Agricultural lender wins $360K with superpriority lien

By Lisa M. Goolik, J.D.

A bank, Guaranty Bank & Trust Company, that perfected its security interest in a debtor’s crops in accordance with Article 9 of the Mississippi Uniform Commercial Code was entitled to the proceeds of the debtor’s crops prior to a competing creditor’s exercise of its right to set-off. The U.S. District Court for the Northern District of Mississippi concluded that Guaranty followed all of the steps to attach and perfect a production-money security interest in the debtor’s crops, entitling the bank to “superpriority” status under Section 9-103 of the UCC (Guaranty Bank and Trust Co. v. Agrex, Inc. d/b/a/ FGDI, May 22, 2015, Bigger, N.).

Background. In 2010, a Mississippi farming partnership entered into a series of commodity futures contracts with Agrex Inc., d/b/a FGDI, a subsidiary of Mitsubishi Corp. The contracts required the partnership to deliver defined amounts of corn and soybeans at agreed upon prices within a specific range of months in 2010. The partnership was unable to perform four of their commodity futures contracts with FGDI in 2010 and later dissolved.

In September 2011, a former partner, David Walker, received and signed a letter from FGDI regarding the four unperformed contracts from 2010. In the letter, FGDI acknowledged the partnership’s dissolution and stated its willingness to assign the contracts to Walker and “roll” the contracts into 2012’s shipments. The letter stated that when FGDI received a signed copy of the letter, “[FGDI] will assign the contracts listed above to the entity ‘David Walker’ and [FGDI] will resend the contracts for your signature;” however, the contracts were never assigned or resent for Walker’s signature. 

During that time, in April 2012, Guaranty executed a loan for $600,000 for the production of crops in the 2012 growing season on Walker’s behalf. Walker signed a loan agreement with Guaranty, secured by his 2012 soybean and corn crops, and a security agreement, secured by his farm products and equipment. Guaranty filed financing statements with the Mississippi Secretary of State’s central filing system, perfecting its security interest in Walker’s 2012 soybean and corn crops, along with his equipment. Walker drew over $400,000 to fund his 2012 growing operation.

At the end of the 2012 growing season, Walker delivered all of his corn and soybean crops to two grain terminals in Mississippi. FGDI notified the grain terminals of their contracts with Walker, and the grain terminals applied the delivered crops to FGDI’s account, after which FGDI sold the grain to the grain terminals. Walker filled all corn contracts but was unable to fill, in full, the soybean contract. FGDI summed up the amounts due Walker and set-off their estimated damages for the partially filled soybean contract. 

Guaranty requested the proceeds of Walker’s crops from FGDI, claiming their recorded financing statement assumed priority over any interest FGDI asserted based on previous contracts with the partnership. In response, FGDI issued a check payable to Walker, Guaranty, and a third party for approximately $57,000, the amount FGDI calculated was in excess of its set-off regarding the unfilled soybean contract.

Assignment. Before addressing the priority dispute, the court began by addressing whether the partnership’s contracts with FGDI, including the unperformed soybean contract, were properly assigned to Walker. Guaranty argued the assignment was not valid, because neither FGDI nor Walker followed through on the assignment letter stating FGDI’s intent to rescind the contracts in the partnership’s name for Walker’s and return the contracts to Walker for signature, implying there was no written agreement to satisfy the Mississippi Statute of Frauds.

The Mississippi Statute of Frauds provides that “a contract for the sale of goods for the price of five hundred dollars ($500) or more is not enforceable by way of action or defense unless there is some writing sufficient to indicate that a contract for sale has been made between the parties and signed by the party against whom enforcement is sought.”

Despite its failure to send the reassignment, FGDI asserted that the partnership’s 2010 contracts were ratified by Walker in 2012, by signing “roll sheets,” which list incremental price changes with related dates and notations, for the previous partnership contract. Viewing the evidence in the light most favorable to FGDI, the court concluded it was “plausible” that Walker ratified the partnership’s contracts by signing the roll sheets.

Priorities. However, the court concluded that Guaranty’s perfected purchase-money security interest assumed priority over FGDI’s claim to the crops' proceeds through set-off. FGDI argued Guaranty’s security interest was subject to the terms of the agreement between FGDI and Walker, which allowed for set-off. FGDI argued Guaranty’s security interest was limited to the proceeds of the crops and was perfected only after Walker assumed the partnership’s agreements.

“Were Guaranty’s interest only in David Walker’s accounts, FGDI’s priority argument would be persuasive; however, Guaranty’s security interest is not solely, nor primarily, in David Walker’s accounts. Guaranty’s paramount interest is in David Walker’s 2012 crops and crop proceeds,” noted the court.

It was undisputed that Guaranty followed the proper procedure and requirements to obtain a production-money security interest in Walker’s 2012 crops and crop proceeds. Guaranty perfected its interest by filing an effective financing statement with the Mississippi Secretary of State, completed all notification requirements, and provided funds to Walker to be used for the production of crops. 

Production-money security interests are granted a higher priority over other secured interests because the obligation incurred by the debtor, for the value given, is restricted to the production of crops. In addition, Section 9-103 of the UCC provides that a production-money security interest does not lose its priority status, “even if: (1) The production-money crops also secure an obligation that is not a production-money obligation; [and] (2) Collateral that is not production-money crops also secures the production-money obligation.”

Accordingly, Guaranty’s production-money security interest, attached at filing, was superior to FGDI’s set-off interest, which may have been created when Walker delivered his crops to the terminal. As a result, the court concluded that Guaranty was entitled to the 2012 crop proceeds before FGDI’s set-off in the amount of $360,000.


For additional analysis and cases like Guaranty Bank and Trust Co. v. Agrex, Inc. d/b/a/ FGDI (N.D. Miss.), subscribe to the Banking and Finance Law Daily.

It's hurry up and wait as CFPB ponders forced arbitration

By Katalina M. Bianco, J.D.

More than 50 Senate and House legislators have joined together to ask the Consumer Financial Protection Bureau to quickly complete its study of pre-dispute arbitration clauses in consumer financial products and services contracts and begin rulemaking to eliminate the clauses. The issue of forced arbitration is somewhat contentious. Banking trade groups have asked the opposite of the bureau: to avoid rushing into rulemaking.

Arbitration study. The CFPB in March issued a report to Congress, on mandatory arbitration clauses. The study is required under Section 1028(b) of the Dodd-Frank Act. The bureau found that the clauses limit consumers’ right to seek legal relief in disputes with financial services companies. The CFPB reported further that in the consumer finance markets covered in the study, very few consumers individually seek relief through arbitration or the federal courts, while millions of consumers are eligible for relief each year through class action settlements.

Letter to Cordray. In a letter to CFPB Director Richard Cordray, the lawmakers said that mandatory arbitration clauses “force individuals into private binding arbitration as a condition of buying a product or service, and are designed to stack the deck against consumers and ensure that the final outcome of forced arbitration is unreviewable by courts.” Congress has recognized the potential harm of these clauses to the rights of consumers, workers, and small business owners and has passed a series of laws to limit the abusive use of forced arbitration clauses in various financial markets, such as mortgages, and in transactions involving auto dealers and others, according to the letter.

 “In total, the study conducted by CFPB at Congress’s request roundly confirms that individuals unknowingly sign away their rights through forced arbitration agreements, which do not reduce consumer costs for financial services,” the legislators wrote. “Moreover, forced arbitration shields corporations from liability for abusive, anti-consumer practices, encouraging even more unscrupulous business conduct at the expense of individuals and law abiding businesses.”

The letter concludes with the lawmakers urging the CFPB to action “Based on this substantial bedrock of evidence.”

Industry groups. In a joint letter to Cordray, several banking and financial services trade groups—the American Bankers Association, American Financial Services Association, Consumer Data Industry Association, Financial Services Roundtable, and U.S. Chamber of Commerce—argue in opposition to the legislators. The trade associations want the CFPB to solicit comments from the public on its study of mandatory arbitration clauses before deciding whether to issue rulemaking. According to the letter, members of the organizations have asked CFPB staff members informally to solicit comments on the study. The associations now are formally requesting that the bureau solicit public feedback.

The associations state that a comment period is necessary for the following five reasons:

1. The bureau’s study is 729 pages, making it impossible for anyone to provide anything other than generalized reactions to the study during the one to two-hour roundtable discussions held by the bureau to obtain feedback.

2. The CFPB’s “limited outreach regarding its study has been, by definition, highly selective.” The organizations say that there are many businesses and consumers who would be affected by a rule regulating arbitration whose views were not solicited by the bureau.

3. Soliciting comments at this time “would at least start the process of compensating for the extreme lack of transparency and refusal to solicit public participation that characterized the Bureau’s study process.” The CFPB issued one Request for Information in 2012 soliciting comments on what topics the study should cover, the groups said.

