Re: Discharge Of Debt And Mortgage

Front 1

When can discharge occur?

Back 1

1) at prepayment (if allowed)
2) upon the last mortgage payment
3) upon acceleration and payment of debt
4) at the end of the balloon.

Front 2

What two kinds of people can make pay-offs of the debt?

Back 2

1) primarily responsible: the owner of the equity of redemption (MR or G)
o when the party primarily responsible pays, the mortgage is extinguished
2) not primarily responsible: those with interests to protect can buy mortgages
o when a party not primarily responsible pays, the mortgage is not extinguished but that person becomes subrogated to the mortgage, as if the mortgage has just been sold to a different owner who can then receive payments from the primarily responsible party
o then when the primarily responsible party pays the non-primarily responsible party, the mortgage evaporates

Front 3

Does actual payment have to occur before the mortgage disappears?

Back 3

No, valid tender also counts.

Valid tender: an offer to pay the full amount and keep the tender good by making sure cash is paid into escrow.

Front 4

What are required for mortgage to be extinguished by the PR party?

Back 4

1) Redemption can be made only when paymewnt is due or earlier if allowed by ME.
2) Payment must be in full.
3) Payment has to be actually received

Front 5

What is the ME required to do after MR/G who is PR redeems?

Back 5

To give payor a written document in recordable form, showing that the mortgage has been extinguished.

Front 6

What are required for mortgage to be extinguished by the NPR party?

Back 6

1) Can only redeem when payment is due (maturity of debt or acceleration)
2) Prepayment not permitted even if ME would allow it
3) NPR party also entitled to the written document showing that the mortgage has been assigned.

Front 7

What is the general/common rule on the right of prepayment?

Back 7

If a mortgage note is silent as to prepayment, there is no right to prepay

Brown v. Cole

Front 8

What is the lock-in provision of many commercial loans?

Back 8

A provision prohibiting prepayment prior to a certain date.

The outcome of this is that if the MR decides to prepay, the lender can name the price.

Front 9

What is a defeasance provision?

Back 9

Some lock-in provisions have a defeasance provision which makes the real estate more marketable because it says that if the MR can substitute other security of comparable value, the mortgage will be put on the new security and the former security will be released.

The new security generally has to be something reliable, like treasury bills.

The Restatement allows for this even in the absence of a defeasance provision.

Front 10

What is the restatement view on the right to prepay?

Back 10

If the mortgage is silent, there is a right to prepay at any time, under the theory that if the lender thinks it is important, the lender can put in specific language disallowing prepayment.

Mahoney v. Furches

Front 11

Are most residential notes and mortgages prepayable?

Back 11

Yes, without penalty for single family and with a yield maintenance clause for multi-family.

VA, FHA, and Freddie Mac/Fannie Mae all only take prepayable notes.

Front 12

What is the effect of prepayments?

Back 12

1) Major repercussions on mortgage law and on the wealth of the average American. It transfers wealth from lender to borrower because borrowers can prepay and refinance whenever interest rates in the market drop and get to keep low interest rates and market rates rise.
2) Reflects itself in mortgage interest rates as a whole as well. In areas with more sophisticated people who will prepay and refinance more often, Fannie Mae/Freddie Mac will price bonds and participation certificates at a higher rate.

Front 13

Are most commercial loans prepayable?

Back 13

Yes, but subject to a prepayment charge.

Front 14

What are the three major types of prepayment provisions?

Back 14

1) Have a right in any year to pay 20% of the principal balance with no penalty at all. If the prepayment exceeds 20% you have to pay 6 months of interest
3) Still common. At the end of a certain term, there is no charge to prepay. Before that time there is a fixed penalty percentage that may decline over time as the loan grows closer to maturity.
3) The one you really have to worry about. Yield Maintenance
a. The term PV helps the borrower

Front 15

What is the yield maintenance provision?

Back 15

An estimation of the difference between the loan interest rate and what they would get if they invested the money.

So, difference between interest rate on loan and interest rate of investment is the penalty interest that must be paid.

Problems could include: 1) tying to too low an interest rate 2) not taking into account present value.

Front 16

Why are prepayment fees used?

Back 16

1) Compensates lenders for cost of making loan (a cost usually amortized over the life of the loan)
2) Is a rough economic complement to the due on sale clause; it prevents MR from shopping around for lower rates

Front 17

Are prepayment fees usually upheld?

Back 17

Yes, outside of the bankruptcy context.

Front 18

What is the justification for the common law rule of no prepayment unless in mortgage?

Back 18

1) Would force lender to accept prepayment it did not bargain for
2) Lender would be exposed to a lesser than anticipated rate of return
3) Possibly adverse tax consequences
4) Added reinvestment costs

Front 19

When is the prepayment reasonable?

Back 19

The prepayment charge should approximate liquidated damages.

Front 20

What happens is the prepayment is deemed unreasonable?

