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Financial Services FLASHPOINTS August 2019

August 15, 2019Print This Post Print This Post

Michael L. Weissman, Levin Ginsburg, Chicago
312-368-0100 | E-mail Michael L. Weissman

This month we consider whether a mortgagor may challenge an earlier state court foreclosure and sale in a federal court case after having previously done so in the state court, whether a bank’s “Sustained Overdraft Fees” constitute usurious interest charges, and whether notice of a claim of a purchase-money security interest must be given to the assignee of the original blanket security interest.

State Court Foreclosure and Sale of Real Estate Precludes Subsequent Federal Attack on Mortgage

In a decision written by a law school classmate of mine, Judge Bruce Selya of the United States Court of Appeals for the First Circuit, the court applied the so-called Rooker-Feldman doctrine (see Rooker v. Fidelity Trust Co., 263 U.S. 413, 68 L.Ed. 362, 44 S.Ct. 149 (1923); District of Columbia Court of Appeals v. Feldman, 460 U.S. 462, 75 L.Ed.2d 206, 103 S.Ct. 1303 (1983)) to block a debtor’s federal court challenge to a mortgage that had been declared valid in a prior state court action. Klimowicz v. Deutsche National Trust Co., 907 F.3d 61 (1st Dist. 2018).

In December 2004, Jeanne M. Klimowicz signed a mortgage in favor of New Century Mortgage Company related to real estate located in Fitchburg, Massachusetts.

New Century filed for bankruptcy relief in 2005. The Klimowicz mortgage was assigned to Deutsche Bank. After that, Klimowicz defaulted on her mortgage payments. She filed a petition for bankruptcy relief on May 24, 2006.

Deutsche Bank then foreclosed on the mortgage in the Massachusetts Land Court. A sale was held, and Deutsche Bank was the highest bidder, thereby becoming the record owner of the property.

Next, Deutsche Bank sued to evict Klimowicz from the premises. In that proceeding, Klimowicz challenged the validity of the assignment of the mortgage to Deutsche Bank. Her challenge was denied.

Five months later, continuing her battle with Deutsche Bank, she filed a civil action in the United Stated District Court for the District of Massachusetts claiming violations of Massachusetts law. The case was dismissed.

On appeal, Kimowicz lost again. Judge Selya cited the Rooker-Feldman doctrine. It is the doctrine applied when the losers in state court proceedings complain in a subsequent federal court case about injuries sustained from state court judgments rendered before the federal case was filed and ask the federal court to grant relief from the state court judgments.

The court’s final commentary was, “Refined to bare essence, the plaintiff is seeking, through her federal suit, to revisit a pair of state-court judgments that did not go her way. The Rooker-Feldman doctrine blocks her path.” 907 F.3d at 67.

What’s the point? In mortgage foreclosure, as in most other aspects of a debtor-creditor relationship, the mortgagor gets only one bite at an apple. Dispositive state court rulings cannot be relitigated in federal courts.

“Sustained Overdraft Fee” Held Not To Constitute Interest Under National Banking Act

In Fawcett v. Citizens Bank, N.A., 919 F.3d 133 (1st Dist. 2019), the court held that a bank’s sustained overdraft fees were not “interest” under the National Banking Act (NBA) and sustained a lower court’s dismissal of the case. There was a vigorous dissenting opinion.

The statutory background for the dispute stems from the NBA and regulations promulgated by the Office of the Comptroller of the Currency (OCC), the regulator of national banks.

The NBA permits national banks to charge interest “at the rate allowed by the laws of the State . . . where the bank is located.” 919 F.3d at 134, quoting 12 U.S.C. §85. But the NBA does not define what “interest” is.

If a charge imposed by a bank is not interest, the OCC’s regulations defining “deposit account service charges” apply. 919 F.3d at 135. The regulations permit a bank in its discretion to assess a deposit account service charge as long as the bank acts within the parameters of “sound banking judgment and safe and sound banking principles.” Id.

In 2007, the OCC issued Interpretive Letter 1082 in response to a bank seeking guidance. The OCC noted that the bank charged a continuous overdraft per diem charge of $5 from the fourth through the eleventh calendar day an account was overdrawn and opined that creating and recovering overdrafts have long been recognized as elements of the discretionary deposit account services that banks provide.

Turning to the case at hand, the court noted that when a Citizens Bank account is overdrawn, the bank can either recover the overdraft or decline to cover the overdraft and return the check as “not sufficient funds.” The bank charges a fee in both instances.

If the bank returns the check, it charges a $35 fee. If it honors the check, it charges a $35 fee, and, after that, if the check has not been made good, the bank charges a Sustained Overdraft Fee as follows: $30 four business days after the overdraft; another $30 after seven business days; and $30 more after ten days. The result is that the bank may charge a customer up to $90 more to honor an overdraft than to refuse to honor the item.

The issue in the case was whether the up to $90 excess overdraft charge was “interest” under the NBA. The complaint stated that the rate charged was clearly in excess of the maximum of 21 percent per annum allowed under Rhode Island law (the state where Citizens Bank was located).

In the district court, the bank’s motion to dismiss was granted and the First Circuit affirmed holding that Interpretive Letter 1082 resolved the case. It said that the OCC’s interpretation of its own regulations was controlling under Auer v. Robbins, 519 U.S. 452, 137 L.Ed.2d 79, 117 S.Ct. 905 (1997).

On appeal, the First Circuit addressed three arguments Fawcett made as to why the OCC’s interpretation should be rejected.