4. Issuing a request for comments now would make the CFPB aware of “the significant defects” in the study that would “fatally taint any proposed rule” by the bureau. The trade associations provide as an example that the report addresses a limited data set of arbitrations in the consumer financial services context to see how arbitration in general functions.

5. Soliciting comments before undertaking a major rulemaking is consistent with the CFPB’s approach in other contexts.

The trade groups suggest a 60-day comment period on the bureau’s study before any rulemaking begins.

For more information about mandatory arbitration clauses, subscribe to the Banking and Finance Law Daily.

NY Fed discusses supervision of all banks ‘great and small’

By John M. Pachkowski, J.D.

The Federal Reserve Bank of New York has released a couple of documents that discuss how it supervises the smallest to largest banks in the Second Federal Reserve District.

The first document consisted of remarks given by F. Christopher Calabia, Senior Vice President, at the Community Bankers’ Conference in New York City. The second document was a  staff report that described the Federal Reserve’s supervisory approach for large, complex financial companies.

In his remarks, Calabia touched on three areas: the importance of community banking from the Federal Reserve’s perspectives as both supervisor and central banker; initiatives launched by the New York Fed to tailor its supervisory approach to the actual risks that community banks present; and the performance of community banks—institutions with less than $10 billion in assets, and larger regional banks—institutions with between $10 and $50 billion in assets.
 

Importance. Calabia noted that community banks have a competitive advantage since they know the local business conditions and their customers better than anyone else. He added this is something that “larger firms may tend to overlook.”

 

Supervisory initiatives. Noting that community banks do not generally pose a systemic threat to the stability of the U.S. financial system, Calabia discussed the steps the New York Fed has taken “to differentiate and distinguish our supervisory programs for the largest firms versus those of our smaller community banks.”

 

Alluding to Benjamin Franklin’s adage that fish and visitors stink in three days, Calabia discussed the initiatives that the New York Fed has started to limit the length of examinations and the period of time that community bank staff must devote to them. He noted that the examination staff is “doing more homework in advance of arriving at your front door to evaluate your firms’ financial condition and performance with regard to capital adequacy, earnings, and liquidity.” Another initiative is the use of automation tools to simplify the examination process and make it more efficient. The result of these initiatives reduced the time the New York Fed staff spent at one bank; namely 32 days in 2011 to 18 days in 2013, or a 40 percent reduction.

 

Calabia also cited changes to the scope of consumer compliance examinations. He noted, “By adjusting our scope to focus on the higher risk lending and deposit areas, we’ve found efficiencies in terms of the numbers of examiners sent onsite and the number of weeks spent onsite.” Calabia continued, “In one case, we sent eight examiners for four weeks to a community bank under our former approach, yet more recently we were able to scale that back to about half the number of examiners and one week less onsite at that particular firm.” He did stress, however, “when risks are higher or problems have been identified, we will devote the appropriate time and resources to understand those challenges.”

 

Bank performance. With regard to the financial condition of community and regional banks, Calabia noted, “it’s been our sense that many have experienced gradual stabilization in their financial health over the past two years. Challenges do remain in the District, as evidenced by the fact that some firms continue to have somewhat lower capital ratios. Interestingly, capital ratios on average for our community and regional banks remain slightly below those of national peer group averages; the good news is that we’ve seen few signs of deterioration in the solvency of supervised firms in our District over the past two years. This more stable performance contrasts with a more volatile period prior to two years ago.” He added that the credit risk profiles of community and regional banks “tend to compare slightly more favorably than those of peer banks nationwide.” Calabia considered this “slightly stronger risk profile” as a reason why some regional and community banks hold a little less capital.

 

Larger bank supervision. In the staff report entitled, “Supervising Large, Complex Financial Companies: What Do Supervisors Do?”, the authors, Thomas Eisenbach, Andrew Haughwout, Beverly Hirtle, Anna Kovner, David Lucca, and Matthew Plosser, describe the Federal Reserve’s supervisory approach for large, complex financial companies. The authors noted that the aim of the report was to help fill a “knowledge gap” regarding the supervisory approach for large, complex financial companies. They also stressed that the report does not assess whether the supervisory approaches taken with these large institutions “are efficient or meet specific objectives.”

 

The report specifically examines the supervision of large, complex bank holding companies and the largest foreign banking organizations and non-bank financial companies designated by the Financial Stability Oversight Council for supervision by the Federal Reserve Board. The authors noted that these firms are the most systemically important banking and financial companies and “thus prudential supervision of them is especially consequential.”

 

The report is divided into four sections. The first section provided an overview and background. The second section describes the broad goals of prudential supervision and the primary strategies adopted to achieve those goals, as outlined in various Federal Reserve System and New York Fed documents; describes the structure of supervision in the Federal Reserve System; and provides an overview of the Financial Institution Supervision Group at the New York Fed. The third section discusses the organizational structure of prudential supervision at the New York Fed. The final section describes the day-to-day activities of these supervisory teams, including monitoring, examinations, and broader supervisory programs, as well as the outcomes of that work.

For more information about bank supervision, subscribe to the Banking and Finance Law Daily.

Internet payday loan ‘coordinator’ fails to convince court of class-action borrowers’ jurisdictional, procedural problems

By Thomas G. Wolfe

In addressing a proposed class action by Minnesota borrowers against MoneyMutual, LLC, a Nevada company that arranged the borrowers’ payday loans with a network of lenders, the Minnesota Court of Appeals was called upon to rule on MoneyMutual’s request to dismiss the action for lack of personal jurisdiction and for failure to join the lenders as indispensable parties.

According to the court’s opinion in Rilley v. MoneyMutual, LLC, the borrowers in the proposed class action alleged that MoneyMutual’s website and advertising “contained false and misleading statements,” that the payday loan coordinator matched the respective borrowers with “lenders that were unlicensed in Minnesota,” and that the payday loans violated Minnesota law. In seeking to dismiss the borrowers’ complaint, MoneyMutual argued that it was a nonresident company that did not actually make the loans and did not specifically target Minnesota residents by its television advertisements and its solicitations via its website and e-mails. The company’s arguments did not prevail to dismiss the borrowers’ complaint.

In affirming the state trial court’s decision to allow the borrowers’ proposed class action to proceed, the Minnesota appellate court determined that the borrowers sufficiently alleged “minimum contacts” to establish personal jurisdiction over MoneyMutual and that MoneyMutual did not adequately demonstrate that “complete relief” could not be obtained in the absence of the lenders.

Notably, in reaching its decision, the state appellate court not only reviewed Minnesota law but also acknowledged the prevalence of e-commerce in the state. For instance, the court asserted that it found it “unwise to disregard contacts through an openly accessible website given the increased tendency for commerce to take place via the Internet, particularly when the website is used to circumvent Minnesota law.” Further, the court determined that “Minnesota has expressed a clear intent to regulate payday lending and to protect its residents from predatory practices by enacting statutes that govern not just lenders, but also those who arrange payday loans.”

For additional analysis of cases like Rilley v. MoneyMutual, LLC, subscribe to the Banking and Finance Law Daily.

Fed speeches pinpoint need to give community banks a break

By Andrew A. Turner, J.D.

Federal Reserve Governor Jerome H. Powell is the latest Fed official to focus on the need to tailor regulation and supervision for community banks. Talking about “Regulation and Supervision of Community Banks,” Powell said that he favors raising the asset threshold for compliance with Volcker rule and incentive compensation requirements, “perhaps to $10 billion.”

Powell noted that community banks rarely engage in activities prohibited by the Volcker rule. He also observed that community banks don’t “face the adverse incentives of compensation agreements that may encourage executives and loan officers to maximize lending volume at the expense of safety and soundness.” In his view, these are areas of risk “almost exclusively” for larger financial institutions

In a November 2014 speech, “A Tiered Approach to Regulation and Supervision of Community Banks,” Federal Reserve Board Governor Daniel K. Tarullo asserted that “tailoring of regulation and supervision for community banks not only seems reasonable, it seems an important and logical next step in financial regulatory reform.” Tarullo was elaborating on earlier remarks, “Rethinking the Aims of Prudential Regulation,” where he discussed a tiered approach to banking regulation and what it would mean for community banks.

Previously, then Federal Reserve Board Chair Janet Yellen, spoke about “Tailored Supervision of Community Banks,” saying that the first step to tailor supervisory expectations, according to Yellen, is determining which supervisory policies should apply to community banking organizations. In other cases, she observed that “it may not make sense to exclude community banking organizations entirely from the scope of a supervisory policy, but we may be able to scale expectations to the size and complexity of the supervisory portfolio, to minimize the burden where possible and appropriate.”

For more information about issues surrounding community bank regulation, subscribe to the Banking and Finance Law Daily.

CFPB says PayPal no pal to consumers, files suit

By Katalina M. Bianco, J.D.

PayPal, Inc., has agreed to pay a total of $25 million to settle charges arising from the operation of its PayPal Credit online credit product, the Consumer Financial Protection Bureau announced. PayPal will pay $15 million in consumer redress and a $10 million civil penalty to settle charges brought by the CFPB under the bureau’s authority to act against unfair, deceptive, or abusive acts and practices.

