When making a secured loan, the process of making sure your collateral is actually – legally – your collateral can be more difficult than expected or later determined. The steps are fairly simple, but the analysis and execution can be lacking for a number of technical reasons which can render your first priority lien a junior lien or gone all together if you are not careful.

Lord, P., Miller, C., Ferrell, W., Arnett, W., Banks, E., Offerman, N., Berry, C., … Warner Home Video (Firm),. (2014). The Lego movie

There are numerous opportunities to mess up collateralizing things for a secured loan.  This blog post will discuss personal property which has its own rules (as opposed to real property).

First, the down side.  If a lien is not properly attached or perfected the lender runs the risk of either being subject to a later lien or all together unsecured if the borrower files bankruptcy.  It’s a big deal.

There are two basic steps to create a lien.  The first step is “attachment” the second step is “perfection”.  Both are equally important but for different technical reasons.  However, the underlying purpose of the exercise is also two-fold.  1 – Agree on what is being pledged and, 2 – let everyone else know.

I. Attachment

When taking a pledge of collateral, the first deal a lender makes is with the borrower.  This agreement is contained (usually) within the security agreement.  This is the document, signed by the borrower, which identifies specifically what things are being pledged (hypothecated, etc.) as collateral.

The security agreement should either: specifically identify what is being pledged, or should enumerate the class of collateral by their defined terms in the applicable uniform commercial code.

The security agreement is the specifics of the agreement to pledge collateral by the borrower to the lender.  (By the way, be sure the borrower actually is the owner of the collateral.  One cannot pledge what one does not own).

There are many traps for the unwary in this process.  The type of collateral pledged may be one of several defined collateral classes depending on how it is being used. Thus, taking a lien on equipment will not give a lender a lien if that equipment is being used as inventory.

Once a lender has properly attached the collateral the lender has a lien on the collateral as between the borrower and lender.  BUT not third parties.

II. Perfection

When taking a pledge of collateral, the second deal a lender makes is with everyone else.  In short, once the lien is attached the lender needs to let everyone else know about the lien, otherwise it’s meaningless to third parties.

Different types of collateral require different types of perfection.  The typical perfection method is filing a form with the secretary of state called a UCC1 form. Other methods are used for specific types of collateral, but that is beyond the scope of this article.

The secretary of state’s filing system provides a public forum which provides legal constructive notice of the filing.  This means that if a UCC1 is filed everyone is on proper notice even if they never look at the filing.

The state of incorporation will determine which secretary of state needs to receive the lenders UCC1.  After that, the next task is the technical compliance with the requirements of filing.  More specifically, the lender needs to put the world on notice as to what the lender’s lien attaches to.  If this is done successfully, then all third parties will be subordinate to the lien of the first lender.

To accomplish this, the lender needs to properly name the borrower by its formal legal name (no DBAs) and give reasonable notice of the collateral pledged.

A failure on either of these can cause a lender to loose priority or the lien all together.  The formal legal name is easier to mess up than you think.  With regard to the collateral, here is where determining exactly the character of collateral becomes important as well.  If your security agreement says “equipment” but your UCC1 says “inventory” then there has not been proper perfection.

If perfection is not proper then there is no way to keep a third party from taking over a first position lien (assuming they attach and perfect properly) and, worse, if the borrower files bankruptcy ANY failure to attached or perfect will be attacked by the trustee and likely render a lien worthless.

There are, frankly, a number of ways to mess up this technical process.  The mind frame to approach securing a loan is “this seems simple, but it’s actually quite complex”.  Oftentimes, a misstep isn’t discovered until years later when it’s too late to remedy.

There is a significant amount more to talk about on the topic, but I wanted to give a brief overview of attachment and perfection.  Email me if you have any good war stories on the topic; they tend to be very interesting.

Things are not great in brick and mortar retail, and they really haven’t been for some time.  Most people are aware of this, but this is a quick note on the status of retail bankruptcy cases and the outlook for the year.

Lions Gate Television Inc. ; created by Matthew Weiner. Mad Men. Season One. Santa Monica, CA :Lionsgate, 2008. Print.

 

In 2017, there were more major retail bankruptcy cases filed than during any given year of the “great recession”.  Twenty-six in total with at least $50MM in liabilities.  Obviously a large number.  The question is whether that trend will continue into 2018 (or, alternatively, if there any more retailers of that size to go under).

So far this year, there have been at least 5 major retail bankruptcy filings.  S&P Global Markets has identified 19 retailers who it believes is at risk of filing bankruptcy in 2018.  While not quite at the record 26, this is still a large volume of retail to go into bankruptcy.