Back 20

If a prepayment charge is deemed an unreasonable estimation of damages it is considered a prepayment penalty and will not be enforced.

Front 21

How are prepayments treated in bankruptcy?

Back 21

Bankruptcy will allow borrowers to prepay and will also only allow prepayment fees and charges that are reasonable (506(b)).

Bankruptcy courts take reasonableness more seriously than state courts and will usually strike down yield maintenance clauses that the state courts would uphold. Cannot exceed the actual damages suffered by the lender.

Then the mortgagee must get in line with all other unsecured creditors.

Front 22

Why don't bankruptcy courts like YM clauses?

Back 22

1) PV of difference between interest rate on loan and the rate on US Treasury obligations of the same maturity. Lender is unlikely to invest in government bonds-->more likely to relend funds on another real estate loan.
2) Doesn't take the time value of money into account so overcompensates lender.
3) Loan is amortized so should not pay interest on original balance.

Front 23

What are the judicial attacks on prepayment fees?

Back 23

1) Usury argument: not usurious b/c they represent a charge for returning money and not interest for the right to use money.
2) Restraint on alienation: Prepayment penalties are not considered an unreasonable restraint on alienation.

Front 24

Liquidated Damages v. Penalty Analysis

Back 24

Reasonable if it is considered a liquidated damages (for actual damages).

Williams v. Fassler: 50% prepayment fee is enforceable because of the tax consequences for E of prepayment.

Outside of the bankruptcy context, most prepayment fees have been deemed reasonable.

The Restatenebt disregards the reasonableness test--Requiring a fee as a condition of prepayment is enforceable.

Front 25

Why do most cases prohibit the collection of the charge where the default and acceleration is caused by an honest inability to pay?

Back 25

1) Once acceleration has occurred, the principal sum is due and the payment is no longer pre
2) By accelerating, the lender has waived its claim to the prepayment fee
3) The prepayment fee clause is intended to govern only voluntary prepayments.

Front 26

What happens if the MR defaults on purpose so that the lender accelerates and MR can prepay without any prepayment charges?

Back 26

The court will probably enforce the fee. In re LHD Realty Corp.

Front 27

What is the effect of a mortgage clause specifically requirement a prepayment fee upon default and acceleration?

Back 27

The Restatement and Westmark case agree that prepayment fee is required.

Front 28

Can MEs include a provision requiring a fee in case of casualty insurance or eminent domain proceeds?

Back 28

Yes.

Front 29

What is the Restatement view on the collectibility of a prepayment fee from casualty insurance proceeds?

Back 29

If it would be feasible to use the proceeds for restoration of the property, but the lender nonetheless insists that they be paid toward the loan balance instead, the lender may not also collect the prepayment fee.

Front 30

How are prepayments b/c of acceleration due to DOS clauses treated?

Back 30

1) Since the lender is the one who refused to allow a transfer, it means that the lender can put the money out at a higher interest rate and therefore should not receive a double benefit from the prepayment. Thus, older cases would hold that the MR was not technically prepaying so the charge was not collectible. – “double dipping”
2) With clauses in the mortgage requiring PP fees in such situations courts often hold that prepayment charges are enforceable.
3) The OTS protects homeowners from this situation and from situations in which the lender fails to approve a transfer within 30 days.
4) The Restatement view is that lenders who disallow transfers because they want to get a better interest rate should not get the prepayment charge but those who disallow transfer because of credit risk should.

Front 31

1st generation cases

Back 31

No PP when acceleration was involuntary.

Front 32

2nd generation cases

Back 32

PP for any type of acceleration at any time.

Front 33

Judicial approach to default interest

Back 33

Allows ME to raise the interest rate in the event of default. From the day of default, the whole principal balance accrues interest at the higher interest rate. The lender can decide not to accelerate but the default triggers the default interest such that all future payments are higher.
o The damage that the lender suffers otherwise is the higher risk of non-payment.
o Although some argue that default interest should not be allowed because it is usurious, every residential first mortgage in the U.S. is exempt from usury laws because of federal preemption.
o Usually this has to be within a reasonable range, like 4-6%, although a 34% increase has been affirmed as well.

Front 34

What are late fees?

Back 34

One-time fees aimed at preventing borrowers from sending payments in late so that they can use the interest rate to their own benefit.
o The damage that the lender suffers otherwise is 1) the interest on the interest payments and 2) costs of following up and getting the payment.

