By Thomas M. Kester
The Supreme Court of the United States has said that “relief is not a matter of absolute right to either party; it is a matter resting in the discretion of the court, to be exercised upon a consideration of all the circumstances of each particular case.”1 This quote embodies the legal maxim lex non exacte definit, sed arbitrio boni viri permittit (“the law does not exactly define (this) but leaves it to the judgment of an honest man”), and this case is a great example of when, how much (and to whom) the law should provide relief.
Once again, good ‘ol mortgage issues are back before the SCOV. If I seemed gloomy in my last post, it was mostly due to the SCOV not addressing a specific question . . . that and Tom Brady not playing in the opening four regular season games (#QuadrupleRingBling #199 #IamTheLockerRoomGuy). But my frown has been turned upside down because the SCOV answers the burning question left on everyone’s mind: what is the impact of a court’s dismissal with prejudice of a lender’s claim on a promissory note and accompanying foreclosure action with respect to the lender’s ability to bring a subsequent claim for default on the note?
In 1993, Borrowers executed a promissory note to GMAC Mortgage Corp., the predecessor-in-interest to Cenlar FSB (Lender), secured by a mortgage. On May 1, 2008 Borrowers default on loan and it appears that Lender accelerated the note.
“The devil is in the details” is what an exorcist with OCD once told me. The factual details about the foreclosure actions in this case are no exception.
First Foreclosure Action
In December 2008, Lender files first action for default on the note and a foreclosure remedy. On May 22, 2009 the trial court issues judgment order. The order does the following things: (1) finding borrowers in default on the note, (2) determines amount owed to Lender, and (3) issues a decree of foreclosure in favor of Lender. The trial court also (4) set a redemption period, (5) (if no redemption occurs) authorized public sale of the property, and (6) “adjudicated borrowers’ indebtedness to lender on the note and acknowledged the possibility of a deficiency judgment against borrower after the sale.”
Borrowers file a “letter of appeal” and argue “that they were in the process of consideration for a loan modification . . . [and] the foreclosure process was to be stopped until complete consideration was offered to them.” Lender was directed by trial court entry order to argue why the appeal should not be granted. In September 2009, the trial court orders Lender to update Borrowers on their loan modification request and held that a certificate of nonredemption would not be issued until Lender compiled with federal mortgage law. The parties entered into a temporary forbearance and trial payment scheme from March-June 2010. The court proceeding was suspended. Sometime shortly after June 2010, Lender indicated it was reviewing the loan-modification application and that it had received a mortgage payment in June 2010. Borrowers, since the forbearance period’s end, were itching to know their balance due to Lender.
The trial court had kept the case on the docket and, on November 1, 2010, held a status conference. Lender failed to appear. The court, sua sponte, issued a “Dismissal Order,” which stated that, among other things, “the court hereby dismisses the case with prejudice for Plaintiff’s failure to prosecute by failing to appear at the scheduled conference today,” and noted that this case had been pending since 2008. Lender did not appeal the order nor did either party file a relief from judgment or order, or a motion to alter or amend. Of particular note: the November 2010 order did not expressly state whether the judgment order and decree of foreclosure issued on May 22, 2009 was vacated.
Second Foreclosure Action
In September 2011, Lender filed a second action for default on the note and foreclosure. and a final hearing on the merits was held in June 2014. Lender showed the total redemption amount and the total accelerated balance owed (assuming a September 1, 2008 default date) at that final hearing. The trial court dismissed the second foreclosure action because Lender “failed to send a new default notice prior to filing the second foreclosure action.” Lender was supposed to give 30 days’ notice of default and an opportunity to cure to Borrower. Court noted that the second action “was based on ‘a new, and different set of operative facts” than the first action. However, the trial court was open to Lender filing a third foreclosure action against Borrowers (assuming that the Lender complied with the notice before acceleration that contained an opportunity to cure provision).
Wrinkles start to form about Lender’s ability to foreclose on the note with a third action. The parties disagreed at the final hearing about the dismissal’s effect on future attempts to re-litigate. On September 18, 2014, the trial court issued a written decision and final judgment order. The trial court held that the May 2009 foreclosure judgment was not in effect, because “the only logical way to construe the court’s November 1, 2010 dismissal of that case was to understand it as vacating the underlying foreclosure judgment.” Furthermore, “Lender did not attempt to enforce the prior foreclosure decree, or request a certificate of nonredemption, but instead filed a new foreclosure action on the same note, using a later default date than the first action.” The trial court held that Lender could recover some payments made for taxes and would need “new, and different date of default” to institute a third foreclosure action
This 30-page document doubles as an academic treatise on mortgage-related procedural conundrums and equitable remedies. There are three main issues the majority opinion addresses:
Issue #1: Impact of the dismissal of the first action on the court’s prior foreclosure judgment
Lender argues that the trial court did not have authority to vacate the final foreclosure judgment. SCOV disagrees, stating that the “November 2010 dismissal of the first foreclosure action . . . effectively vacated the foreclosure judgment for lender.” If didn’t, “then it would have created an irremediable legal limbo” and an “unreasonable interpretation” would have resulted. SCOV doesn’t touch Lender’s argument about the November 2010 decision’s authority to vacate the May 2009 foreclosure action. SCOV states that it was not error to conclude that first foreclosure action’s final judgment “was vacated by implication” and Lender cannot collaterally attack the final judgment’s dismissal at this point.