The effects of these bankruptcies often leave a huge hole in retail centers and may have a ripple effect with landlords across the country.  Toy’s R Us recently ceased operations and will liquidate all 735 stores in the U.S.  (Interesting side note, the lead attorney for Toys R Us sang the iconic Toys R Us jingle on their first day in Court.).

I am already hearing from landlords that there is little desire to lease to retail because it’s almost a foregone conclusion they will fail.  The preference seems to be restaurants. Because of the terms of these leases (in years) it’s likely to change the landscape of what these consumer facing developments look like for some time.

In addition to landlords, the equity funds who commonly have bought out and leveraged these retail stores may also feel the pitch.  A common theme repeated in the Toys R Us case is a leveraged buyout which places an un-serviceable amount of debt on the company leading to failure.  In the case of Toys R Us, the total debt is about $5 billion, requiring about $400MM annually to service.  That’s a lot of Paw Patrol to sell.

The cause of the decline of brick and mortar retail is beyond this blog post.  However, the effect on lenders who have loans out to these retailers will likely be negative again this year.

For all of those lenders, now would be a good time to review your collateral position in hard assets and consider cash flow when a renewal is requested.  Might also dust off that landlord subordination agreement to see if there is anything else you need to add.  I work on these quite frequently and they can go south pretty quick.

In good times many lenders are willing to approve a loan which is secured only by accounts receivable.  The ability to value A/R seems more straightforward than it actually is when considering underwriting.  There are several legal and practical problems with collecting A/R which will reduce its ultimate value to a lender if the lender ends up needing to monetize the A/R following default.  This post will discuss A/R and collecting the A/R.

Let’s begin with the basics: what is an account receivable (“A/R”)?  It’s a common misconception that A/R is the payment.  A/R is actually the right to receive the payment.  When a payment is made, the A/R ceases to exist.

So, when a lender takes a blanket lien against A/R, the lender is really encumbering the right to receive payment from third parties in the future, not the cash in the bank account.

Misunderstanding this can cause problems in a few ways.  One of the most common issues I have seen is when the borrower reports A/R that is actually just revenue.

In a hypothetical scenario: the borrower sells equipment.  A buyer orders some equipment online and at the same time pays for it. Then borrower ships buyer the equipment.  Borrower generates an invoice to account for the payment and the transaction closes.

Oftentimes an unsophisticated borrower will assume that this transaction created an account receivable, when, in fact, it did not.  Further, the borrower will then turn around and report the transaction as an account receivable on a borrowing base report or loan application.  Doing so can cause issues with covenants and underwriting for the lender if the lender is not aware of the misstep.  Simply stated, there is no A/R in this hypothetical and therefore there is no collateral to collect on if things go south.

Another problem I commonly see is when a lender overvalues the A/R when considering underwriting or loan modifications.  A/R’s true value for a lender is the lender’s ability to monetize the outstanding A/R at the time of the default.  Three basic things work against the lender in the scenario when the lender needs to collect A/R.

First – the reason the lender is seeking to collect A/R is because the borrower is in default.  Usually a borrower is in default because business has been going poorly.  Poor economic performance usually also means that the A/R that exists has diminished over time because the borrower has been doing less business.

Second – the practicality of collecting A/R is difficult.  The lender is immediately at a disadvantage because the lender doesn’t have the books and records of the borrower to show who actually owes money on an outstanding A/R.  It’s great to look at a balance sheet and see $10MM in A/R, but it’s another thing all together to track down the specifics.  I have been in situations where the A/R records were all on a cloud server which was deleted.  Next, the lender will oftentimes need to pursue the A/R in its own name, one way or another.  It’s likely that the account debtor (the person who bought the equipment) would simply ignore a demand by the lender to pay up.  There a number of reasons for this.  Part of the problem is that if the lender needs to actually resort to bringing a lawsuit, all of the evidence of the A/R is really the borrower who may not be helpful on the witness stand.

Third – Finally, there is the unknown relationship between the borrower and the account debtor.  Most all of the account debtors have some excuse about why they did not pay the invoice.  Usually these excuses include: the equipment was no good, I have a credit that’s not reflected, I have a deal with the borrower where I don’t have to pay, I returned the item, or – in cases of fraud – I have never heard of the borrower.  (All of which I have heard).  The facts related to all of these excuses will likely be unknown to the Bank when it tries to monetize the A/R and, if the excuses are true, may result in an offset to the A/R.

