This Client Bulletin addresses the recently enacted District of Columbia and Virginia Predatory Lending legislation. As this Bulletin went to press, the City Council of Philadelphia also passed a Predatory Lending ordinance which is the subject of Client Bulletin 2001-15.

The District of Columbia Protections from Predatory Lending and Mortgage Foreclosure Improvements Act of 2000 (the "Act") became effective on April 3, 2001. This Act regulates predatory lending, and also codifies and revises deed of trust and foreclosure procedures in D.C. The Predatory Lending provisions will not take effect until the earlier of (i) 150 days after the effective date of the Act; or (ii) 60 days after the effective date of the rules promulgated under the Act. As a result, the potential effective date of the Predatory Lending provisions can be as early as June 2001.

The Act clarifies and modifies mortgage law by changing residential lending practices as they relate to deeds of trust, liens, and foreclosures. The Act aligns financing laws to include portions of the Restatement of Law Third of Property (Mortgages) as adopted May 14, 1996 by the American Law Institute. In addition to expanding mortgage law to include the Restatement of Law Third of Property, the Act performs seven other key functions:

1. prohibits predatory lending abuses in the District;
2. defines specific loan types that might be predatory and provides the homeowner the opportunity for judicial review of the loan prior to the foreclosure sale;
3. codifies a definite foreclosure process;
4. requires a lender to foreclose by judicial foreclosure on a residential deed of trust recorded after 60 days after regulations have been issued under the Act, unless an Information Form was recorded with the deed of trust;
5. provides an extended right for residential homeowners to reinstate their loans while keeping foreclosure expenses low;
6. audits all foreclosure sales for compliance with procedures and proper allocation of foreclose sale proceeds; and
7. prohibits prepayment penalties on 1–4 family residential deed of trust loans.

The following is a brief summary of the Protections from Predatory Lending and Mortgage Foreclosure Improvements Act of 2000 as it pertains to liens, deeds of trust, and foreclosures.

A. Summary of D.C. Predatory Lending Law

(1) Scope—The Act generally imposes restrictions on the type and manner in which financing is placed on first mortgages. The Act only applies to "Home Loans" as defined in Section 101(12) of the Act. Home Loans are defined as owner-occupied principal dwelling real property with one or more structures. The Act increases the information exchange and develops lending practices to ensure borrowers are more aware of their financing agreements, thereby reducing their risk of default. The proposed law would not affect (a) home equity conversion mortgages, (b) construction loans, (c) purchase money loans, (d) refinancing principal dwelling loans with an APR below a "home loan reference rate" as defined in the Act, (e) simultaneous first and second lien loans, (f) loans made in conformity with Federal Home Loan Mortgage Corporation or Federal Mortgage Association, (g) loans guaranteed or insured by agencies of the United States, the District, or any state or municipal government, (h) loans made in conformity with a documented loan program of the specified home loan organizations which maintains a net worth exceeding $10 million, which loan programs have been reviewed and approved by the Mayor, (i) home equity loans, (j) bridge loans, and (k) specified loans for owner’s principal dwelling with initial funding exceeding $1 million.

(2) Prohibited Practices—To encourage a more informative lending procedure and add extra protections for the borrower, the Act sets forth specific guidelines for the issuance of home loans. In particular, the Act prohibits the following practices as being predatory:

1. making a home loan when the borrower is unable to make the loan payments;
2. making a loan that directly finances credit insurance;
3. financing certain closing costs on refinancing of a secured loan within 18 months;
4. encouraging the borrower to default on existing debts;
5. financing at a greater APR than provided for under Title 12 of the Code of Federal Regulations;
6. failing to report favorable payment history to a reporting agency;
7. collecting unconscionable fees;
8. providing default interest rates;
9. collecting improper charges;
10. failing to give disclosure notice;
11. collecting improper prepayment premiums;
12. failing to extend balloon payments;
13. waiving violations; and
14. failing to provide mandatory arbitration clauses.

