Friday, August 4, 2017

FYI: 9th Cir Rules Mortgage Underwriters Not Exempt Under FLSA

The U.S. Court of Appeals for the Ninth Circuit recently held that mortgage underwriters were not exempt under the federal Fair Labor Standards Act ("FLSA") and were therefore entitled to overtime compensation for hours worked in excess of forty per week.

After analyzing the specific details of the underwriters' responsibilities, the Ninth Circuit panel concluded that, because the underwriters' primary job duty did not relate to their employer bank's management or general business operations, the administrative employee exemption to the FLSA's overtime requirements did not apply. 

Recognizing that there was a split between the Second Circuit and Sixth Circuit as to whether the underwriters are exempt, the Ninth Circuit adopted the Second Circuit's conclusion that "the job of underwriter falls under the category of production rather than administrative work," and, thus, the administrative exemption under the FLSA does not apply.

A copy of the opinion is available at:  Link to Opinion

The Plaintiff and the other members of the class were mortgage underwriters for the defendant bank ("Bank").  The Bank sold mortgage loans to consumers seeking to purchase or refinance homes, and then the Bank would resell the funded loans on the secondary market. 

The mortgage loan application process was streamlined.  A loan officer or broker worked with a borrower to select a particular loan product. A loan processor then ran a credit check, gathered further documentation, assembled the file for the underwriter, and ran the loan through an automated underwriting system. The automated system then applied certain guidelines based on the information input and then returned a preliminary decision.

From there, the file went to a mortgage underwriter, who verified the information put into the automated system and compared the borrower's information against the applicable guidelines, which are specific to each loan product.  The underwriters were responsible for thoroughly analyzing complex customer loan applications and determining borrower creditworthiness in order to ultimately decide whether the Bank will accept the requested loan. The underwriters could impose conditions on a loan application and refuse to approve the loan until the borrower satisfied those conditions.

The decision as to whether to impose conditions is ordinarily controlled by the applicable guidelines, but the underwriters could include additional conditions. They could also suggest a "counteroffer" — which would be communicated through the loan officer — in cases where a borrower did not qualify for the loan product selected, but might qualify for a different loan.

Underwriters could also request that the Bank make exceptions in certain cases by approving a loan that did not satisfy the guidelines.  After an underwriter approved a loan, it was sent to other Bank employees who finalized the loan funding. According to the underwriters, whether a loan was funded ultimately depended on factors beyond their control. Another group of Bank employees then sold the funded loans in the secondary market.

Initially, the trial court denied cross motions for summary judgment and set the case for trial. But later, on the parties' joint motion for reconsideration, the trial court concluded that the underwriters qualified for the administrative exemption under the FLSA, based on the finding that their primary duty included "quality control" or similar activities directly related to the Bank's general business operations.  Thus, the trial court granted summary judgment in favor of the Bank.  Plaintiff appealed.

As you may recall, the FLSA requires employers to compensate its employees time and a half of their regular pay for all hours worked over forty in a week.  Under the FLSA, certain employees "employed in a bona fide executive, administrative, or professional capacity" are exempt from the overtime requirements. See 29 U.S.C. § 213(a)(1).

The Ninth Circuit recognized that the exemptions under the FLSA are to be narrowly construed, and the employer bears the burden of establishing they apply.  According to the Court, the FLSA "is to be liberally construed to apply to the furthest reaches consistent with Congressional direction", and the exemptions "are to be withheld except as to persons plainly and unmistakably within their terms and spirit."

In assessing whether the administrative exemption applied, the Court relied on the Department of Labor's ("DOL") regulations interpreting the FLSA. In order for the administrative exemption to apply, the employee must (1) be compensated not less than $455 per week; (2) perform as her primary duty "office or non-manual work related to the management or general business operations of the employer or the employer's customers;" and (3) have as her primary duty "the exercise of discretion and independent judgment with respect to matters of significance." 29 C.F.R. § 541.200(a). An employee's primary duty is "the principal, main, major or most important duty that the employee performs." 29 C.F.R. § 541.700(a).

At issue in this case was the second requirement.  In order to satisfy that requirement, an employee's primary duty must involve office or "non-manual work directly related to the management policies or general business operations" of the Bank or the Bank's customers. See 29 C.F.R. § 541.200. "An employee must perform work directly related to assisting with the running or servicing of the business, as distinguished, for example, from working on a manufacturing production line or selling a product in a retail or service establishment." 29 C.F.R. § 541.201(a).

This has commonly been referred to as the "administrative-production dichotomy." Its purpose is "to distinguish 'between work related to the goods and services which constitute the business' marketplace offerings and work which contributes to 'running the business itself.'" DOL Wage & Hour Div. Op. Ltr., 2010 DOLWH LEXIS 1, 2010 WL 1822423, *3 (Mar. 24, 2010).  According to the Ninth Circuit, "[t]his requirement is met if the employee engages in 'running the business itself or determining its overall course or policies,' not just in the day-to-day carrying out of the business' affairs."

