decision and the impact it may have on future closings. To safeguard against similar claims in the future, closers should only disburse funds in a manner consistent with the HUD. Any post-closing requests from payees for re-direction of sale proceeds must be disclosed, in writing, to the lender in advance of payment. To be sure, transparency of the transaction will be vital to prevent lenders from relying on the TATCO decision to shift the liability to the title company on fraudulent transactions. Further, closers must recognize the high degree of care which the fiduciary role places upon them. Without question, lenders will seize on the TATCO decision to support their claims against escrow officers.

HOME EQUITY

Marketic v. U.S. Bank Nat'l Ass'n, 436 F. Supp. 2d 842 (N.D. Tex. 2006)

In Marketic v. U.S. Bank Nat'l Ass'n, 436 F. Supp. 2d 842 (N.D. Tex. 2006) the borrower removed the designation for agricultural use on the tax roll for her ranch property, and, after closing a home equity loan, redesignated the property for agricultural use on the tax roll. The court decided that homestead property, if subsequently re-designated for agricultural use by a borrower of a home equity loan, is protected from forced sale under Section 50(a)(6)(I), regardless of how the property was designated when the borrower incurred the debt. The court outlined several reasons including the following:

The Texas Legislature must have known that a property's designation may vary from year-to-year and, therefore, had the legislature intended for the property tax designation to be relevant only at the time the "debt" underlying the foreclosure action was incurred, it would have written such a condition into the constitutional text.

The court found nothing in the legislative history to indicate it was the Legislature's intent that the only relevant property tax designation is at the time the loan was executed.

The court also noted the following:

The amendment does not prevent homestead property designated for agricultural use from being pledged as collateral for a home equity loan; it merely "protects" the homestead property from "forced sale." See Tex. Const. art. XVI, § 50(a)(6)(I). In this regard, § 50(a)(6)(I) places the risk on the lender to ensure that any homestead property that may be securitized as collateral for a loan will not be designated for agricultural use in the event of foreclosure.

Furthermore, because this Court is a federal court, its interpretation of § 50(a)(6)(I) on this narrow

issue of law is not binding precedent in the Texas state courts.[*] Because Marketic has presented evidence that the property is currently designated for agricultural use, the Court finds that a genuine material issue of fact remains on *whether the land subject to US Bank's lien qualifies as land that is designated for agricultural use and is therefore immune from foreclosure. Accordingly, the Court denies Defendant's motion for summary judgment on this issue.

In Marketic, the court also addressed "discount fees" for purposes of the three percent fee limit under Section 50(a)(6)(E) and concluded they were interest rather than fees. The court stated:

The Court disagrees with Plaintiff's analysis. As Defendant correctly notes, the 3% percent cap on fees was not exceeded because the $3,900 that Marketic paid for discount points qualifies as "interest" under § 50(a)(6)(E). In Texas, "discount points" that are charged to originate a home-equity loan are not "fees" related to the origination of the loan for purposes of § 50(a)(6)(E), as long as the points are charged at the beginning of the loan term and were paid in consideration for a lower interest rate on the outstanding debt. See Tarver v. Sebring Capital Credit Corp., 69 S.W.3d 708, 712-13 (Tex. App.-Waco 2002, no pet.)(holding that discount points do not qualify as "fees" because they are not charged to "originate, evaluate, maintain, record, insure, or service the extension of credit.")(citing Tex. Const. art. XVI, § 50(a)(6)(E)). Instead, such payments qualify as "interest" for purposes of § 50(a)(6)(E), even though both points and interest may be computed on the principal amount of the loan. Id.; accord, Pelt v. U.S. Bank Trust Nat. Ass'n, 2002 WL 31006139*4 (N.D. Tex. 2002).

In order to address this issue, a Constitutional Amendment was submitted to the voters November 4, 2007 and passed. It became effective December 4, 2007 and amended the Constitution as follows:

Section 50(a). The homestead of a family, or of a single adult person, shall be, and is hereby protected from forced sale, for the payment of all debts except for: (6) an extension of credit that: (I) is not secured by homestead property that on the date of closing is designated for agricultural use as provided by statutes governing property tax, unless such homestead property is used primarily for the production of milk. Additionally, the Texas legislature amended Section 23.42 of the Texas Tax Code to prohibit the designation of land for agricultural use if it is subject to a home equity loan described by Section 50(a)(6), Article 16, Texas Constitution. This is effective January 1, 2008.

