The remedy of foreclosure is available in the event of a borrower’s monetary default (non-payment) or technical default (e.g., failure to pay taxes or keep the property insured). In order to determine if there has been a default, the loan documents—the note, the deed of trust, the loan agreement, and so forth—should be carefully examined. Notice and opportunity to cure requirements contained in these documents and applicable statutes must be strictly followed if a foreclosure is to be valid.
Foreclosures may be judicial (ordered by a court following a judgment in a lawsuit) or non-judicial (“on the courthouse steps”). These two remedies cannot be pursued simultaneously. Kaspar v. Keller, 466 S.W.2d 326, 328 (Tex.App.—Waco 1971, writ ref’d n.r.e.). Most foreclosures in Texas are non-judicial. These are governed by Chapter 51 of the Property Code and are held on the first Tuesday of each month between 10 a.m. and 4 p.m. at a designated spot (usually at or near the county courthouse). The effect of foreclosure is to cut off and eliminate junior liens, including mechanic’s liens, but not tax obligations.
Notices of foreclosure sales of a residential homestead must be filed with the county clerk and posted (usually on a bulletin board in the lobby of the courthouse) at least 21 calendar days prior to the intended foreclosure date. Notices are entitled “Notice of Trustee’s Sale” or “Notice of Substitute Trustee’s Sale.” They provide information about the debt, the legal description of the property, and designate a three-hour period during which the sale will be held. In larger metropolitan areas there are foreclosure listing services which publish a monthly list of properties posted for foreclosure.
Reviewing the Loan File
The first step in determining how to proceed in a potential foreclosure situation is to conduct a thorough due-diligence review of the loan file. This would include: (a) listing the identity and capacity of all parties involved, including any guarantors; (b) reading the deed of trust (making sure it was recorded) in order to see what specific notice and foreclosure requirements it may contain; (c) examining the note to see if there is an original in the lender’s possession and if there exists a specific monetary or technical default; (d) reviewing any notices that may have been given to see if they comply with requirements of the deed of trust, the note, and applicable law—in other words, has required notice and opportunity to cure been given to the borrower? (e) clearly ascertaining the subject collateral and what exactly it includes; (f) inquiring as to whether or not there are tenant leases that may alter the rights of the lender; (g) determining if adequate insurance will be in effect during the pendency of the foreclosure; and (h) obtaining an updated title report to ensure that ownership has not changed and no new liens have been recorded.
Weaknesses or omissions in the foregoing list could mean trouble for the lender. It is important for a lender and its attorney to be broadly confident that it has a solid case, built on solid documents, before moving forward with foreclosure.
Statute of Limitations
One of the first steps in assessing a loan default and contemplating a foreclosure is to make sure that the lender is acting within the statute of limitations. Notes are not enforceable forever, nor does a lender have an indefinite right to foreclose. Section 16.035(d) of the Civil Practice & Remedies Code states that a foreclosure is void if not commenced within four years of the date the cause of action accrues. “As a general rule, the accrual date is the maturity date of the note, rather than the earlier date of the borrower’s default. . . . But there is an exception to that rule: If the real property lien contains an optional acceleration clause . . . then the cause of action accrues when the lender exercises its option to accelerate the maturity date of the note.” Swoboda v. Ocwen Loan Servicing, LLC, 579 S.W.3d 628 (Tex.App.—Houston [14th Dist.] 2019, no pet.).
What does it mean to say that a cause of action accrues? “A statute of limitations restricts the period within which a party can assert a right, and the limitations period begins to run when the claim accrues. . . . Generally, a claim accrues when facts come into existence that authorize a claimant to seek a judicial remedy, when a wrongful act causes some legal injury, or whenever one person may sue another. . . . One exception to the general rule of accrual is the discovery rule. The discovery rule is limited to those rare circumstances where the nature of the injury incurred is inherently undiscoverable and the evidence of injury is objectively verifiable. . . . An injury is not inherently undiscoverable when it could be discovered through the exercise of reasonable diligence. . . . The discovery rule defers accrual of a claim until the injured party discovered, or in the exercise of reasonable diligence should have discovered, the nature of the party’s injury and the likelihood that the injury was caused by the wrongful acts of another…. The rule expressly requires a plaintiff to use reasonable diligence to investigate the nature of the injury and its likely cause once the plaintiff is apprised of facts that would make a reasonably diligent person seek information. . . . It is the discovery of the injury and its general cause, not discovery of the exact cause in fact, that starts the running of the limitations period.” Latouche v. Perry Homes, LLC, 606 S.W.3d 878 (Tex.App.—Houston [14th Dist.] 2020, pet. denied).