The Court observed that the Second Circuit and Sixth Circuit had reached conflicting rulings on whether the administrative exemption applied to mortgage underwriters.  According the Second Circuit, "the job of underwriter . . . falls under the category of production rather than of administrative work."  Davis v. J.P. Morgan Chase & Co., 587 F.3d 529, 535 (2d Cir. 2009).

On the other hand, the Sixth Circuit concluded that mortgage underwriters are exempt administrators, explaining that they "perform work that services the Bank's business, something ancillary to [the Bank's] principal production activity." Lutz v. Huntington Bancshares, Inc., 815 F.3d 988, 995 (6th Cir. 2016).  The Sixth Court determined mortgage underwriters performed "administrative work because they assist in the running and servicing of the Bank's business by making decisions about when [the Bank] should take on certain kinds of credit risk, something that is ancillary to the Bank's principal production activity of selling loans." Id. at 993.

Turning the facts of this case, the Ninth Circuit agreed with the reasoning of the Second Circuit, and concluded that the underwriters "did not decide if the Bank should take on risk, but instead assess whether, given the guidelines provided to them from above, the particular loan at issue falls within the range of risk the Bank has determined it is willing to take."

The Court continued, "assessing the loan's riskiness according to relevant guidelines is quite distinct from assessing or determining the Bank's business interests. Mortgage underwriters are told what is in the Bank's best interest, and then asked to ensure that the product being sold fits within criteria set by others."

The Ninth Circuit also cited to the DOL's regulations to support its conclusion.  "The financial-services industry example also includes descriptors that do not correspond with the underwriters' primary duty, which aims more at producing a reliable loan than at 'advising' customers or 'promoting' the Bank's financial products." See 29 C.F.R. § 541.203(b).  The Court emphasized that underwriters do not "advis[e] customers at all, nor do they market[], servic[e] or promot[e] the employer's financial products."

The Court then summarized its ruling as follows:

"We conclude that where a bank sells mortgage loans and resells the funded loans on the secondary market as a primary font of business, mortgage underwriters who implement guidelines designed by corporate management, and who must ask permission when deviating from protocol, are most accurately considered employees responsible for production, not administrators who manage, guide, and administer the business."

The trial court had granted the Bank's motion for summary judgment on the basis that the underwriters performed work related to "quality control."  The Ninth Circuit, however, concluded that the record evidence did not support such a conclusion.

The Court concluded that the underwriters' primary duty did not go to the heart of the Bank's internal operations, but instead went to the marketplace offerings and were related to the production side of the Bank's business.  

Accordingly, the Ninth Circuit reversed the trial court's granting of summary judgment in favor of the bank and remanded with instructions to enter summary judgment in favor of the plaintiff class.


Eric Tsai
Maurice Wutscher LLP 
71 Stevenson Street, Suite 400
San Francisco, CA 94105
Direct: (415) 529-7654
Fax: (866) 581-9302
Mobile: (714) 600-6000
Email: etsai@MauriceWutscher.com

Admitted to practice law in California, Nevada and Oregon




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Friday, July 21, 2017

FYI: 9th Cir Holds "Free and Clear" Bankruptcy Sale Was Not Rejection of Unexpired Leases, Did Not Implicate 11 U.S.C. § 365(h)

The U.S. Court of Appeals for the Ninth Circuit recent held that a bankruptcy trustee was authorized to sell real estate free and clear of unexpired leases under 11 U.S.C. § 363(f), and the sale was not a rejection of the unexpired leases and therefore did not implicate 11 U.S.C. § 365(h).

In so ruling, the Ninth Circuit adopted the minority approach established in Precision Indus., Inc. v. Qualitech Steel SBQ, LLC, 327 F.3d 537 (7th Cir. 2003), which held that sections 363 and 365 may be given full effect without coming into conflict with one another. 

By allowing the bankruptcy trustee to sell the property free and clear of the unexpired leases, in the Ninth Circuit’s view, the estate was able to fetch higher price for the property and maximized recovery for all creditors.

A copy of the opinion is available at:  Link to Opinion

The developer (“Developer”) of a 5,700-acre resort in Montana obtained a $130 million loan secured by a mortgage and assignment of rents from a lender, who later assigned the note and mortgage to a limited liability company.  A collection of interrelated entities owned the resort and managed its amenities, including a ski club, golf course, and residential and commercial real-estate sales and rentals.  At issue are two leases of commercial property at the resort.