[*] Id. In an Order dated July 14, 2006, denying the Defendant's Motion for Reconsideration, the court again repeated the non-binding nature of its decision and states "More significantly, the Court explicitly stated in its memorandum opinion that its interpretation of § 50(a)(6)(I) was not binding precedent anywhere in the state of Texas and anticipates that the issue will be ultimately decided by the Texas state courts."

HOME EQUITY

LaSalle Bank National Ass'n v. White

In LaSalle Bank National Ass'n v. White,[1] the court addressed whether the home equity loan was secured by homestead property designated for agricultural use and, if the home equity loan was constitutionally invalid, whether the bank was entitled to equitable subrogation for the portion of the loan proceeds used to pay the borrower's purchase money lien and outstanding property taxes. A short summary follows.

The court considered whether the home equity loan was secured by homestead property designated for agricultural use. The property, with the exception of one acre, was "qualified open-space land" and was valued under Subchapter D of the Texas Property Tax Code. The court concludes "that article XVI, section 50(a)(6)(I)'s use of the phrase 'designated for agricultural use as provided by statutes governing property tax' refers to land put to an agricultural use as defined by, and assessed for tax purposes under both subchapter C and subchapter D of the Tax Code."[2] (See Tex. Prop.Tax Code ch. 23, Subchapters C and D.) The court held that "Because White's land was 'designated for agricultural use as provided by [subchapter D of] ... [the] property tax override protected bool RequireAuthenticatedUser { get { return false; } } override public Guid ContentRecordKey { get { return new Guid("a18e54cb-db52-48a2-9b22-88d1a4f46607"); } } override public Guid ContentHierarchyKey { get { return new Guid("66faaad0-c11a-4841-9a61-3ae88aed3696"); } } protected override void EnsureChildUserControls() { base.EnsureChildUserControls(); Asi.Web.UI.IUserControl childUserControl; Guid key; AddChildUserControl(ContentPage1); childUserControl = ciNewContentHtml as Asi.Web.UI.IUserControl; if (childUserControl != null) AddChildUserControl(childUserControl); key = new System.Guid("0ce3c6c4-5b7c-4e8c-8a7d-6b3031af2826"); if(!ContentItemKeyMap.ContainsKey(key)) ContentItemKeyMap.Add(key, ciNewContentHtml); },' the Texas Constitution prohibited it from being used as security for a home equity loan."[3]


The court also initially found that the doctrine of equitable subrogation was not eliminated by Section 50(e) and held the bank entitled to equitable subrogation.[4] The dissent argued "The doctrine of equitable subrogation should not be applied to circumvent the constitutionally – mandated penalty of forfeiture."[5] On October 11, 2006, the opinion was withdrawn by an en banc decision, with 2 justices dissenting. The Court declined to permit equitable subrogation finding that the Constitution mandated the penalty of forfeiture. On December 21, 2007 the Texas Supreme Court issued a per curium opinion (no oral argument) and reversed the Court of Appeal's

judgment in part, finding that the forfeiture penalty did not preclude the lender's recovery of the refinanced portion pursuant to principals of equitable subrogation. The principal, interest, and liens related to the cash out portion of the loan were forfeited pursuant to Section 50(e) of the Constitution.

The Court of Appeals and Supreme Court opinions can be criticized in connection with their application of Section 50(e), which many would argue is not a forfeiture provision. Section 50(e) was intended to permit the common practice of rolling in reasonable closing costs and securing them with a lien, but not requiring that they be subject to a home equity loan. There are other provisions dealing with forfeiture in the home equity loan context, Section 50(a)(6)(x), which neither the appellate court nor the Supreme Court addressed.


Accordingly, for now at least, one should treat any designation on the tax roll for agricultural use (except dairy) or open space and the like under both Texas Tax Code Chapter 22 Subchapters C and D as prohibited property for home equity loans. Moreover cash out refi home equity loans must still receive careful examination and treatment because of the need to preserve evidence and the ability to prove up equitable subrogation also recognizing that the cash out amounts are subject to forfeiture for failure to comply with the Texas Constitution.

