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Switching Foreclosure Rules in the Middle of the Game

posted by Adam Levitin

Yves Smith has an interesting post up on Naked Capitalism about Florida Governor Rick Scott suggesting that Florida could switch from judicial to nonjudicial foreclosures as a way to solve its foreclosure overload. (At a Congressional hearing last fall, the head of BAC testified that 70% of judicial foreclosures are in Florida, a testament to that state's high default rate and large population among judicial foreclosure states.)  

Putting aside the political questions of whether should engage in such a change and whether the votes are there, I think there's a really interesting legal question lurking in the suggestion. Can a state change from judicial to nonjudicial foreclosure as applied to existing mortgages? (Let's assume that it would only apply to future foreclosures, however.) 

The question has some parallels in retroactive application of changes in the bankruptcy law to the detriment of secured creditors (generally a no-no, but Supreme Court cases leave open the possibility of a public interest exception to retroactivity).  I would think that the same analysis would apply to state foreclosure law changes as to bankruptcy law, namely, whether the change has deprived a party of a property right.  In the case of foreclosure law, the answer is clearly yes.  

There is monetizable value to procedural rights in foreclosure. Economist Karen Pence has a great study showing that mortgage availability is lower (meaning mortgages cost more) in judicial foreclosure jurisdictions. In other words, those homeowners are buying procedural protection (think of it as a type of insurance). Changing the game on homeowners, beyond smacking of unfairness, would actually be depriving them of fairly-bargained for value. It would also unjustly enriching lenders, not just in the way that Yves identifies--namely that they won't undergo judicial scrutiny of their cases--but that they will get paid premium judicial foreclosure rates for non-premium nonjudicial foreclosure law. I think that in such circumstances, homeowners (and not just those in default, but everyone currently with a mortgage in Florida) arguably have a case (possibly a class case) that such a change is taking their property without just compensation. Whether that produces an injunction or just damages is a separate question, but I don't think Florida can change the rules of foreclosure midstream free of cost. 



The very proposition reflects a rather fundamental misunderstanding by Governor Rick Scott about the nature of non-judicial foreclosure. In essentially every state that non-judicial foreclosure prevails, this is the case because the legislature in those states have NOT probibited the use of privately negotiated contractual private rights of sale and have very often expressly provided a statutory mechanism for such private rights of sale by legislative enactment.

But even in non-judicial foreclosure states, foreclosures can and are conducted both judicially and non-judicially. When they are conducted non-judicially, it is because the borrower freely enterred into a mortgage loan arrangement which provided for a private right of sale in either a mortgage or, more often, a deed of trust (if you can call it "freely" when lenders have universally elected to offer ONLY loans containing a non-judicial remedy).

It is by the express terms of the private right of sale which are included within the mortgage, deed of trust or other mortgage security instrument, that such sales are conducted. And Article I, Section 10, expressly precludes states from enactment of legislation which impairs the obligation of contracts.

It is hard to see how one writes legislation which not only allows for the use of non-judicial foreclosures, but also imposes a non-judicial foreclosure on parties whose contracts were already concluded without running afoul of both Article I, Section 10, and the 14th Amendment.

It is one thing to waive one's due process rights. It is quite another to have these taken away from one by legislation and given to the counterparty of a contract already agreed to.

This is hardly a matter worthy of discussion. Aside from the inherent unfairness and even the Constitutional impediment, while the criminal element in control of the banking industry might wish for such a result, I can think of no faster way for the Republican Party to lose control of not only the Governorship, but also both houses of the legislature than to even entertain such insanity.

It is also probably worth noting that those commissioned by the banks to calculate the increased costs associated with a state's election to preclude use of non-judicial foreclosure are engaged in such an intellectually dishonest argument that this merits a separate refutation.

Ever since the creation of the Federal National Mortgage Association (Fannie Mae), mortgage rates and prices are established nationally. That is, the SAME interest rates prevail in the judicial foreclosure states and non-judicial foreclosure states without regard to the efficiency or cost of foreclosure. While private lenders and private mortgage investors theoretically COULD punish states with stronger consumer protection provisions by charging higher consumer interest rates for mortgage loans, I have seen NO EVIDENCE that ANY DO. To the contrary, the impetus to have strong geographic diversity in an investment pool absolutely overwhelms any additional marginal cost in the conduct of foreclosures.

I suppose that if states with singularly small populations and housing markets, like Delaware, Vermont and South Dakota were to pass legislation requiring a five year foreclosure process, that some mortgage investors would probably pass, no lender can afford to simply IGNORE the Florida or California market and loan pools which excluded these states would not be as diversified as those which include them.

Strong consumer and regulatory enforcement can also curb reckless lending. The surest way to hold down the costs of foreclosure is to minimize its occurence. In those states where statutes or state Constitutional provisions restrict cash out equity refinances, there was very little speculative bubble and the foreclosure problem is minimal.

If Governor Scott wants to get control over the foeclosure problem in his state, he should probably revisit the statutes which allowed for all manor of excess, including rather brazen fraud in Florida condomenium development. Of course, it is the condo developers who are lining the pockets of elected officials throughout the state, so this seems unlikely. For that matter, passing state legislation which prohibits cash out refinancing would probably protect borrowers and taxpayers alike.

One difference from the bankruptcy situation - you not only have to worry about the U.S. Constitution, it also has to be constitutional under Florida's Constitution.

I don't know a lot about Florida's Constitution - except that it enshrines the Florida homestead exemption as a constitutional right, causing all sorts of issues in litigating fraudulent conveyances.

