Mortgage Banking Update - October 4, 2012

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Maryland Ruling Highlights Risks of Mortgage Loans Secured by Property Under Litigation

A recent decision of Maryland's intermediate appellate court illustrates the risks of making a mortgage loan secured by real property that is the subject of pending litigation.

In Murphy v. Fishman, the Court of Special Appeals of Maryland ruled that a lender's deed of trust was invalid because, at the time that the loan was made, the borrower's title to the collateral property was being challenged in a pending lawsuit.

The case involved an allegedly fraudulent property transfer by an elderly woman to her son, just days before she died and for no consideration. After the deed was recorded, the woman's estate sued to invalidate the conveyance to the son. While that litigation was pending, the son obtained a mortgage loan and granted the lender a deed of trust on the property as collateral.

The estate ultimately prevailed in its lawsuit. As a result, the court imposed a constructive trust on the property, and it was conveyed back to the estate. When the lender sought to foreclose on its deed of trust, the estate moved to dismiss the foreclosure. The estate argued that the son had obtained title by fraudulent conveyance, and therefore was never in a position to grant the lender an interest in the property.

The Maryland court agreed with the estate. Relying on the well-established doctrine of lis pendens, the court rejected the lender's assertion that it was entitled to protection as a bona fide purchaser for value under Maryland law.

The court ruled that "because the Lender had constructive notice of the Estate Lawsuit . . . at the time it acquired an interest in the Property, it was not entitled to the protections to which a bona fide purchaser is entitled, and was not entitled to foreclose on the Property. In sum, the lis pendens provided constructive notice, at the time the mortgage was acquired, of the existing interest in the Property, thereby precluding the Lender from protection as a bona fide purchaser."

The case serves as a cautionary tale of the importance of a thorough search of court records for pending litigation prior to extending a mortgage loan.

Ballard Spahr's Mortgage Banking Group includes litigators with extensive experience defending the validity of mortgages and deeds of trust for lenders, loan servicers and foreclosure trustees. For further information, please contact Robert A. Scott at 410.528.5527 or scottr@ballardspahr.com.

- Robert A. Scott


FDIC Revises Classification System for Citing Violations

The Federal Deposit Insurance Corporation has revised its classification system for citing violations identified in compliance examinations. The new system, which is being used for compliance examinations started on or after October 1, 2012, could reflect the FDIC's increased focus on consumer compliance in the wake of the enactment of the Dodd-Frank Act and creation of the Consumer Financial Protection Bureau.

As described in Financial Institution Letter 41-2012, the new system consists of the following three levels:

  • Level 3/High Severity. These are violations that "have resulted in significant harm to consumers or members of a community" and for which the FDIC typically seeks aggregate restitution of more than $10,000. It also includes "pattern or practice" fair lending violations.
  • Level 2/Medium Severity. These are violations "reflecting systemic, recurring, or repetitive errors that represent a failure of the bank to meet a key purpose of the underlying regulation or statute." The effect on consumers may be "small, but negative" or potentially negative if uncorrected, and such violations may include those for which the FDIC seeks restitution of $10,000 or less.
  • Level 1/Low Severity. These are "isolated or sporadic" violations or "systemic violations that are unlikely to affect consumers or the underlying purposes of the regulation or the statute." Such violations usually result from individual instances, a failure to follow established procedures, or minor errors in the implementation of procedures.

An examination report will describe a Level 3 or 2 violation under a distinct header, with Level 3 violations shown first on the violations page. Management's response to a Level 3 or 2 violation will be included in the report's discussion of the violation. A Level 1 violation will be listed with a blanket statement indicating management's actions or intentions to address it, and the report will not include a Level 1 violation that is adequately addressed during the examination and does not indicate weakness in the bank's compliance system.

The new system replaces a two-level system in which violations were designated as either "significant" or "other." According to the FDIC, "[t]he change is intended to help focus the institution's attention on the most significant issues identified during the examination" so the institution can appropriately prioritize efforts to address them. A possible result of the new system is that FDIC examiners will classify violations that were previously placed in the "other" category and not considered serious as now having potentially serious consequences.