The discovery rule can therefore be summarized as follows: the cause of action accrues, and the statute of limitations begins to run, when the claimant knows or reasonably should have known about the condition or breach.
“A secured [mortgage] lender must bring suit to foreclose on a real property lien not later than four years after the day the cause of action accrues. Civil Practice & Remedies Code Sec. 16.035(a). As a general rule, the accrual date is the maturity date of the note, rather than the date of a borrower’s default. If, as here, the security instrument contains an optional acceleration clause, the cause of action accrues when the lender exercises its option to accelerate the maturity date of the note.” Citibank N.A., Trustee v. Pechua, 624 S.W.3d 633 (Tex.App.—Houston [14th Dist.] 2021, pet. pending).
Note, however, that a two-year statute of limitations is the minimum upon which the parties may agree in cases involving real property: “A stipulation, contract, or agreement that establishes a limitations period that is shorter than two years is void in this state.” Civ. Prac. & Rem. Code Sec. 16.070.
Foreclosure notices must be given to the borrower in accordance with Property Code sections 51.002 et seq. and the deed of trust. The content of foreclosure notices is technical and must be correct to order to insure a valid foreclosure that cannot later be attacked by a wrongful foreclosure suit. Clients often protest when their lawyer advises re-noticing the debtor—“But I’ve already sent them an email telling them they are in default.” Not good enough. “To lawfully exercise an option to accelerate upon default provided by a note or deed of trust, the lender must give the borrower both notice of intent to accelerate and notice of acceleration, and in the proper sequence.” Further, “both notices must be clear and unequivocal.” Karam v. Brown, 407 S.W.3d 464 (Tex.App. —El Paso 2013, no pet.).
Required Notices to a Residential Homestead Borrower
Accordingly, two certified-mail notices to the borrower are required, the first being a “Notice of Default and Intent to Accelerate” which gives formal notice of the default and affords an opportunity for the borrower to cure (at least 20 days for a homestead, although if the deed of trust is on the FNMA form, 30 days must be given). Note that S.B. 766 and S.B. 472, which did not make it out of committee in the 81st Legislature, would have extended the 20-day period. This legislation may be revived in the future. Many lawyers consider it best to routinely give a 30-day notice, in order to be safe, even if the deed of trust or applicable statute calls for a lesser minimum period of time.
After the cure period has passed, a “Notice of Acceleration and Posting for Foreclosure” must be sent to a residential homestead borrower at least 21 days prior to the foreclosure date. This second letter must also specify the location of the sale and a three-hour period during which the sale will take place. A separate “notice of foreclosure sale” should be enclosed. This notice is also filed with the county clerk and physically posted at the courthouse. If there is going to be a change in the trustee who was named in the deed of trust, it will also be necessary to file a written appointment of substitute trustee signed by the lender.
Foreclosure on non-homestead or commercial property is less regulated, but must still comply with the requirements and timelines set forth in the deed of trust.
Notices are addressed to the last known address of the borrower contained in the lender’s records (this is the legal requirement), but it is wise for the lender to double-check this to avoid later claims by the borrower that notice was defective. Attention should also be paid to electronic communications. In Bauder v. Alegria, 480 S.W.3d 92 (Tex.App.—Houston [14th Dist.] 2015, no pet.), the court found that text messages from the borrower were reasonable notice of the borrower’s change of address. In spite of this ruling, it would be reckless for any attorney or prudent investor to rely on text messaging for any such legally important purpose.