It is the Florida Constitution that caused Judge Proctor to observe, many years ago: "One may sojourn on the beaches of the Gold Coast of Florida with property values reaching to the stars and keep a homestead of unlimited value free of claims of the trustee or creditors."

Are there likely to be Florida Constitutional land mines, in addition to all the other problems with this dumb idea? I think it is likely.

Plus, the whole concept just has that nasty ex-post facto-ey odor about it that probably isn't going to be masked with a quick spray of the Lysol of convenience.

The point about the power of sale in a deed of trust being different from a mortgage in a judicial foreclosure state also appears to be an insurmountable due process issue. That is not the deal the parties made when the note and mortgage were signed.

Even though the "ex-post facto" prohibition in the U.S. Constitution applies only to criminal laws, the due process/takings issues involved in governments undoing express private contract rights - in combination with the political blow back - are going take a terrible situation and make it worse.

For example: who's going to be first up to pay good money for 'title' to a Florida property with a non-judicial foreclosure in the chain of title? And how much would you be willing to pay for that bundle of [litigation] rights?

Property law is the opposite of life: no one wants it to be a box of chocolates. You ALWAYS want to know what you are going to get when you buy or transfer real estate. No other area of the law has more old cases cited as valid, binding precedent every day in courts around the country. Property law must have the virtue of certainty - so we try to keep it the same, so everyone knows what the they have.

Putting Florida property law in a blender, as Governor Scott would be doing in trying to legislate this switch, would be a political mistake of Weiner-ian proportions.

I think Rick Scott is going to get feedback from some folks with a little legal background and pretend he never brought this up.

How about we change the rule now, apply the change to only new loans, and use resulting data to evaluate whether a retroactive application is appropriate? I've heard no one come out against non-judicial foreclosure generally. And by adding the option to contract for judicial foreclosure as one comment mentioned, I can't see there being much opposition. At the very least, if problems compound down the road as some expect, we'll have a release valve option we can evaluate more precisely.

OT: I demand a Dodgers bankruptcy post!

Great analysis and great comments as well. Thanks.

@Jay Thomas:

>>I've heard no one come out against non-judicial foreclosure generally.

You must be absolutely OUT OF YOUR MIND!

Do you really think that the fact that courts in non-judicial foreclosure states are congested with foreclosure cases in which egregious forgery, perjury, evidence fabrication and other fraud on the court is rampant would somehow make out a case for further depriving borrowers of their rights?

What needs to be and WILL BE examined over the next few years is whether non-judicial foreclosure should EVER be allowed in ANY state given the epic criminality by our nations' financial institutions and attorneys.

While the financial institutions seem to think that they can continue to manipulate the politicians that they have bought and aid for into serious breach of public trust, the public's patience for bailouts and handout to criminal enterprises is at its end!

William A. Roper, Jr.

Leaving aside the questionable Constitutionality and the absolutely horrid lack of merit of the proposal, there is another matter which also deserves mention.

And that is the fact that the single issue which almost uniformly unites conservatives and Republicans is the sanctity of property rights.

Despite the fact that corporatists have corrupted and bought off Democrats and Republicans in Congress alike and play our President for the weak puppet that he is, underlying the conservative resurgence in the U.S. is a rather acute anger at the betrayal of conservative priciples by the corporatists. This anger underlies the Tea Party movement.

It is truly ironic that Governor Rick Scott is so totally tone deaf to the views of those who put him in office. To any extent that Gov. Scott is actually able to enact the change that is proposed, he will not only be a single term governor, but he will probably cost the Republican Party any chance of carrying Florida in the 2012 Presidential election. The level of hostility is Florida is, in fact, now so high, that I would go so far as to predict that if the legislation were enacted that Gov. Scott would very likely to become the first Governor in modern American history to be assassinated. (I say that NOT as any sort of threat, but rather a recognition that when fully one quarter of the households in your state face imminent foreclosure, to begin lobbying for legislation to SPEED FORECLOSURES and curry favor to large out of state banks and a corrupt in state real estate lobby, precisely the OPPOSITE of what the governor's core constitutency HOPED FOR and EXPECTED, will be viewed as a betrayal and worse by some very desparate people.)

Lest there be any doubt about the direction of Gov. Scott's political fortunes, I would recommend a reading of this article appearing this evening in the online edition of the New York Times:

"Sinking Poll Numbers May Put Florida in Play" (June 27, 2011)

Although the non-judicial foreclosure proposal is not mentioned in the article and probably hasn't yet been measured in a Florida poll, I assure you that foreclosure touches essentially EVERY household in the state of Florida and this is one issue about which EVERYONE Democratic and Republican will UNITE against the interests of the too big to fail banks and the real estate lobby. Clearly, Democrats didn't like Gov. Scott anyway and standing up to public unions, while cutting spending didn't help. But the betrayal of his core constituency by selling out to the banks will absolutely doom his political future.

The move to change Florida from a judicial to nonjudicial foreclosure state is not new. The Florida Bankers Association has been trying to get bills passed for the past 2 years. We have been successful at blocking the bills by making phone calls, sending letters, contacting our Representative, and holding protest rallies at the Capitol in Tallahassee (look up Rally in Tally).

I agree with Mr. Roper that if Governor Scott pursues this avenue, he will be setting himself up for anarchy in Florida. Florida is already seething because of the rocket dockets and other shenanigans of the court and foreclosure mills.

If anyone is interested, I have copies of the previous bills.

Short and sweet addition to the excellent post and commentary above: Massachusetts (aka Proud Home of the Ibanez decision) is a non-judicial foreclosure state.

You still have to do paperwork... and stuff.

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