- Barbara S. Mishkin


CFPB Settlement Requires $112.5 Million Payment by American Express

In another demonstration of aggressive enforcement, the Consumer Financial Protection Bureau on October 1, 2012, announced that it had settled its enforcement actions against various American Express entities alleging a wide range of compliance violations. The settlement requires American Express Bank, FSB (AEBFSB) and American Express Centurion Bank (AECB) to make restitution payments totaling $85 million. In addition, the banks, their holding company, and its parent company are required to pay a total of $27.5 million in civil monetary penalties to the CFPB, the Office of the Comptroller of the Currency, the Federal Reserve Board, and the Federal Deposit Insurance Corporation.

The enforcement actions originated with the FDIC's routine examination of AECB in 2011 conducted jointly with AECB's state regulator. The FDIC then shared the examination results with the CFPB, which conducted a targeted examination of AEBFSB. In these examinations, the FDIC and CFPB looked at practices going back to 2003. Based on their findings, the CFPB and FDIC charged the American Express entities with the violations outlined below.

  • Violation of the Dodd-Frank Act prohibition of unfair, deceptive, or abusive acts or practices as a result of (1) credit card solicitations by AECB that led consumers to believe they would receive $300 in addition to bonus points by signing up for the card, and (2) debt solicitations by both banks and their holding company that led consumers who agreed to settle old debt to believe that (a) the settlement would be reflected on their credit reports and improve their credit score, and (b) their remaining debt would be waived or forgiven. According to the FDIC, these debt collection practices were misleading because the settled debts were not reported to consumer reporting agencies and may have been too old to appear on a credit report, and there was no prominent disclosure to consumers who applied for a new card that their remaining debt needed to be repaid before an application would be processed.
  • Violation of the Equal Credit Opportunity Act requirement for a credit scoring system to be properly designed and implemented as a result of AECB's failure to fully implement for applicants over age 35 a system that treated applicants differently based on age.
  • Violation of the Truth in Lending Act limitations on credit card late charges as a result of both banks imposing a late charge equal to 2.99 percent of the customer's balance.
  • Violation of the Fair Credit Reporting Act as a result of the failure of both banks to report consumer disputes to consumer reporting agencies.

The consent orders entered by the CFPB and FDIC include the following relief:

  • Consumers who were charged late fees greater than $35 will receive a refund of the excess amount, plus interest.
  • Consumers who settled their accounts and were denied a new credit card will receive $100 and a pre-approved offer for a new card on terms approved by the CFPB and FDIC. In addition, the banks are prohibited from denying future applications because the consumer did not repay the entire balance. Customers who paid the "waived or forgiven" amount to receive a new card will be refunded that amount, plus interest.
  • Consumers who made payment on debts not reported to consumer reporting agencies will be refunded the amount they paid, plus interest.
  • Consumers who opened a credit card account after receiving a solicitation that indicated they would receive $300 for doing so will receive $300.
  • Consumers over the age of 35 who would have been approved for credit under the scoring system that was not fully implemented must be invited to reapply.

The consent orders also require the banks to hire independent auditors and conduct annual audits of their compliance with consumer protection laws. In addition to the restitution and penalties assessed in those consent orders, separate orders assessing civil monetary penalties were entered by the CFPB (against  the banks' holding company), the OCC (against AEBFSB), and the Fed (against the banks' holding company and its parent company).

 

- Barbara S. Mishkin


Ancillary Agreements
Guest column from members of our Mergers and Acquisitions/Private Equity Group

Overview

The term "ancillary agreements" describes the various agreements executed and delivered by the parties at the closing of an M&A transaction to supplement the terms of the definitive acquisition agreement. Although the ancillary agreements needed vary from deal to deal, most will fit into one of the following categories:

  • Escrow agreements;
  • Documents of transfer;
  • Agreements for post-closing services;
  • Agreements for post-closing commercial arrangements; and
  • Agreements restricting the seller's activities after closing.

Although these agreements are not executed and delivered until closing, they are typically negotiated at the same time as the definitive acquisition agreement and the agreed-upon forms thereof are attached as exhibits to that agreement. This approach avoids complications and disputes in the period between signing the definitive acquisition agreement and closing the transaction.