The Developer defaulted on loan payments and petitioned for bankruptcy protection.  The limited liability company had a claim of more than $122 million secured by the mortgage on the property, making it the largest creditor in the bankruptcy, and subsequently assigned its interest to an assignee (“Creditor”).  The bankruptcy trustee and Creditor agreed to a plan for liquidating “substantially” all of Developer’s real and personal property, and stated that the sale would be “free and clear of all liens.”

The trustee moved the bankruptcy court for an order authorizing and approving the sale free and clear of all liens except for certain specified encumbrances, and provided that other specified liens would be paid out of the proceeds of the sale or otherwise protected. 

The two leases at issue were not mentioned in either the list of encumbrances that would survive the sale, or the list of liens which protection would be provided.  The lessees (“Lessees”) objected and argued that 11 U.S.C. § 365 gave them the right to retain possession of the property notwithstanding the trustee’s sale.

After the bankruptcy court authorized the sale, Creditor won the auction with a bid of $26.1 million and argued that its bid was contingent on the property being free and clear of the leases.  The bankruptcy court approved the sale, and the order stated that the sale was free and clear of any “Interests,” a term defined to include any leases “(except any right a lessee may have under 11 U.S.C. § 365(h), with respect to a valid and enforceable lease, all as determined through a motion brought before the Court by proper procedure).”

The trustee then requested leave to reject the two leases because the subject property was no longer property of the estate.  Meanwhile, Creditor moved for a determination that the property was free and clear of the leases.  Lessees renewed their prior arguments as objections to Creditor’s motion.

At the evidentiary hearing, the bankruptcy court determined, among other things, that one of the leases was below fair market rental value, that the leases were junior to Creditor’s mortgage, and were not protected from foreclosure of Creditor’s mortgage by subordination or non-disturbance agreements.  Based on these findings, the bankruptcy court held that the sale was free and clear of the two commercial leases.  Lessees appealed to the district court, which affirmed, and this appeal followed.

The principal issue on appeal is whether the two leases survived the trustee’s sale of the property to Creditor. 

As you may recall, 11 U.S.C. § 363 authorizes the trustee to sell property of the estate, both within the ordinary course of business and outside of bankruptcy.  See 11 U.S.C. § 363(b), (c).  Sales may be “free and clear of any interest in such property of an entity other than the estate,” only if:

(1) applicable nonbankruptcy law permits sale of such property free and clear of such interest;
(2) such entity consents;
(3) such interest is a lien and the price at which such property is to be sold is greater than the aggregate value of all liens on the property;
(4) such interest is in bona fide dispute; or
(5) such entity could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest.

11 U.S.C. § 363(f).

Meanwhile, 11 U.S.C. § 365 of the Code authorizes the trustee, “subject to the court’s approval,” to “assume or reject any executory contract or unexpired lease of the debtor.”  11 U.S.C. § 365(a).  The rejection of an unexpired lease leaves a lessee in possession with two options:  treat the lease as terminated (and make a claim against the estate for any breach), or retain any rights—including a right of continued possession—to the extent those rights are enforceable outside of bankruptcy.  11 U.S.C. § 365(h).

When the trustee sells property free and clear of encumbrances, and one of the encumbrances is an unexpired lease—federal courts have addressed the interplay between 11 U.S.C § 363 and 11 U.S.C. § 365 in different ways.

The majority of bankruptcy courts that have addressed this issue held that sections 363 and 365 conflict when they overlap because “each provision seems to provide an exclusive right that when invoked would override the interest of the other.”  In re Churchill Props., 197 B.R. 283, 286 (Bankr. N.D. Ill. 1996); see also In re Haskell, L.P., 321 B.R. 1, 8-9 (Bankr. D. Mass. 2005); In re Taylor, 198 B.R. 142, 164-66 (Bankr. D.S.C. 1996).  These courts held that section 365 trumps section 363 under the canon of statutory construction that the specific prevails over the general, and the legislative history regarding section 365 evinced a clear intent by Congress to protect a tenant’s estate when the landlord files bankruptcy.

However, in Precision Indus., Inc. v. Qualitech Steel SBQ, LLC, 327 F.3d 537 (7th Cir. 2003), the U.S. Court of Appeals for the Seventh Circuit held that sections 363 and 365 may be given full effect without coming into conflict with one another, because lessees are entitled to seek “adequate protection” under 11 U.S.C. § 363(e), and were not without recourse in the event of a sale free and clear of their interests. 

The Ninth Circuit here followed the Seventh Circuit, and held that sections 363 and 365 did not conflict.  Section 363 governed the sale of estate property and section 365 governed the rejection of a lease, and according to the Ninth Circuit, where there was a sale but no rejection (or a rejection, but no sale), there was no conflict between the statutes.  Here, because the parties agreed that the two leases were not rejected prior to the sale, the Ninth Circuit ruled that section 365 was not triggered. 

