Breaking and Entering as a Legal November 4, 2011 Obligation: - - PDF document

SLIDE 1

Breaking and Entering as a Legal Obligation: Amendments to Chicago Ordinance Continue Trend of Forcing Lenders to Maintain Vacant Property Even Before Assuming Title

By Nanci L. Weissgold, Phoebe S. Winder, and Ryan M. Tosi1

When is breaking and entering a home you do not own a legal obligation and not a crime? In Chicago, and in an increasing number of jurisdictions around the country, mortgagees and servicers of residential loans are required to monitor and maintain vacant properties before they obtain legal title. The Chicago City Council recently adopted a controversial amendment to the Chicago Municipal Code that significantly expanded the definition of an “owner” of vacant property. Specifically, the definition of “owner” includes, among other institutions, “mortgagees,” “assignees,” and “agents” that have yet to take actual possession of vacant property or legal title to such property. This first amendment drew so much criticism that the Council subsequently proposed and passed a second, alternate amendment which agreed to remove mortgagees from the definition of owner and instead created a separate code section setting forth specific maintenance requirements for mortgagees. The second amendment is expected go into effect on November 19, 2011.

The Chicago Amendment

This fall, Chicago passed a measure (the “First Chicago Amendment”) continuing the trend of potential for lender liability with respect to vacant property. The First Chicago Amendment broadened the definition of an “owner” of vacant property to include “any person who alone, jointly or severally with others is a mortgagee who holds a mortgage on the property, or is an assignee or agent

• f the mortgagee.”2 The amended definition of “owner” required subject entities to maintain vacant

property and the exterior and interior of buildings on such property and to meet certain minimum standards, including removal of debris, securing buildings by boarding up openings, and not allowing water to accumulate on the property.3 Failure to comply with the minimum standards would have resulted in substantial penalties. Violations would have resulted in a fine of $500 to $1,000 per offense, and each day that a violation continued would have constituted a separate, fineable offense.4 In addition to the liability, an “owner” has to pay a registration fee (that can range from $250 to $1,000 every six months) and pay the costs associated with maintaining the property. The First Chicago Amendment took effect on September 17, 2011.5 Those in support of the First Chicago Amendment claimed it would “protect the community” from the hazards and negative effects of vacant properties.6 Opponents, however, were troubled by the fact that the First Chicago Amendment made the mortgagee responsible as the “owner” of a vacant property, despite the mortgagor maintaining legal title and the possessory interest in the property.7 November 4, 2011

Practice Group(s): Mortgage Banking & Consumer Financial Products

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Breaking and Entering as a Legal Obligation: Amendments to Chicago Ordinance Continue Trend of Forcing Lenders to Maintain Vacant Property Even Before Assuming Title

2 In early November, however, the Chicago City Council unanimously passed a second, compromise amendment (the “Second Chicago Amendment”), which it struck with the mortgage industry and which continue to make mortgagees liable for some maintenance requirements on properties that are vacant and unregistered, but removed mortgagees from the definition of owner and created a separate code section setting forth specific maintenance requirements for mortgagees.8 The Second Chicago Amendment still requires mortgagees to register, inspect, and maintain vacant property or face fines, but the requirements are more limited than under the First Chicago Amendment. Mortgagees do not need to register a vacant property if the property is already registered by the mortgagor or another mortgagee of the property.9 When registration by a mortgagee is necessary, it would be required every six months, but the registration fee of $500 is required only once.10 The Second Chicago Amendment also created “affirmative defenses” mortgagees could raise to those duties.11 These defenses – which defeat the need to inspect or maintain vacant property – include, the property is occupied; the mortgagee is barred performing these duties by an automatic bankruptcy stay; the mortgage was not in default at time of violation; the mortgagee cured all violations within 30 days after receiving notice of them; and the owner has raised claims or defenses or requested mediation against the mortgagee in bankruptcy proceedings.12 Additionally, the Second Chicago Amendment protects mortgagees from civil or criminal liability for complying with the ordinance unless the act or omission “constitutes gross negligence or willful, wanton, or intentional misconduct.”13 The terms of this second ordinance represent one avenue by which mortgagees can attempt to protect themselves, if state or local governments insist on making mortgagees liable for maintaining vacant properties.