 According to the CFPB, PayPal Credit is a line of credit that Pay Pal customers can use to buy products from online merchants. Similar to when using a credit card, consumers can buy products using PayPal Credit and repay the credit over time, incurring interest and fees in the process. However, PayPal engaged in a number of illegal actions when creating and managing PayPal Credit accounts, the bureau’s complaint charges.

These actions included:

• failing to honor advertised promotions;
• charging deferred interest that consumers could not avoid because they could not make contact with the company;
• enrolling consumers in PayPal Credit without the consumers’ consent or knowledge;
• forcing consumers to use PayPal Credit when they wanted to use a different payment method;
• failing to post payments, and imposing late fees when consumers could not make payments due to website failures; and
• making billing errors and mishandling billing disputes.

 

"Tens of thousands of consumers who were attempting to enroll in a regular PayPal account, or make an online purchase, were signed up for the credit product without realizing it,” CFPB Director Richard Cordray said. Other consumers were enrolled when they tried to cancel or back out of their applications. In part, this was caused when PayPal set PayPal Credit as the default payment for all purchases, Cordray said.

 

Under the settlement agreement, PayPal will make refunds to consumers who were improperly enrolled in PayPal Credit, who mistakenly paid for a purchase using PayPal Credit, or who incurred interest or fees due to PayPal’s “inadequate disclosures and flawed customer-service practices,” Cordray said. The company has not admitted any wrongdoing as part of the settlement.

For more information about CFPB enforcement actions, subscribe to the Banking and Finance Law Daily.

Sen. Shelby releases, defends regulatory relief proposal

By Richard A. Roth, J.D.

A discussion draft of the financial regulatory relief bill that Senate Banking Committee Chairman Richard Shelby (R-Ala) has been mulling has been released, along with a section-by-section summary. The far-reaching bill aims to ease restrictions on mortgage credit, reduce the examination and supervision burdens on smaller institutions, tighten up the Financial Stability Oversight Council’s process for designating systemically important financial institutions, and make technical corrections to the Dodd-Frank Act. It also would initiate an inquiry into reorganizing the Federal Reserve System.

Many of the provisions of the discussion draft should be non-controversial, including some that mirror bills passed by the House of Representatives and sent to the Senate in April. Perhaps in an effort to gain bipartisan support, the bill apparently would make no changes to the structure or authority of the Consumer Financial Protection Bureau.

Organization. The “Financial Regulatory Improvement Act of 2015” is divided into eight titles:

• Title I—Regulatory Relief and Consumer Access to Credit
• Title II—Systemically Important Bank Holding Companies
• Title III—Greater Transparency for the Financial Stability Oversight Council Process for Nonbank Financial Companies
• Title IV—Improved Accountability and Transparency in the Regulation of Insurance
• Title V—Improving the Federal Reserve System
• Title VI—Improved Access to Capital and Tailored Regulation in the Financial Markets
• Title VII—Taxpayer Protections and Market Access for Mortgage Finance
• Title VIII—Dodd-Frank Wall Street Reform and Consumer Protection Act Technical Corrections 

Federal Reserve System reorganization. Shelby’s bill would not make substantial changes to the Federal Reserve System, although it would require the Fed and Federal Open Market Committee to give more details about their decision-making processes. The Fed chairman’s semi-annual policy testimony would be augmented by quarterly reports in which the FOMC would describe the rules or strategies it relied on when determining monetary policy. The FOMC report also would be required to explain any differences between expected and actual economic performance in the previous quarter.

The summary makes clear there is no intent to require the FOMC to use any particular rules in its decision-making; rather, the Committee is to disclose the rules that it has used.

The bill would call for two actual changes. First, the President of the Federal Reserve Bank of New York would become subject to the Senate’s advice-and-consent authority. Second, the FOMC would assume the authority to set the interest rates for banks’ reserve accounts. However, the bill would create an independent commission to investigate the reorganization of the Fed’s districts.

Mortgage and consumer credit. Title I of the bill includes both provisions that are intended to aid in credit availability and provisions that would reduce regulatory burdens on smaller banks. Credit-related provisions include:

• creating a process for residents to ask the CFPB to designate their area as a rural area, which would give mortgage lenders more flexibility; 
• allowing mortgage loans held in the originating lender’s portfolio to be considered Qualified Mortgages as long as riskier loan terms are not included; 
• excluding insurance escrow amounts from a loan’s points and fees for determining whether a loan is a high-cost mortgage; 
• easing lending restrictions on manufactured home loans; and 
• removing the need for a three-day waiting period after a mortgage loan disclosure and before the loan closing when the only change is an interest rate decrease. 

Provisions intended to ease small-institution supervisory burden include:

• reducing the need for annual privacy notices; 
• creating an ombudsman within the Federal Financial Institutions Examination Council to assist financial institutions; 
• doubling the asset threshold for the 18-month examination cycle, to $1 billion; 
• indexing many Dodd-Frank Act dollar thresholds for inflation; 
• permitting highly rated community banks to use short form Call Reports in two quarters each year; and 
• exempting from the Volcker Rule banks that have $10 billion or less in assets or that are owned by a holding company with $10 billion or less in assets. 

FSOC activities. The bill would likely reduce the number of bank holding companies that the FSOC would designate as SIFIs by creating two different asset-size thresholds. A company with $500 billion in total consolidated assets would automatically be deemed to be systemically important. However, institutions in the $50 billion-to-$500 billion range could be designated as SIFIs only after a detailed consideration of criteria such as their size, interconnectedness, complexity, and international activities.

A BHC being considered for SIFI designation would be entitled to receive information on the basis of the proposal and to participate in the deliberations. Designations would be reconsidered at least once every five years, again with significant input from the BHC.

If the FSOC decides to consider a nonbank financial company for SIFI designation, the company would have a right to information and participation comparable to what is afforded a BHC. Designations would be revisited annually, and the company would be entitled to an FSOC hearing every five years. As far as SIFI designations, the bill does not include any specific protections for insurance companies or other nonbank financial companies.

Under the bill, all members of the FSOC’s agency governing boards would be entitled to attend FSOC meetings. According to the summary, only the heads of each agency currently can attend and participate in meetings. Unlike some earlier proposals, the bill would not require that congressional committee chairmen be welcomed.

Insurance regulation. Shelby’s proposal notes that it is the sense of Congress that the McCarran-Ferguson Act remains the best way to regulate the business of insurance. The bill also would prevent the Federal Deposit Insurance Corporation from taking assets of a savings and loan holding company that also is an insurance company without the agreement of the company’s state insurance regulator that doing so will not interfere with the liquidation of the company or the recovery of its policyholders.

Should there be international discussions on capital standards for insurance companies, the bill instructs the Fed and FDIC to develop a consensus position with state insurance regulators. The Fed and the Treasury Department would be required to keep Congress informed on any international discussions.

GSEs. Under the bill, Fannie Mae and Freddie Mac guarantee fee increases could not be used for any purpose other than GSE business functions or housing finance reform. The Treasury department would be prohibited from disposing of any GSE preferred stock other than as directed by Congress.

Additionally, there would be minimum annual levels of required private sector risk-sharing. Risk-sharing minimums would increase by at least 150 percent each year, and at least half of the total amount would be transactions that allow the GSEs to share single-family mortgage credit risk with the private sector on mortgage loans prior to receiving a guarantee—“front-end risk sharing.”

"Myth vs. Reality." In advance of the Banking Committee hearing, Shelby posted a "Myth vs. Reality" comparison of the bill in an effort to dispel some misunderstandings about his intent. Many of the points address the effects the bill would have on the FSOC.

According to Shelby, the bill would not change the asset threshold for what constitutes a SIFI. The FSOC still could designate a $50 billion BHC a SIFI, and a $500 billion BHC would automatically be a SIFI. The difference would be that an institution in the $50 billion-to-$500 billion range would be designated only after a detailed analysis.

The proposed SIFI process for nonbanks is based on procedures the FSOC already has implemented or should be using, Shelby asserts. The procedures would reveal to companies the risks that are of concern to regulators, which could help companies reduce those risks. That would be good for the entire financial system, Shelby observes.

Regulators' authority to require stress tests and resolution plans or impose other prudential standards would not be reduced, Shelby says. The agencies simply would have more discretion, which would enhance their ability to tailor regulatory requirements to a bank's needs.

Shelby emphasizes that the bill might result in non-binding recommendations on reorganizing the Federal Reserve System districts, but it will not result in the restructuring of the Fed. Neither would the bill prescribe any specific rules for the FOMC's use in setting monetary policy.

Shelby also rejects assertions that the bill would allow mortgage lenders to return to originating excessively risky loans. The new type of Qualified Mortgage that would be created would require lenders to retain 100 percent of the risk of a loan--as opposed to the 5 percent "skin in the game" requirement--thus ensuring the lender suffered the entire loss from any loan that failed.