The Ninth Circuit noted that a limitation in the majority approach was that while it protected lessees, a property subject to a lease would presumably fetch a lower price and therefore reduce the value of the property of the estate.  Therefore, this approach is contrary to the goal of maximizing creditor recovery, which was a core purpose of the Bankruptcy Code.


Accordingly, the Ninth Circuit affirmed the lower courts’ ruling that the bankruptcy trustee’s sale of Debtor’s property was free and clear of unexpired leases.


Eric Tsai
Maurice Wutscher LLP 
71 Stevenson Street, Suite 400
San Francisco, CA 94105
Direct: (415) 529-7654
Fax: (866) 581-9302
Mobile: (714) 600-6000
Email: etsai@MauriceWutscher.com

Admitted to practice law in California, Nevada and Oregon




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Wednesday, July 5, 2017

FYI: 9th Cir Holds Bankruptcy Cram Down Valuations to Use "Replacement Value" Not "Foreclosure Value"

The U.S. Court of Appeals for the Ninth Circuit recently held that for cram-down valuations, 11 U.S.C. § 506(a)(1) requires the use of "replacement value" based upon the adoption of the replacement value standard in Associates Commercial Corp. v. Rash, 520 U.S. 953, 956 (1997).

In so ruling, the Ninth Circuit interpreted Rash to instruct that valuation of collateral in a cram-down must be based on the debtor's desires (i.e., the proposed use of the collateral in the debtor's plan of reorganization), and without consideration of the value that the secured creditor would realize in an immediate sale. 

Accordingly, this ruling effectively shifts the risk in cram-down valuations to the secured creditor regardless of the type of debtor and the nature of the property.  

A copy of the opinion is available at:  Link to Opinion

A real estate developer ("Developer") obtained financing from various lenders to fund the development of an apartment complex in Phoenix, Arizona.  The bulk of the financing came from a loan that was guaranteed by the United States Department of Housing and Urban Development ("HUD"), and funded through bonds issued by the Phoenix Industrial Development Authority.  The City of Phoenix and the State of Arizona provided the balance of the funding secured by junior liens.

To secure financing and tax benefits, Developer entered into agreements requiring the apartment complex be used for affordable housing.  

Developer defaulted on the loan with HUD and a bank ("Bank") purchased the loan from HUD.  In connection with the sale, HUD released its regulatory agreement.  However, the loan sale agreement confirmed that the property remained subject to the other "covenants, conditions and restrictions." 

Bank began foreclosure proceedings and a receiver was appointed.  The receiver agreed to sell the apartment complex to a third party in December 2010.  But, before the sale could close, Developer filed a Chapter 11 bankruptcy petition.  Over Bank's objection, Developer sought to retain the complex in its proposed plan of reorganization, exercising the "cram-down" option in 11 U.S.C. § 1325(a)(5)(B).

As you may recall, a successful cram-down allows the reorganized debtor to retain collateral over a secured creditor's objection, subject to the requirement in § 506(a)(1) that the debt be treated as secured "to the extent of the value of such creditor's interest" in the collateral.  The value of that claim is "determined in light of the purpose of the valuation and of the proposed disposition or use of such property."  Id.

The central issue in the reorganization was the valuation of Bank's collateral – i.e., the apartment complex.  Developer argued that the complex should be valued as low-income housing based on its intended use, while Bank argued that the complex should instead be valued based on its replacement value, which was a higher value because the complex would no longer be used as low-income housing after foreclosure. 

Bank's expert valued the complex at $7.74 million, under the assumption that a foreclosure would remove any low-income housing requirements.  Bank's expert also opined that the value of the property was only $4,885,000 if those requirements remained in place.  Developer's expert valued the property at $2.6 million with the low-income housing restrictions in place, and at $7 million without. 

The bankruptcy court held that under § 506(a)(1), the value of the property was $2.6 million because Developer's plan of reorganization called for continued use of the complex as low-income housing.  The bankruptcy court also declined to include in the value of the complex the tax credits available to Developer.  Bank then elected to treat its claim as fully secured under 11 U.S.C. § 1111(b).

The bankruptcy court confirmed the plan of reorganization, which provided for payment in full of Bank's claim over 40 years.  The reorganization plan required the junior lienholders to relinquish their liens, but provided for payment of their unsecured claims in full, without interest, at the end of the 40 years.

The bankruptcy court found the plan fair and equitable under 11 U.S.C. § 1129(b)(1) because Bank retained its lien, would receive an interest rate equivalent to the prevailing market rate, and could foreclose (and therefore obtain the property without the restrictive covenant) should Developer default on the reorganization.  And, based on Developer's financial projections, the bankruptcy court found the plan feasible under 11 U.S.C. § 1129(a)(11).