[1] No. 04-05-0054-CV, 2006 WL 1152337 (Tex. App.-San Antonio May 3, 2006, pet. for reh'g filed May 18, 2006, opinion withdrawn and substituted by en banc court (2 justices dissenting), October 11, 2006)
[2] White, 2006 WL 1152337 at *3.
[3] White, 2006 WL 1152337 at *4.
[4] See also, Langston v. GMAC Mortg. Corp., 183 S.W. 3d 479 (Tex. App.-Eastland 2005, no pet.) (applying equitable subrogation to enforce home equity lien).
[5] White, 2006 WL 1152337 at *6.

HOME EQUITY

Michael Curry and Tammy Curry v. Bank of America, N.A.Court of Appeals Number: 05-06-00065-CV, 2007 WL2325522 (Tex. App.–Dallas Aug. 15, 2007, no pet).

This decision of the Dallas Court of Appeals is very helpful to mortgage lenders and title insurers.

The Currys sued Bank of America (the "Bank"), seeking a declaratory judgment that their Texas Home Equity Loan and resulting lien were void for failure to comply with the home equity provisions of the Texas Constitution. The trial court granted summary judgment in favor of the Bank. The Fifth Court of Appeals affirmed.

The Currys first notified the Bank through letters and their initial pleading that their loan was invalid under the Texas Constitution without specifying why their loan was invalid. Much later on in the litigation, through an amended pleading, the Currys argued that the loan was invalid because it was not closed at a title company, an attorney's office, or at the Bank. The decision of the Dallas Court of Appeals cannot be better stated than the court's own language:

Applying the appropriate standard, we conclude the Currys failed to meet their burden because they did not conclusively establish they notified the Bank. . . .

The letter, however, did not contain any factual basis or details in support of this "preliminary determination." Although the home equity provisions are silent as to the extent of notice the borrower must give, we conclude the Currys needed to do more than make a general allegation and had to describe how the loan is non-compliant. . . . To determine how to cure its noncompliance, a lender must be aware of what that non-compliance is. . . .it would defeat and render meaningless the requirement that the borrower notify the lender of defects if the borrower needed to merely state, without detail, that the loan was infirm. Although section 153.91 [of title 7 of the Texas Administrative Code] was enacted and became effective after the Currys filed suit, we note it provides that notice is adequate under the cure provision if it "include[s] a reasonable description of the alleged failure to comply . . . ." The Currys' November 24 letter containing no factual basis or details is inadequate and their contention that it satisfied the notice requirement is without merit. Because the Currys failed to conclusively establish they notified the bank and the bank conclusively negated this element, they have failed to satisfy their burden and we do not need to address whether the Bank's offer to cure satisfied its obligation to cure.

Accordingly, the trial court had not erred in granting the Bank's motion for summary judgment.

FIRST LOAN

Daniel K. Fix and Barbara J. Fix v. Flagstar Bank, FSB; First American Title Insurance Company of Texas; Court of Appeals Number: 02-07-00030-CV

Decided by the Second Court of Appeals Fort Worth (November 21, 2007). The Westlaw cite for the Opinion is 2007 WL 4126919. It has not yet been put into the Southwest Reporter, but it eventually will be. Westlaw does not indicate that the Fixes have filed any petition to the Supreme Court.

On March 29, 2002, the Fixes executed a Texas Home Equity Note ("First Loan") in the original principal amount of $288,000.00 to Liberty Lending in exchange for $264,242.64 in cash, $13,769.53 that was applied to pay off the existing purchase-money mortgage, and $9,987.83 that was applied to settlement charges. It is undisputed that the First Loan established a valid Texas Home Equity Loan as provided by the Texas Constitution. The First Loan was secured by an undisputed First Lien on property in Denton County (the "Property"). On January 17, 2003, Appellants executed a Promissory Note to Flagstar in the original principal amount of $287,000.00 ("Second Loan").