For more information about financial regulatory reform, subscribe to the Banking and Finance Law Daily.

Financial Services Committee explores federal data breach legislation

By Lisa M. Goolik, J.D.

The House Financial Services Committee held a hearing, “Protecting Consumers: Financial Data Security in the Age of Computer Hackers,” on May 14, 2015, to explore whether federal legislation relating to data security and breach notification standards is warranted. At the committee’s request, witnesses shared their perspectives on why and how data breaches occur; how consumers are notified following a breach; what security measures and standards are in place to prevent breaches; what types of payment system technologies are under development; and what national standards are needed.

New technologies. Jason Oxman, Chief Executive Officer, Electronic Transactions Association, testified that the payments industry is already deploying new technology to address fraud. Oxman pointed out that because liability for cyber attacks in the United States often falls to the companies in the payments industry, members of the ETA “have a strong interest in making sure fraud does not occur.”

“We are leading the migration to EMV (chip cards). EMV makes counterfeit card fraud virtually impossible,” said Oxman. EMV—which stands for EuroPay, Mastercard, Visa—is the global standard for integrated circuit, or “chip” cards. EMV cards generate a dynamic security code with each transaction, unlike a magnetic stripe card which uses the same static code with every purchase. Thus, explained Oxman, EMV is an effective tool to combat the manufacture and use of counterfeit cards and card-present fraud.

Oxman also described the use of point-to-point encryption, whereby card data is encrypted starting from the moment the card is swiped or tapped and ending at final authorization, and tokenization, which replaces card data with a unique alphanumerical identifier that is only valid for a single transaction.

In addition, Brian Dodge, Executive Vice President, Communications and Strategic Initiatives, Retail Industry Leaders Association, described the efforts of the retail community to enhance cybersecurity throughout the industry, including an $8 billion investment to upgrade payment terminals to accept the more secure “Chip” credit cards. Dodge urged banks to issue “Chip and PIN” credit cards instead of the less secure “Chip and Signature” cards, which lack the two factor authentication protection that has dramatically reduced fraud in Europe and Canada. However, Oxman was critical of Dodge’s proposal, arguing that a Chip and PIN requirement “may prove too burdensome for smaller merchants, whose consumers benefit from moving quickly through checkout lines with ‘swipe and go.’ ”

To Oxman’s point, Stephen Orfei, General Manager of the Payment Card Industry (PCI) Security Standards Council (SSC), stated, “No single technology is a panacea; security technology is constantly evolving and requires a multi-layered approach across the payment chain.” As a result, the SSC, in collaboration with its members in the industry, has developed standards that cover payment applications, card production, PIN security, EMV Chip Terminals, tokenization, and point-to-point encryption. “These technologies can dramatically increase data security at vulnerable points along the transactional chain,” explained Orfei. Orfei also advocated for a supportive infrastructure, stating that an effective security program “is not focused on technology alone; it includes people and process as key parts of payment card data protection.”

“Recent breaches at retailers underscore the complex nature of payment card security and the need for ongoing vigilance. A complex problem cannot be solved by any single technology, standard, mandate, or regulation,” Orfei concluded. “It cannot be solved by a single sector of society—business, standards-setting bodies, policymakers, and law enforcement—must work together to protect the financial and privacy interests of consumers.”

Setting national standards. In her opening statement, Ranking Member Maxine Waters (D-Calif) expressed her desire to see a national standard that complements the states’ protections, crediting “the good work of those states that for years have been at the front lines of this fight. I believe that any federal preemption should complement states’ protections and ensure, at a minimum, that state attorneys general continue to play an important role in enforcement and notification standards.” She added that a minimum standard should not “hamstring our states’ and federal regulators’ ability to continue adapting and strengthening protections for consumers.”

Waters also sought a solution that would preserve a private right of action and ensure that affected individuals and financial institutions have legal recourse. Waters was also concerned that consumers “be consistently provided with clear disclosures of the rights and remedies available to them.”

Representative Randy Neugebauer (R-Texas) also pressed for a national standard, arguing that because the payments systems are global, a national data security standard and a national breach notification standard are needed. Neugebauer advocated for a standard that minimizes regulatory requirements, such as federal supervision and rulemaking, but emphasizes a “strong federal enforcement mechanism.”

Tim Pawlenty, President and Chief Executive Officer, Financial Services Roundtable, called for federal legislation that would create “a strong, meaningful data security requirement for all companies that handle sensitive customer information but currently have no federal requirement to protect it.” However, Pawlenty also cautioned that “any standard or process Congress creates should not be prescriptive, inflexible or overly burdensome for small businesses.”

Pawlenty also urged Congress to pass a federal data breach notification bill that includes data security standards, such as a “common-sense notification process firms should follow in the event they discover a breach of information that could put consumers at risk of harm, and that ensures consumers are notified in a timely manner, but that allows for a delay for law enforcement investigation.”

Self-described consumer and privacy advocate, Laura Moy, Senior Policy Counsel, Open Technology Institute, called for a national standard that would “strengthen, or at the very least preserve, important protections that consumers currently enjoy.” Moy advocated for federal legislation that: does not eliminate data security and breach notification protections for types of data that are currently protected under state law; provides a means to expand the range of information protected by the law as technology develops; and includes enforcement authority for state attorneys general. In addition, federal legislation “should not ignore the serious physical, emotional, and other nonfinancial harms that consumers could suffer as a result of misuses of their personal information,” said Moy.

International concerns. Rep. Ed Royce (D-Calif), who is also Chairman of the House Foreign Affairs Committee, raised questions about cyber attacks that originate from, or are funded by, foreign governments, asking Pawlenty, “What can or should be done... to hold these countries accountable in situations like this, and how do we do that?” Pawlenty responded that the United States must address the issue on a “country to country” level. “As you may know, under current law, the only entity that can fire back … is the U.S. government. Private entities cannot ‘hack back’ so the deterrent or consequences for this potential behavior can only come from the U.S. government,” answered Pawlenty.

Industry reaction. Following the hearing, Richard Hunt, President and Chief Executive Officer of the Consumer Bankers Association, released a statement applauding the decision to hold the hearing, noting, “In light of the alarming number of cyber threats, we believe it is time for Congress to advance legislation which will achieve a fair, reasonable and uniform data security standard across all industries to better safeguard consumers’ sensitive personal and financial information before breaches occur.”

This story was previously published in Banking and Finance Law Daily.

Vitter, Warren introduce bill to halt megabank bailouts

By Stephanie K. Mann, J.D.

Senators David Vitter (R-La) and Elizabeth Warren (D-Mass), members of the Senate Banking Committee, have introduced the Bailout Prevention Act (S. 1320), legislation intended to halt megabank bailouts during a financial crisis by responsibly limiting the Federal Reserve’s lending authority. It would also close a loophole that creates risk-taking exemptions for megabanks Goldman Sachs and Morgan Stanley. The senators had previously called for stronger limitations on the Federal Reserve’s use of its emergency lending powers in an August 2014 letter to the Fed.

“It’s no secret that Too Big to Fail is still around. If another financial crisis happened tomorrow—and that’s still a real risk—nobody doubts that megabanks would be calling on the federal government to bail them out again,” Vitter said. “Our legislation makes common sense reforms to the Fed’s emergency lending powers to protect taxpayers the next time the megabanks lead us into another crisis.” Warren added that financial institutions will have a greater incentive to manage their risks carefully if they know that they will be unable to get cheap cash from the Fed in a crisis.

Legislation. According to the bill's sponsors, the Bailout Prevention Act would improve market discipline by responsibly limiting the Fed’s emergency lending authority. Specifically, the act would limit emergency lending by:

• requiring lending programs to be truly broad-based—the Fed may only create facilities or programs that allow five or more institutions to participate in a significant manner;
• restricting lending to only those institutions that are not insolvent. The Fed and all other banking regulators with jurisdiction over an institution that wishes to participate in a lending program must certify—based on analysis of assets and liabilities over the preceding four-month period—that the borrower is not insolvent, and must provide a contemporaneous written explanation of their analysis;
• requiring lending to be provided at a penalty rate—the Fed may only offer loans that are 500 basis points or more above the cost of borrowing for the U.S. Treasury for a similar loan term; and
• reducing the risk of future bailouts and market manipulation by closing the loophole that allows two megabanks to engage in nearly unrestricted activities with physical commodities.

The Bailout Prevention Act would explicitly permit the Fed to create a program that does not satisfy the broad-based requirement or the penalty rate requirement, but the Fed must obtain congressional approval for that program within 30 days under expedited procedures spelled out in the Act. If the Fed fails to obtain congressional approval within that time period, it must terminate the program

This story previously appeared in the Banking and Finance Law Daily.

Ask and you shall receive fails: Hensarling subpoenas federal heavyweights

By Katalina M. Bianco, J.D.

