News & Updates

By Raymond J. Ostler

The 18th century British politician Edmund Burke is credited with identifying four “estates” vital to a functioning democracy: legislative, executive, judicial and the “fourth estate,” a free press. Each estate acts to counter-balance the others in order to protect ordinary citizens from abuse by the more powerful elite. For almost three hundred years these four estates have operated successfully, if not always in harmony. Now a government agency seeks to disrupt this balance by becoming a “fifth estate,” not necessarily accountable to the other four.

Since its inception in 2011, the Consumer Financial Protection Bureau (“CFPB”) has become a $600 million dollar behemoth, not so much counterbalancing the other four estates as ignoring them. The CFPB has aggressively taken on the role of protector of consumers. Whether the harm to citizens is real or imagined, the CFPB seems determined to “protect” the consumer, regardless of the cost to retailers and bankers.

The CFPB mission is to “empower, enforce and educate” consumers. To accomplish this goal the CFPB has insinuated itself into the fabric of almost every commercial business, especially banking, retail, collection and credit reporting companies. Its website maintains a tote board, like a modern day telethon, of how much money ($11.4 billion) it has obtained for the benefit of how many consumers (25 million). www.consumerfinance.gov.

Currently the CFPB is pushing to re-animate consumer class action litigation by promulgating a new rule which will allow consumers to disregard the plain language in their consumer contract and to disregard existing legislation and judicial precedent. On May 24, 2016 the new rule (12 CFR 1040) was posted for public comment. The rule, which could take effect in 2017, will allow consumers to disregard the arbitration clauses made part of their contract, ratified by Congress and upheld by the U.S. Supreme Court.

Consumer class action litigation was a plague upon many retailers and financial service companies prior to 2000. In most cases even though the harm to the individual consumer was slight, the cost of defense was prohibitively expensive. Early settlements were common in order to avoid the extraordinary cost of defending even specious claims. This problem was addressed in three ways. First, many consumer contracts, especially those used by banks and retailers, now include the use of mandatory arbitration clauses that prohibit the consumer from filing a class action complaint unless and until the matter in dispute was arbitrated. Second, Congress passed both the Federal Arbitration Act (FAA) and Class Action Fairness Act (CAFA) which validated mandatory arbitration clauses in retail contracts and reduced abusive practices in class actions. Thirdly, in 2011, the Supreme Court upheld the use of mandatory arbitration clauses in the case of AT&T Mobility LLC v. Concepcion, 131 S. Ct. 1740, 1752 (2011). Simply put, both Congress and the Supreme Court validated the use of arbitration clauses in contracts signed by a consumer. This has been an effective deterrent to class action lawsuits and saved banks and retailers untold millions of dollars in fees. None of this matters because the CFPB is determined to change this status quo.

The new CFPB rule would prohibit so-called “forced arbitration” clauses. According to the CFPB, banks and retailers use mandatory arbitration clauses “to deny customers an opportunity to file class action lawsuits.” According to CFPB Director Richard Cordray “(s)igning up for a credit card or opening a bank account can often mean signing away your right to take the company to court if things go wrong.” Apparently Mr. Cordray does not consider the consumer’s right to “just say no” and seek a different bank or vendor to be a viable option.

The comment period to oppose this rule ended on August 22, 2016. Banking groups opposed to the rule argued that it will cost banks and retailers between $2.62 billion to $5.23 billion on a continuing five-year basis to defend the additional estimated 6,042 class actions that will be brought after the proposed rule becomes final. Furthermore these costs are expected to increase over time. The irony is that there seems to be little hope that this extraordinary industry cost will result in any real consumer benefit. CFPB’s own study showed that at least 87% of all consumer class actions do not benefit the consumer. When “successful,” the CFPB found that the average payout was about $32.35 to the consumer. Meanwhile, millions of dollars will be paid by retailers and banks to defend claims which already have a contractually bargained for remedy.

The proposed CFPB regulation is intended to circumvent the sanctity of written contracts, to repeal existing legislation and to overturn Supreme Court precedent. The CFPB is not a counterbalance to the other four “estates.” Instead the CFPB seeks to force its will on the non-consumer corporate citizen when the agency disagrees with the protections already in place by contract, statute or court decision.

Editors Note: Ray was first to argue that the CFPB holds itself to be unaccountable to the other branches of government. On October 11, 2016, in PHH Corporation v. CFPB, 2016 WL 5898801, the United States Court of Appeals for the District of Columbia ruled that CFPB was subject to presidential oversight and control. However, this will undoubtedly end up in the Supreme Court. And probably a Supreme Court with nine justices.

What to do with a substantial windfall after the sale of an REO foreclosure property is likely a problem few mortgagees have faced since before 2008. However, as the market continues to improve in some areas, mortgagees will at least be comforted to know that they are not required to use such a windfall as a setoff against deficiency judgments obtained in foreclosure.  A new case out of the Second Appellate District makes clear that when a mortgagee obtains a deficiency judgment against a mortgagor in a foreclosure action, purchases the property a judicial sale, and then resells it to a third party for an amount in excess of the price paid at the judicial sale, the mortgagor is not entitled to a setoff in enforcement proceedings to recover the deficiency. Old Second National Bank v. Jafry, 2016 IL App (2d) 150825.

In Jafry, the bank obtained a judgment of foreclosure and sale showing an outstanding loan balance of $1,362,329. The bank was the only bidder at the judicial sale, obtaining the property with a bid of $900,000.

The court approved the sale and entered a deficiency judgment against the defendants in the amount of $577,876.  The bank then sold the property to a third party for $1,320,000. The bank also initiated collection proceedings against the defendants, seeking the full deficiency judgment amount of $577,876 plus interest.

The defendants sought an equitable setoff, requesting that the deficiency judgment be reduced by the difference between the amount the bank sold the property for and its winning bid at the judicial sale.  They argued that allowing the bank to seek the full deficiency essentially entitled them to a double recovery.  The trial court dismissed the petition, and the defendants appealed.

The appellate court based its decision upon the nature of the relationship between the mortgagee and mortgagor, and how it changes as the foreclosure action progresses. When a mortgagee acquires a certificate of purchase after a judicial sale, a new relationship is created, which is in no way dependent on, or influenced by, the prior contract between the mortgagee and the mortgagor. Id. at ¶11 citing Johnson v. Zahn, 380 Ill.  320 (1942).  Put differently, the foreclosure ends the mortgagor-mortgagee relationship, and transfers the rights, title and interest of both the mortgagor and mortgagee to the purchaser.

The court pointed out that the right to setoff is derived from either a contractual right or equity. Brannen v. Seifert, 2013 IL App (1st) 122067, ¶95. Since the foreclosure terminates the contractual relationship between the parties, there is no contractual right to setoff. The court found no equitable right either since a mortgagee has no right to increase its deficiency judgment if it ultimately sells an REO property for less than its bid. The court essentially reasoned that if the mortgagor is not liable for future losses, it should not be entitled to future gains.

The ruling should be welcome clarification for mortgagees, as it prevents a situation in which lender would have to account for the costs and reasonableness of its improvements to REO properties, as well as fluctuations in the real estate market. It also precludes the need for mortgagees to account for potential future setoffs in determining their bid amounts. Mostly, it is comforting to see the appellate court reach a decision that does not create another opportunity for defendants to extend the foreclosure proceedings and erode the finality of an order approving the sale.