After confirmation, a third party ("Investor) invested $1.2 million in the complex.  Bank then obtained a stay of the plan of reorganization from the district court pending appeal.  The district court affirmed the bankruptcy court's valuation of the complex with the low-income housing restrictions in place, but held that the tax credits should have been considered.  Both parties appealed.

After the various appeals were consolidated, the Ninth Circuit initially reversed the bankruptcy court's order approving the plan of reorganization, holding that the court should have valued the apartment complex without the affordable housing requirements.  In re Sunnyslope Hous. Ltd. P'ship, 818 F.3d 937, 940 (9th Cir. 2016).  More specifically, the Ninth Circuit initially held that under § 506(a)(1), replacement cost "is a measure of what it would cost to produce or acquire an equivalent price of property" and that "the replacement value of a 150-unit apartment complex does not take into account the fact that there is a restriction on the use of the complex."

The Ninth Circuit then granted Developer's petition for rehearing en banc to resolve three issues:  (1) whether the bankruptcy court erred by valuing the apartment complex assuming its continued use after reorganization as low-income housing, (2) whether the plan of reorganization was fair, equitable, and feasible, and (3) whether the district court errored in now allowing Developer to withdraw its § 1111(b) election.

First, the Ninth Circuit analyzed the bankruptcy court's valuation with the restrictive covenants.

The Ninth Circuit previously established that, "[w]hen a Chapter 11 debtor or a Chapter 13 debtor intends to retain property subject to a lien, the purpose of a valuation under section 506(a) is not to determine the amount the creditor would receive if it hypothetically had to foreclose and sell the collateral."  In re Taffi, 96 F.3d 1190, 1192 (9th Cir. 1996) (en banc).  "The foreclosure value is not relevant" because the creditor "is not foreclosing."  Id.  In Taffi, the Ninth Circuit noted that its decision was consistent with the approached of all but one circuit – the Fifth Circuit — which had adopted a foreclosure-value standard in In re Rash, 90 F.3d 1036 (5th Cir. 1996) (en banc).  See In re Taffi, 96 F.3d at 1193. 

The Supreme Court of the United States in In re Rash reversed the Fifth Circuit, holding consistent with Taffi, that "§ 506(a) directs application of the replacement-value standard," rather than foreclosure value.  Rash, 520 U.S. 953, 956 (1997).  In so ruling, the Supreme Court held that the value of collateral under § 506(a)(1) is "the cost the debtor would incur to obtain a like asset for the same 'proposed … use.'"  Id. at 965. 

Thus, according to the Ninth Circuit, in Rash the Supreme Court held that, in a reorganization involving a cram down, the proper guide was the replacement value.  Therefore, the essential inquiry is to determine the price that a debtor in Developer's position would pay to obtain an asset like the collateral for the particular use proposed in the plan of reorganization.  Id. 

However, Bank alternatively argued that the property should be valued at its "highest and best use" – that is, housing without any low-income restrictions. 

The Ninth Circuit rejected the argument because absent foreclosure, the very event that the Chapter 11 plan sought to avoid, Developer cannot use the property except as affordable housing, nor could anyone else.  In fact, Rash expressly instructed that a § 506(a)(1) valuation cannot consider what would happen after a hypothetical foreclosure—the valuation must instead reflect the property's "actual use."  Id., at 963.

Next, Bank attempted to distinguish Rash by arguing that foreclosure value is greater than replacement value in this case.  But, as the Ninth Circuit explained, Rash implicitly acknowledged that this outcome might occasionally be the case, and the Supreme Court nonetheless adopted a replacement-value standard.  Id., at 960.  Thus, following the Supreme Court's guidance in Rash, the Ninth Circuit was unconvinced that the foreclosure value should be used in place of replacement value.

Bank also argued that the low-income housing requirements do not apply to its security because HUD released its regulatory agreement, and all other covenants are junior to its lien.  The Ninth Circuit again disagreed because while the junior liens were subordinate to Developer's, it was undisputed the restrictions they impose continue to run with the land absent foreclosure.  Thus, according to the Court, the low-income housing requirements were properly considered in determining the value of the collateral.

Additionally, Bank's amici argued that valuing the collateral with the low-income restrictions in place would discourage future lending on like projects. 

The Ninth Circuit disagreed because "while the protection of creditors' interests is an important purpose under Chapter 11, the Supreme Court has made clear that successful debtor reorganization and maximization of the value of the estate are the primary purposes."  In re Bonner Mall P'ship, 2 F.3d 899, 916 (9th Cir. 1993).  Allowing the debtor to "rehabilitate the business" generally maximizes the value of the estate.  Id.

Here, Bank bought the Developer's loan at a substantial discount knowing the risk that the property would remain subject to the low-income housing requirements.  Thus, the Ninth Circuit concluded that valuing Bank's collateral with those restrictions in mind did not subject the lender to more risk than it consciously undertook.

