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However, the Servicer had, for years, treated the deed of trust addresses as outdated and sent all prior correspondence to the new updated addresses.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