There are clearly a number of hurdles to monetizing A/R.  From a preliminary perspective, the A/R that exists when a lender takes a lien against A/R will not be the A/R that might be available for collection at a later date.  The lender is simply betting that the borrower will continue to generate A/R at a rate acceptable even in a time of default at some unknown time in the future.

In some recent minor news coverage the issue of attorney-client privilege has come up.  It often is surprising to non-lawyers (and non-litigators) how limited that privilege actually is in scope.  Many clients tend to assume that any conversation with an attorney will be protected.  However, the scope of the attorney client privilege is much more limited, and, not understanding that will result in your “privileged” communications becoming public record.

It's raining privilege
Peter Pan. Copyright Disney 1953

Let’s start with the general rule of attorney client privilege.  Communications between an attorney and client concerning legal strategy and analysis will be protected from compelled disclosure as long as the privileged isn’t waived.   This will be true so long as the communications don’t implicate the attorney in assisting an ongoing crime or fraud.

There are a few elements there to consider.  The first is obviously that there must be an attorney client relationship.  The classic law school exam is whether giving advice at a cocktail party will create such a relationship.  In order for an attorney client relationship to exist there need not be money that changes hands (think pro bono work).  However, there does need to be an agreement to create the relationship.  (The answer to the law school exam question is “don’t give legal advice at cocktail parties”, btw).  As a corollary to this, if an attorney is acting without direction (or knowledge) of the act of the client it may be determined to be outside of the scope of even an existing attorney-client relationship.

Next, the communication must be between only the client and attorney.  Including anyone else in the communication will waive the privilege.  In fact, if the client casually mentions only a small part of the communication to a third party, the privilege will be waived as to the entire communication or perhaps even topic.  For corporate clients, the “client” is the officers and directors and any employee whose duties make him/her necessary to include in the matter.

Perhaps equally important, the communication needs to be directed at the attorney to invoke attorney client privilege.  A common mistake is merely cc’ing an attorney in an attempt to invoke the privilege.  (I am looking at you board members).  This will likely not give rise to the privilege unless the attorney is an active part of the conversation.

Perhaps most importantly, the communication must concern legal strategy or legal analysis.  This is the part that trips the most people up.  If a client emails an attorney and asks about the pro’s and con’s of a business deal from a business perspective that communication likely won’t be privileged.  In instances where – for example – an email is discussing business matters and legal matters, if the legal matter discussion does not predominate the communication’s purpose the privilege will likely be waived.

As a footnote to the legal strategy or analysis section, facts are NOT privileged.  A client cannot avoid admitting a fact because of attorney client privilege.

Finally, simply writing “ATTORNEY-CLIENT PRIVILEGED” on the top of a document (or anywhere) is not a magic way of invoking the privilege.

The notion that including an attorney on communication is some type of fairy dust that sprinkles privilege is simply not true, despite a very common misconception.

Of course, there are good practices to avoid falling into a situation where your purported privileged communications turn out to be public.  There are also a few other types of privileges which may be invoked which are not discussed in this blog post.  If there is any interest I might post a more full description of the various claims to privilege.    Additionally, I have not touched on the crime fraud exception, which, depending on upcoming news stories may also be touched upon in a future blog post.

Until then, remember the golden rule.  If you wouldn’t want it published on the front page of the Wall Street Journal, don’t write it in an email.

In prior posts I have discussed what bit coin is, in terms of describing the technical aspects of the thing.  Bit coin is only one of numerous non-fiat currencies which currently exist, and seems to be the most common.  In this post I will not be focusing on the technical nature of non-fiat currencies, but rather consider what the character of a non-fiat currency is legally.  Stated more directly, is a bit coin legally a currency, security, instrument or something else.

The trick is to realize that there is no coin

Bear with me, because this is a long post.

To state the obvious, bit coin is not a currency in the sense it was issued by a sovereign.  However, non-fiat currency is not unheard of in the world.  You could argue with a straight face that the game tokens at Chucky Cheese are a form of non-fiat currency.  They can be exchanged for value (say a video game or perhaps a trinket) and there is a market to exchange them with others – if you happen to be 10 years old.  But to say that a game token is legally the same thing as a bit coin over simplifies that notion that something which represents value and can be exchanged in necessarily a currency.

In reality, anything can retain value and be exchanged for something else of value.  This is the basis for early barter system economies, such as the Mesopotamian culture.  However, currency has only one imperative, which is to be valuable.  Unlike bartering wheat for timber, a currency cannot be used to make bread or build a house.  Its only purpose is to retain value.