Next, the bankruptcy court ruled that Developer's plan was fair and equitable because Developer retained its lien and received the present value of its allowed claim over the term of the plan.

As you may recall, the cram-down provision in 11 U.S.C. § 1129(b) requires that the reorganization plan be "fair and equitable."  The secured creditor must retain its lien, § 1129(b)(2)(A)(i)(I), and receive payments over time equaling the present value of the secured claim, § 1129(b)(2)(A)(i)(II). 

The interest rate chosen must ensure that the creditor receives the present value of its secured claim through the payments contemplated by the plan of reorganization.  Till v. SCS Credit Corp., 541 U.S. 465, 469 (2004).

The question before the Ninth Circuit was whether the plan provided payments equal to the present value of the secured claim.

Bank argued that it did not receive the present value of its secured claim because the interest rate adopted in the plan, 4.4%, is lower than the original rate on its loan.  However, the bankruptcy court determined that the 4.4% interest rate on the plan payments would result in Bank receiving the present value of its $3.9 million security over the term of the reorganization plan.  The relevant national prime rate was 3.25%, and the bankruptcy court adjusted that rate upward to account for the risk of non-payment.  The bankruptcy court also heard testimony that the market loan rate for similar properties was 4.18%. 

Additionally, plan confirmation requires a finding that the debtor will not require further reorganization.  11 U.S.C. § 1129(a)(11).  The debtor must demonstrate that the plan "has a reasonable probability of success."  In re Acequia, 787 F.2d 1352, 1364 (9th Cir. 1986).

In this case, the record showed that Developer would be able to make plan payments, and expert testimony confirmed that the collateral would remain useful for 40 years – the term of the plan.  The bankruptcy court also found that the balloon payment feasible because it was secured by property whose value exceeded the value of the remaining Developer's claim. 

Thus, the Ninth Circuit affirmed the bankruptcy court determination with respect to plan fairness and feasibility.

Turning to Bank's final argument regarding its § 1111(b) election, the Appellate Court found no error in the bankruptcy court's ruling.

As you may recall, § 1111(b) of the Bankruptcy Code allows a secured creditor to elect to have its claim treated as either fully or partially secured.  An election affects the treatment of the unsecured portion of the claim under the plan and the procedural protections afforded to the creditor.  11 U.S.C. § 1129(a)(7)(B).  In absence of a contrary order by the bankruptcy court, the creditor must make this election before the end of the disclosure statement hearing.  Fed. R. Bankr. P. 3014.

Bank argued that the bankruptcy court erred in not allowing it to make a second election after the district court remanded and required the tax credits to be added to the valuation.  When Bank made its election, the plan provided for 40 years of payments of principal and interest providing the creditor with the present value of its $2.6 million secured claim, with a final balloon payment covering the remainder of the debt. 

However, after remand, according to the Ninth Circuit, the only difference to Bank was that its annual payments will be more and the balloon payment at the end of the 40 years will be less.  Thus, the Appellate Court held that allowing a second election would not only provide Bank with a second bite at the apple, it would not make a material difference in the outcome of the election.

Accordingly, the Ninth Circuit affirmed the judgment of the district court.


Eric Tsai
Maurice Wutscher LLP 
71 Stevenson Street, Suite 400
San Francisco, CA 94105
Direct: (415) 529-7654
Fax: (866) 581-9302
Mobile: (714) 600-6000
Email: etsai@MauriceWutscher.com

Admitted to practice law in California, Nevada and Oregon




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Monday, July 3, 2017

FYI: 9th Cir BAP Affirms Dismissal of "Wrongful Securitization" Allegations

The Bankruptcy Appellate Panel of the U.S. Court of Appeals for the Ninth Circuit recently affirmed the dismissal of an adversary proceeding without leave to amend, holding that:

(a) the debtors failed to state a claim for wrongful foreclosure under California law;

(b) the debtors failed to state a claim for breach of contract or breach of the implied covenant of good faith and fair dealing because they were not third-party beneficiaries of the Pooling and Servicing Agreement;

(c) the debtors failed to state a claim for breach of the deed of trust or breach of the implied covenant of good faith and fair dealing by executing the notice of default; and

(d) the debtors failed to state a claim for violating § 2923.5 of California's Civil Code or for violating California's unfair competition law.

A copy of the opinion is available at:  Link to Opinion

Husband and wife borrowers obtained a loan to purchase their home in Livermore, California. The loan was secured by a Deed of Trust, which named a title company as trustee and a national bank as both lender and beneficiary.

The bank sold the Note and Deed of Trust and the purchaser deposited both into a mortgage-backed securities trust pursuant to a Pooling and Servicing Agreement ("PSA"), which named another national bank as trustee. The language of the trust required the transfer of assets into the trust within 90 days after the trust pool's start date, but the Note and Deed of Trust allegedly were not deposited into the trust until 2012.