B.  D.C. Provisions Concerning Lien Instruments / Deeds of Trust

Although the Act focuses on prohibiting predatory practices and protecting the borrower, the Act also establishes criteria for creating a valid lien instrument. In general, a lien is enforceable without personal liability for its performance. Additionally, there is no need for consideration to enforce the lien. All lien instruments securing a preexisting obligation are enforceable. The obligation under the lien is valid regardless of whether the obligation is upon the borrower or some other person. Also, the instrument itself, regardless of whose obligation it is to pay, shall be measurable or readily reducible in terms of money at the time of enforceability.

For a valid lien, the lien instrument shall be executed in the same manner as an absolute deed, and will become enforceable against the parties and others in similar fashion as an absolute deed. The instrument must identify the performance obligation and state the monetary equivalent in United States currency. In addition, all conditional and unconditional guarantees must be included. Liens conveyed on real property may be acknowledged and recorded in the same manner as an absolute deed, and may be secured by any combination of interest, fees, advances, enforcement expenses, and/or indemnification obligations. All obligations under the lien providing a covenant to share income or revenue must be specified within the lien itself.

Liens cannot be formed through negative covenants, nor do they create a right of possession. Any lien creating a possessory interest is void unless it is made contemporaneously with the lien instrument and concludes independently in the event of default. There is a presumption that a lien instrument is not created by the borrowers’ promise not to encumber or transfer an interest in real property, without other evidence of the parties’ intent.

The Act provides requirements necessitating the filing of the deed. Every deed or encumbrance of the residential property must be recorded with the land records as provided by Section 205 of the Act. Every deed of trust or mortgage that encumbers residential real property (e.g., amendments, modifications, or supplements), that is recorded among the land records after 60 days of the effective date of the Mayor’s regulation must attach an information form. If the noteowner elects to foreclose by judicial foreclosure and not by power of sale, then the informational form need not be attached; however, a certification to the deed of trust or mortgage must be attached detailing the manner of foreclosure. The informational form shall contain the following:

1. the names and addresses of the borrower, owner and original note owner;
2. the address, the assessment and taxation lot and square numbers, the recorded lot and square numbers, if different, and the then-current assessed value of the residential real property encumbered by the deed of trust or mortgage;
3. the maximum principal amount of the note secured by the lien instrument, the amount of the loan funded at the settlement, and the total amount of all origination/discount points and fees charged to the borrower and owner;
4. the name and business address of every mortgage lender and mortgage broker involved in placing or originating the loan, or a certification by the note owner that no mortgage lender or mortgage broker was involved in placing or originating the loan;
5. for each mortgage lender or mortgage broker involved in placing or originating the loan:

   (a) the mortgage lender’s or mortgage broker’s District of Columbia license number under the Mortgage Lenders and Brokers Act of 1996 ("Mortgage Lenders and Brokers Act of 1996")

   (b) certification by the mortgage lender or mortgage broker to the borrower, owner and the Mayor that the mortgage lender or mortgage broker is exempt from the licensing requirements of the Mortgage Lenders and Brokers Act of 1996 and a detailed explanation of the basis for the exemption;

6. the name and address of the title company, attorney, or person conducting the settlement of the loan who is responsible for collecting and disbursing any loan proceeds at the settlement;
7. a certification by the borrower and owner of the number of residential lien instruments, regardless of lien priority, that have been granted by the owner on the residential real property in the 18-month period before the date of the loan closing;
8. a certification by the original note owner or original note owner’s agent to the borrower, owner and Mayor that:

   (a) the deed of trust or mortgage secures or does not secure a home loan and

   (b) a reasonably detailed analysis of the basis for that conclusion has been provided to the borrower and owner in writing;

9. whether any single-premium credit insurance was paid for from the loan proceeds; and
10. other information and certifications as required by the Mayor.

Before a lien instrument can convey an estate in real property, it shall: (1) be executed; (2) acknow-ledged and recorded in the same manner as an absolute deed; (3) take effect both as to the parties and to others, (e.g., bona fide purchasers, and interested persons) in the same manner and with the same conditions as an absolute deed. To become effective against others, the Recorder of Deeds must record the lien instrument among the land records in similar fashion as an Article 9 of the Uniform Commercial Code filing.