In the United States, this is enough for the criminal justice system to have determined that bit coin is money for the purpose of the various criminal statutes concerning money laundering, purchase of illegal items, and transferring money to conspirators.

On the civil side of the law, the Courts have yet to settle on a definition of its character.  The notion of a bit coin as a currency is, in my opinion, driven by the name itself.  If it was called bit-value, bit-stock, or bit-note the immediate perception might be different.

In fact, some forward thinking companies issue Initial Coin Offerings (an “ICO”) which is similar to an IPO, but instead of shares in the company in the traditional sense, the company will issue “coins” to investors which function more as token on ownership rather than as a fungible currency.  In using an ICO, the coins are tracked with the blockchain technology allowing for the quick and anonymous transfer of the coins instantaneously to anyone anywhere.

These ICO coins are certainly not currency because they act as ownership stakes in a company and, while they hold value and can be exchanges for value, the ICO coin is not fungible with another company’s ICO coin.

By the same token (pun intended), is a bit coin itself fungible?  While one bit coin will equal another bit coin on the exchanges, each bit coin is supremely unique because of its hashing and ownership on the ledger.

Perhaps the hashing is analogous to a dollar bills serial number, but the ownership function on the ledger has no analogous characteristic with currency.   Without the ledger there could not be a decentralized ability to transfer a bit coin from one person to another, and without that ability anything of “value” is really worthless.  It is therefore, I believe, a central element of bit coin that it requires a ledger, which likes the bit coin to the owner’s wallet.

Equally import is that fiat-currencies are backed by the sovereign while bit coin is backed by nothing but the common belief that it has value.

Both of these issues, I think, sets bit coin apart from a currency, which requires no ledger or mechanism to keep track of ownership and (for fiat currency) requires sovereign backing.  While the true owner of the bit coin may remain anonymous, the owner must like his/her wallet and public key to each of his/her bit coin.

What then, if not currency?

As mentioned above, some types of block chained “coins” are much closer to a security than a typical bit coin.  In fact, the SEC has recently ruled that these token type coins from an ICO are regulated.  However, the bit coin (and similar) are not shares of a going concern which will be run primarily by others from which you hope to capture a gain from such operations.

Rather, its value with only the purpose of being value.

If I may, I think that a bit coin is most like a letter of credit payable in a foreign currency.  The obligation of this “bit-letter of credit” would be the bit coin market place.  When a bit coin owner wants to cash out, he/she attempts to convert the bit coin into some sovereign currency, say US Dollars, by selling / assigning that “bit-letter of credit” to a person willing to accept the rights to the “bit-letter of credit”.

The letter of credit analogy is supported by the fact that actual letters of credit can be traded in exchange for value.  And, if you had a letter of credit payable in Yen, but needed US Dollars, you would be subject to the currency fluctuations among the two.

In fact, the Knights Templar, who pioneered the original letters of credit, allegedly used a cipher on the documents to ensure their validity and kept records on their ledgers.  Additionally, these letters of credit were traded as if currency because of the belief in the credit worthiness of the Knights Templar – who were not a sovereign and were specifically not subject to any sovereign by papal bull.

We are still $20 short. Who did not chip in for the tab.

Indeed, the a modern letter of credit can be assigned, and to do so requires notice to the Bank which is recorded on the bank’s ledger.  Additionally, a letter of credit is not backed by the sovereign.

For this reason, I think bit coins are most analogous to a letter of credit in terms of its legal character.

Please feel free to disagree or comment below.  This in an emerging issue and input is appreciated.

Facebook terms reviewed.  This blog is usually not a data security blog (although it’s something I care about); but the recent scandal with Facebook made me curious just what users agree to by using the site.  As the saying goes, “if the product is free, you are the product.”

The Sound Of Music Party GIF - Find & Share on GIPHY

Credit: The Sound of Music, 1965. 20th Century Fox.

Say goodbye to you personal data.

Full disclosure, I do not maintain a Facebook page.  I understand the benefits of it, but it’s not for me.  Recently, the FCC has announced an investigation into Facebook and its CEO has been called to Capital Hill over the data sharing scandal.  The headline, of course, is that Facebook shared its information and that information was used to sway the election in the US in 2016.  The underlying issue is, what, if anything did users agree to by using the site. This blog post reviews some of those things.

In general, the terms of service with Facebook are what will govern the relationship between Facebook and the user.  The first thing you need to know is that the terms of service are scattered around a lot of hyperlinks.  Links within links.  If you want to know the true terms, be prepared to spend a long time navigating the site.