Escrow Agreements

Escrow agreements are used when a seller has agreed to escrow part of the purchase price for a specific period after closing. Escrow agreements are typically among three parties—the seller, the buyer, and the escrow agent, which is usually a bank or other financial institution. Escrow agreements establish the escrow account and provide for when and how the buyer can make claims against those funds for either a working capital adjustment, losses that are indemnified by the seller under the purchase agreement, or both. Additionally, escrow agreements typically set forth the rights and responsibilities of the escrow agent, how the funds are to be invested by the escrow agent, and the allocation of investment income on the escrowed funds between the buyer and the seller, as well as the reporting of such income for federal tax purposes. At the end of the specified escrow period (unless there is a pending claim), the account balance is disbursed to the seller.

Documents of Transfer

Documents of transfer are delivered at the closing of asset acquisitions to evidence and effect the transfer of assets and liabilities from the seller to the buyer. This category of ancillary agreements includes bills of sale, assignments and assumptions, and deeds. Documents of transfer are typically short, simple agreements between the buyer and the seller that state that the seller has transferred the specified assets or liabilities to the buyer, and that the buyer has accepted the assignment of such assets and has assumed any such liabilities. Bills of sale are used to transfer tangible personal property, while assignments and assumptions are used to transfer intangibles such as contractual rights and obligations. Intangible assets registered with a third party, such as trademarks, patents and domain names, are typically transferred by a separate, specific assignment and assumption agreement because that agreement will need to be filed with the appropriate third party. Deeds are used to transfer real property.

Agreements for Post-Closing Services

Agreements for post-closing services, such as transition services agreements, employment agreements, and consulting agreements, are important ancillary agreements because such agreements facilitate the smooth transition of the business from the seller to the buyer. Under a transition services agreement, a seller agrees to provide the buyer with key  support services, such as accounting or information technology services, for a limited time after closing until the buyer can provide those functions or transition them to a third party. Transition services agreements can also be used to allow the buyer to access facilities or other assets that are used by the purchased business but that are not part of the transferred assets. Consulting agreements are used for a seller to provide general knowledge about the purchased business and related services to the buyer, usually on a part-time basis. Employment agreements for key employees are also frequently used to allow the buyer to access the historical knowledge and existing skills of senior management.

Agreements for Post-Closing Commercial Arrangements

Agreements for post-closing commercial arrangements, such as supply agreements, distribution agreements and real property leases, set forth the terms and conditions of commercial relationships between the parties following the closing. These agreements typically are needed for the buyer to operate the business in the same manner as it was operated by the seller immediately before the closing. For example, the parties may enter into a supply agreement when the business being sold obtains inventory from another business unit of the seller or an affiliate of the seller not included in the transaction. Similarly, the parties may enter into a post-closing distribution agreement when the sales force serving the target business is being retained by the seller and not included in the transaction. A post-closing real property lease agreement is typically entered into in cases in which either the seller does not want to sell the real property used in the business or the buyer would rather lease the property rather than buy it.

Agreements Restricting Seller's Activities

Although provisions restricting the seller's activities after closing are sometimes set forth in the definitive acquisition agreement, transactions may also be structured to have a non-competition or non-solicitation agreement delivered at closing as an ancillary agreement. The objective of these agreements is to prevent the seller from using its knowledge of the transferred business to take actions that could harm the business after closing. Under a non-competition agreement, a seller usually agrees for a specific period not to directly or indirectly operate, invest in, or provide services to competing businesses that operate in the same field and geographical location. Under a non-solicitation or no-hire agreement, a seller agrees for a specific period that it will not solicit or hire any employees whose employment has been transferred to the buyer.

Ballard Spahr's Mergers and Acquisitions/Private Equity Group has extensive experience drafting and negotiating purchase agreements on behalf of both buyers and sellers in both public and private M&A transactions. For further information, please contact Craig Circosta at 215.864.8520 or circostac@ballardspahr.com, or Sandra Wintner at 215.864.8407 or wintners@ballardspahr.com.

Craig Circosta and Sandra Wintner


Another Social Media Policy Declared Overbroad

The National Labor Relations Board's spotlight on employee use of social media—and employers' efforts to restrict it—continues. Less than two weeks after the NLRB issued its first decision concerning an employer's social media policy, an NLRB Administrative Law Judge (ALJ) declared overbroad part of another policy, saying it violated the National Labor Relations Act. At issue is the extent to which such policies may infringe on an employee's right to speak out about workplace problems and concerns.

