In recent years, legal challenges to automated overdraft programs have centered on posting order to enhance fees, particularly high-to-low debit posting. We now have a good judicial decision from Missouri that involves a class-action where the plaintiffs allege that a state-chartered bank was violating the Missouri usury laws by charging debit card overdraft fees of $25 to $30. The Missouri court of appeals rejected those claims on the ground that debit card overdraft fees were not interest under the usury laws, but statutorily-permitted "service charges" imposed on a deposit account.
On October 16, 2016, a split panel of the D.C. Circuit ruled that the CFPB is unconstitutional because it violates the separation of powers. On January 31, 2018, the full D.C. Circuit reversed the panel and voted 7-3 to affirm the constitutionality of the CFPB, particularly its structure of a single director who can't be fired by the President without cause. PHH Corp. v. CFPB, 2018 U.S. App. LEXIS 2336 (1/31/18). Given the impact of the CFPB on bank deposit products and agreements, the new decision is significant indeed. In this story, we will review the October 2016 ruling, then come back to the full D.C. Circuit decision, primarily in the words of the court.
Background. Sheldon Fong (“Fong”) and his related associates had multiple commercial loan relationships with East West Bank (“Bank”). During the course of these relationships, in order to secure a personal loan obligation running in favor of Bank, he pledged his certificate of deposit in the amount of approximately $1,000,000.00 (“CD”). Additionally, in order to make loan payments or to pay off a loan, he authorized specific transfers from his personal money market deposit account (“MMDA”) or a certificate of deposit over which he had control (referenced by the Court as Fong’s certificate of deposit account registry service and defined as “CDARS”).
Electronic signatures are recognized by United States federal and state law. They can generally be challenged on two grounds: (1) that the parties did not intend to conduct the transaction by electronic means, or (2) that the E-signature was not the act of the purported signatory. If these can be overcome, then the signature is valid.
A Kentucky bankruptcy court recently held that a secured lender did not have a perfected security interest in hotel or restaurant revenue, thereby allowing a debtor to use cash from those operations without restriction. In re Lexington Hospitality Group, LLC, 2017 Bankr. LEXIS 3782 (Bankr. E.D. Ky. November 1, 2017). Yet the secured party had all the loan documents you would expect a secured party to have for this type of loan, and made only a modest, debatable mistake on its financing statement. We think the secured party missed some important points in arguing its position, and the court also missed these points in its analysis.
Every state gives creditors a post-judgment right to garnish a debtor's funds in a bank account. Federal law protects certain federal benefit payments from bank garnishment, but beyond that the states vary considerably in the protections they provide. Generally, the state protections are quite limited.
If a secured lender wants to hold a foreclosure sale of its collateral, often the best practice is to bring some expertise to bear. Following the directions of an expert in the type of collateral that is to be sold could protect the lender's right to a deficiency claim. This is particularly true when the collateral is unusual and the creditor has no experience in the area. A recent case from New York shows the benefit of using experts.
The GM bankruptcy case is the gift that just keeps on giving. First, there were five years of litigation on whether a mistaken termination statement covering a $1.5 billion secured loan was "authorized" within the meaning of Article 9 of the UCC. Then there was a legal malpractice suit brought by some of the secured lenders/investors against the Mayer Brown law firm which represented GM and whose paralegal made the mistaken UCC filing; the plaintiffs lost on the ground that they had no standing because Mayer Brown was not their counsel. Another interesting twist in the litigation was that, before the Second Circuit ruled that the mistaken termination statement was effect to wipe out the lenders' security interest, the lenders were allowed to receive full payment; thus, the unsecured creditors' avoidance action was transformed into a monstrous claw-back claim.
In our prior story, we reported on a recent Florida case where a governmental entity was held liable as an account debtor for double payment because it ignored a deflection notice sent by an assignee/factor of accounts receivable. UCC 9-406 was the critical UCC provision. Another recent Florida case applies the UCC 9-406 rules that the deflection notice passed muster under Article 9, but denied summary judgment in favor of the factor because waiver defenses raised issues of fact. Sometimes it seems like litigation comes in clusters.
Article 9 of the UCC codifies some ancient contract rules including the rule that, when a merchant assigns its accounts receivable to a factor, the account debtor must begin making payments directly to the factor if it receives a "deflection notice." Failure to deflect payment to the factor can impose big-time liability on the account debtor. But what if the account debtor is a governmental entity? Is it immune from having to pay twice—once to the merchant assignor and then to the factor? In a recent case from Florida, the court imposed double liability on a state agency (account debtor) that ignored the factor's deflection notice. We think the decision is correct, and that a 2005 Ohio Supreme Court decision is wrong.
On October 24, 2017, the United States Senate voted 50-50 to kill the CFPB rule that would ban arbitration clauses containing class-action waivers in consumer financial services contracts. Then, as President of the Senate, Vice President Pence broke the tie. It seems clear that President Trump will sign the disapproval resolution. In the end, it was a highly partisan vote, mirroring the deep divisions in the country as a whole. We suspect, however, that it was the issuance of a 17-page Treasury Department Report the day before the Senate vote that tipped the balance in favor of overturning the CFPB rule. The Treasury Report can be accessed at https://www.treasury.gov/press-center/press-releases/Documents/10-23-17%20Analysis%20of%20CFPB%20arbitration%20rule.pdf.