For example, section I of the Data Use policy states:

Things you do and information you provide. We collect the content and other information you provide when you use our Services, including when you sign up for an account, create or share, and message or communicate with others. This can include information in or about the content you provide, such as the location of a photo or the date a file was created. We also collect information about how you use our Services, such as the types of content you view or engage with or the frequency and duration of your activities.

The “Services” are defined here https://www.facebook.com/help/1561485474074139 and include basically everything Facebook does, as well as its affiliates, which are identified here: https://www.facebook.com/help/111814505650678?helpref=faq_content.

In short, anything you consent to by using any of these pages, or their mobile apps can be shared.   Importantly, the permissions on some of the apps allow Facebook to monitor you phone calls and text messages even outside of the Facebook app.  https://arstechnica.com/information-technology/2018/03/facebook-scraped-call-text-message-data-for-years-from-android-phones/

But that’s just the beginning.  Facebook collects all of your payment and credit card information.  Again, in section I of the data use policy, a user agrees that:

Information about payments. If you use our Services for purchases or financial transactions (like when you buy something on Facebook, make a purchase in a game, or make a donation), we collect information about the purchase or transaction. This includes your payment information, such as your credit or debit card number and other card information, and other account and authentication information, as well as billing, shipping and contact details.

By using Facebook, you agree that Facebook can track you on the web and in real life:

Device information. We collect information from or about the computers, phones, or other devices where you install or access our Services, depending on the permissions you’ve granted. We may associate the information we collect from your different devices, which helps us provide consistent Services across your devices. Here are some examples of the information we collect:

  • Attributes such as the operating system, hardware version, device settings, file and software names and types, battery and signal strength, and device identifiers.
  • Device locations, including specific geographic locations, such as through GPS, Bluetooth, or WiFi signals.
  • Connection information such as the name of your mobile operator or ISP, browser type, language and time zone, mobile phone number and IP address.

Facebook then can use all of that information and provide it to third parties, because the users agreed to it.

Apps, websites and third-party integrations on or using our ServicesWhen you use third-party apps, websites or other services that use, or are integrated with, our Services, they may receive information about what you post or share. For example, when you play a game with your Facebook friends or use the Facebook Comment or Share button on a website, the game developer or website may get information about your activities in the game or receive a comment or link that you share from their website on Facebook. In addition, when you download or use such third-party services, they can access your Public Profile, which includes your username or user ID, your age range and country/language, your list of friends, as well as any information that you share with them. Information collected by these apps, websites or integrated services is subject to their own terms and policies.

Facebook users also allow Facebook to provide your “cookies” to third parties affiliated with Facebook.  The terms use for cookies states:

Where do we use cookies?

We may place cookies on your computer or device, and receive information stored in cookies, when you use or visit:

  • The Facebook Services;

  • Services provided by other members of the Facebook family of companies; and

  • Services provided by other companies that use the Facebook Services (such as companies that incorporate the Like button or Facebook’s advertising services into their websites and apps).

 

Do other parties use cookies in connection with the Facebook Services?

Yes, other parties may use cookies on the Facebook Services to provide services to us and the businesses that advertise on Facebook.

For example, our measurement partners use cookies on the Facebook Services to help advertisers understand the effectiveness of their Facebook advertising campaigns and to compare the performance of those campaigns to ads displayed on other websites and apps. Learn more about the companies that use cookies on the Facebook Services.

Third parties also use cookies on their own sites and apps in connection with the Facebook Services. To understand how other parties use cookies, please review their policies.

To help temper the extremely broad usage of your data, Facebook states in its Terms that “You own all of the content and information you post on Facebook, and you can control how it is shared through your privacy and application settings.”  However, the background data being harvested is not “posted” on Facebook.  In essence, Facebook is saying “the pictures are yours but your soul is mine”.

There are a lot of things users sign away by using Facebook.  In my opinion users agree that all of their data and habits can be used by Facebook and third parties for a wide range of things.

By using Facebook, you are agreeing that Facebook can track you, your friends and anyone who shares information about you.  Facebook can monitor you communication; both inside and outside of the platform.  Perhaps, most importantly, it seems as if that Facebook can sell all of that information to the highest bidder.

Welcome to being the product.

 

The foregoing is simply the opinion of the author, and not a legal opinion.