It is prudent to send legal notices by both first-class and certified mail—and not just in the area of foreclosure. Why? The reason has to do with Texas’ mailbox rule, i.e., that a notice properly deposited in the U.S. mail is presumed to be delivered. “Common sense . . . dictates that regular mail is presumed delivered and certified mail enjoys no [such] presumption unless the receipt is returned bearing an appropriate notation.” McCray v. Hoag, 372 S.W.3d 237, 243 (Tex.App.—Dallas 2012, no pet. h.). The best practice is not to scrimp on the notices or the plausible addresses to which they are sent. A careful lender will send notices to all likely addresses where the borrower may be found. Potentially duplicate notices do no legal harm (they consume only paper and postage) and may be useful if the foreclosure is challenged.
Other lienholders (whether junior or senior) are not entitled to notice. Depending on the first lienholder’s strategy, however, it may be useful to discuss the issue with them.
Reinstatement of the Note after Acceleration
If the borrower is able to cure the default after a note has been accelerated, a reinstatement agreement should be executed unless the terms of the debt have been changed (e.g., payments have been lowered or the term extended) in which case a hybrid reinstatement /modification agreement or even a new note (called a “replacement note”) may be more appropriate.
Sometimes, however, a lender will get careless. A note will be accelerated but the lender does not proceed with foreclosure, choosing instead to resume accepting payments from the borrower without any formal reinstatement agreement. In such a case, it may be said that the lender has waived or “abandoned” the acceleration. “A noteholder that has accelerated the maturity date of a loan may unilaterally abandon that acceleration and return the note to its original terms.” Pitts v. Bank of New York Mellon Trust Company, 583 S.W.3d 258 (Tex.App.—Dallas 2018, no pet.). Again, to reiterate a point made frequently in this book, if there is a material change or modification to an existing contractual relationship, get it in a signed writing.
Fair Debt Collection Practices
Foreclosure notice and demand letters are attempts to collect a consumer debt. Accordingly, the federal Fair Debt Collection Practices Act (15 USC 1962, et seq., the “FDCPA”) and its companion Texas statute, the Texas Debt Collection Act contained in Finance Code Chapter 392, both apply. The term “debt” is defined by the FDCPA as “any obligation or alleged obligation of a consumer to pay money arising out of a transaction in which the money, property, insurance, or services which are the subject of the transaction are primarily for personal, family, or household purposes, whether or not such obligation has been reduced to judgment.” 15 U.S.C. Sec. 1692a(5). Failure to disclose and provide verification of the debt when the borrower has requested it in writing has serious penalties under both laws, as do threats, coercion, or similar heavy-handed practices.
Requirements for collection letters—including foreclosure notice and demand letters—are found in 15 U.S.C. Sec. 1692(g). In the world of collection attorneys, such letters are referred to as “G notices.” A proper G notice (such as a notice of default on a real estate loan) must advise the debtor of the amount of the debt; the name of the current creditor; the debtor’s right to dispute the debt, both verbally and in writing; and the debtor’s right to know the address of the original creditor. These requirements pertain to the specifics of the debt itself. The collector must also disclose that it is a debt collector, that it is attempting to collect a debt, and that any information obtained will be used for that purpose.
Real estate attorneys (or anyone else) sending foreclosure notices and conducting a foreclosure are, whether they are fully aware of it or not, debt collectors when it comes to communicating with a debtor for purposes of attempting to collect or reinstate a defaulted real estate note. As such, the court-applied standard is to require compliance with the FDCPA when viewed from the point of view of an unsophisticated consumer. Youngblood v. GC Servs., Ltd. P’ship, 186 F. Supp. 2d. 695 (W.D. Tex. 2002). The conceptual overlap with the definition of a consumer under the Deceptive Trade Practices Act is unavoidable here. Having said the foregoing, it is unlikely that mere technical or procedural violations of the FDCPA will get a collector in trouble; some materiality including real injury to the debtor will likely be required to establish liability under the statute. Spokeo, Inc. v. Robins, 578 U.S. 330 (2016).
