Kralik & Jacobs LLP

Memorandum

To: Clients and Friends

From: John Kralik and Lois Jacobs

Date: July 25, 2008

On July 8, 2008, Governor Schwarzenegger signed California State Senate Bill 1137. The bill was the California legislature’s reaction to the wave of foreclosures in the California marketplace. The purpose of the statute is to insure that the foreclosing party contacts the borrower during the foreclosure process to discuss alternatives. In addition, there are provisions to insure maintenance of foreclosed properties and give tenants displaced by the foreclosure process some extra time to move out. While most lenders are already taking these types of steps anyway, the significance of the statute is that by setting a legal standard, the new law may set a trap for lenders who do not adequately document their compliance with the statute.

Question: What Loans does the Statute apply to?

The new restrictions on foreclosure apply to loans that were made after January 1, 2003 to December 31, 2007, for residential property that is the primary residence of the borrower. The statute will expire in January 2013 unless re-enacted. The provisions regarding maintenance of foreclosed property and notice to renters being evicted from foreclosed properties take effect immediately.

I. New Restrictions on Foreclosures. (New Cal. Civ. Code § 2923.5.)

A. Summary:

The new law is meant to encourage lenders to “contact” borrowers during the foreclosure process. It does so by prohibiting the filing of a notice of default until 30 days after “contact is made” with the borrower. Although such contacts are probably already being made, by making this a statutory requirement, more precise documentation of those “contacts” will be necessary to prove that sufficient efforts were made to contact the borrower.

Contacting Borrowers: The lender is obligated to contact the borrower in person or by telephone and must:

1. “discuss the borrower’s financial situation”

2. “explore options for the borrower to avoid foreclosure”

3. tell the borrower s/he has a right to a subsequent meeting and, if requested, the meeting must be scheduled within 14 days

4. provide the borrower with a toll free number to help them find a HUD-certified counseling agency. [1]

B. Questions and issues:

1. Once a borrower is contacted, what do you say to them? The statute is not specific other than to say that the financial condition of the borrower and options to avoid foreclosure must be “explored.”

Recommendation: The lender should develop a script that assures that a significant discussion occurs and that meaningful options are offered in a manner that does not unfairly discriminate based on race or other invidious class distinction.

2. Does a specific workout plan need to be offered? Because there are no specific requirements of what options a lender must offer, it doesn’t seem that a failure to offer any specific option should be basis to challenge a foreclosure. The legislature has declared its “intent” that borrowers be offered a “loan modification or workout plan.” Further, it has said that “a servicer acts in the best interests of all parties if it offers a workout plan where “anticipated recovery” under the workout plan exceeds the “anticipated recovery” through foreclosure.” Because this is a vague standard based on a prediction of the future, no one who is not an oracle can truly say whether the specific options a lender may present would meet this standard, but if a plan that the lender believes in good faith will meet this standard is offered to the borrower, then the lender should be able to claim that it acted in good faith towards that borrower.

Recommendation: Before contacting the borrower, consider obtaining a BPO or other estimate of value and determining whether your net projected recovery from the disposition of the REO would provide support for the type of plan and amount of a concession you offer a delinquent borrower.

3. Are there alternatives to compliance with the new law? The requirement of a “contact” or “proof of contact” does not apply when there is either a “surrender of the property” or a “delivery of the keys” to the lender. Thus, if the lender truly desires the security quickly, and the foreclosing party does not have the extra time to comply with this new statute, additional compensation may be needed to get the borrower to agree to one of these actions.

C. What Lenders will need to do to foreclose:

At the very least, the new statute will slow the foreclosure process while lenders attempt to have their personnel develop new procedures both to comply with the statute, and to document compliance with the statute in the event that borrowers challenge a foreclosure based upon lack of compliance with the statute.

New P & P’s will be necessary. In essence, once the new law’s notice provisions go into effect on September 6, 2008, servicing personnel will need to implement new procedures or revise current procedures to assure that a foreclosure can occur on loans in California that are covered by this new statute. First, these procedures must assure that a proper attempt has been made to contact the borrower. Then, procedures must be established to either:

· Document that the contact or meeting with the borrower took place and that the borrower’s financial condition and alternatives were discussed., or

· Show compliance with the extraordinary efforts required under the statute to establish that a borrower could not be contacted.

We can offer more specific guidance on the policies and procedures to our clients.

II. Additional Posting and Mailing Directed at Renters. (New Cal. Civ. Code § 2924.8.)

A. Summary: The statute provides that when a notice of sale is mailed and posted, an additional notice must be posted and mailed to the “resident of property subject to foreclosure sale” containing specific warnings required by the statute.