I’ll admit it.  One of my favorite words is “allonge”.  It breaks up my otherwise decumbent register with something exotic.  Legally, it’s a way to assign a promissory note to another party who then has the rights to assert the promissory note against the obligors.  The last post discussed the importance of compliance with simple legal requirements.  But, what happens if the simple act of signing the allonge is done by an entity which doesn’t exist?  Does the new note holder have the right to assert the promissory note against the obligors. The Fifth Circuit says, “Yes”.

Credit: M.C. Escher

In this case the commercial real estate special purpose entity (“SPE”) and its guarantors fought to avoid a foreclosure (and deficiency) with the lender, and eventually get poured out by the 5th Circuit.  However, I am writing about the opinion because of an interesting holding concerning the various assignments that occurred of the promissory note following execution.

In the case, the SPE borrower (“Borrower”) was obligated on a commercial mortgage note.  After the promissory note was originally executed by the Borrower and original lender the note was transferred several times by assignment and accompanying allonge.  Eventually, the note was assigned to US Bank, as trustee for a CMBS trust.

One of the intermediate assignments was from Greenpoint Mortgage Funding to Aurora Bank.

Borrower was able to prove to the trial court that Aurora Bank did not actually exist at the time of the assignment into Aurora Bank. On this basis, the Borrower sought to attack US Bank’s ability to assert the note against the Borrower.  In considering the argument, the 5th Circuit held:

“This logic and conclusion treats as legally insignificant whether Aurora existed at the time of the transfers and therefore had a legal capacity to either endorse the Note or assign the Deed to US Bank.  Assuming without holding that any of the Deed assignments from Greenpoint to Aurora to US Bank were forgeries under Texas law…,and acknowledging that a forgery makes a Deed assignment void…, when the foreclosing party is the holder of the promissory note, any defects in the Deed assignment are irrelevant.”

This holding is predicated almost entirely on the rule that the mortgage follows the note, which is discussed in some detail in the opinion.

For the litigators, the opinion also contains good language concerning diversity with regard to trusts.  For the UCC folks, the opinion has a full paragraph discussing instrument negotiation.  Finally, the case has a brief discussion on fraudulent misrepresentation.

Interestingly, despite raising a host of legal challenges, the Borrower and the guarantors appear never to have raised a challenge to the note being an instrument – which would remove the holder in due course rights which underpin the opinion.

So, the lesson here: good news for all you banks out there who do not exist yet hold debt.

5th Circuit opinion in SGK Properties, LLC v. US Bank, case no. 17-20130

 

 

When things go south, it’s the little things that can get you into trouble.  When the servicer on a commercial mortgage sent the notice of foreclosure to the address on the deed of trust, but not to the known updated address of the obligors the obligors counter-sued for breach and the case has been pending now for eight years.  In a recent 5th Circuit opinion, the Court found that failure to serve the proper address can be an independent cause of action which is not precluded by the obligors own breach to repay the loan.

Things you don’t notice on takeoff can have an effect at landing

Around the year 2000, the original lender made a commercial mortgage loan to a multifamily apartment complex (“Borrower”) for several million dollars.  The original lender assigned the loan to Fannie Mae, which then used a national bank as a servicer (the “Servicer”).  The property met certain criteria which allowed it to qualify for low income tax credits, which were passed on to the Borrower limited partners of the various trusts in the corporate structure of the Borrower.

In 2010 the Borrower defaulted on the loan by non-payment of the monthly payments.  Upon default the servicing automatically transferred to Fannie, who hired a law firm to perform a non-judicial foreclosure of the property.

The law firm requested from the Servicer the addresses for the various notice parties for the non-judicial foreclosure, which the Servier provided.  The notice addresses provided by the Servicer were the notices contained in the relevant deed of trust related to the loan.

However, the Servicer had, for years, treated the deed of trust addresses as outdated and sent all prior correspondence to the new updated addresses.  That information was not shared with the law firm, who proceeded to send the statutory foreclosure notices to the old deed of trust addresses.

Long story short, the borrower and guarantors did not get the notices of default, acceleration or foreclosure.

The law firm proceeded to foreclose upon the property, which Fannie Mae bid in at the sale.  This triggered, among other things, an IRS recapture of the tax credits in an amount of $1.2MM, which Fannie then had to pay out of pocket.

After the sale, the borrower and guarantors filed a lawsuit against the law firm, the Servicer and Fannie Mae for a number of claims including breach of contract for failure to send the notices to the correct addresses.

After some litigation, the law firm and Servicer were eventually dismissed following motions for summary judgment, leaving only Fannie Mae – the note holder.

