Is a loan buyer affected by claims a borrower might have against the selling lender?
If the loan is in default at the time it is purchased, which is almost always the case with distressed loans, the buyer cannot achieve ‘holder in due course’ status. This means the buyer is subject to all of the defenses that the borrower might have against the selling lender and perhaps its predecessors. The borrower may bring lender liability defenses, such as those related to errors in funding or other defects in loan administrations, against the loan buyer, even though the buyer itself is not at fault. Often, the selling lender’s files offer few clues as to the existence of these defenses, particularly if no foreclosure complaint has been commenced or answered by the borrower.
The Florida loan statute of frauds offers protection to lenders and loan buyers by requiring that all agreements related to the lender’s obligations under the loan must be in writing and signed by the lender in order to be enforceable against the lender. This reduces the risk of the borrower claiming rights based on alleged verbal inducements or agreements by the lender, but leaves open the risk of lender liability claims based on other facts and theories.
What about borrower defenses based on the Truth in Lending Act?
If the collateral is residential property and the loan has been outstanding for less than three years, the loan should be examined for Truth in Lending Act (TILA) compliance. Investors often don’t realize that they can be held responsible for TILA violations committed by the loan originator if the violation is ascertainable from the documents. If a violation exists, the consequences can be disastrous. The borrower’s remedies include rescission of the security interest in the collateral, which essentially leaves the loan holder with an unsecured note.
There is another issue if residential property is involved. Some ordinances have been passed in which foreclosing lenders are required to maintain and repair properties while the case is pending and, following certificate of title and prior to resale, to obtain inspections of the property. Upon completion of required code upgrades, the lender is required to obtain a new certificate of use and/or occupancy for the property. This cost of satisfying these requirements can be substantial and adds an element of risk to the investment.
Erica L. English is a shareholder with Katz Barron Squitero Faust. Reach her at (305) 856-2444 or [email protected].