Legality of the Chicago Amendments Making Lenders Liable to Maintain Properties without Legal Title

Even though the terms of the Second Chicago Amendment are less onerous than those of the First Chicago Amendment, serious legal questions still exist as to whether Chicago’s City Council has the power to treat mortgagees as akin to owners for purposes of protecting vacant buildings. As an initial matter, the Second Chicago Amendment as passed appears to conflict with existing law. Illinois state statutes setting forth Mortgage Foreclosure Law expressly dictate that “[n]o mortgagee shall be required to take possession of the mortgages real estate, whether upon application made by any other party or otherwise.”14 This provision directly contravenes the attempt of the Second Chicago Amendment to treat a mortgagee as akin to an owner or force the mortgagee take possession before foreclosure.15 Moreover, under Illinois precedent, home rule units – like the City of Chicago – only have authority to enact an ordinance if (1) the subject pertains to local government affairs and is not of statewide or national concern; and (2) the General Assembly of Illinois can restrict the concurrent exercise of a home rule unit’s power by enacting a law specifically limiting such power.16 Given the fact that the Second Chicago Amendment appears to “contravene[] a state statute, or otherwise intrude[] upon the bailiwick of a governmental branch,” the Illinois courts should “not hesitate[] to find it an invalid exercise of home rule authority.”17 The Second Chicago Amendment potentially implicates other laws such as trespass and wrongful entry provisions, which act to prohibit lenders from entering or controlling property prior to such time as legal title passes to the lender. Indeed, to the extent a vacant property was owned by a borrower that had filed bankruptcy, federal bankruptcy protections, including the Bankruptcy Code’s automatic stay provision would also act to limit the acts a lender could take prior to such time as the automatic stay was lifted. Even if the Second Chicago Amendment is found not to contradict state or federal

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Breaking and Entering as a Legal Obligation: Amendments to Chicago Ordinance Continue Trend of Forcing Lenders to Maintain Vacant Property Even Before Assuming Title

3 law, however, it could arguably be struck down as addressing a statewide or national concern, because mortgage foreclosure law should be consistent statewide – both for mortgagees and mortgagors. The Second Chicago Amendment also runs contrary to analogous environmental law standards, which provide that a lender is exempt from liability for environmental clean up under the federal Comprehensive Environmental Response, Compensation and Liability Act on property the lender holds or acquires title to, where the lender “without participating in the management of a vessel or facility, holds indicia of ownership primarily to protect his security interest in the vessel or facility.”18 Even within the realm of property law, lender liability laws like the Second Chicago Amendment, create tension. Traditionally, lenders have not been responsible for maintaining property, including vacant property, before obtaining legal title to it, whether through foreclosure or otherwise.19 Many jurisdictions have codified this principle by making the legal title holder solely responsible for the maintenance of a vacant property.20

Implications of the Second Chicago Amendment

Not only does the Second Chicago Amendment – as well as other lender liability laws – clash with existing state and federal law, it also runs counter to nationwide efforts by state and federal governments, and by mortgage servicers, to keep borrowers in their homes and to provide them with the opportunity to avoid foreclosure.21 By forcing mortgagees to take control of vacant properties prior to foreclosure, the Second Chicago Amendment encourages mortgagees to complete the foreclosure process quickly in order to obtain legal title to the properties they are obligated to maintain.22 It also runs counter to the current stance of the Department of Justice’s United States Trustee Program, which contends that mortgagees should inspect properties less frequently.23 But the Second Chicago Amendment has the contrary effect, forcing mortgagees to inspect properties more often. Mortgagees are required to inspect properties frequently to determine if they are vacant and, if so, whether they are in compliance with the minimum standards for vacant properties.24 Moreover, mortgagees must regularly inspect not only known vacant properties, but all properties in that jurisdiction where the borrowers are in default,25 raising costs for mortgagees and mortgagors.26 Thus, the Second Chicago Amendment – and other lender liability laws – may cause mortgagees to either raise the costs of credit

• r even avoid extending credit in jurisdictions that impose such property maintenance obligations.27