The guarantor’s motion for summary judgment on breach of contract was initially granted by the trial court, but then denied on reconsideration.  The basis for reconsideration was Fannie Mae’s assertion that the guarantor’s cannot prove breach of contract by Fannie Mae because the guarantor’s cannot prove that the Borrower was not in breach (ie, for non-payment).  As you may know, one of the elements for asserting a breach of contact claim is that the plaintiff was not in breach, itself.  However, like all Texas rules, there are exceptions.

After the MSJ/reconsideration ruling, the guarantors appealed to the 5th Circuit, who issued the recent opinion.  The 5th Circuit agrees with the general prospect that a plaintiff cannot assert a breach of contract claim if the plaintiff has also breached.  Importantly, the 5th recognized an exception to that rule.  The 5th stated:

“We conclude that Fannie Mae’s agreement in the deed of trust to give notice of foreclosure was independent of the [Guarantors’] agreement under the note to pay monthly installments to satisfy the debt.  The obligation to give notice of foreclosure would not even arise unless and until the [Guarantors] were in default under the note.”

In so holding, the 5th Circuit holds that a breach of the payment requirement is legally different from a notice requirement in the deed of trust, which can independently give rise to a claim by the borrower and guarantor against a lender/noteholder.

There are probably a few lessons here for everyone.  Perhaps most importantly is the time frame.  The initial notice of default was sent in 2010.  The simple issue of sending notice has given rise to a lawsuit that has now been pending for years after the notices went out.  Moreover, the 5th Circuit didn’t resolve the matter, it simply remanded the issues back to the trial Court.

Legal issues aside in the ruling, it’s important to remember that missing even small legal prerequisites in a collection scenario (with desperate guarantors) can expose note holders to serious jeopardy for years.

5th Circuit opinion in Williams v. Wells Fargo, case no. 16-20507

An appeals court holding, and pending U.S. Supreme Court case, could up-end FDIC enforcement procedures.  One of the interesting recent themes in Game of Thrones is the basis for power.  In these United States, the power of judges originally comes from the United States Constitution.  And, it turns out; if you don’t follow the rules of the Constitution your Court might not actually have any power.

Credit: Game of Thrones. Home Box Office, Television 360, Grok! Studio, Generator Entertainment, Bighead Littlehead.

The matter begins with the FDIC investigating a director and officer of a bank.  The individual, Mr. Burgess, is accused by the FDIC of improper expense practices and misuse of bank property.

Mr. Burgess first stood accused before an FDIC Administrative Law Judge (an “ALJ”) who issued its findings that Mr. Burgess did, in fact, do the bad things he was accused of.  Next, those findings were then passed on to the FDIC Board, which largely agreed with the findings and assessed civil penalties against Mr. Burgess which included being kicked out of the banking industry forever.

Faced with banking banishment, Mr. Burgess petitioned the 5th Circuit Court of Appeals to stay the FDIC’s order while he appealed it.  The first line of attack against the FDIC was that the ALJ violates the U.S. Constitution Appointments Clause because the ALJ judge was not properly appointed pursuant to the Clause.  Without a Constitutional basis the ALJ would therefore have no power or right to hear any matters.

In an interesting ruling, the Court found that Mr. Burgess made a strong showing that he was likely to succeed with his argument that the ALJ was unconstitutional because the appointment o the Judges to the ALJ were not in accordance with the Appointments Clause.

With this holding, the Court went on to prevent enforcement of the FDIC order punishing Mr. Burgess while he appealed.

It is important to remember that the ALJ didn’t actually issue any order, rather the ALJ simply provided findings and recommendations to the FDIC to consider in assessing the penalty.  The Court found that the ALJ’s inherent ability to frame the issue and rule on evidence was sufficient to upend the whole FDIC enforcement process if it turns out the ALJ lacked any power under the Constitution because it violated the Appointments Clause.

Burgess v. FDIC, cause no. 17-60579, In the United States Court of Appeals for the Fifth Circuit.

Bitcoin first came into public existence in 2008 with the first coins “mined” by a person/group named Satoshi Nakamoto.  As you are probably aware, Bitcoin is a method of transferring value electronically and without the need for any money issued by a sovereign entity.

The first thing to know about Bitcoin is that it is totally decentralized.  There is no master server and no bank vault with anything tangible in it.  Bitcoin exists only as complex mathematics on random computers around the world.  However, once you own a Bitcoin, you can spend is like money with anyone who will accept Bitcoin.

What is the Public Ledger

The driving factor for most Bitcoin believers is the lack of centralization or government oversight.  There is no actual coin and there is no government keeping track of who owns any particular coin.  However, this begs the question: How do does anyone know who actually owns a Bitcoin.