Financial Services Committee Chairman Jeb Hensarling (R-Texas) has issued subpoenas to three federal agencies for failure to respond with requests for information and documents relating to active investigations. The subpoenas were issued to the Department of Justice, Treasury Department, and Federal Reserve Bank of New York. According to Hensarling, all three agencies were warned that failure to respond could lead to subpoenas.

Hensarling said that the three government agencies “chose to unlawfully obstruct, delay and withhold information that our Committee and the taxpayers have the right to know,” necessitating the subpoenas. “These agencies have failed to respond to repeated requests—one of which dates back more than two years. In light of this extraordinary stonewalling, the Committee is left with no reasonable alternative but to subpoena long-overdue information.”

In addition to his statement, Hensarling attached background information that details the Committee’s efforts to obtain records and information from the agencies.

Department of Justice. The Committee said that the DOJ withheld information that would help it determine whether the Dodd-Frank Act put an end to “too big to fail” or whether further legislation is necessary. On March 8, 2013, former Oversight and Investigations Subcommittee Chairman Patrick McHenry (R-NC) and Hensarling requested that the DOJ provide the Committee with records pertaining to the DOJ’s decisions not to prosecute large financial institutions based on the potential impact that such a prosecution may have on the national economy. Hensarling said that the Committee has not yet received any records responsive to the Committee’s request with the exception of “a small sampling of documents” relating to the HSBC investigation.

The Committee Chair alleges that the DOJ also failed to provide records that the Committee seeks in order to determine if the DOJ brought a case against McGraw-Hill Companies, Inc. and Standard & Poor’s Financial Services LLC (S&P) in retaliation against S&P for its 2011 decision to downgrade the government’s credit rating.

New York Fed. Hensarling said that the New York Fed has failed to respond to requests for records related to the Obama administration’s contingency planning regarding the debt ceiling. The inquiry was directly related to the Committee’s “efforts to understand what effect, if any, a default on sovereign debt would have on capital markets.”

Treasury Department. Hensarling charges that the Treasury Department has not fully cooperated with the Committee’s efforts to assess the debt ceiling contingency planning, nor has it complied with the Committee’s request for records related to a money laundering investigation of HSBC.

Waters speaks out. Prior to issuing the subpoenas, Hensarling wrote to Rep. Maxine Waters (D-Calif), Ranking Member of the Committee, informing her of his upcoming action and outlining the details leading to the subpoenas. Waters issued a statement in response to the issuance of the subpoenas, voicing her “strong objections to the process by which the subpoenas were issued.” She included in her statement a letter she wrote to Hensarling in answer to his correspondence.

In her letter to the Chair, Waters wrote, “It is characteristically undemocratic to now use your newly-vested unilateral authority to authorize and issue subpoenas in order to eliminate the ability of Members of this Committee—both Democrat and Republican—to openly debate the merit and necessity of such subpoenas.”

Waters said she was unconvinced that issuing subpoenas was Hensarling’s “only reasonable alternative” to get the information sought by the Committee. She admitted that some of the requests were months, if not years, old, but said she was aware that the agencies had made “reasonable and significant efforts to provide documentation and comply with the original requests.”

New York Fed statement. The New York Fed issued a statement that it “treats its responsibilities as fiscal agent to the Department of the Treasury and its accountability to the U.S. Congress with the utmost seriousness.” The bank said it is reviewing the Committee’s subpoena. In addition to the statement, the New York Fed attached previous correspondence sent to the Committee in response to the document requests.

For more information about the Committee and Chair Hensarling, subscribe to the Banking and Finance Law Daily.

Will Dodd-Frank impact a decade’s growth by $985B?

By John M. Pachkowski, J.D.

Douglas Holtz-Eakin, President of the American Action Forum, has released a “short paper” that looks at the growth impacts of the banking sector’s response to the various new regulatory requirements imposed by the Dodd-Frank Act and the burden of compliance costs. Among the requirements mentioned by Holtz-Eakin were enhanced capital requirements, revamped securitization rules, changed oversight of derivatives, and imposition of the Volcker Rule, that required 398 separate rulemakings.

 

Subject to large uncertainties. Using a modified version of a standard model of economic growth—the Solow model—Holtz-Eakin determined that the growth consequences would result in $895 billion in reduced Gross Domestic Product or $3,346 per working-age person over the next 10 years. He cautioned that the computation “is subject to large uncertainties, but the order of magnitude is instructive.”

 

The framework used by Holtz-Eakin focused on the links between saving and investment in the economy as a whole. To “flesh out” the growth implications of the increased Dodd-Frank burdens, he used data from the Bureau of Economic Analysis to develop estimates of the share of capital in national income; the gross national saving rate; and the ratio of output to capital.

 

Tiered risk regulatory structure. Responding to Holtz-Eakin’s analysis, William Moore, the Executive Director of the Regional Bank Coalition, stated, “This study confirms what regional banks already know from experience: there are real, significant costs to the American economy as a result of Dodd-Frank.” He added, “This study demonstrates that if Congress would implement a more appropriately tiered to risk regulatory structure, regional banks would be able to do more of what we do best: invest in local communities to help grow good jobs with good wages.”

 

Following the release of the analysis, a number of advocacy groups and commentators sought to disprove Holtz-Eakin’s figures and methodology.

 

Multiple, significant flaws. The advocacy group Americans for Financial Reform stated that the study had multiple, significant flaws. AFR believed that the AAF study both exaggerates the growth costs of regulation and fails to include benefits from regulation that would substantially exceed even these exaggerated costs.

 

The first major flaw identified by AFR is the failure to incorporate any of the benefits of improved financial sector regulation. Extensive economic research shows that the benefits of greater financial sector stability alone will exceed the costs claimed by the AAF. If Dodd-Frank cuts the annual probability of a financial crisis in half, it will create $2.9 trillion in economic benefits over the next decade. This figure alone is more than triple the costs claimed in the AAF study, and does not even count the substantial benefits that will accrue from improvements in consumer protection and economic fairness.

 

Secondly, AFR believes that the AAF study exaggerates the growth impacts of regulation in several ways. The study assumes that all regulatory costs will be subtracted from capital investment, even though some regulatory costs themselves involve capital investment and some compliance costs will be funded by spending reductions (e.g. cuts in top executive compensation) at financial institutions. The study also appears to assume that temporary transitional regulatory costs extend permanently, according to AFR. Finally, the study assumes that increases in bank capital (higher equity vs. debt in bank funding) are identical to a tax on investment, which is highly questionable.

 

Terrible priority. In a posting, Mike Konczal, a fellow with the Roosevelt Institute, called Holtz-Eakin’s paper “a bad analysis, immediately violating the first thing you learn in corporate finance: capital structure doesn’t dictate funding costs.”

 

Konczal took exception to Holtz-Eakin’s focus on higher capital requirements functions as a tax. He noted that equating higher capital requirements to a tax is “a terrible move with serious consequences, and if they are going to do it, they need to do better than this.”

 

Scare tactic. Finally, David Dayen, of the The Fiscal Times, wrote that the figure of $985 billion “is not that big.” He noted, “Using a 10-year period magnifies the raw dollar amount. U.S. annual GDP in 2014 was $17.4 trillion. An $895 billion cost over 10 years amounts to 0.059 percentage points annually, per the AAF numbers,” and added, “Dodd-Frank costs 0.059 percentage points a year” doesn’t look good in a headline. Dayen also noted that the $3,346 cost to every working-age American “sounds huge until you realize that this is over a 10-year period, and the actual number is less than a dollar a day.”

 

For more information about the Dodd-Frank Act, subscribe to the Banking and Finance Law Daily.

Is bankruptcy debtor’s ‘split claim’ theory for mortgage debt owed to bank sustainable under right conditions?

 By Thomas G. Wolfe, J.D.

While the U.S. Supreme Court recently addressed a procedural issue in a Chapter 13 bankruptcy case, Bullard v. Blue Hills Bank, there are some interesting sub-issues lurking in the background for banks that have filed claims in bankruptcy proceedings to recover their mortgage debt, only to find that the debtor has proposed to “split” that claim into secured and unsecured claims as part of the debtor’s overall repayment plan.

Turning to the Supreme Court’s May 4, 2015, decision in Bullard v. Blue Hills Bank (Docket No. 14-116), the Court unanimously ruled that a bankruptcy court’s order denying confirmation of a debtor’s proposed repayment plan—impacting a mortgage lending bank and other creditors—did not constitute a final, appealable order. As a result, in keeping with the bankruptcy court’s decision declining to confirm the debtor’s proposed repayment plan to, among other things, split his approximately $346,000 mortgage debt owed to the bank into a $245,000 secured claim and a $101,000 unsecured claim, the debtor’s proposed “hybrid” treatment of the mortgage debt was not allowed.