A third-party default services company recorded a Notice of Default against the borrowers' property acting as agent or trustee for the beneficiary. The trustee then recorded Substitution of Trustee naming the default services company as trustee, after which the default services company recorded a Notice of Trustee's Sale.

The borrowers filed for bankruptcy shortly thereafter, but failed to pay as required by their reorganization plan, and the bank originally named as trustee filed a motion for relief from stay, which the bankruptcy court granted.

The borrowers then filed an adversary proceeding, alleging that the transfer of the Deed of Trust into the trust was void because it breached the PSA ninety-day transfer requirement. They also alleged breach of the Deed of Trust and supposed violation of two California statutes.

The bankruptcy court dismissed the adversary complaint without leave to amend. The borrowers appealed to the district court, which affirmed the dismissal. They then appealed the Ninth Circuit.

On appeal the Ninth Circuit was presented with two questions: "(1) whether the bankruptcy court correctly concluded that the [borrowers'] Adversary Complaint failed to state a claim and (2) whether the bankruptcy court erred in denying the [borrowers] leave to amend."

The Ninth Circuit first addressed the borrower's claim for wrongful foreclosure, explaining that under California law a residential borrower "has standing to claim a nonjudicial foreclosure was wrongful because an assignment by which the foreclosing party purportedly took a beneficial interest in the deed of trust was not merely voidable but void. … Unlike a voidable transaction, a void one cannot be ratified or validated by the parties to it even if they so desire."

The Court rejected the borrowers' argument that the assignments of the Deed of Trust were void, relying on three California Courts of Appeal opinions all holding that "such an assignment is merely voidable" because "an unauthorized act by the trustee is not void but merely voidable by the beneficiary." Thus, the Ninth Circuit found that the district court correctly dismissed the wrongful foreclosure claim.

Turning to the borrowers' claim for breach of contract of the PSA or breach of the implied covenant of good faith and fair dealing under the PSA, the Ninth Circuit rejected the borrowers' argument that they were third-party beneficiaries of the PSA, relying on "numerous California appellate courts [that] have held, borrowers, … are not third-parties [sic] beneficiaries of the PSA." Accordingly, the Court concluded that "the district [court] correctly ruled that the [borrowers] failed to state a claim for either breach of the express agreement or the related breach of the implied covenant of good faith and fair dealing under the PSA."

The Ninth Circuit next rejected the borrowers' argument that the lender/beneficiary bank breached the Deed of Trust because it did not sign the Notice of Default and its agent, the default services company, "could not record the Notice of Default because the Notice was issued three months before [the default services company] was substituted as Trustee."

The Court reasoned that their argument lacked merit because the express terms of the Deed of Trust did not require the lender/beneficiary bank "to execute the Notice of Default, but rather, it can cause the Trustee to execute a written notice of default."  Because "a substitution of trustee was recorded naming [the default services company] as Trustee, … [it] had the authority to issue the Notice of Default [under Cal. Civ. Code § 2934a(d)]" which provides that "[o]nce recorded, the substitution shall constitute conclusive evidence of the authority of the substituted trustee or his or her agents to act pursuant to this section."

The Ninth Circuit also rejected the borrowers' argument that the bank breached the implied covenant of good faith and fair dealing "by obscuring the identity of the true holder of the beneficial interest making it impossible for them to know to whom to make their mortgage payments" because they "have not alleged that their payments were not accurately credited, that they sustained any damages, or that they were not in default. Having failed to identify any prejudice, the district court properly dismissed their claims."

The Court then addressed the borrowers' claim that the substituted trustee violated Cal. Civ. Code § 2923.5, which provides that "[a] mortgage servicer, mortgagee, trustee, beneficiary, or authorized agent may not record a notice of default until either thirty days after initial contact with the borrower or thirty days after satisfying the due diligence requirements."

Because the Notice of Default was signed by the substitute trustee as agent for the lender/beneficiary bank, a substitution of trustee was thereafter recorded, and "[t]he only remedy for noncompliance with [Section 2923.5] is the postponement of the foreclosure sale[,]" the Court concluded that the district court correctly dismissed the borrowers' claim under section 2923.5.

Turning to the borrowers' remaining claim that defendants violated California's unfair competition law ("UCL"), which "prohibits unlawful, unfair, deceptive, untrue or misleading advertising[,]" the Ninth Circuit found that the borrowers "failed to establish standing to bring a claim under the UCL."

The Ninth Circuit reasoned that in order to have standing to bring a UCL claim, "the plaintiff must '(1) establish a loss or deprivation of money or property sufficient to qualify as injury in fact, i.e., economic injury, and (2) show that the economic injury was the result of, i.e., cause by, the unfair business practice …."  The Court noted that a plaintiff fails "to satisfy this causation requirement if he or she would have suffered 'the same harm whether or not a defendant complied with the law.'"