As noted, the FDCPA requires that a borrower be given 30 days to make a written request to obtain verification of the debt. The lender or its attorney may nonetheless give notice of default, accelerate the debt, and even post for foreclosure in less time, but the foreclosure sale itself should not be conducted until the 30-day debt verification period has expired.
Notwithstanding the foregoing, a trustee exercising the power of sale contained in a deed of trust is not a debt collector (Prop. Code Sec. 51.0075(b)).
Home Equity Loans are a Different Case
Article 16, Section 50(a)(6) contains the requirements for home equity lending, i.e., the extension of credit secured by a lien on a borrower’s homestead evidenced by a “Texas Home Equity Security Instrument” rather than the usual deed of trust. Although an expedited foreclosure process is available in the event of default, a home equity lien may be foreclosed only by means of a court order which provides a specific date for the sale to take place. Wells Fargo Bank, N.A. v. Robinson, 391 S.W.3d 590 (Tex.App.—Dallas 2012, no pet.).
Rules 735 and 736 of the Texas Rules of Civil Procedure govern the process by which a lender may file a verified application in the local district court seeking foreclosure of a home equity loan. The proceeding is limited in scope. “The only issue to be determined in a Rule 736 proceeding is the right of the applicant [the lender] to obtain an order to proceed with foreclosure under the applicable law and the terms of the loan agreement, contract or lien sought to be foreclosed. A respondent [the borrower] may file a response to the application, but the response may not raise any independent claims for relief, and no discovery is permitted.” In re One West Bank, FSB, 430 S.W.3d 573 (Tex.App.—Corpus Christi 2014, pet. denied).
Foreclosure Pursuant to an Executory Contract
In the days before the 2005 reforms to the Property Code concerning executory contracts, a buyer-tenant was truly at a disadvantage when it came to a contract for deed. Buyer-tenants could forfeit all sums paid if they defaulted and be evicted as ordinary tenants. No longer. If the buyer-tenant has paid more than 40% of the amount due or made 48 or more monthly payments, then pursuant to the equity-protection provisions of Property Code Section 5.066, the seller-landlord must provide a 60-day notice of default and opportunity to cure the default. If the default is not cured, then a trustee may be appointed who can proceed with a non-judicial foreclosure.
Properties may (and often do) have multiple liens against them. “A valid foreclosure on a senior lien (sometimes referred to as a ‘superior’ lien) extinguishes a junior lien (sometimes referred to as ‘inferior’ or ‘subordinate’) if there are not sufficient excess proceeds from the foreclosure sale to satisfy the junior lien. . . . In general, mechanic’s liens whose inception is subsequent to the date of a deed-of-trust lien will be subordinate to the deed-of-trust lien.” Trinity Drywall Systems, LLC v. TOKA General Contractors, Ltd., 416 S.W.3d 201 (Tex.App.—El Paso, 2013, no pet.). As to competing M&M liens, a perfected M&M lien is deemed to relate back in time to the date of its inception.
Leases, including ground leases, are generally terminated by a foreclosure sale as well. Kimzey Wash, LLC v. LG Auto Laundry, LP, 418 S.W.3d 291 (Tex.App.—Dallas 2013, no pet.).
Notice to the IRS
The best practice is to do a title search prior to foreclosure to determine if there is an IRS tax lien or other federal lien. If so, notice must be given to the IRS and/or the U.S. Attorney at least 25 days prior to the sale, not including the sale date. 26 U.S.C. Sec. 7425(c)(1). If this is not done, any IRS tax lien on the property will not be extinguished by the sale. Note that the IRS also has 120 days following the sale to redeem the property, although this seldom happens. The successful bidder on an IRS-liened property is therefore not entitled to breathe a sigh of relief until the 121st day.