First, it said that under the OCC’s regulations a charge is either interest or a non-interest charge. The latter includes category “deposit account service charges.” 919 F.3d at 135. By characterizing the type of fees Fawcett was challenging as deposit account service charges, the OCC rejected the assertion the charges were interest.

Second, the court found that the flat dollar excess overdraft fees were simply deposit account service charges because (1) they were based on an account agreement with the bank’s customer, (2) they were directly related to deposit account services (monitoring, recovery of the debit balance), (3) there was no evidence of activity associated with an extension of credit, and (4) the charges were imposed in a manner quite different from conventional interest charges.

But in stating its third and final conclusion, the court was careful to issue this caveat: “We hold only that flat excess overdraft fees like Citizens Bank’s ‘Sustained Overdraft Fees’ are not ‘interest’ under the NBA.” 919 F.3d at 140.

What’s the point? Banks that follow the Citizens Bank model should be sheltered (at least for now) from attack. But there was a vigorous dissenting opinion that might generate an en banc (total panel) review or a petition to the U.S. Supreme Court.

Purchase-Money Secured Creditor Loses to Holder of Blanket Security Interest for Failure To Notify Assignee

In TSA Stores, Inc. v. Sport Dimension Inc. (In re TSAWD Holdings, Inc.), 601 B.R. 599 (D.Del. 2019), the issue was whether a purported purchase-money secured creditor had properly perfected its claim of a perfected purchase-money security interest. The court held that it hadn’t.

On March 2, 2016, The Sports Authority Holdings, Inc., and its affiliates (collectively, “the debtors”) filed voluntary petitions under Chapter 11 of the Bankruptcy Code.

In 2006, the debtors had procured a secured term loan that eventually amounted to $300,000. Bank of America was the administrative agent for the term loan. By the date of the bankruptcy filing, it amounted to $276,000 plus interest.

The term loan was secured, in part, by a second priority security interest in the debtors’ inventory. Necessary UCC filings were made to perfect a security interest. On December 31, 2015, Wilmington Savings Fund Society, FSB, replaced Bank of America as administrative agent.

During the bankruptcy case, the holder of the first priority security interest was paid in full and the term loan providers moved up to a first priority security interest.

An inventory supplier to the debtors, named Sport Dimension, sold gloves to the debtors under a consignment arrangement in which the sale proceeds were divided 55 percent to the debtors and 45 percent to Sport Dimension. It was not until January 25, 2016, about one month before the debtors filed for bankruptcy relief, that Sport Dimension did a UCC filing. It gave notice to Bank of America but not to Wilmington.

In the bankruptcy case, there was litigation in which Wilmington requested a ruling that it had a perfected security interest senior to Sport Dimension’s. Sports Dimension, of course, claimed its security interest primed Wilmington’s.

Apparently aware of the fact that its claim of UCC priority was on shaky ground, Sport Dimension argued that the issue of UCC priority was irrelevant because the dispute was not governed by Article 9. That argument was premised on the contention that Sports Dimension’s arrangement with the debtors was not a “consignment” as that term is defined by Article 9. Section 9-102(a)(20) of the UCC defines a “consignment” as

[a] transaction, regardless of its form, in which a person delivers goods to a merchant for the purpose of sale and:

(A) the merchant:

(i) deals in goods of that kind under a name other than the name of the person making the delivery;

(ii) is not an auctioneer; and

(iii) is not generally known by its creditors to be substantially engaged in selling the goods of others. 601 B.R. at 603.

The court said the first two requirements clearly had been met, and the only issue was whether the debtors were not generally known by their creditors to be substantially engaged in the sale of goods of others.

Based on the fact that Wilmington’s duties as administrative agent for the term lenders entailed “acquiring, holding and enforcing any and all Liens on Collateral,” the court said it was certainly Wilmington’s obligation to ascertain whether there were other liens on the property it held as collateral for the term loan. 601 B.R. at 604. The court concluded that if Wilmington had actual knowledge of Sports Dimension’s consignment relationship with the debtors, that knowledge would be imputed to the term lenders.

Insofar as Wilmington’s knowledge was concerned, the court noted that prior cases had established a 20-percent threshold for determining whether a consignment arrangement (as defined in the UCC) existed, i.e., whether at least 20 percent of the purported consignee’s inventory consisted of goods of others held on a consignment basis.

Based on a stipulation by the debtors that they never held more than 14 percent of their inventory on a consignment basis and Sports Dimension’s concession that it had no evidence that Wilmington or the term lenders had actual knowledge of the consignment arrangement, the court said, “The priorities of the parties’ interests is governed by Article 9.” 601 B.R. at 607.

Having been characterized as a consignor of goods delivered to the debtors, Sports Dimension had the status of the holder of a purchase-money security interest that was subject to the priority rules of Article 9.

To qualify for a purchase-money security interest, Sports Dimension had to have sent an authenticated notice to any holder of a conflicting security interest. Sports Dimension had sent notice to Bank of America on January 25, 2016, but not to Wilmington even though Wilmington had earlier (on December 31, 2015) filed a UCC1 financing statement reflecting its status and address. Noting there was no evidence that Bank of America forwarded the notice to Wilmington, the court ruled for Wilmington.

What’s the point? A lender seeking purchase-money status must give notice to all prior perfected parties, including those whose priority is based on an assignment from an earlier perfected party.

For more information about financial services, see COMMERCIAL AND INDUSTRIAL LOAN DOCUMENTATION — 2018 EDITION. Online Library subscribers can view it for free by clicking here. If you don’t currently subscribe to the Online Library, visit www.iicle.com/subscriptions.

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