The Chicago Amendment Continues a Trend of New Lender Liability for Vacant Properties in Other Jurisdictions

The City of Chicago, however, is not alone. Several jurisdictions have recently imposed varying levels of liability on lenders to perform inspections or other tasks related to the maintenance of properties before obtaining title. New York law, for example, makes a mortgagee responsible for maintenance of vacant properties “until such time as ownership has been transferred through the closing of title in foreclosure, or other disposition, and the deed for such property has been duly recorded.”28 New Jersey law requires mortgagees to maintain vacant properties after filing foreclosure action but only if the properties are deemed a public “nuisance.”29 In March 2008, the City of Boston passed an ordinance requiring owners to maintain vacant properties and defining “owner” as, among

• ther things, “a mortgagee in possession of such a property.”30 More recently, the City of Springfield,

Massachusetts, passed an ordinance similar to Boston’s, defining mortgagees as owners for the purposes of maintaining vacant properties.31 In 2010, the City of Los Angeles adopted an ordinance providing that vacant “[p]roperties shall be maintained by the beneficiary/trustee” holding the note or

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Breaking and Entering as a Legal Obligation: Amendments to Chicago Ordinance Continue Trend of Forcing Lenders to Maintain Vacant Property Even Before Assuming Title

4 deed of trust.32 And the City of Chula Vista, California, promulgated an ordinance mandating that “[a]ny beneficiary/trustee who holds a deed of trust … shall perform an inspection of the property” to determine if it is vacant and may be responsible for maintenance.33

Conclusion

Both Chicago Amendments are controversial to say the least. It is anticipated that challenges will be brought to test the validity of the Second Chicago Amendment, even though its terms are less onerous than the terms in the First Chicago Amendment, as well as lender liability laws in other jurisdictions. Time will tell whether the obligations imposed on mortgagees by lender liability laws will have the intended effect of protecting borrowers or will instead result in more property inspection fees and increased borrowing costs for future mortgagors. Authors:

Nanci L. Weissgold nanci.weissgold@klgates.com +1. 202.778.9314 Phoebe S. Winder phoebe.winder@klgates.com +1. 617.261.3196 Ryan M. Tosi ryan.tosi@klgates.com +1. 617.261.3257

1

The authors would like to express their thanks to Matthew N. Lowe for his contributions to this client alert.

2

See CHICAGO, ILLINOIS, AMENDMENT OF CHAPTER 13-12 OF CHICAGO MUNICIPAL CODE CONCERNING OWNER AND MINIMUM REQUIREMENTS FOR VACANT BUILDINGS, ORD. NO. SO2011-5547 at § 13-12-124(e) (Passed July 28, 2011), available at http://chicago.legistar.com/LegislationDetail.aspx?ID=923767&GUID=5B7316FC-1189-4D15-8CC4- D55AA5A852D6&Options=Advanced&Search (hereinafter “FIRST AMENDMENT OF CHAPTER 13-12”).

3

See CHI. MUN. CODE § 13-12-135 (setting forth minimum requirements for vacant buildings).

4

See id. at § 13-12-135(f).

5

See FIRST AMENDMENT OF CHAPTER 13-12, supra note 2, § 3 (noting amendment takes affect “10 days after its passage and publication”).

6

See City Embracing Legislation Tackling Abandoned Homes, CHICAGO TRIBUNE, July 28, 2011 available at http://articles.chicagotribune.com/2011-07-28/news/ct-met-vacant-building-ordinance-20110728_1_freddie-mac-

• rdinance-housing-crisis (quoting Alderman Pat Dowell’s comments in support of the amendment and noting

endorsement by Mayor Rahm Emanuel).

7

See Letter from Tom Deutsch, Exc. Director, American Securitization Forum, to The Honorable Rahm Emanuel, Mayor of Chicago et al. (July 26, 2011) at 2, available at http://www.americansecuritization.com/uploadedFiles/ASF_Letter_re_Chicago_Ordinance_7_26_11.pdf (hereinafter “ASF Letter”); Letter from Alfred M. Pollard, General Counsel, Federal Housing Finance Authority, to The Honorable Rahm Emanuel, Mayor of Chicago et al. (July 27, 2011) at 1-2, available at http://asf.informz.net/z/cjUucD9taT0xMjM4NjA5JnA9MSZ1PTc2NTI4MjU5MCZsaT01NDE5MjQy/index.html (hereinafter “FHFA Letter”).