The Second Loan was a refinance of the First Loan. On their Uniform Residential Loan Application dated January 17, 2003, submitted to Flagstar in support of the Second Loan, the Fixes requested that the Second Loan be used to refinance the First Loan and specifically identified the Property as collateral. The unpaid balance on the First Loan of $285,794.00 was reported in the Schedule of Liabilities, naming "Flagstar Bk" as the mortgage holder.

At closing, the entire amount of the second loan was used to pay off the First Loan and property taxes, both of which were valid liens against the homestead.
Unfortunately, the second loan was closed within one year of the First Loan, and the second loan was closed with a "conventional" Note and Deed of Trust.
In the executed Deed of Trust and Rider to the Deed of Trust Renewal and Extension Agreement for the Second Loan, the Fixes and Flagstar expressly agreed that principles of contractual subrogation would apply to the Second Loan.

 The Fixes claimed that the Second Loan is invalid under the Texas Constitution because it omitted required notices and was closed prior to the first anniversary of the closing of the First Loan. They argued this should result in Flagstar's forfeiture of all principal and interest on the Second Loan.
Assuming Flagstar's loan to the Fixes violated the home equity loan provisions of the Texas Constitution, Flagstar contends it timely offered to cure the violation. Thus, Flagstar argues that it was protected from the forfeiture provisions of the Texas Constitution. An issue of contention on appeal was whether the Fixes could give notice of non-compliance to Flagstar orally and whether the alleged oral notice was sufficient to put Flagstar on notice of its non-compliance.

Flagstar further contended that separate and apart from the proper offer to cure, it is entitled to the application of the doctrines of legal and equitable subrogation. Under these doctrines, Flagstar would be entitled to step into the shoes
of the prior lender to the extent Flagstar paid off the prior loan and taxes. In this case, the amount of equitable and contractual subrogation is essentially the same as the amount of the Second Loan.

In their lawsuit the Fixes claimed:
  1. That Flagstar cannot avoid the penalties imposed by the Constitution by claiming to be subrogated to prior loans.
  2. That Flagstar failed to timely cure after notice of the violations.
  3. That Flagstar failed to cure within a reasonable time under an earlier version of the Constitution or failed to cure within sixty days under a more recent version of the Constitution. Flagstar took the opposite position on all points raised by the Fixes.
Both the Fixes and Flagstar filed Motions for Summary Judgment, and the 16th District Court of Denton County granted the Motion of Flagstar and denied the Motion of the Fixes.

The Fixes appealed to the Second Court of Appeals in Fort Worth, and the Court heard oral argument on October 16, 2007. On November 21, 2007, the Court issued its opinion.
The Court first held that because the Second Loan was executed in January 2003, the September 2003 amendment to Texas Constitution article XVI, ' 50(a)(6)(Q)(x) was inapplicable. The Court refused to apply the constitutional amendment retroactively. The 2003 amendment added specific ways a lender could cure a home equity loan's constitutional violation and requires a lender to cure within sixty days.As a result the Court applied the pre-2003 amendment version of the Texas Constitution to the case. Although the Court noted that "explicit provisions" of the Fix-Flagstar contract required written notice, the Court assumed that Fix's oral notification of the loan's defects was sufficient. The Court further noted that Flagstar and First American responded, at the latest, three months from this notice. The Court then went on to hold that the Flagstar and First American's offer to cure occurred within a reasonable time period. Therefore, Flagstar and First American prevailed.

 Because Flagstar and First American prevailed on the "cure" issue, the Court did not have to address the parties' arguments regarding whether the Doctrines of Contractual and Equitable Subrogation can be applied in a home equity loan case. If the Court had held against Flagstar and First American on the cure issue, and had held that subrogation applied, Flagstar would have had a valid lien against the Property in the original amount of $287,000.00 less payments made in the meantime. If the Court had held that subrogation did not apply, Flagstar, as title insurer, would have forfeited principal and interest and would have had no lien no against the Property even though all of the funds went to pay off valid liens. Under the scenario, the Fixes would have received a windfall of $287,000.00 less payments.

The similar subrogation case, of LaSalle Bank N.A. v. White is pending in the Texas Supreme Court. The TLTA filed amicus curiae briefs in both cases. Hopefully, the Texas Supreme Court will rule that subrogation does apply in a home equity loan case.