The Court concluded that the borrowers lacked standing because "they cannot establish the second prong." Their "home would have been foreclosed regardless of the alleged deficiencies in the timing of the assignments of the [Deed of Trust] and Substitution of Trustee. [They] have not disputed that they stopped making payments, causing the loan to go into default." Because it was the borrowers' default "that triggered the lawful enforcement of the power of sale clause in the deed of trust, and the triggering of the power of sale clause subjected [the borrowers'] home to nonjudicial foreclosure, not any procedural deficiencies in the assignment … they do not  have standing to pursue a claim under the UCL."

Finally, the Ninth Circuit found that the district court correctly dismissed the borrowers' claims without leave to amend "because any amendment would be futile."

The Ninth Circuit affirmed the district court's dismissal of the borrowers' claims without leave to amend.


Eric Tsai
Maurice Wutscher LLP 
71 Stevenson Street, Suite 400
San Francisco, CA 94105
Direct: (415) 529-7654
Fax: (866) 581-9302
Mobile: (714) 600-6000
Email: etsai@MauriceWutscher.com

Admitted to practice law in California, Nevada and Oregon




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Friday, June 2, 2017

FYI: 9th Cir Holds City of LA's FHA "Discriminatory Lending" Claims Failed for Lack of "Robust" Causal Link

The U.S. Court of Appeals for the Ninth Circuit recently affirmed a trial court's summary judgment ruling in favor of a bank and against the City of Los Angeles ("City") on the City's claims that the bank violated section 3605(a) the federal Fair Housing Act ("FHA") through alleged discriminatory lending practices, and that the bank was unjustly enriched.

A copy of the opinion is available at:  Link to Opinion

As you may recall, section 3605(a) of the FHA makes it unlawful for financial institutions "to discriminate against any person in making available such a transaction, or in the terms or conditions of such a transaction, because of race [or] color." 42 U.S.C. § 3605(a).

The City alleged both disparate impact and disparate treatment theories of discrimination, but primarily presented evidence to support disparate impact.  The City also sued the bank for alleged unjust enrichment.

The trial court entered summary judgment in favor of the bank and against the City on all claims.  This appeal followed.

Initially, the Ninth Circuit observed that to establish a prima facie disparate impact claim the City must demonstrate a statistical disparity and show that a policy or policies caused the disparity.  Tex. Dep't of Hous. & Cmty. Affairs v. Inclusive Cmtys. Project, Inc., 135 S. Ct. 2507, 2523 (2015).  Further, the City must show a "robust" causal link between the policy and the disparity.  Id.  If the City fails to demonstrate a causal connection, then it "cannot make out a prima facie case of disparate impact." Id.

The Ninth Circuit did not analyze whether the City showed a statistical racial disparity, because it found that the City did not show the required "robust" causal link necessary between any disparity and the banks's facially-neutral policy.  

The City alleged three facially-neutral policies caused a disparity: (1) the bank's compensation plan allegedly provided incentives to its loan officers to issue higher-cost loans; (2) the bank's marketing supposedly targeted low-income borrowers; and (3) the bank allegedly did not properly monitor its loans for any disparities.

The Ninth Circuit determined that the City did not show how that the first two policies were causally connected to the alleged racial disparity in a "robust" way, as required, because the policies "would affect borrowers equally regardless of race."

Additionally, the Ninth Circuit rejected the City's third claim that the bank did not adequately monitor any loans for disparities because this was "not a policy at all."

Thus, the Ninth Circuit held that the trial court correctly entered summary judgment in favor of the bank and against the City on the City's FHA claim because there was no genuine issue of material fact "as to a policy with a robust casual connection to any racial disparity."

The Ninth Circuit next turned to the City's unjust enrichment claim.  As you may recall, under California law, a court may award unjust enrichment "where the defendant obtained a benefit from the plaintiff by fraud, duress, conversion, or similar conduct." Durell v. Sharp Healthcare, 108 Cal. Rptr. 3d 682, 699 (Ct. App. 2010).

The Ninth Circuit concluded that the City's claimed lost tax revenue and increased spending on services did not confer any benefit upon the bank, as required to prevail on an unjust enrichment claim.  Thus, the Ninth Circuit held that the trial court correctly determined that there was no genuine issue of triable fact as to the City's unjust enrichment claim.

Accordingly, the Ninth Circuit affirmed the trial court's judgment order in favor of the bank and against the City.


Eric Tsai
Maurice Wutscher LLP 
71 Stevenson Street, Suite 400
San Francisco, CA 94105
Direct: (415) 529-7654
Fax: (866) 581-9302
Mobile: (714) 600-6000
Email: etsai@MauriceWutscher.com

Admitted to practice law in California, Nevada and Oregon




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