The answer is the Public Ledger.  To overly simply the Public Ledger, it’s a spreadsheet that exists on private computers all over the world known as nodes.  These nodes run on personal computers of people who download Bitcoin mining applications.  All of these random computers around the world share the Public Ledger and confirm not just ownership of a particular Bitcoin, but also the transfer of a Bitcoin from one wallet to another.

When a transaction of Bitcoin occurs the Public Ledgers are notified.  The transaction causes several things to occur.  Among them, the hashing on the blockchain is updated, there is a proof of work, and if all of the math checks out, then the Bitcoin is transferred to the recipient’s wallet.

What is a wallet?

A wallet is exactly what is sounds like.  It is a person’s repository of Bitcoin.  Wallets are held at recognized exchanges online.  Something like a deposit account, but with no rules and no FDIC.  Importantly, the wallet doesn’t actually hold anything.  Rather, the wallet is simply something a Bitcoin is assigned to in a Blockchain.  A bit like signing your name on one of those ride-sharing bikes.

What is Bitcoin Mining

So, to recap, there is no government regulation and the records of the transaction are on the Public Ledger that maintained by random people.  Why would anyone actually bother to keep the system working?  The answer is Bitcoin mining.

Bitcoin mining is the act of processing the transaction of a Bitcoin from one wallet to another.  For reasons discussed below, this takes a lot of computer power.  However, each time a transaction is processed a new block in the Blockchain is hashed and in return, the Bitcoin miner is awarded a fee in bitcoin for the work.  As more transactions are completed, these bit coin fees diminish.  These fees are the source all bit coin, including the “genesis” Bitcoins from 2008.

What is the Blockchain and Hashing

The short version is: the idea is simple but the execution is very complicated.  The Blockchain is the lineage of each Bitcoin from inception to the current owner as reflected on the Public Ledger.  Again, to over simplify, think of the Blockchain as stacking wooden blocks with a new block added everyone a new Bitcoin owner owns a particular Bitcoin.  The rub is proving ownership on a network of nodes, which is where the Hashing comes in.

You can think of the Hashing as the glue between the wooden blocks making up the Blockchain.  This where the complex math comes in and we circle back to the Bitcoin miners.

Each block gets a new Hash. If you looked at a Hash, it would look like a long string on random numbers and letters; but they act as a public encryption password for the owner of the Bitcoin.  You can (loosely) think of the Hash as a lock on a bike.

Every time a Bitcoin is transferred to another wallet the miners will process that transaction and add a new block to that Bitcoin, and that will give rise to a new Hash.  This new Hash can be though of as an additional lock on the bike.  So, if the new owner wants to access its Bitcoin it must know the prior bike lock combination and the new lock combination.  Meaning, every new transaction adds to the level of mathematical complication.

Here is why is gets harder and harder for computers to mine Bitcoin.  As Bitcoins are transferred over and over again Bitcoin miners are forced to compute more and more complex mathematics as they encrypt lock after lock. (Think bike locks on bike locks).

What is a Bitcoin?

Its very complicated mathematics.  In fact, its cryptology.  But more importantly – is Bitcoin “currency”?  Of course, currency and its production is regulated by a governing body.  Here the creation of Bitcoin is regulated by processing power of random computers to compute the complicated cryptology that I simplistically refer to as a bike lock.  Moreover, Bitcoin is mathematically designed to max out at 21 million Bitcoin.

A prevailing question is how to legally characterize Bitcoin: is Bitcoin a “currency”, a “commodity” or a “security” for the purposes of regulation by an actual government?

At this point is important to recall that the genesis of any Bitcoin is the mining process.  There is no sovereign currency that can simply be created by the acts of a citizen.  A citizen can earn a dollar, but cannot simply print a dollar.  In terms of being a security, the owner of a Bitcoin has not bought into anything other than the belief in the nodes and others belief in the Bitcoin.

Perhaps then the Bitcoin is a commodity?  However, for this or any cryptocurrency I would caution against using a legacy legal term to describe Bitcoin except for analogy.

Encryption is Key

I have glossed over a lot of the very complicated encryption that goes into Bitcoin.  Like anything complicated, it is difficult to include everything relevant in a blog post.

One thing I would like to mention is that the Bitcoin wallet has become less and less confidential.  Rather, even with Tor masking it is appearing that movement of Bitcoin can be more easily tracked by a sovereign entity, which strikes at the heart of the purpose of Bitcoin.