Issue #2: Effect of dismissal of the first action “with prejudice”
Issue #2 is the big, complicated question (“What is the effect of a court’s dismissal on the merits of a foreclosure action, including a contractual claim on the promissory note, on the lender’s ability to pursue a later claim for default on the note and foreclosure as a remedy?”), and the SCOV majority even admits that “there is no perfect answer to this question.”
Here is my best short explanation of this issue: when a lender accelerates a note, they are saying “every remaining payment is due.” By dismissing “with prejudice,” the dismissal was an adjudication on the merits and the merits included “every remaining payment is due.” A future claim cannot be based on the same factual scenario per claim preclusion (i.e., by dismissing “with prejudice”). However, because future factual scenarios usually include one of these “every remaining payment due” payments (like in this case), and these factual scenarios are claim precluded by the “with prejudice” dismissal, what can the lender do to enforce the note? Well, there are a few approaches courts have taken. Some courts have completely shut out future actions and others have taken a polar opposite approach. Issue #2 also raises other questions: What actually happened in the first foreclosure action? Can the Borrowers be in default in the second foreclosure action? If the note has already been accelerated, is the Lender “forever barred from collecting on the note”? The answers to these questions, at least in the SCOV’s majority opinion, are not “entirely satisfactory.”
The SCOV examines the two noted approaches to this question: (1) foreclose all future claims against all remaining debt and (2) allow some future claims against some remaining debt.
Let’s start with Approach #1. Maine and Ohio courts have taken this approach. A Maine court held that “The obligations to pay each installment merged into one obligation to pay the entire balance on the note,” such that dismissal with prejudice operates an adjudication on the merits, and claim preclusion applies. Ohio, similarly, held that “because from the time of the original breach, the borrower had ‘owed the entire amount of the principal’ the same amount of which was alleged in all three complaints,” the lender was barred from pursuing their claim further.
Approach #1 has a logical and a practical issue for the SCOV. Logically, the “court’s necessary ruling on the merits—that there has been no default at all—essentially invalidates the lender’s acceleration,” and an on the merits determination “seems to invalidate the attempted acceleration, not to preserve it as an element of a final judgment that precludes future attempts to collect on the note.” As for the practical issue, the SCOV believes it “deprives the lender of any repayment of principal or interest on a significant loan, while yielding the borrowers a free, or deeply discounted, house.” This practical issue also frustrates attempts to reach a mutually agreement, as it “might . . . discourage lenders from engaging in the kind of forbearance and negotiation that preceded the trial court’s dismissal of the first foreclosure action in this case.” Approach #1 isn’t looking too hot.
Maybe Approach #2 is better. More courts have followed Approach #2. A Florida case put forth hypothetical scenarios to bolster #2, whereby “[I]f the plaintiff in a foreclosure action goes to trial and loses on the merits, we do not believe such plaintiff would be barred from filing a subsequent foreclosure action based upon a subsequent default,” or “In those instances [where a mortgagor may prevail at trial by showing they are not in default], the mortgagor and mortgagee are simply placed back in the same contractual relationship with the same continuing obligations.” Florida’s decision, breaking away from res judicata, “rests upon a recognition of the unique nature of the mortgage obligation and the continuing obligations of the parties in that relationship,” but, the Florida court does envision situations where it would be unjust and inequitable to use Approach #2.
Indiana (“subsequent and separate alleged defaults under the note create a new and independent right in the mortgagee to accelerate payment on the note in a subsequent foreclosure action”), North Carolina (two prior voluntary dismissals “do not bar third foreclosure action where periods of claimed default were different”), and the Third Circuit Court of Appeals (“parties’ stipulated dismissal with prejudice of the first foreclosure action could not bar a subsequent mortgage foreclosure action based on defaults occurring after dismissal of the first action”) all concur that Approach #2 is the better approach.
But Approach #2 isn’t perfect. For starters, “How is the borrower to know what principal is due, when it is due, or even where to send the check?” This case highlights these very issues, as “lender would not confirm the amount owed and would not accept their payment, essentially forcing a ‘new’ default.” To the SCOV, realistically using Approach #2 “would ignore the significant asymmetry in sophistication and information intrinsic to most mortgage lender-borrower relationships,” as many borrowers wouldn’t know about Approach #2 or how it works. Another issue is what interest and penalties are due during this interim period between actions? What sort of property purgatory would this create? Oh brother, Approaches #1 and #2 both don’t look good. Perhaps there is an approach…that is neither too hot, nor too cold… but just right. Perhaps a “Goldilock’s approach” can exist.