Due Diligence Prior to Purchasing Property at a Fore-closure Sale
Buying property at foreclosure sales is a popular form of investment but it contains traps for the unwary. The investor’s goal is to acquire instant equity in the property by paying a relatively modest sum at the foreclosure sale. However, apparent equity can evaporate if the property is loaded down with liens and unpaid taxes. It is advisable, therefore, to check the title of the property that will be sold. Is the lien being foreclosed a second or third lien? If so, then the first lien (usually a purchase-money lien held by a mortgage company) will continue in force. First liens are king. They are not extinguished by foreclosure of an inferior lien. What about IRS liens? Improvement liens? Liens imposed by homeowners associations? Any or all of these could consume whatever equity might otherwise have existed in the property. If an investor is unsure as to which liens will be wiped out in a foreclosure sale, then copies of each lien document should be pulled and taken to the investor’s real estate attorney for review.
As far as researching title is concerned, obtaining a title report is a good idea. One should also obtain copies of the warranty deed and any deeds of trust or other lien instruments.
If more information is needed about the property itself, one can contact the trustee named in the Notice of Trustee’s Sale. Trustees vary in their level of cooperation but are often willing to provide additional information if they have it. They may have a copy of an inspection report on the property which they may be willing to share. It might even be possible to arrange to view the property if it is unoccupied.
The investor should also check the military status of the borrower, since Property Code Section 51.015 prohibits non-judicial foreclosure of a dwelling owned by active duty military personnel or within 9 months after active duty ends. Knowingly violating this law is a Class A misdemeanor.
It goes without saying that the investor should physically inspect the property if at all possible although one should not trespass on occupied property to do this. It is legal, however, to stand in the street (public property) and take photos.
When one buys at a foreclosure sale, it is “as is.” Property condition is therefore important. When buying residential properties in particular, an investor should be especially curious about condition of the foundation (learn to recognize signs of settlement), whether the property is flood-prone, and whether or not there may be environmental contamination (generally not a problem if the house is in a restricted subdivision). It is usually best to avoid any property that suffers from one or more of these deficiencies. Other items that involve significant expense are the roof and the HVAC system.
The past or continuing presence of hazardous substances can impose huge potential liability (particularly on commercial properties) since both Texas and federal law provide that any owner of property (including the investor) is jointly and severally liable with any prior owner for cleanup costs. In other words, there is joint and several liability throughout the chain of title. The Texas Commission on Environmental Quality (“TCEQ”) maintains a web site at www.tceq. state.tx.us where the environmental history of a property can be researched.
It is, of course, important not to bid more than the equity in the property (fair market value less the total dollar amount of the liens, if any, that will survive the foreclosure sale). So how does one discover fair market value? Again, it is a question of getting the right information. One of the best ways to do this is to obtain a comparative market analysis or broker price opinion (BPO) from a realtor.
Foreclosures can be rendered void by last-minute bankruptcy filings. Some professional investors will check with the bankruptcy clerk’s office the morning of the sale to make sure that the borrower has not filed under any chapter of the U.S. Bankruptcy Code before they bid on the property. A prudent practice. Note that the bankruptcy clerk’s office opens at 9 a.m. and bidding commences at 10 a.m. Checking bankruptcy filings is a wise precaution if the borrower has previously filed or threatened bankruptcy. It can be cumbersome and inconvenient to get money back from a trustee on a void sale; plus, there are lost time and opportunity costs to consider.
Conduct of the Sale
Foreclosure sales in the larger counties can seem chaotic, with many sales going on at once. There are two general types: sales by trustees (usually attorneys) for individual and institutional lenders and sales by the county sheriff for unpaid taxes. Sales are held at the location designated by the commissioners of the county where the property is located—often the courthouse steps or close by.
The sale is conducted by the named trustee unless a substitute trustee has been duly appointed and notice of the appointment has been filed of record. Prop. Code Sec. 51.0074(a). As a practical matter, the foreclosing trustee is usually the attorney for the lender. However, the trustee “must act with absolute impartiality and with fairness to all concerned.” First Fed. Sav. & Loan Assoc. of Dallas v. Sharp, 359 S.W.2d 902, 904 (Tex. 1962). Before the day of sale, a trustee should obtain written instructions from the lender clearly directing that the sale be conducted and addressing any special circumstances that may arise (e.g., in the event of a credit bid).