By way of background, Louis Bullard filed a petition for Chapter 13 bankruptcy in federal court in Massachusetts in December 2010. In keeping with bankruptcy procedure, Bullard filed a proposed repayment plan “listing the various claims he anticipated creditors would file and the monthly amounts he planned to pay on each claim over the five-year life of his plan.”

Bullard’s chief debt was the roughly $346,000 he owed to Blue Hills Bank in connection with the mortgage the bank held on Bullard’s multifamily house. Notably, the mortgage was significantly “underwater;” Bullard’s house was worth substantially less than the $346,000 amount that Bullard owed Blue Hills Bank.

Under his repayment plan, Bullard proposed a “hybrid treatment” of the mortgage debt owed to the bank. Essentially, the debtor proposed “splitting the debt into a secured claim in the amount of the house’s then-current value (which he estimated at $245,000), and an unsecured claim for the remainder (roughly $101,000).” Under this proposal, Bullard would continue making his regular mortgage payments to Blue Hills Bank on the secured claim, “which he would eventually repay in full, long after the conclusion of his bankruptcy case.” However, Bullard planned on treating the unsecured claim “the same as any other unsecured debt, paying only as much on it as his income would allow over the course of his five-year plan.” Along these lines, Bullard’s plan called for him to pay “only about $5,000 of the $101,000 unsecured claim” by the end of the five-year plan, and any remaining balance on the unsecured portion of the loan would be discharged. 

After Blue Hills Bank objected to Bullard’s proposed repayment plan and a hearing was held, the bankruptcy court declined to confirm it. Although the bankruptcy court acknowledged that some other bankruptcy courts within the First Circuit had allowed split-claim arrangements, the court concluded that “Chapter 13 did not allow Bullard to split the Bank’s claim as he proposed unless he paid the secured portion in full during the plan period.” Consequently, the bankruptcy court ordered the debtor to submit a new plan for approval.

However, instead of submitting a new repayment plan, Bullard appealed to the Bankruptcy Appellate Panel (BAP) of the First Circuit. In turn, the BAP determined that the bankruptcy court’s order denying confirmation of the proposed repayment plan was not final because Bullard was “free to propose an alternate plan.” Still, the BAP decided to exercise its discretion to hear an interlocutory appeal and considered the merits of the Bullard’s appeal. In upholding the bankruptcy court’s decision, the BAP agreed that Bullard’s proposed “hybrid treatment” of the bank’s claim was not permitted.

Bullard then appealed the BAP’s ruling to the First Circuit. The First Circuit adopted the majority view among the federal circuits that a court’s order denying confirmation of a proposed repayment plan “is not final so long as the debtor remains free to propose another plan.” Ultimately, the Supreme Court agreed with the First Circuit’s decision. The practical effect of the Court’s decision on the procedural issue was to keep intact the bankruptcy court’s refusal to recognize Bullard’s “split claim” theory, concerning the mortgage debt owed to the bank, as part of the proposed repayment plan.

Still, a few queries about the debtor’s “split claim” theory linger. For example, if Bullard—or any other bankruptcy debtor for that matter—had proposed to pay all of the secured portion of the underlying mortgage debt to the bank during the repayment plan period, would that have passed muster? In other words, under the right conditions, is a bankruptcy debtor’s “split claim” theory still a sustainable one? Apart from the procedural issues addressed in the Bullard decision, would the federal circuits view the viability of a bankruptcy debtor’s “split claim” theory for mortgage debt the same way in the bankruptcy context?




For more information about Bullard v. Blue Hills Bank, subscribe to the Banking and Finance Law Daily.

First bank scammed in mortgage assignment scheme has superior interest

By Lisa M. Goolik

A Florida appellate court has concluded that the Uniform Commercial Code, and not the Florida recording statute for mortgage assignments, should govern the sale or assignment of a note in a mortgage transaction. As a result, HSBC Bank USA, N.A., the bank that was first to take possession of a borrower’s promissory note and related mortgage, was entitled to the priority of its interest, despite the existence of more than one promissory note as the result of a fraudulent scheme (HSBC Bank USA, N.A. v. Perez, May 5, 2015, Gross, J.).

Background. In April 2006, the borrower, Rolando Perez, obtained a loan and mortgage from Federal Guaranty Mortgage Company. The mortgage was recorded the following month in Broward County’s public records. At closing, Perez executed two nearly identical promissory notes in FGMC’s favor, both for the same amount and both secured by the same mortgage. The execution of two promissory notes was part of a larger fraudulent scheme that included other loans.

In June 2006, HSBC Bank took possession of one of the borrower’s “original” promissory notes. The note was specially endorsed from FGMC to American Home Mortgage Corp. and from American Home Mortgage Corp. to HSBC. HSBC did not record its mortgage assignment until April 24, 2009.

Two months after HSBC took possession of its note, in August 2006, LaSalle Bank took possession of the borrower’s second “original” promissory note. The note obtained by LaSalle Bank contained special endorsements completing the chain of ownership. LaSalle Bank recorded this assignment on Aug. 12, 2009.

After Perez defaulted and all payments stopped, both banks commenced separate foreclosure lawsuits. Although the cases were consolidated, HSBC—without naming or serving LaSalle Bank—obtained a final judgment of foreclosure and sold the property. With the issue of the dual promissory note still unresolved, the banks entered into an agreed order vacating the final judgment, sale, and issuance of certificate of title. 

Frustrated by the divestment of title, the purchasers intervened in the consolidated lawsuits and sought a declaratory judgment establishing “whether HSBC or LaSalle is the owner and holder of the FGMC Note and Mortgage which both parties seek to enforce.” If HSBC was found to be the rightful owner, the purchasers hoped to ratify the prior sale and retain possession of the property.

The trial court found in favor of U.S. Bank, which had assumed LaSalle Bank’s interest in the matter, after applying Florida’s recording statute for mortgage assignments, Sec. 701.02. The court concluded that because U.S. Bank (LaSalle Bank) obtained its assignment of the same mortgage prior to HSBC’s recording of the assignment, U.S. Bank maintained a priority interest over HSBC as a subsequent bona fide purchaser.

Applicable law. The Florida appellate court began with a determination that Article 9 of the Florida UCC applied to the transaction. While Article 9 generally does not apply to the creation of a mortgage in real property, if the note in a mortgage transaction is sold or assigned, Article 9 applies to the security interest created in favor of the purchaser or assignee of the note, said the court.  

Further, the court noted that any doubt that Sec. 701.02 does not apply was alleviated in 2005 when the Florida legislature added subsection 701.02(4). The subsection specifically provides that the UCC governs “the attachment and perfection of a security interest in a mortgage upon real property and in a promissory note or other right to payment or performance secured by that mortgage” and that an “assignment of such a mortgage need not be recorded under this section for purposes of attachment or perfection of a security interest in the mortgage under the Uniform Commercial Code.”

As a result, once HSBC took possession of the note, it acquired an Article 9 security interest in the note, the court found. Under Section 9-109, HSBC’s possession of the note gave it “an attached security interest in the mortgage lien that secure[d] the note.” And once HSBC perfected its security interest in the note, its security interest in the mortgage lien was similarly perfected.

“This scenario is consistent with the notion that the promissory note, not the mortgage, is the operative instrument in a mortgage loan transaction, since ‘a mortgage is but an incident to the debt, the payment of which it secures, and its ownership follows the assignment of the debt,’” the court reasoned.

Attachment. Turning to the issue of attachment, the court found that HSBC’s security interest in the note and underlying lien attached, at the latest, when it took possession of its note. In accordance with Section 9-203 of the Florida UCC, a security interest attaches to collateral “when it becomes enforceable against the debtor with respect to the collateral.” An assignment of a promissory note attaches, or becomes enforceable against the assignor and debtor with respect to the collateral, when: (1) value has been given; (2) the assignor has rights in the collateral or the power to transfer rights in the collateral to a secured party; and (3) the assignor has either “authenticated a security agreement that provides a description of the collateral” or the assignee has taken possession of the note under Section 9-313.

Perfection and priorities. In addition, HSBC’s security interest was perfected when it took possession of the note, the court concluded. Under Section 9-313, a security interest in a promissory note may be perfected by taking possession of the original promissory note. In theory, the inability to produce a note that is in a secured party’s possession would effectively give notice of the secured party’s interest. 

Moreover, the timing and method of perfection determine the priority of security interests. In general, conflicting security interests rank according to time of filing or perfection. In addition, Section 9-330 provides that “a purchaser of an instrument has priority over a security interest in the instrument perfected by a method other than possession if the purchaser gives value and takes possession of the instrument in good faith and without knowledge that the purchase violates the rights of the secured party.”

Thus, the court concluded that, by taking possession of the promissory note before LaSalle Bank, HSBC was the first to perfect its interest in a note connected to the underlying mortgage.

Remedies. The court conceded that the existence of two “original” notes due to the fraudulent scheme causes the application of Article 9 to the instant case “slippery.” However, the court noted that, in the overwhelming majority of cases, “perfection by possession of a note will not be problematic … and avoids the cost of imposing a recording procedure disruptive to the lending industry based on difficult facts.”