B. What Lenders will need to do to foreclose: Additional notices with the required statutory language will need to be drafted, posted and mailed. Notices must be in English, Spanish, Chinese, Tagalog, Vietnamese and Korean. (Don’t despair, an unspecified government agency will provide these translations.) Declarations of service of these notices will need to be drafted and placed in the file of the trustee or foreclosure service.

C. Questions and Issues

Can a borrower prevent foreclosure if the lender fails to comply with this requirement? As this notice is really meant for renters, it would seem that a challenge based on the failure to give a notice to the renter could not be made by the borrower, but predictably, there is nothing in the statute that makes that clear.

III. Legislative Attempt at Revisions to Duties of Servicers Under Pooling and Servicing Contracts. (Cal. Civ. Code Section 2923.6.)

Summary: The legislature appears to be struggling with its desire to mandate that lenders offer loan modifications that take into account the fall in property values, while realizing that it cannot do so without rewriting existing loans and loan servicing contracts in a manner that might raise constitutional challenge. As a compromise, it has instead declared its “intent” that such loan modifications be offered where the “anticipated recovery” under the workout plan exceeds the “anticipated recovery” through foreclosure. Additionally, the legislature has made a declaration that any duty that servicers have under a pooling and servicing agreement to “maximize net present value” is actually owed to “all parties in a loan pool.” Presumably, this is meant to include such a duty to the borrower as well.[1] The legislature has also declared that a servicer “acts in the best interests of all parties” where it offers a loan modification plan were the anticipated recovery to the lender under the workout exceeds what is anticipated in foreclosure. As noted above, this requires predicting the future, so it would be difficult to prove that a particular loan modification offer actually was in compliance with this legislative intent but steps such as obtaining a BPO, drive by appraisal or other valuation of the mortgaged property could help show a good faith effort to comply.

What must lenders or servicers do to comply with this new statute? It is not clear that they have to do anything. However, to the extent the lender can determine the present value at the time the counseling and foreclosure process begins and the anticipated recovery that would result from disposing of a property after foreclosure, it may be in a better position to establish that it acted in a manner that was intended to maximize its recovery. This could allow a servicer or a party to argue that it has acted in good faith when making a workout offer to a borrower notwithstanding the vague legislative standard. Perhaps if a servicer is accused of breaching a pooling and servicing agreement by offering such loan modifications, it could argue that it was merely attempting, in good faith, to comply with this statute. But the statute hardly makes such an argument conclusive, and it might be unconstitutional if it did. The sweeping language of this section has some troublesome implications, particularly to the extent it imposes some special duty of care to borrowers in this arena that could ultimately expand into other areas of the creditor-debtor relationship.

IV. Duty to Maintain Property Purchased at a Foreclosure Sale. (New Cal. Civ. Code § 2929.3)

A. Summary: A “legal owner” of a “vacant, residential property” purchased at a foreclosure sale, must “maintain” that property. If it fails to do so, it may be fined up to $1,000 per day by a “governmental entity.” The governmental agency must give 30 days notice of the condition. There is an opportunity to cure within the 30 days, and a right to a hearing to contest any fine imposed.

B. Issues and Questions:

1. What does it mean to fail to “maintain a property”? The definition is vague. It means a “failure to care for the exterior of the property.” A couple of legislative pet peeves were spelled out as failures, including “permitting excessive foliage growth,” failing to keep out “trespassers or squatters” and failing to prevent “mosquito larvae from growing in standing water.”

V. Additional Notice to Quit Required for Tenants in Possession at the Time of Foreclosure. (New Cal. Civ. Procedure Code § 1161b.)

Summary: Renters who are in possession at the time of foreclosure must be given a 60 notice to quit before they can be evicted. This new requirement does not apply to those persons who are a “party to the note.” Presumably, the mortgagor does not get an extra sixty days because he has already had notice. This law seems to apply to all “tenants or subtenants” of a “rental housing unit.”[2]

What a Lender who acquires at a foreclosure sale must do to evict: Assuming that there are otherwise good grounds to evict a renter in possession at the time of a foreclosure sale, the notice to quit must be revised to be at least sixty days. All other laws, state and local laws regarding the eviction must also be complied with.

General Questions:

Where do I find these new laws? The law adds provisions to California’s Civil Code and Code of Civil Procedure. The new provisions will be California Civil Code Sections 2923.5, 2923.6, 2924.8, 2929.3 and California Civil Procedure Code Section 1161b. If your resource has not been updated subsequent to the enactment of these new laws on July 8, 2008, then don’t rely on it.