Section 75-1.1 and Mortgage Servicing: Lessons From a Federal Bankruptcy Court in New York
Ellis & Winters
Claims under N.C. Gen. Stat. § 75-1.1 can turn up in unexpected places—including a bankruptcy court in Manhattan. Recently, a section 75-1.1 claim made its way from Hyde County, North Carolina, to the Big Apple, courtesy of the bankruptcy proceedings of GMAC Mortgage and its parent, Residential Capital.
In re Residential Capital, LLC, a decision of the U.S. Bankruptcy Court for the Southern District of New York, illustrates the potentially broad scope of “unfair” conduct under section 75-1.1.
The Claims at Issue
In Residential Capital, Rex and Daniela Gilbert sued their mortgage servicer to contest a foreclosure on their house on Ocracoke Island. The Gilberts accused GMAC Mortgage of charging usurious interest on the loan, providing inadequate loan disclosures under the federal Truth in Lending Act at loan origination, and submitting a false affidavit in the later foreclosure proceedings. As often happens in North Carolina lender-liability cases, the Gilberts argued that each type of alleged misconduct stated an independent violation of section 75-1.1.
Although the Gilberts filed their lawsuit in Hyde County Superior Court, the lawsuit was removed to the U.S. District Court for the Eastern District of North Carolina, which dismissed the Gilberts’ claims. The Gilberts appealed to the U.S. Court of Appeals for the Fourth Circuit, which reinstated several of their claims, including some of their claims under section 75-1.1.
The Gilberts’ appellate victory against GMAC and Residential Capital was short-lived, however, because these companies declared bankruptcy before the Fourth Circuit even issued the mandate in the Gilberts’ appeal. The bankruptcy filing stayed the Gilberts’ claims against GMAC and Residential Capital, leading the Gilberts to file a proof of claim for six million dollars in the bankruptcy proceedings. When GMAC and Residential Capital objected to the Gilberts’ claims, the claims came before the U.S. Bankruptcy Court for the Southern District of New York for a ruling on the objections.
The Bankruptcy Court’s Analysis
The bankruptcy court separately considered whether each type of conduct alleged by the Gilberts was a 75-1.1 violation. Each part of the court’s analysis offers a useful lesson.
First, the bankruptcy court decided that even though the Gilberts’ loan was too large to be covered by North Carolina’s usury statutes, the loan could still violate section 75-1.1 on a usury-like theory. The court stated that “collection of interest in excess of the rate provided for by agreement may rise to the level of a violation of [section 75-1.1] where the conduct was unfair or deceptive.” This reasoning shows how the potential scope of section 75-1.1 exceeds the scope of other consumer protection statutes, such as usury statutes.
Second, the court rejected the Gilberts’ argument that GMAC violated section 75-1.1 by not allowing the Gilberts to rescind their loan. Here again, the court reasoned that even if GMAC’s actions did not violate the federal Truth in Lending Act, the conduct could nonetheless be unfair for 75-1.1 purposes. In other words, the court analyzed the Gilberts’ claim as one for direct unfairness.
The court, however, concluded that GMAC acted substantively fairly when it rejected the Gilberts’ demand for rescission. The court noted that the Gilberts had not shown any material disclosure errors, and it stressed that GMAC had offered to reexamine its denial of rescission if the Gilberts came forward with additional information. This conclusion reflects another important point: for direct-unfairness claims, whether conduct is “unfair” often turns on the court’s choice of the facts to focus on. Matt Sawchak and Kip Nelson make this point in their 2012 North Carolina Law Review article.
Third, the bankruptcy court held that “[t]he execution of false affidavits is ‘an unfair and deceptive practice within the meaning of [section 75-1.1].’” The court quoted In re Chesson, a 2012 decision of the U.S. Bankruptcy Court for the Middle District of North Carolina. In Chesson, though, the claimant made payments in reliance on a false affidavit. That was not the case with the Gilberts. In their case, the false affidavit communicated information to the court that oversaw their foreclosure, not to the Gilberts themselves.
Thus, Residential Capital seems to overlook the North Carolina Supreme Court’s recent decision in Bumpers. Bumpers rejects the idea that a plaintiff can recover treble damages under section 75-1.1 for a representation “in the air,” so to speak. Instead, a private plaintiff under section 75-1.1 must show that he actually and reasonably relied on the misrepresentation at issue. Residential Capital, like a recent unpublished decision of the North Carolina Court of Appeals, shows that where false affidavits are concerned, defendants would benefit by pointing out that even affidavits are representations.
Finally, Residential Capital illustrates the wide range of authorities that can come up in 75-1.1 cases. In its analysis of the 75-1.1 claim, the bankruptcy court cited decisions not only from courts in North Carolina, but also from New Mexico, Maine, and the Seventh Circuit. Given the fact-specific nature of most 75-1.1 cases, a litigant—especially one who is dealing with a 75-1.1 claim outside of North Carolina—should expect that the court could travel far to decide whether the defendant’s conduct qualifies as unfair or deceptive.
As Residential Capital shows, section 75-1.1 can play a leading role in litigation over mortgage practices. Lenders and mortgage servicers that can document reasonable conduct, and that have implemented practices to make sure that their loan documents and affidavits are accurate, will be best positioned to defend these claims.
The run of section 75-1.1 in the Big Apple is being extended by popular demand.
On the eve of the above post, the court in the Residential Capital case issued another opinion on section 75-1.1. This new opinion involves claims by a different North Carolina homeowner, Jennifer Wilson.
Like the opinion on the Gilberts’ claims, the Wilson opinion emphasizes false statements in connection with a foreclosure. It holds that if a loan servicer tampered with (or forged) the endorsements on a promissory note before it presented the note to the court overseeing a foreclosure, that misconduct would have two effects:
— First, the misconduct would deprive the foreclosure judgment of issue-preclusive effect in the homeowner’s later lawsuit.
— Second, the tampering would be deceptive conduct that would support a section 75-1.1 claim. See star pages 12-13 of the opinion.
The Wilson opinion also quotes at length from Matt Sawchak and Kip Nelson’s 2012 article on section 75-1.1. See footnote 9 of the opinion.
Lauren Golden contributed to this post.