Volume 129 Number 10 November/December 2012

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1 The Banking Law Journal Volume 129 Number 10 November/December 2012 Headnote: The Source-of-Strength Doctrine Part II Steven A. Meyerowitz 865 The Source-of-Strength Doctrine: Revered and Revisited Part II Paul L. Lee 867 The Evolution of the SEC Whistleblower: From Sarbanes- Oxley to Dodd-Frank Sarah L. Reid and Serena B. David 907 Seller Financing of Foreclosed Residential Properties Consumer Protection and Compliance Considerations Elizabeth C. Yen 916 Treasury Releases Model Agreement for an Alternative FATCA Framework Benjamin Berk, Cynthia D. Mann, Ehab Farah, and Bridget M. Weiss 923 New York Appeals Court Decision Highlights Defenses For Financial Institution Defendants Against Structured Product Claims Eric Rieder 929 The Scope (and Limitations) of the Attorney-Client Privilege when Communicating with In-House Counsel Sean Hanlon 934 Italy s New Rules on Notes and Commercial Paper Vania Petrella, Pietro Fioruzzi, and Claudio Di Falco 940 Banking Briefs Terence G. Banich 947

2 Editor-in-chief Steven A. Meyerowitz President, Meyerowitz Communications Inc. Board of Editors Paul Barron Professor of Law Tulane Univ. School of Law George Brandon Partner, Squire, Sanders & Dempsey LLP Barkley Clark Partner, Stinson Morrison Hecker LLP John F. Dolan Professor of Law Wayne State Univ. Law School Thomas J. Hall Partner, Chadbourne & Parke LLP Kirk D. Jensen Partner, BuckleySandler LLP Satish M. Kini Partner, Debevoise & Plimpton LLP Douglas Landy Partner, Allen & Overy LLP Paul L. Lee Partner, Debevoise & Plimpton LLP Jonathan R. Macey Professor of Law Yale Law School Martin Mayer The Brookings Institution Stephen J. Newman Partner, Stroock & Stroock & Lavan LLP Sarah L. Reid Partner, Kelley Drye & Warren LLP Heath P. Tarbert Partner, Weil, Gotshal & Manges LLP Stephen B. Weissman Partner, Rivkin Radler LLP Elizabeth C. Yen Partner, Hudson Cook, LLP Bankruptcy for Bankers Howard Seife Partner, Chadbourne & Parke LLP Regional Banking Outlook James F. Bauerle Keevican Weiss Bauerle & Hirsch LLC Recapitalizations Christopher J. Zinski Partner, Schiff Hardin LLP Banking Briefs Terence G. Banich Member, Shaw Gussis Fishman Glantz Wolfson & Towbin LLC Intellectual Property Stephen T. Schreiner Partner, Goodwin Procter LLP The Banking Law Journal (ISSN ) (USPS ) is published ten times a year by A.S. Pratt & Sons, 805 Fifteenth Street, NW., Third Floor, Washington, DC Periodicals Postage Paid at Washington, D.C., and at additional mailing offices. Copyright 2012 THOMPSON MEDIA GROUP LLC. All rights reserved. No part of this journal may be reproduced in any form by microfilm, xerography, or otherwise or incorporated into any information retrieval system without the written permission of the copyright owner. Requests to reproduce material contained in this publication should be addressed to A.S. Pratt & Sons, 805 Fifteenth Street, NW., Third Floor, Washington, DC , fax: For subscription information and customer service, call Direct any editorial inquires and send any material for publication to Steven A. Meyerowitz, Editor-in-Chief, Meyerowitz Communications Inc., PO Box 7080, Miller Place, NY 11764, smeyerow@optonline. net, (phone) / (fax). Material for publication is welcomed articles, decisions, or other items of interest to bankers, officers of financial institutions, and their attorneys. This publication is designed to be accurate and authoritative, but neither the publisher nor the authors are rendering legal, accounting, or other professional services in this publication. If legal or other expert advice is desired, retain the services of an appropriate professional. The articles and columns reflect only the present considerations and views of the authors and do not necessarily reflect those of the firms or organizations with which they are affiliated, any of the former or present clients of the authors or their firms or organizations, or the editors or publisher. POSTMASTER: Send address changes to The Banking Law Journal, A.S. Pratt & Sons, 805 Fifteenth Street, NW., Third Floor, Washington, DC