The holder in due course rule, which dates back centuries, allows a bona fide purchaser of a negotiable instrument to take the instrument free of claims and defenses. A common example is a check given for an underlying obligation such as the sale of goods. The payee of the check deposits it and takes off with the funds before the item has a chance to clear. When the drawer of the check discovers that the goods are defective, it immediately stops payment on the item. The check is dishonored and bounces back to the bank of first deposit, which can't charge it back against the payee's account because the payee has taken off for parts unknown.
On September 19, 2017, the Consumer Financial Protection Bureau (CFPB) released a "small entity compliance guide" relating to its newly effective arbitration rule. The arbitration rule – which was released this July and has since been met with industry criticism and controversy – prohibits certain financial services companies from relying on arbitration clauses to block class action lawsuits. As institutions of all sizes work to understand the rule and ensure their financial products and agreements are compliant by the mandatory compliance date of March 19, 2018, the release of a small entity compliance guide is a welcome additional resource for assisting smaller institutions such as community banks and credit unions with implementation of the rule's requirements.
Over the last five years, this newsletter has analyzed the huge litigation generated by a hard-working paralegal's mistaken filing of a termination statement covering the wrong secured loan—a term loan to General Motors in the amount of $1.5 billion. It was a colossal filing error. After trips to the Second Circuit and the Delaware Supreme Court, the result was that the mistaken termination statement, filed with the Delaware secretary of state, was "authorized" under the rules of Article 9. As a result, the unsecured creditors committee took a giant step in avoiding the big security interest under the strongarm clause of the Bankruptcy Code. In re Motors Liquidation Co., 777 F.3d 100 (2d Cir. 2015).
Securitized real estate mortgages continue to raise "standing" issues for secured lenders seeking to foreclose. The cases illustrate how the law of negotiable instruments under the UCC, including the use of allonges to substitute for indorsements on the note itself, is crucial for determining standing. A recent decision from Ohio illustrates the point. The court holds that allonges may be paperclipped to the note, without stapling. Therefore, the securitization trustee could foreclose on the mortgage. And in a recent case from Connecticut, the court okayed an allonge even though there was space for the indorsement on the note itself.
Over the last five years, we have seen some notable pieces of litigation around the country between "first-priority" real estate mortgages and condo homeowner associations (HOA) armed with state "super-priority" statutory liens for unpaid assessments. This priority litigation occurs after the owner of a condo or a coop apartment defaults on both the mortgage and the HOA assessments on the condo unit. Mortgagees are now coming to the realization that their "first-priority" mortgage may be wiped out by a "super-priority" claim of an HOA. A non-judicial foreclosure sale by the HOA could eliminate an entire mortgage that was recorded long before any HOA assessments were levied. Two of the leading cases are SFR Investments Pool I, LLC v. U.S. Bank N.A., 2014 Nev. LEXIS 126 (Nev. 2014) and Chase Plaza Condo Ass'n v. JP Morgan Chase Bank, N.A., 98 A.3d 166, 2014 D.C. App. LEXIS 317 (D.C. Cir 2014).
The Sixth Circuit recently issued a new ruling in the famous Purdy case that has been the subject of two prior articles in this newsletter. In re Purdy, 2017 U.S. App. LEXIS 16735 (6th Cir. Aug. 31, 2017). In the first article on Purdy, published September 2014, we discussed the Sixth Circuit's first ruling in the case—that a cattle lease was a "true lease" instead of a financing arrangement. As we noted in the article, that ruling was one of many in a long line of "true lease" cases around the country.
On July 10, 2017, the Consumer Financial Protection Bureau (CFPB) released its long-awaited and controversial final rule on arbitration agreements in contracts for consumer financial products and services. The rule, which takes effect 60 days after its release and requires compliance with its terms 180 days after that, prohibits certain financial services companies from relying on arbitration clauses to block class action lawsuits. It will effectively open up the gates to more class action lawsuits relating to consumer financial products such as installment loans, credit cards and checking accounts, and will have a significant impact on the financial services industry.
On July 19, 2017, the Court of Appeals for the Third Circuit issued the latest (and perhaps last) ruling from the massive SemCrude bankruptcy concerning owner/producer lien rights and buyer take-free rules. In re Semcrude L.P., 2017 U.S. App. LEXIS 12975 (3d Cir. July 19, 2017). Following review in a “related-to” bankruptcy proceeding, the Third Circuit affirmed the summary judgment issued by the bankruptcy court and district court, further solidifying the law concerning the competing rights of owners, producers, first purchasers, and downstream purchasers of oil and gas for which an owner or producer never received payment.
Another legislative season has largely come to an end. As always, there were numerous measures introduced around the country with the potential to affect those who search or file UCC and other lien records. This article identifies some of the 2017 initiatives and trends that might be of particular interest to those who follow UCC Article 9 and lien-related developments.