I wouldn’t say the SCOV’s approach is 100% Goldilock-esque or rests in the exact middle between Approaches #1 and #2. It has more Approach #2 than Approach #1. The SCOV’ approach has five components:
#1: “we conclude that any principal, interest, penalties, or other liabilities from borrower to lender that accrued before the default and attempted acceleration on which the first foreclosure action was predicated have been definitively adjudicated in borrower’s favor. No subsequent claim by the lender can incorporate claimed arrearages of any sort that were due from borrower to lender on or before the date of default on which the first action was based.”The SCOV carves out a major caveat: “If a mortgage note establishes a procedure for dealing with an attempted acceleration to which a court rules adversely on the merits, that procedure may govern.” I’ll leave to the opinion of the financial big wigs whether or not all their Vermont mortgage notes (drafted or modified post-Malenfant) should contain an explicit procedural clause dealing with a potential similar factual scenario.
#2: “during the pendency of the first action that was dismissed with prejudice, no arrearage with respect to principal or interest, or fees or penalties for nonpayment of borrower’s monthly obligation, could have accrued.” Why? Because “lender effectively suspended borrower’s obligation to make monthly payments of principal and interest such that, until such monthly obligation was reinstated, borrower cannot be found in default or otherwise penalized for failing to make the payments.”
#3: “lender cannot claim that any interest on the outstanding principal balance accrued during the pendency of the foreclosure action.”
#4: “the court’s dismissal of the first foreclosure action “with prejudice” can “unaccelerate” the loan and restore borrower’s obligation to make monthly payments toward the still-outstanding principal and associated interest, but lender, having accelerated the loan, must provide notice to borrowers of the remaining principal amount due, the monthly payments due, the date payments are due, how to make those payments, and that failure to make the payments when due will constitute a default, with the consequences outlined in the note.”
#5: “lender is not precluded from recovering real estate taxes it paid to preserve its security interest in the property,” because the mortgage itself states that tax payments are added to the security interest.
Issue #3: Dismissal of the second foreclosure action
The issue here is what is the “prospective application of its dismissal of this second foreclosure action to future actions.” Because the second action’s dismissal was based on the “lender’s failure to provide a notice of default, rather than as an adjudication on the merits, the preclusive effect of the second dismissal may not be the same as the preclusive effect of the first.” The second dismissal did talk about what would needed to happen to have a proper third foreclosure action—precluding certain claims that don’t meet this articulated fact pattern—but SCOV says it will wait for the next trial court to figure that one out first and defers judgment on that issue.
If Justice Dooley’s dissent was a flavor, it would be spicy (muy caliente) because it definitely burns.
Right off, Dooley says “such claims are not permissible” and he would “hold that no subsequent missed payments under an accelerated note, regardless of whether they occurred before or after an action adjudicating foreclosure, can give rise to a new claim that would save lender’s case from dismissal on res judicata grounds, absent an indication the parties had modified the terms of the agreement or the lender had reinstated the loan, neither of which is present in the instant case.”
Dooley addresses the elephant in the room: Why are we treating claim preclusion different in the mortgage context? Let me sum up a plausible explanation: the 2008 Recession happened, foreclosure actions rose exponentially, new procedural issues (like what happened in this case) made things screwy, and courts were faced with (according to a Yale Law Journal) “the specter of ‘free houses’” for delinquent homeowners.
To Dooley, the majority opinion messes with “settled claim preclusion law, giv[ing] the lender a windfall it doesn’t deserve and, most important, lets lender’s counsel avoid most of the consequences of the way it practices law in our courts.” The sizzle begins when he states “I doubt a loss in this case will have much effect on lender, which, by its own estimation, has serviced approximately $1.65 million loans, totaling $351 billion dollars.” But el fuego comes when he says it bluntly and pointedly: “the modus operandi of the law firm [representing Lender and who also served as counsel to the lender in Pinette] . . . is to deal with obstacles in its handling of foreclosure cases by ignoring those obstacles” and, “Fundamentally what the firm’s litigation strategy seeks is inconsistent adjudication.” Ouch. I hope Dooley doesn’t start writing Yelp reviews full time after his departure from the SCOV. [As a side note, The SCOV Blog commends and thanks Justice Dooley for his service on the Vermont Supreme Court]
Dooley has issue with the majority “instruct[ing] the plaintiff on how to structure its actions and mortgage foreclosure complaint so it can prevail in the next mortgage foreclosure action.” Nor does he think the majority’s analysis is complete, summing it up as “analyzed as an equitable mortgage foreclosure case and not, first and foremost, as an action on the note with the mortgage as security. There is no analysis of how there can be a new default on an accelerated note.”
Finally, a message to lawyers: “We need to send a clear message to counsel and its clients that these methods of conducting litigation are unacceptable and will not get them the remedies they seek even in part. The message should not be that they may file foreclosure action after foreclosure action until they finally win.” Wait—you mean the Vermont court system isn’t like a slot machine? I thought three “bar” appearances in a row guaranteed a win?
1 Willard v. Tayloe, 75 U.S. 557, 565 (1869).↩