3 Seller Financing of Foreclosed Residential Properties Consumer Protection and Compliance Considerations Elizabeth C. Yen The author provides an overview and examples of certain federal and state consumer protection and compliance issues that may need to be considered when offering seller financing or similar financial accommodations to facilitate the transfer of ownership interests in residential real estate owned properties. Businesses that own residential real estate as the result of mortgage foreclosures (sometimes referred to as Real Estate Owned or REO properties) typically seek to sell such properties to third parties, and may agree to offer seller financing to creditworthy buyers to facilitate these sales. Such seller financing raises various consumer protection and compliance issues, including (for example) possible mortgage lender licensing requirements and state and federal disclosure issues. For example, Conn. Gen. Stat. Section 36a-487(b) exempts from the Connecticut mortgage lender license requirement entities that own real Elizabeth C. Yen is a partner in the Connecticut office of Hudson Cook, LLP. Ms. Yen, a past chair of the Truth-in-Lending Subcommittee of the Consumer Financial Services Committee of the American Bar Association s Section of Business Law and a past chair of the Consumer Law Section of the Connecticut Bar Association, is a fellow of the American College of Consumer Financial Services Lawyers and on the board of editors of The Banking Law Journal. She can be reached at ecyen@hudco.com. 916 Published by A.S. Pratt in the November/December 2012 issue of The Banking Law Journal. Copyright 2012 THOMPSON MEDIA GROUP LLC

4 Seller Financing of Foreclosed Residential Properties property who take back from the buyer of such property a secondary mortgage loan in lieu of any portion of the purchase price of the property. This license exemption is notably limited to seller financing in the form of a junior mortgage lien, and would not apply if the seller of Connecticut REO property wanted to offer first lien priority purchase money residential mortgage financing to a creditworthy buyer. Conn. Gen. Stat. Section 36a-487(a) also exempts federally insured banks and credit unions (whether state chartered or federally chartered), operating subsidiaries of federally chartered banks, and wholly owned subsidiaries of Connecticut chartered banks and Connecticut chartered credit unions (provided, however, that such wholly owned subsidiaries give written notice to the Connecticut Banking Commissioner before engaging in any residential mortgage lending activity). In addition, Conn. Gen. Stat. Section 36a-487(b) exempts certain entities from the Connecticut mortgage lender license requirement, including entities that make five or fewer [Connecticut] residential mortgage loans within any period of twelve consecutive months. This license exemption might be useful if REO properties are held in the names of special purpose entities created for the specific purpose of holding and managing specific Connecticut REO properties (provided that none of these special purpose entities makes more than five Connecticut consumer-purpose residential mortgage loans in any rolling 12-month period, unless another license exemption applies). However, a business that is not otherwise exempt from licensing (for example, because it is not a federally insured depository institution and also not a subsidiary of a federally chartered or Connecticut chartered depository institution) and does not use special purpose entities to hold and administer its Connecticut REO properties may find it difficult to qualify for this particular Connecticut mortgage lender license exemption. Moreover, even if the seller of the REO property is exempt from the Connecticut mortgage lender license requirement, its employees who function as mortgage loan originators or as loan processors or underwriters might need to be licensed under applicable state law. 1 Seller Financing REO sellers may offer seller financing to for-profit and nonprofit businesses purchasing REO properties, generally without triggering mortgage 917

