The SCRA can be a Minefield: Recent Ninth Circuit Opinion Addresses Foreclosure Protection

by Bradley Arant Boult Cummings LLP
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On February 7, the U.S. Ninth Circuit Court of Appeals issued its opinion in Brewster v. Sun Trust Mortgage, Inc. The decision stands as a stark reminder to mortgage lenders and servicers of the importance of verifying a borrower’s military status prior to initiating foreclosure actions. Perhaps more importantly, the opinion signals what appears to be the Ninth Circuit’s expansion to certain pre-foreclosure collection activities of the protections afforded to persons in active duty under the federal Servicemembers Civil Relief Act (SCRA). Specifically, the court defined the term “foreclosure” for purposes of Section 533 of the SCRA to include attempted collection of foreclosure fees related to a non-judicial foreclosure initiated but subsequently rescinded by a predecessor mortgage servicing company. While the opinion involves a California foreclosure and is limited as binding precedent to the Ninth Circuit Court of Appeals, it is likely that future litigants will seek to apply the court’s reasoning more broadly.

In Brewster, the original servicer initiated a non-judicial foreclosure proceeding against the borrower pursuant to California law by filing a notice of default (NOD). At some point in the non-judicial foreclosure process, the servicer determined that the borrower was a reservist mobilized to active duty, halted the foreclosure, and rescinded the NOD. The fees and costs incurred as a result of the non-judicial foreclosure, however, remained on the borrower’s account. The servicer transferred the account, with the foreclosure fees incurred on that file, to a new servicer. While the new servicer did not commence foreclosure activities against the borrower, it left the foreclosure fees incurred by the first servicer in place. As a result, when the second servicer initiated collection activities, it also sought to collect foreclosure-related fees arising from the rescinded foreclosure. During the period of the second servicer’s collection efforts, the borrower remained in military service.

The borrower filed suit against both servicers, alleging violation of Section 533(c) of the SCRA. The federal district court dismissed the claims against the subsequent servicer for failure to state a legally cognizable claim. The district court premised its decision on the theory that a party does not violate Section 533 unless it forecloses without permission from the court, and in this case, the subsequent servicer did not “foreclose” on the borrower. The district court acknowledged that the fees assessed against the borrower from the first foreclosure likely were improper but stated “there is no cause of action for violating the spirit of the SCRA.” The court held that Section 533 forbids foreclosing on the home of a servicemember under certain circumstances but because the subsequent servicer did not foreclose on the borrower, it was not liable under Section 533.

On appeal before the Ninth Circuit, the subsequent servicer argued that the SCRA applied only to the foreclosure that was terminated before the servicer assumed the servicing rights of the borrower’s mortgage. In other words, the servicer’s position was that no SCRA violation existed because a foreclosure action (a) did not exist when it assumed servicing obligations, and (b) was never commenced because the second servicer never pursued a sale, foreclosure, or seizure.

The circuit court rejected the servicer’s argument, reasoning that the plain language of the statute suggests that “foreclosure” covers more than just the formal foreclosure proceeding. The court also relied upon the California statutes governing the non-judicial foreclosure process, observing that (a) initiation of a non-judicial foreclosure and assessment of fees constitutes “foreclosure” because it is one of several steps in the foreclosure process, and (b) the statute includes numerous requirements for imposing fees related to basis, timing, and reasonableness. Relying upon the statutory procedure and taking into account the broad construction given to the statutory language of the SCRA to effectuate the legislative purpose of the statute, the court held that the attempted collection of fees related to an NOD on a California property constitutes a violation of § 533 of the SCRA regardless of whether the NOD had been rescinded.

One important aspect of the opinion relates to the court’s discussion of the assessment of punitive damages against the second servicer. At oral argument, the circuit court requested that the parties provide supplemental briefs as to whether servicemember borrowers are entitled to punitive damages under the SCRA. The United States Department of Justice (DOJ) submitted an amicus brief in support of the position that punitive damages are available, citing a district court opinion providing that “punitive damages are available for willful and wanton violation of the SCRA.” Both the borrower and the DOJ argued that the “all appropriate relief” language in the SCRA invokes the U.S. Supreme Court’s “appropriate relief” jurisprudence. Under the logic of the “appropriate relief” line of cases, punitive damages are available for certain SCRA violations—for example, those that are tortious, intentional, and outrageous. Accordingly, the possibility exists that the second servicer may be exposed to both actual and punitive damages as a result of the SCRA violation in this case.

Under the logic of Brewster, a servicer or lender could face a punitive damages award for failing to determine the military status of a borrower prior to initiating collection efforts, even if it never proceeds to foreclosure. While most servicers likely perform SCRA searches prior to commencing foreclosure proceedings (and at key milestones throughout the foreclosure process) to ensure compliance with the SCRA, it may come as a surprise to those servicers that their pre-foreclosure collection efforts could also result in SCRA liability. To address this potential issue, servicers should evaluate their SCRA policies and procedures to determine whether enhancements need to be made to ensure future compliance with Brewster.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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