Further, the court noted that Florida law does not leave U.S. Bank without a remedy. Under Sec. 673.4161, U.S. Bank has an action for breach of warranty against the transferor of the note. However, the court recognized the remedy may be “more theoretical than practical” due to the scheme to defraud.


This story previously appeared in the Banking and Finance Law Daily.

Hog wild: Court enlists Iowa Supreme Court to resolve priority issues

By Lisa M. Goolik

The U.S. District Court for the Northern District of Iowa has enlisted the assistance of the Iowa Supreme Court to determine whether a feed supplier must file a new financing statement every 31 days for feed delivered in the preceding 31-day period in order to maintain lien perfection and retain superpriority status under Iowa’s agricultural supply dealer lien law (Iowa Code Sec. 570A.4).

Background. The debtor, Crooked Creek Corporation, operated a farrow-to-finish hog operation, raising hogs from birth. Oyens Feed & Supply, Inc. provided the debtor’s sole source of hog feed.

The debtor filed for Chapter 12 bankruptcy on Aug. 18, 2009, and the livestock was sold. The proceeds were deposited in a cash collateral account. The debtor owes Oyens roughly $342,000 for unpaid feed. Oyens filed financing statements on May 28, 2009, and Aug. 14, 2009, to perfect its lien for the debtor’s feed purchases.

The debtor also owed Primebank $1.2 million on two promissory notes, of which approximately $315,000 remains after write-offs and other transactions. Primebank perfected its secured position in 1997 with a standard Article 9 “blanket lien,” which included the debtor’s hogs, and properly renewed its interest in 2002 and 2007.

Oyens asserted that it was entitled to the proceeds of the hogs' sale, contending its lien held superpriority status under Iowa's agricultural supply dealer lien law. The bankruptcy court, however, concluded that to retain superpriority status, Oyens was required to file a financing statement every 31 days in order to maintain perfection of its lien as to feed supplied within the preceding 31 day period. As a result, the court held that Oyens had a superpriority claim for only $156,000—reflecting only the feed delivered in the 31-day periods before its May 28, 2009, and Aug. 14, 2009, financing statements—and an unsecured claim for the remaining $186,000.

Applicable provisions. Section 570A.5 of Iowa’s agricultural supply dealer lien provisions states that a properly perfected agricultural supply dealer lien in livestock has priority over subsequent liens, as well as priority over an earlier perfected lien or security interest “to the extent of the difference between the acquisition price of the livestock and the fair market value of the livestock at the time the lien attaches or the sale price of the livestock, whichever is greater.” 

To perfect an agricultural supply dealer lien, Sec. 570A.4 provides that “the agricultural supply dealer must file a financing statement in the office of the secretary of state … within thirty-one days after the date that the farmer purchases the agricultural supply." 

Filing requirements. On appeal, Oyens challenged the bankruptcy court’s conclusion that Oyens was required to file a financing statement every 31 days. Oyens argued that the law does not limit the duration of the lien to 31 days but, instead, limits the retroactive perfection of the lien to 31 days. As a result, Oyens contended that a single financing statement may be filed to perfect the lien as to future deliveries and as to feed delivered up to 31 days before the filing. Accordingly, the district court certified the following question to the Iowa Supreme Court:

“Pursuant to Iowa Code Sec. 570A.4, is an agricultural supply dealer required to file a new financing statement every thirty-one (31) days in order to maintain perfection of its agricultural supply dealer’s lien as to feed supplied within the preceding thirty-one (31) day period?”

"Acquisition price." In addition, Primebank challenged the bankruptcy court’s ruling that the “acquisition price” under Sec. 570A.5 is $0 when hogs are born in the facility. Primebank noted that even though the hogs were born at the debtor’s facility, the debtor incurred certain costs associated with gaining possession and ownership of the hogs. Thus, the district court has also certified the following:

“Pursuant to Iowa Code Section 570A.5(3), is the “acquisition price” zero when the livestock are born in the farmer’s facility?”

It should be noted this is not the first time that the Iowa Supreme Court has been called on to resolve an issue of law in the matter. In 2011, the Iowa Supreme Court concluded that Primebank’s lien was superior insofar as it covered the purchase price of the hogs, but that Oyens had priority on increases in the hogs’ value from acquisition price to final sale.



To follow future developments in Oyens Feed & Supply, Inc. v. Primebank (N.D. Iowa), be sure to subscribe to the Banking and Finance Law Daily.

CFPB orders road repairs

By Andrew A. Turner, J.D.

A land-development company and individuals involved in a property development have been ordered by the Consumer Financial Protection Bureau to repair the Tennessee county roads at Hawks Bluff Development that they failed to maintain as promised in marketing materials. It was back in July 2013, that a call to action in the Bluffites blog urged residents to complain to the CFPB that they were not delivered the promised goods and services when they bought their land.

The CFPB exercised its authority under the Interstate Land Sales Full Disclosure Act, a statute formerly administered by the Department of Housing and Urban Development, until the Dodd-Frank Act transferred enforcement authority to the Bureau. The CFPB said that the developers falsely represented that roads would be maintained until they were dedicated to and accepted by county government.

Under the terms of a consent order, the developers will be required to repair roads in the development to the CFPB’s satisfaction and consistent with an engineering report to be prepared by an independent consultant. Within 60 days, a comprehensive compliance plan for road repair must be submitted to the CFPB Enforcement Office for review. Any changes in the compliance plan requested by the CFPB must be made within 15 days. The developers will be required to implement and adhere to the steps and deadlines outlined in the approved compliance plan.

The consent order also includes provisions for compliance monitoring by the CFPB. Modification of non-material requirements, such as reasonable extensions of time, requires a written request to the CFPB Enforcement Office.

For more information about the CFPB’s arbitration study, subscribe to the Banking and Finance Law Daily.

Unpaid homeowners association assessments and fees are subject to lien, collection law

By Thomas G. Wolfe, J.D.

The Supreme Court of Appeals for West Virginia recently decided that a homeowners association in a planned community asserted a valid, “consensual” common-law lien against the real property of homeowners for unpaid assessments, attorney’s fees, and costs allegedly owed to the association. At the same time, however, the state’s high court also ruled that, in attempting to enforce the lien to collect the unpaid amounts, the homeowners association was subject to the debt-collection provisions of the West Virginia Consumer Credit and Protection Act.

The decision is noteworthy not only because the court recognized the lien of the homeowners association, but also because the court viewed the underlying debt of unpaid assessments as “consumer” debt.

 Before examining the reasons for the court’s decision in Fleet v. Webber Springs Owners Association, Inc., some background may be helpful. According to the court’s opinion, Webber Springs Owners Association, Inc. (Webber Springs) elected to be a “West Virginia Limited Expense Liability Planned Community.” In keeping with West Virginia law concerning such a planned community, Webber Springs’ assessments were capped. Further, Webber Springs properly recorded a declaration that “delinquent unpaid assessments are both liens against the real estate and the personal obligation” of the homeowners in the planned community.

In 2011, after certain homeowners were deemed to be several years delinquent on payment of their assessments to the homeowners association, Webber Springs recorded “notices of liens” with the applicable county recorder’s office. Essentially, the recorded notices purported to “create liens for the unpaid assessments, attorney’s fees, and costs, on the real property” owned by the homeowners.

Later, in 2012, the Webber Springs homeowners association filed separate complaints in state court against three homeowners who were delinquent on paying their assessments. In response, the homeowners asserted counterclaims against Webber Springs for alleged violations of the debt-collection provisions of the West Virginia Consumer Credit and Protection Act.

Eventually, the individual cases were consolidated, and after the state trial court ruled in favor of the homeowners association, the West Virginia Supreme Court granted the homeowners’ petition to hear the appeal of that decision.

In connection with the lien issue, the homeowners argued that the liens asserted by Webber Springs for delinquent assessments, attorney’s fees, and costs were invalid and unenforceable under West Virginia law. The West Virginia high court disagreed. While the court acknowledged that generally a common-law lien against real property is not recognized or enforceable in West Virginia under the state’s applicable statute, the court pointed to another provision of the statute for the proposition that it was not the intention of the West Virginia legislature “to affect consensual common law liens.”

Although the homeowners argued that they never truly “consented” to the lien by Webber Springs, the court dismissed that argument. The court maintained that the homeowners’ association’s lien for delinquent assessments was a valid consensual lien because, among other things, Webber Springs had recorded the pertinent declaration with the county recorder and the language contained in the respective deeds of the homeowners clearly stated that the homeowners consented to be bound by such declarations. With these findings in mind, the court held that “consensual common law liens against real property are valid and enforceable in West Virginia.”