There is no standard or required statutory script for a trustee to follow in auctioning property, although it is a good idea for a trustee to have one prepared. Before the bidding begins, a trustee may set “reasonable conditions” for the sale and the bidding (Prop. Code Sec. 51.0075(a))—for example, terms of payment requiring either cash or cashier’s check. Trustees then usually go on to recite the details of the note and lien, the fact that the note went into default, proper notice was given, the note was subsequently accelerated, the property was duly posted for foreclosure, and the property is now for sale to the highest bidder. As noted above, the trustee has a duty to conduct the sale fairly and impartially and not discourage bidding in any way (this can result in “chilled bidding,” which is a defect).
Bidding at the Sale
It is important that the bidding process be fair and impartial and any action that could be construed as “chilling the bidding” be avoided. Powel v. Stacy, 117 S.W.3d 70 (Tex.App.—Fort Worth 2003, no pet.). “Texas law recognizes that a mortgagee [lender or trustee] is under a duty to avoid affirmatively deterring third-party bidding by acts or statements made before or during the foreclosure sale.” Other than that, “a mortgagee is under no duty to take affirmative action beyond that required by statute or deed of trust to ensure a ‘fair’ sale.” Pentad Joint Venture vs. 1st Nat. Bank, 797 S.W.2d 92 (Tex. App.—Austin, 1990).
The lender often bids the amount of the debt plus accrued fees and costs, so this bid can be anticipated. If the sale generates proceeds in excess of the debt, the trustee must distribute the excess funds to other lienholders in order of seniority and the remaining balance, if any, to the borrower.
Chapter 22 of the Business & Commerce Code requires a winning bidder (other than the foreclosing mortgagee or mortgage servicer) to supply the trustee with certain information pertaining to the buyer’s identity, including name, address, taxpayer number, and photo ID. Failure to supply such information may result in the trustee canceling the sale. Clearly this statute has implications for a purchaser whose goal is to remain anonymous. If anonymity is important, an investor should anticipate these requirements and establish an entity such as an LLC for these purposes.
If the investor is the successful bidder, he or she should be prepared to make payment without delay or within a mutually agreed-upon time. In order to be prepared, seasoned bidders carry with them some cash plus an assortment of cashier’s checks in different amounts made payable to “Trustee.” If the high bidder is for any reason unable to complete the purchase, then the trustee will reopen the bidding and auction the property again. The successful bidder will, within a reasonable time, receive a trustee’s deed or substitute trustee’s deed which conveys the interest that was held by the borrower in the property—no more, no less.
Property Code Section 51.009 states that a buyer at a foreclosure sale “acquires the foreclosed property ‘as is’ without any expressed or implied warranties, except as to warranties of title, and at the purchaser’s own risk; and is not a consumer.” The “consumer” part of that statement is meant to prevent any DTPA claims.
Compared to other states, Texas has a streamlined non-judicial foreclosure process that is nearly as quick as an eviction. The minimum amount of time from the first notice to the day of foreclosure is 41 days, unless the deed of trust is a FNMA form, in which case the time is 51 days, although it is never wise to cut any legal deadline that close. Why risk a void sale or give the borrower a possible wrongful foreclosure claim?
The advantage of a foreclosure over an eviction is that there are no effective defenses to the foreclosure process except for the borrower to block it with a temporary restraining order or file bankruptcy. For either option, the buyer needs money and probably an attorney.
Rescission of a Non-Judicial Foreclosure Sale
Property Code Section 51.016 permits a non-judicial foreclosure sale to be rescinded by a mortgagee, a trustee, or a substitute trustee within 15 days under certain specific circumstances: if the legal requirements of the sale were not met; if the borrower cured the default before the sale was conducted; if it turns out that a receivership or dependent probate administration was in effect; if a condition of sale set by the trustee was not complied with; or if the borrower filed bankruptcy and there was an automatic stay in effect when the sale took place. Written notice of the rescission must be given to the buyer (who gets his or her money back) and each debtor (who must return any excess profits). Anyone interested in challenging the rescission has 30 days to do so.