Applying the rationale developed in three groundbreaking reports by the NLRB's Acting General Counsel over the past year, and the Board's own September 7 Costco decision, the ALJ concluded that the social media policy in question could be interpreted to "chill" employee exercise of the right to engage in protected, concerted activity (such as group protests of working conditions or other efforts to address work-related issues), a right the federal law guarantees to union and non-union workers alike.

In EchoStar Corp., the ALJ found overbroad a prohibition against "disparaging or defamatory comments" about the company, its employees, customers, and their products/services because the ban could be reasonably interpreted to prohibit work-related complaints protected by the law. While an employer may prohibit "defamatory" comments, the broader rule against "disparagement" went too far. The ALJ concluded that the policy's "savings clause" (which directed employee questions to the human resource department and advised that applicable law would control) did not rescue the rule.

The ALJ in EchoStar also reviewed other employer rules, finding overbroad policies limiting employee contact with the media; a requirement that employees maintain confidentiality in company investigations; and a prohibition against insubordination, to the extent that this term was defined to prohibit activities that "undermine" the company. In all of these rulings, the ALJ again works within recent (and sometimes controversial) Board precedent and guidance.

Ballard Spahr's Labor and Employment Group routinely assists employers in NLRB compliance and in drafting social media policies. If you have questions or concerns about social media in the workplace, please contact Denise M. Keyser, 856.761.3442 or keyserd@ballardspahr.com, Mary Cate Gordon, 856.761.3464 or gordonmc@ballardspahr.com, or the lawyer in Ballard Spahr's Labor and Employment Group with whom you work.

Denise M. Keyser and Mary Cate Gordon


President Obama Signs Three-Year Reauthorization of E-Verify Program into Law

On September 28, 2012, President Obama signed into law a bill that reauthorizes the E-Verify program for three years.

The legislation extends use of the U.S. Department of Homeland Security's (DHS's) Internet-based E-Verify system, which confirms an employee's employment eligibility by comparing information included on the employee's Form I-9 and Social Security Administration and DHS records. Set to expire on September 30, 2012, the program will now continue until at least 2015.

The program, launched in 1997 and originally known as the Basic Pilot Program, was designed to facilitate compliance with federal restrictions on the employment of unauthorized aliens. Initially voluntary, participation has since become mandatory for all federal contractors and for those contracting with several states.

Further, since last year's Supreme Court decision in Chamber of Commerce v. Whiting, states have had unquestioned authority to require private employers operating within their borders to use the program. So far, 19 states have enacted legislation requiring at least some employers to do so. Therefore, employers should review the law in their jurisdiction to ensure that they are compliant with any state statutes related to their use of the E-Verify system.

If you have questions about the extension or its implications, please contact John G. Kerkorian at 602.798.5408 or kerkorianj@ballardspahr.com, Christopher T. Cognato at 215.864.8612 or cognatoc@ballardspahr.com, or the member of the Labor and Employment Group with whom you work.

John G. Kerkorian and Christopher T. Cognato


Connecticut to Require Licensing of Employees of Third-Party Loan Processors and Underwriters

Connecticut has provided clarification of loan processor and underwriter licensing. Under a recent amendment, employees of third-party loan processors and underwriters are not exempt, even if employed by a licensed lender or broker, and must obtain a Loan Processor/Underwriter License. The requirements for these individuals are similar to those for mortgage loan originators. Entities seeking to license their loan processor or underwriter employees are now required to submit an Exempt Company Registration to sponsor their employees on the NMLS. This amendment took effect on October 1, 2012.

Connecticut has added exemptions from mortgage licensure obligations for certain individuals. Additionally, bona fide nonprofit organizations will be exempt from mortgage broker licensing requirements to the extent that the bona fide nonprofit acts as a mortgage broker for residential mortgage loans that are exclusively made by corporations (or their affiliates) who make those loans exclusively for the their employees' benefit or to promote home ownership in urban areas. These exemptions were effective October 1, 2012.

Connecticut also has added a new obligation for Qualified Individuals and Branch Managers of licensed mortgage lenders, mortgage correspondent lenders, and mortgage brokers. Effective November 1, 2012, each Qualified Individual and Branch Manager must be licensed as a mortgage loan originator.

California Adds an Exemption to its Finance Lenders Law

California recently added an exemption to its Finance Lenders Law for community advantage lenders. A "community advantage lender" is an entity authorized by the U.S. Small Business Administration to deliver community advantage loans. This exemption is effective January 1, 2013.