8

CHICAGO, ILLINOIS, AMENDMENT OF CHAPTER 13-12 OF CHICAGO MUNICIPAL CODE CONCERNING OWNER AND MINIMUM REQUIREMENTS FOR VACANT BUILDINGS, ORD. NO. SO2011-8066, available at

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Breaking and Entering as a Legal Obligation: Amendments to Chicago Ordinance Continue Trend of Forcing Lenders to Maintain Vacant Property Even Before Assuming Title

5

http://chicago.legistar.com/LegislationDetail.aspx?ID=986507&GUID=4F651E52-334B-41EB-88CE- 177766FE044B&Options=&Search= (hereinafter “SECOND AMENDMENT OF CHAPTER 13-12”); see also Chicago City Council Legislative Information Center, Ord. No. SO2011-8066, available at http://chicago.legistar.com/LegislationDetail.aspx?ID=986507&GUID=4F651E52-334B-41EB-88CE- 177766FE044B&Options=&Search (noting that the full City Council passed the updated amendment on November 2, 2011 by a vote of 49 in favor and none against).

9

• Id. at § 13-12-126(a)(1); see also id. at § 13-12-126(c)(2) (creating an “affirmative defense” to the ordinance if

“the owner or another mortgagee has registered the building . . .”).

10

• Id. at § 13-12-126(a)(1).

11

• Id. at § 13-12-126.

12

Id.

13

• Id. at § 13-12-127.

14

735 ILL. COMP. STAT. 5/15-1702(a).

15

Compare Id. with SECOND AMENDMENT OF CHAPTER 13-12, supra note 8.

16

See Village of Glenview v. Zwick, 826 N.E.2d 1171, 1175 (Ill. App. Ct. 2005).

17

See City of Oakbrook v. Suburban Bank and Trust Co., 845 N.E.2d 1000, 1010 (Ill. App. Ct. 2006).

18

42 U.S.C. § 9601(20)(A)(iii).

19

See RESTATEMENT (THIRD) OF REAL PROP.: MORTGAGES § 4.1(a) (1997) (“[a] mortgage creates only a security interest in real estate and confers no right to possession of that real estate on the mortgagee”).

20

See, e.g., CONN. GEN. STAT. §§ 7-148hh & 7-148ii (2011) (not including mortgagee in definition of owner as applied to statute requiring registration and maintenance of vacant properties); D.C. CODE §§ 42-3131.05 & 42-3131.06 (2011) (same); TEX. LOC. GOV’T CODE § 214.231 (2010) (same).

21

See, e.g., Golden State Law Group San Diego, http://www.goldenstatelawca.com/110955/2011/04/26/slow- down-the-foreclosure-process.html (last visited Aug. 23, 2011) (offering borrowers tips on how to slow foreclosure); Illinois Legal Aid, http://www.illinoislegalaid.org/index.cfm?fuseaction=home.dsp_content&contentID=6790 (last visited Aug. 23, 2011) (same).

22

See SECOND AMENDMENT OF CHAPTER 13-12, supra note 8 (requiring mortgagees to maintain vacant properties before foreclosure and without legal title); N.Y. REAL PROP. ACTS. LAW § 1307(1) (2011); New Jersey Foreclosure Fairness Act, Pub. L. No. 2009, c. 296 (enacted Jan. 17, 2010); BOSTON, MASS., MAINTENANCE OF VACANT, FORECLOSING RESIDENTIAL PROPERTIES, ORD. NO. 16-52 (2008); LOS ANGELES, CAL., FORECLOSURE REGISTRY PROGRAM, ORD. NO. 181,185 (2010); CHULA VISTA MUN. CODE § 15.60 et seq. (2007).