Front 35

Judicial approach to late fees

Back 35

1) These are typically upheld if they are a set fee or a percent of the late installment, but are considered an invalid penalty if they are ever a percentage of the principal amount.
2) Fannie Mae/Freddie Mac allow these after a 15 day grace period
§ Fannie Mae/VA – 4%
§ Freddie Mac – optional up to 5%
3) States often have nominal amounts like $10 or 4-5% of late installment, whichever is greater + grace period
4) FHA/VA says 2% and only if it is more than 15 days late
5) Judicial approach: will be struck down if not a reasonable estimation of ME’s actual damages but courts are reluctant to strike them down as usurious because 1) MR could have avoided interest by not defaulting and 2) it could wipe out all interest if found usurious

Front 36

Fleet Bank of Mass. V. One-o-Six Realty

Back 36

1) MR purposely was not paying the balloon because the interest rate on the mortgage was low so it preferred to use the money for other purposes.
2) When Fleet bought an action to get the note paid the court determined that damages were allowed because the lender faced an increase in the risk of non-payment. 3) Thus, default interest was allowed. However, the late fee was overturned because it was 5% of the balloon, which the court determined was a penalty, despite Fleet’s argument that it was just a percentage of the last payment. BALLOON PAYMENT IS NOT AN INSTALLMENT.

Front 37

What is the main rule about the enforceability non-monetary obligations?

Back 37

The black letter law and the Restatement both say that a valid mortgage must support an obligation that can be reduced or liquidated into a money amount.

Thus, a promise to provide “care and support” is a valid mortgage but a promise for “love and affection” is not because the former can be monetized and the latter cannot.

Can never foreclose a non-monetary promise by power of sale-->need a court.

Front 38

What are the reasons for the non-monetary obligations rule?

Back 38

1) If there is a foreclosure, we need to know how to divide up the purchase price between MR and ME for purposes of deficiency judgments, etc.
2) Junior lienholders would not know how much to bid at foreclosure sales if there were non-monetized obligations.
3) Impossible to get 2nd mortgages because the junior won’t know how burdened the land is

Front 39

Devlin v. Weiner

Back 39

Devlins convey land to Weiners in exchange for the payoff of a mortgage and three building options, all valued at $84,000.

This is a valid form of consideration.

Front 40

What is the merger doctrine?

Back 40

When ownership of the land and ownership of the mortgage coalesce in one person, the mortgage merges into the fee title. As a result, the mortgage, and in some instances, the debt, disappear.

Front 41

Restatement view on merger doctrine

Back 41

Disregards the existence of the merger doctrine.

If FMV of property acquired by ME is more than the debt they can’t recover on E1.

Unjust enrichment theory instead: If the FMV is worth less than the debt they can recover on E1 for that amount to make them whole.

Front 42

Mid-Kansas v. Dynamic

Back 42

The foreclosure purchase by MK at the foreclosure sale of E2 destroyed its right to sue MR personally on the E1 debt. This is because it should have bid at most the FMV of the land less the amount of the senior lien and should not be able to collect on the first mortgage debt.

This logic is only sound if the land is at least worth the sum of both mortgages. If it is not, then the bank should be able to get a deficiency judgment. Some courts will follow this instead of the merger doctrine.

Front 43

How can the merger doctrine be avoided?

Back 43

1) Using judicial foreclosure and foreclosing both mortgages together.
2) Foreclosing on E1 first, which does not apply the doctrine of merger.
3) Using the Restatement approach and rejecting the merger doctrine.

Front 44

Deed in lieu of foreclosure

Back 44

After a default, MR agrees to deed land to E1 in lieu of foreclosure.

E avoids cost of foreclosure and is assured of getting security back.

MR gets to protect credit rating and in some states protect against having a deficiency judgment.

Front 45

What is the danger of using a DIL?

Back 45

In all but one or two states (i.e., Alabama) the DIL does not have the effect of foreclosure--> it does not wipe out junior interests. So, JL is not destroyed.

The danger in this is that the doctrine of merger applies and makes the E1 mortgage disappear. An E2 then becomes E1 and can foreclose free and clear.

Front 46

How do different jurisdictions handle a DIL?

Back 46

1) 90% of the states reject merger in this situation b/c gives E2 an unintended benefit. In general, when the intent is not clear, the courts presume an intent to benefit the person in whom title to the land and ownership of the mortgage merged (E1). E1 is allowed to stand in the place of both MR and itself and foreclose, thus wiping out E2. Usually E1 is the P in such a situation. The purchase price goes first to E1, then to E2, then surplus goes to MR (who is also E1)
2) Restatement says that the deed in lieu ME who either assumes an existing junior lien or takes with actual knowledge of it will be deemed to have waived the right to foreclose against it
3) Some courts and the Restatement will not uphold a post-default deed in lieu of foreclosure when there is still a “mirage of hope.” Basile v. Erhal Holding Corp. CA allows them to encourage workout agreements.

Front 47

What is the most important thing for E1 to do before getting a DIL?

Back 47

1) Perform certain due diligence. Most important: get a title check to see what is on the property below the mortgage. If the title report shows junior interests, E1 can’t take a DIL unless those junior interests will release their claim for a nominal amount of money.
Can’t have a DIL if there are junior interests.
2) Appraisal: see how close the value of the real estate is to the debt-->see if its fair for MR to give the DIL
3) Environmental assessment: Even if not liable under CERCLA could still be liable in tort.