Next, the court addressed the debt collection issue. The homeowners argued that even if Webber Springs held a valid consensual lien for unpaid assessments, it did not have a common-law lien for attorney’s fees and costs. In support of their argument, the homeowners invoked provisions of the West Virginia Consumer Credit and Protection Act (WVCCPA) governing debt collection practices. The homeowners contended that the state trial court had erred in ruling that the West Virginia Act did not apply. On this point, the West Virginia Supreme Court agreed.

Ultimately, the appellate court determined that the state trial court had “erred in granting partial summary judgment in favor of Webber Springs based upon its erroneous conclusion that the WVCCPA was not applicable. Likewise, the … court erred in finding that the Homeowners’ WVCCPA counterclaims are barred by the statute of limitations.” Accordingly, the court ruled that the WVCCPA did apply to the case.

Since the lower court did not make any rulings on the homeowners’ WVCCPA claims that Webber Springs was prohibited from collecting attorney’s fees and costs, the West Virginia high court remanded the matter to the state trial court for a determination of the particular issues.

Notably, Justice Loughry filed a concurring opinion in the case. Loughry emphasized that, given the “broad language” of the WVCCPA’s debt collection provisions, he “begrudgingly” concurred with the majority’s decision that those provisions “apply to a homeowners association’s attempts to collect delinquent assessments.” “However, I urge the Legislature to review the policy considerations behind the applicability of the WVCCPA to such assessments and other similar non-consumer debts,” he added.


For more analysis and cases like Fleet v. Webber Springs Owners Association, Inc., subscribe to the Banking and Finance Law Daily.

Supreme Court to consider injury needed to create standing

By Richard A. Roth, J.D.

The Supreme Court has granted a website operator’s request that it consider whether a consumer who claimed no actual injury has standing to sue for alleged Fair Credit Reporting Act violations. According to the U.S. Court of Appeals for the Ninth Circuit, constitutional standing to sue could be based simply on the website operator’s alleged violation of a right created by the act (see Robins v. Spokeo, Inc.).

The appeal has the potential to affect claims under a number of other laws as well, since standing to sue is an issue of constitutional rather than just statutory dimensions. Suits under the Real Estate Settlement Procedures Act, Electronic Funds Transfer Act, Equal Credit Opportunity Act, Fair Debt Collection Practices Act, and even the National Bank Act have raised the question of whether a plaintiff has suffered an injury sufficient to confer standing. Depending on its breadth, the Court’s eventual decision also could affect the determination of whether a named plaintiff in a class action has standing to assert claims based on injuries to other class members that he has not personally experienced.

Claimed FCRA violations. Spokeo, Inc., operates a “people search engine” website that offers users personal information about individuals, including information on the subject’s marital status, education, and financial condition. In this case the consumer claims that the website included inaccurate information about him, saying incorrectly that he held an advanced degree and was wealthy, and that this was both interfering with his ability to get a job and causing him emotional distress. He also asserts that Spokeo knew the information was inaccurate and that the company marketed its information for purposes that were covered by the FCRA, making the company a consumer reporting agency subject to the Act.

At Spokeo’s request, a federal district court judge dismissed the complaint. According to the judge, the consumer had not described any actual or imminent harm resulting from the inaccurate information. Rather, he had raised only the possibility of an injury in the future. This did not constitute an injury in fact that would create federal court jurisdiction, the judge decided.

The Ninth Circuit reversed that decision.

Standing to sue. The U.S. Constitution gives federal courts subject matter jurisdiction only over “cases and controversies,” and this requires a plaintiff to establish standing to sue. To establish standing, a plaintiff must demonstrate that:

• he has suffered an injury in fact—a concrete and particularized, actual or imminent, injury;
• the injury can be fairly traced to the defendant’s challenged actions; and
• the court likely has the ability to redress that injury.

Spokeo’s petition for certiorari challenges the Ninth Circuit’s decision that the consumer could have suffered an injury in fact based only on a violation of the FCRA’s requirements relating to the accuracy of consumer report information, in the absence of any “concrete harm” resulting from the inaccuracy.

Appellate court decision. According to the Ninth Circuit, a person suing for a violation of a right granted by a statute does not need to show an actual injury; rather, he needs to describe some “concrete, de facto” injury. In this case, the consumer had to show that Spokeo had violated his statutory right, not someone else’s right. Also, he had to show that the statutory right in question protected against individual harm rather than collective harm. The consumer had met both tests, the court said.

CFPB position. In accepting Spokeo’s petition, the Court seemingly rejected arguments in an amicus curiae brief by the Consumer Financial Protection Bureau urging the Court not to review the Ninth Circuit decision. According to the bureau’s brief, the appellate court made the correct decision and there is no conflict with decisions by other U.S. appellate courts that calls for a Supreme Court resolution.

The bureau argued that Spokeo’s publication of inaccurate information about the consumer caused a concrete, particularized injury to a legally protected interest that affected the consumer in a personal way. Congress has the authority to give people the ability to sue to vindicate their freedom from being the subjects of inaccurate information, the bureau maintained.

Being a subject of inaccurate information is a tangible harm, the CFPB emphasized. It is an invasion of privacy, and it is a concrete harm regardless of whether the consumer can “prove some further consequential injury.”

For more information about consumer financial protection litigation, subscribe to the Banking and Finance Law Daily.

Amex ordered to drop prohibition on "steering" by merchants

By Stephanie K. Mann, J.D.

American Express can no longer bar merchants that accept Amex cards from “steering” customers to another brand of payment or debit card, said the Eastern District of New York in U.S. v. American Express Co. Merchants will be able to offer customers a discount or rebate to encourage the use a different card or post signage of the merchant's preference for a particular brand. The federal district court in Brooklyn, N.Y., issued a permanent injunction, prohibiting Amex from enforcing its so-called “anti-steering” rules and ordering the firm to delete language from its agreements with merchants that prevent them from encouraging customers to use other cards. Unless the order is stayed, the permanent injunction is to take effect in 30 days and to remain in effect for 10 years.

The permanent injunction follows the court's Feb. 19, 2015, decision, finding that the Department of Justice and 17 state attorneys general established at trial that the Amex rules violated Sec. 1 of the Sherman Act. The court had asked the parties to try to reach an agreed-upon remedy. Noting, however, that the parties “reached only limited common ground,” the court “generally adopt[ed] proposals made by the Government and reject[ed] competing proposals made by Defendants.” The court described American Express’s core proposals as “too narrow or unwieldy to effectuate the remedial objectives of a permanent injunction under the Sherman Act.”

The court identified language in contracts between Amex and merchants that was no longer enforceable; however, it did not go so far as to craft contract language to inform merchants of their right to engage in steering, as the government had requested. The court explained that it would not “put words into American Express’s mouth.” However, the injunction included affirmative contractual language, establishing a “safe harbor” of acceptable language concerning merchant signage and oral communications.

Boundaries of permitted steering. Generally, the court's order gives merchants the ability to decide when it is in their best interests to steer. The court rejected Amex’s proposals that steering be permitted only on a transaction-by-transaction basis—using a calculation of “All-In Merchant Fee” supplied by Amex—and only to a “Less Expensive General Purpose Card.” The court's order also permits steering to credit or charge cards, as well as debit cards, even though debit and credit network services were found to comprise separate relevant markets for purposes of the court's market power analysis. “[T]he mere fact that debit cards are not part of the general purpose credit and charge card network services market does not mean that the court lacks the power to include brands of debit cards within the scope of the Permanent Injunction,” the court explained.

In addition, the court rejected a request from Amex that the permanent injunction contain a provision that would “confirm . . . that American Express is entitled to exercise its right not to do or continue to do business with a merchant that chooses to steer Card Members away from its Cards.” The court explained that, under the circumstances, it could limit an antitrust violator’s right to refuse to deal.

Compliance provisions. In addition to notifying Amex-accepting merchants of changes to its Non-Discrimination Provisions (NDPs) in its agreements with merchants, as required by the permanent injunction, the order also contains compliance provisions to guarantee that Amex “meets its obligations and changes its perception of and response to steering by merchants.” The court pointed to Amex’s “previous, aggressive enforcement of the NDPs, and certain of the positions that it took at trial,” as the bases for the “robust compliance provisions.” The court rejected Amex’s argument that compliance provisions were reserved only for antitrust violators who engaged in criminal, intentional, or malfeasant conduct.

Department of Justice reaction. “We are pleased that the court has ordered American Express to eliminate its illegal anti-steering rules,” Leslie Overton, Acting Assistant Attorney in charge of the Department of Justice Antitrust Division, said in a statement released late last night. “These rules have stifled competition among credit card networks by blocking merchants from encouraging their customers to use particular credit cards. The court’s remedy will benefit merchants, who pay more than $50 billion in credit card ‘swipe fees’ annually, as well as the consumers who ultimately bear these costs. Merchants’ ability to encourage the use of particular credit card networks will incentivize American Express and its competitors to compete to earn a greater share of a merchant’s business. The court’s order reinforces the victory the department has won for consumers.”


For more information about credit card steering, subscribe to the Banking and Finance Law Daily.