The lien instrument can be assigned, transferred, or enforced pursuant to Section 208 of the Act. For a valid transfer, the note secured by the deed of trust or mortgage shall comply with the Uniform Commercial Code. In addition to U.C.C. requirements, once the deed of trust or mortgage on real property has been transferred, the transferor or the transferee at the transferee’s option shall either (a) record the instrument of transfer among the land records, or (b) record a certificate of transfer as described in Section 208 of the Act. However, Section 208(g) states that the section does not imply that recordation of such instrument or certificate of transfer is necessary to transfer to transferee the benefit of the security provided by the deed of trust or mortgage.

Unless otherwise agreed upon, the borrower can make a payment on the note secured by the lien instrument at any time prior to maturity. Additionally, the borrower has the right to make the payment in whole or in part. Even if the borrower makes a prepayment, the borrower is not entitled to a reduction in monthly or scheduled payments, unless the note agreement states otherwise.

C. Foreclosures

The Act establishes new foreclosure procedures, which are tailored to help the unsophisticated borrowers deal with lending practices with which they are unfamiliar and cause a greater risk of foreclosure. These procedures allow the borrower a greater opportunity to remain in possession of its residential real property. The Act provides greater protections for a borrower who has defaulted on a predatory loan. To assure the proper party obtains possession to the property at foreclosure, the Act outlines several protections. One particular advantage to the borrower is its ability to claim the initial loan was predatory. Under the Act, homeowners are assured a fair and just interpretation of the residential lien instrument, through their ability to request that the foreclosure go through judicial foreclosure.

A borrower who is personally liable or an owner of the residential property can request the trustee or assignee to pursue a judicial foreclosure when (1) a residential lien instrument recorded after January 1, 2001, does not have a properly completed information form attached to it, (2) a home loan is allegedly predatory, as described infra, or (3) a residential lien instrument specifically states it must be foreclosed by judicial foreclosure or it is limited to judicial foreclosure by the Act. All judicial foreclosure requests must be written, and include a description of any predatory violation, supporting documentation, and any installment payments required under the foreclosure. Once all the proper pleadings and notices have been issued, the court shall schedule an expedited hearing. In the judicial foreclosure proceeding, the court shall determine:

1. whether a debt is secured by a residential lien instrument;
2. the amount of the debt;
3. whether a default under the note or other obligation or the residential lien instrument occurred;
4. whether the residential lien instrument securing the note or other obligation contained the requisite information; and
5. whether the note owner, beneficiary, mortgagee, secured party, trustee or assignee for foreclosure performed a predatory act.

A beneficiary or mortgagee can commence a foreclosure proceeding once an uncured default has occurred beyond any grace period given to cure the default, so long as the lien instrument has been recorded among the land records. Unless otherwise provided therein, the lien instrument includes the right to foreclose by power of sale foreclosure. Foreclosure initiated by a trustee or assignee shall not commence until the noteowner, obligee, beneficiary, mortgagee, or secured party, has provided the trustee or assignee written instructions to foreclose the lien instrument and specify the process through which the foreclosure will occur.

Prior to any foreclosure proceeding, the party foreclosing must provide notice of the foreclosure. Notice can be achieved by providing a notice of commencement of foreclosure. Depending on the type of loan to be foreclosed, the notice of commencement of foreclosure must contain specific information. Section 502 of the Act details the necessary information for the notice of commencement of foreclosure, which includes:

1. the street address of the real property being foreclosed;
2. the legal description of the real property being foreclosed as stated in the lien instrument, including assessment and taxation lot and square numbers and whether the real property is residential real property which had an assessed value at the time of recording the residential lien instrument of $1 million dollars or less;
3. the last known name of the owner;
4. the nature of the uncured default and the amount due under the lien instrument as of the date of the last overdue payment, including accrued interest;
5. for a residential lien instrument or as required by any lien instrument, the right of the borrower or owner to cure the default and reinstate the maturity date and other terms of the note or other obligation and lien instrument as provided in section 405 with an explanation of what the borrower or owner needs to do to cure the default and reinstate the maturity date and other terms of the note or other obligation and lien instrument;
6. for a residential lien instrument encumbering residential real property which had an assessed value at the time of recording the residential lien instrument of $1 million or less, the name of the person to whom a check should be made payable and an address in the District of Columbia where the check can be delivered in order to reinstate or redeem;
7. notice of the borrower’s or owner’s right to bring a court action to assert the non-existence of a default or any other defense of the borrower or owner to the acceleration and foreclosure;
8. the date, time and place of the foreclosure sale auction;
9. the name, type of entity, domicile and notice address for the noteowner or beneficiary, mortgagee or secured party secured by the lien instrument;
10. the name, address, and contact information for the trustee or assignee for foreclosure, and the noteowner, beneficiary, mortgagee, or secured party, as applicable, and the attorney representing each of them in the foreclosure;
11. whether the noteowner or obligee has the original note or other obligation in its possession, or has provided a lost note affidavit to the trustee or assignee for foreclosure;
12. the identity, name, address, and telephone number of the person maintaining the copies required by section 513;
13. whether the note and lien instrument qualify as a home loan;
14. notice of the borrower’s or owner’s right, if any, to request a judicial sale foreclosure and the procedures by which such a sale may be requested;
15. if the note and lien instrument qualify as a home loan, the monthly amount necessary to satisfy the required conditions during challenge as defined in section 703(a), and the person to whom such monthly amount must be paid; and
16. any other information the Mayor determines to include.

D. Conclusion Concerning The D.C. Act

Lenders making deed of trust loans in the District of Columbia and borrowers should review their current lending practices and procedures, to be in a position to comply with the new lending requirements. The lawyers at Reed Smith can assist with this effort. We can provide you with a copy of the proposed Act and a more detailed analysis and strategic plan upon request.

II. Virginia Predatory Lending, Provisions

The recently adjourned session of the Virginia General Assembly adopted two pieces of legislation aimed at correcting perceived abuses by mortgage lenders. One measure, HB 2708, was chief-patroned by Delegate Wittington W. Clement (D-Danville), who is also a candidate for the Democratic nomination for Virginia Attorney General. This legislation adds a substantial new provision to the Virginia statutes regulating mortgage lender or mortgage broker practices. It prohibits the "flipping" of mortgage loans. Flipping is defined as refinancing an existing mortgage loan within 12 months after the refinanced loan was originated if the new loan "does not benefit the borrower, all circumstances considered," a phrase which the bill does not define. On the other hand, the bill does provide that a benefit to the borrower occurs whenever the borrower’s monthly payment on its new debt is lower than the total of all monthly obligations being financed. Also constituting a "benefit to the borrower" are situations in which the duration of the loan changes, the borrower receives cash in excess of costs and fees as part of the refinancing, or there is a change from an adjustable to a fixed-rate loan.

The bill provides a safe harbor from the anti-flipping provisions in any case in which a mortgage loan is made after a borrower has initiated communications with a mortgage lender or broker. If the mortgage lender or broker has communicated with the borrower, any loan resulting from such contact would still be exempt from the anti-flipping rule, if the mortgage lender or broker did not communicate with the borrower through some advertising or other medium which "targets" a specific borrower. The bill does not elaborate upon what is meant by targeting a specific borrower.

The other legislation which will get the attention of Virginia mortgage lenders and brokers is HB 2787, relating to predatory lending practices. This bill was patroned by Del. Don McEachin (D-Richmond) who is contesting Del. Clement for the Democratic nomination for Virginia Attorney General. At one point, HB 2787 would have prohibited any mortgage loan for which the sole security is residential real estate. There were obvious problems with that approach. Ultimately, the legislature changed directions and simply made it a prohibited predatory practice for a mortgage lender or broker to recommend or encourage a borrower to default on an existing loan in connection with making a loan that refinances all or any portion of the pre-existing debt.

Both bills have been approved by Governor Gilmore. They will become law on July 1, 2001.