23

See, e.g., In re Gray, 447 B.R. 524, 526-28 (E.D. Mich. 2011) (discussing allegations by U.S. Trustee as to “whether so many inspections were necessary and whether the associated fees were reasonable”); Gretchen Morgenson, A Low Bid for Fixing a Big Mess, N.Y. Times, May 14, 2011, available at http://www.nytimes.com/2011/05/15/business/15gret.html?pagewanted=all (discussing investigation against mortgagees by Director of the Executive Office of the U.S. Trustee Program, Clifford J. White III).

24

See FIRST AMENDMENT OF CHAPTER 13-12, supra note 8 (requiring mortgagees to maintain vacant properties);

• CHI. MUN. CODE § 13-12-135 (setting forth minimum maintenance requirements for vacant buildings); N.Y. REAL PROP.
• ACTS. LAW § 1307(1) (2011) (stating that lenders can enter property “for the limited purpose of inspections . . .”); CHULA

VISTA MUN. CODE § 15.60.040 (2007) (requiring lenders to conduct inspections “upon default by the trustor, prior to recording a notice of default”).

25

See FIRST AMENDMENT OF CHAPTER 13-12, supra note 8 (applying mortgagee’s duty to maintain a property to vacant properties); CHULA VISTA MUN. CODE § 15.60.040 (2007) (making lender responsible for determining vacancy and maintaining property when vacant).

26

See Uniform Security Instrument for Illinois, Freddie Mac, ¶ 9, available at http://www.freddiemac.com/uniform/unifsecurity.html#highlights (recognizing that when a mortgagee pays property maintenance costs it “shall become additional debt of Borrower secured by this Security Instrument.”); Anonymous, Rahm’s Home Improvement: Chicago bleeds mortgage lenders for money from vacant property, WALL ST. J., Aug. 24, 2011 (arguing the Amendment “will raise the price of loans for future homeowners as banks . . . pass down the increased cost”) (hereinafter “Rahm’s Home Improvement”).

27

See ASF Letter, supra note 7, at 2 (recognizing disincentive imposed by the Amendment on extending credit); Rahm’s Home Improvement, supra note 26 (quoting a Moody’s Senior Analyst as stating that the lenders would “limit or exclude geographic locations with such lender liability laws”).

28

N.Y. REAL PROP. ACTS. LAW § 1307(1) (2011).

29

New Jersey Foreclosure Fairness Act, Pub. L. No. 2009, c. 296 (enacted Jan. 17, 2010).

30

BOSTON, MASS., MAINTENANCE OF VACANT, FORECLOSING RESIDENTIAL PROPERTIES, ORD. NO. 16-52 (2008).

31

SPRINGFIELD, MASS., REGULATING THE MAINTENANCE OF VACANT AND/OR FORECLOSING RESIDENTIAL PROPERTIES,

• ORD. NO. 7.50 et seq. (2011).

32

LOS ANGELES, CAL., FORECLOSURE REGISTRY PROGRAM, ORD. NO. 181,185 (2010).

33

CHULA VISTA MUN. CODE § 15.60.040 (2007).

SLIDE 6

Mortgage Banking & Consumer Financial Products Practice Contact List

K&L Gates’ Mortgage Banking & Consumer Financial Products practice provides a comprehensive range of transactional, regulatory compliance, enforcement and litigation services to the lending and settlement service industry. Our focus includes first- and subordinate-lien, open- and closed-end residential mortgage loans, as well as multi-family and commercial mortgage loans. We also advise clients on direct and indirect automobile, and manufactured housing finance relationships. In addition, we handle unsecured consumer and commercial lending. In all areas, our practice includes traditional and e-commerce applications of current law governing the fields of mortgage banking and consumer finance. For more information, please contact one of the professionals listed below. LAWYERS Boston