5 The BANKING Law Journal lender license requirements, since credit extended to businesses falls outside many (although not all) state lender license regimes. 2 However, REO sellers may not necessarily want to limit themselves to offering seller financing to business purchasers, 3 and in the present tight underwriting environment, REO sellers may not always be able to successfully refer interested consumer purchasers to third party lenders for purchase money financing. TILA Setting state mortgage lender and related license requirements to one side, state and federal disclosure requirements also need to be considered when the owner of REO property offers seller financing to creditworthy buyers. For example, consumer purpose credit offered by the seller of REO property to an individual purchaser may be subject to Truth-in-Lending requirements, unless the seller only extends consumer credit secured by dwellings five or fewer times in a calendar year and does not otherwise enter into consumer credit transactions. 4 In addition, if an REO seller agrees to sell its interest in an REO property to an individual who already had an ownership interest in that property, and charges rates or fees that are high enough to cause the mortgage financing to fall within the scope of Section , Section (a)(17)(v) would excuse only the first such consumer credit transaction entered into by the REO seller with a consumer borrower in a 12-month period (provided further that no mortgage broker was involved in such transaction) after entering into one such Section transaction, the REO seller would thereafter be subject to Truth-in-Lending requirements for any additional consumer purpose mortgage transaction entered into for the next 12 months. 5 Truth-in-Lending requirements do not apply to extensions of credit entered into primarily for a business, commercial or agricultural purpose and also do not apply to extensions of credit to business entities 6. If Truth-in- Lending disclosures are required, it is important to recall that seller financing is considered a credit sale (defined at 12 CFR Section (a)(16) to include a sale in which the seller is a creditor ). The Total Sale Price and downpayment should be disclosed pursuant to 12 CFR Section (j) in connection with a credit sale transaction. If the REO purchaser is a mortgagor who lost title to the property as a 918

6 Seller Financing of Foreclosed Residential Properties result of foreclosure, some thought should also be given to whether the transaction is subject to the Truth-in-Lending right of rescission or is eligible for a residential mortgage transaction exception to the rescission right (as well as a residential mortgage transaction exception to 12 CFR Section ). Residential mortgage transactions are purchase money transactions where the consumer buyer had not previously purchased and acquired some interest to the dwelling. 7 For example, Official Staff Comment 5 to Section (a) (24) indicates that financing to enable one co-owner of residential real estate to buy out another co-owner s interest in the real estate would not be a residential mortgage transaction. Similarly, the financing of a balloon payment due under a land sale contract would not be a residential mortgage transaction. 8 These types of consumer credit transactions (i.e., credit transactions entered into primarily for personal, family or household purposes) would therefore be subject to the Truth-in-Lending right of rescission if the transactions are secured by property used as the consumer s primary residence. Other Disclosure Requirements Certain additional residential property transfer disclosure requirements might (or might not) apply to sales of REO properties acquired as the result of a foreclosure. For example, Conn. Gen. Stat. Section b(b)(10) excuses REO property sellers from having to provide a Connecticut residential property condition report, if the REO property was acquired by a judgment of strict foreclosure or by foreclosure by sale or by a deed in lieu of foreclosure. Some states specifically regulate the conditional installment sale of real property (sometimes referred to as bond for deed, contract for deed or land contract transactions). 9 Other states might effectively disallow such transactions or treat such transactions as the functional equivalent of purchase money mortgages. 10 Consequently, applicable state laws and court cases should be carefully considered before entering into these types of transactions. REO property owners that prefer to rent some of their REO properties to residential tenants until residential property sales prices stabilize 11 should consider state landlord-tenant laws and the obligations of landlords to their residential tenants (as well as state laws giving residential tenants various evic- 919

7 The BANKING Law Journal tion, security deposit, and other rights as against their landlords). In addition, a residential lease containing a purchase option and lease provisions that shift the landlord s property maintenance and other obligations to the individual residential tenant could potentially cause some state courts to consider the lease transaction to be an equitable mortgage. 12 Credit Sales Certain bailments or leases of REO property to consumers also may be considered credit sales for Truth-in-Lending purposes. 12 CFR Section (a)(16) includes certain types of bailment and lease arrangements within the scope of the defined term, credit sale, unless the arrangements are terminable without penalty at any time by the consumers. More specifically, a credit sale for Truth-in-Lending purposes includes a bailment or lease pursuant to which the consumer: (i) Agrees to pay as compensation for use a sum substantially equivalent to, or in excess of, the total value of the property and service involved; and (ii) Will become (or has the option to become), for no additional consideration or for nominal consideration, the owner of the property upon compliance with the agreement. 13 Conclusion Given the fact-specific nature of potentially relevant laws and court decisions, this article of necessity can only provide an overview and examples of certain federal and state consumer protection and compliance issues that may need to be considered when offering seller financing or similar financial accommodations to facilitate the transfer of ownership interests in residential REO properties. Notes 1 See, e.g., Conn. Gen. Stat. Section 36a-486(b)(2)(A), exempting from the Connecticut mortgage loan originator license requirement employees of depository 920