• R. Bruce Allensworth

bruce.allensworth@klgates.com +1.617.261.3119 Irene C. Freidel irene.freidel@klgates.com +1.617.951.9154 Stanley V. Ragalevsky stan.ragalevsky@klgates.com +1.617.951.9203 Brian M. Forbes brian.forbes@klgates.com +1.617.261.3152 Andrew Glass andrew.glass@klgates.com +1.617.261.3107 Phoebe Winder phoebe.winder@klgates.com +1.617.261.3196 Charlotte John H. Culver III john.culver@klgates.com +1.704.331.7453 Amy Pritchard Williams amy.williams@klgates.com +1.704.331.7429 Chicago Michael J. Hayes Sr. michael.hayes@klgates.com +1.312.807.4201 Dallas David Monteiro david.monteiro@klgates.com +1.214.939.5462 Miami Paul F. Hancock paul.hancock@klgates.com +1.305.539.3378 New York Philip M. Cedar phil.cedar@klgates.com +1.212.536.4820 Elwood F. Collins elwood.collins@klgates.com +1.212.536.4005 Steve H. Epstein steve.epstein@klgates.com +1.212.536.4830 Drew A. Malakoff drew.malakoff@klgates.com +1.216.536.4034 San Francisco Jonathan Jaffe jonathan.jaffe@klgates.com +1.415.249.1023 Elena Grigera Babinecz elena.babinecz@klgates.com +1.415.882.8079 Seattle Holly K. Towle holly.towle@klgates.com +1.206.370.8334 Washington, D.C. Costas A. Avrakotos costas.avrakotos@klgates.com +1.202.778.9075 David L. Beam david.beam@klgates.com +1.202.778.9026 Melanie Hibbs Brody melanie.brody@klgates.com +1.202.778.9203 Krista Cooley krista.cooley@klgates.com +1.202.778.9257 Daniel F. C. Crowley dan.crowley@klgates.com +1.202.778.9447 Eric J. Edwardson eric.edwardson@klgates.com +1.202.778.9387 Steven M. Kaplan steven.kaplan@klgates.com +1.202.778.9204 Phillip John Kardis II phillip.kardis@klgates.com +1.202.778.9401 Rebecca H. Laird rebecca.laird@klgates.com +1.202.778.9038 Laurence E. Platt larry.platt@klgates.com +1.202.778.9034 Phillip L. Schulman phil.schulman@klgates.com +1.202.778.9027

SLIDE 7

Mortgage Banking & Consumer Financial Products Practice Contact List

Nanci L. Weissgold nanci.weissgold@klgates.com +1.202.778.9314 Kris D. Kully kris.kully@klgates.com +1.202.778.9301 Morey E. Barnes morey.barnes@klgates.com +1.202.778.9215 Kathryn M. Baugher kathryn.baugher@klgates.com +1.202.778.9435 Emily J. Booth emily.booth@klgates.com +1.202.778.9112 Holly Spencer Bunting holly.bunting@klgates.com +1.202.778.9853 Andrew L. Caplan andrew.caplan@klgates.com +1.202.778.9094 Rebecca Lobenherz becky.lobenherz@klgates.com +1.202.778.9177 Melissa S. Malpass melissa.malpass@klgates.com +1.202.778.9081 David G. McDonough, Jr. david.mcdonough@klgates.com +1.202.778.9207 Eric Mitzenmacher eric.mitzenmacher@klgates.com +1.202.778.9127 Stephanie C. Robinson stephanie.robinson@klgates.com +1.202.778.9856 Tori K. Shinohara tori.shinohara@klgates.com +1.202.778.9423 Kerri M. Smith kerri.smith@klgates.com +1.202.778.9445 David Tallman david.tallman@klgates.com +1.202.778.9046 PROFESSIONALS Government Affairs Advisor / Director of Licensing Washington, D.C. Stacey L. Riggin stacey.riggin@klgates.com +1.202.778.9202 Regulatory Compliance Analysts Washington, D.C. Dameian L. Buncum dameian.buncum@klgates.com +1.202.778.9093 Teresa Diaz teresa.diaz@klgates.com +1.202.778.9852 Robin L. Gieseke robin.gieseke@klgates.com +1.202.778.9481 Brenda R. Kittrell brenda.kittrell@klgates.com +1.202.778.9049 Dana L. Lopez dana.lopez@klgates.com +1.202.778.9383 Patricia E. Mesa patty.mesa@klgates.com +1.202.778.9199 Daniel B. Pearson daniel.pearson@klgates.com +1.202.778.9881 Jeffrey Prost jeffrey.prost@klgates.com +1.202.778.9364