8 Seller Financing of Foreclosed Residential Properties institutions and of subsidiaries that are owned and controlled by a depository institution and regulated by a federal banking agency, provided that such employees are acting for their employer depository institution or subsidiary, and are either federally registered as mortgage loan originators or are not required to be federally registered. See also, e.g., Conn. Gen. Stat. Section 36a-486(b)(3)(B), exempting from the loan processor/underwriter license requirement those loan processors and underwriters who are employed by a federally insured depository institution or a subsidiary of a federally chartered or Connecticut chartered depository institution, provided they work under the direction and are subject to the supervision of a federally registered mortgage loan originator employee of such depository institution or subsidiary. 2 See, e.g., Conn. Gen. Stat. Section 36a-485. Mortgage lenders subject to Connecticut s mortgage lender license requirements must generally make residential mortgage loans, either directly (in their own names) or indirectly (through table funding or similar arrangements). Residential mortgage loans are loans primarily for personal, family or household use that [are] secured by a mortgage, deed of trust or other equivalent consensual security interest on a dwelling. 3 See also, e.g., OCC Bulletin (Guidance on Potential Issues With Foreclosed Residential Properties) (December 14, 2011), copy available at gov/news-issuances/bulletins/2011/bulletin html (cautioning federally chartered banks about possible negative reaction and potential reputation risk from [REO] disposition practices that favor, as purchasers of foreclosed properties, investors (paying cash) over owner-occupants (purchasing with financing) ). 4 See 12 CFR Section (a)(17)(v). 5 Certain purchase money residential mortgage transactions entered into with purchasers who do not have any pre-existing ownership interest in the property are exempt from the scope of 12 CFR Section , as discussed in the text accompanying note 8, but would generally need to be counted for purposes of determining whether the REO seller has entered into more than five dwelling-secured consumer credit transactions in a calendar year. 6 See 12 CFR Section (a). 7 See Official Staff Comment 5 to 12 CFR Section (a)(24). 8 Id. See also, e.g., In re Mattera, 128 B.R. 107 (Bankr. E.D. Pa. 1991). 9 See, e.g., Mich. Comp. Laws Section et seq. (setting forth certain requirements for land contract mortgages) and Ohio Rev. Code Section et seq. (setting forth the minimum requirements for executory land installment contracts, and vendor and vendee rights and obligations under such contracts). 10 See, e.g., Maglies v. Estate of Guy, 936 A.2d 414, 193 N.J. 108, 123 (2007) ( courts have refused to recognize installment, or conditional sales, of real property and have called such transactions what they are, namely mortgages with completed conveyances 921

9 The BANKING Law Journal of property, thereby preventing undue advantage from occurring based on a label attached ) (citations intentionally omitted) and Tomlinson v. Clarke, 825 P.2d 706, 118 Wash.2d 498, (1992) ( There is no valid reason to distinguish between those cases in which legal title is conveyed to secure the payment of a debt and those cases in which legal title is retained to secure the payment of a debt ) (footnore intentionally omitted). 11 See, e.g., Federal Reserve Policy Statement on Rental of Residential Other Real Estate Owned Properties (April 5, 2012), copy available at gov/newsevents/press/bcreg/bcreg a1.pdf and OCC Bulletin (Guidance on Potential Issues With Foreclosed Residential Properties) (December 14, 2011), n. 3 supra. 12 See, e.g., Cleveland v. O Brien, 2010 U.S. Dist. LEXIS (D.N.J. 2010) (unpublished). See also, by way of analogy, Official Staff Comment 7 to 12 CFR Section (a)(1), discussing the difference between a long term personal property lease transaction subject to Regulation M (Truth in Leasing) and a similar transaction subject to Regulation Z (Truth-in-Lending). Certain personal property lease transactions with purchase options will be subject to Regulation Z if the consumer assumes the indicia of ownership, including the risks, burdens and benefits of ownership upon consummation of the transaction. 13 See 12 CFR Section (a)(16) and text accompanying n. 6 supra. 922