In the event that proceeds of the foreclosure sale exceed the amount due on the note (including attorney’s fees and expenses), then surplus funds must be distributed to the borrower. More often, however, the price at which the property is sold at foreclosure is less than the unpaid balance on the loan, resulting in a deficiency. A suit may be brought by the lender to recover this deficiency any time within two years of the date of foreclosure. Prop. Code Sec. 51.003. Federally-insured lenders have four years.
As part of a defense to a deficiency suit, the borrower may challenge the foreclosure sales price if it is below fair market value, and receive appropriate credit if it is not. Prop. Code Sec. 51.003(b). Note that “fair market value” is, according to the statute, determined by reference to the foreclosure sales price—at least if the borrower does not exercise its right to have a court determine this number. The argument by one lender that fair market value should be computed according to the amount for which the bank later sold the property has been rejected. PlainsCapital Bank v. Martin, No. 13-0337 (Tex. 2015).
Any money received by a lender from private mortgage insurance is credited to the account of the borrower. Case law states that the purpose of this is to prevent mortgagees from recovering more than their due.
What happens when multiple sources of collateral secure the same loan? Should a deficiency amount be determined after each individual property sale or after all sales are completed? The answer, of course, could have serious consequences for the borrower’s aggregate personal liability. The 14th Court of Appeals in Houston affirmed that it was necessary to look at the big picture and consider whether or not a deficiency exists after all properties have been foreclosed upon. Marhaba Partners Limited Partnership v. Kindron Holdings, LLC, 457 S.W.3d 208 (Tex.App.—Houston [14th Dist.] 2015, pet. denied).
For borrowers on non-homestead properties, deficiencies can be as significant a loss as the foreclosure itself since the IRS deems the deficiency amount to be taxable ordinary income.
Servicemembers Civil Relief Act
The Servicemembers Civil Relief Act (or SCRA found at 50 U.S.C. App. Sec. 501 et seq.) provides protections for those serving in the armed forces. For example, except by court order, a landlord may not evict a servicemember or dependents from the homestead during military service. The SCRA provides criminal sanctions for persons who knowingly violate its provisions.
Right of Redemption
There is no general right of redemption by a borrower after a Texas foreclosure. The right of redemption is limited to:
(1) Sale for unpaid taxes. After foreclosure for unpaid taxes, the former owner of homestead or agricultural property has a two-year right of redemption (Tax Code Sec. 34.21a). The investor is entitled to a redemption premium of 25% in the first year and 50% in the second year of the redemption period, plus recovery of certain costs that include property insurance and repairs or improvements required by code, ordinance, or a lease in effect on the date of sale. For other types of property (i.e., non-homestead), the redemption period is 180 days and the redemption premium is limited to 25%.
(2) HOA foreclosure of an assessment lien. Property Code Section 209.011 provides that a homeowner may redeem the property until no “later than the 180th day after the date the association mails written notice of the sale to the owner and the lienholder under Section 209.101.” A lienholder also has a right of redemption in these circumstances “before 90 days after the date the association mails written notice . . . and only if the lot owner has not previously redeemed.” These provisions are part of the Texas Residential Property Owners Protection Act designed to reign in the once arbitrary power of HOAs (Chapter 209 of the Code). Note that an HOA is not permitted to foreclose on a homeowner if its lien is solely for fines assessed by the association or attorney fees.
“It has long been the practice of in Texas to liberally construe redemption statutes in favor of redemption. [However, for] redemption under Section. 209.011 the owners . . . bear the burden at trial of proving a right to redemption.” The burden is carried when the homeowner demonstrates substantial compliance with the statute. Laguan v. Lloyd, 493 S.W.3d 720, 723-24 (Tex.App.—Houston [1st Dist.] 2016, no pet.).
A prudent investor should be prepared to hold the property and avoid either making substantial improvements to it or reselling it until after any applicable rights of redemption have expired, even though redemption is statistically unlikely.
Foreclosure gives the new owner title; the next step is to obtain possession. It is generally necessary to give the usual 3-day notice to vacate and file a forcible detainer petition in justice court. After judgment, the new owner must wait until the constable posts a 48-hour notice on the door and then forcibly removes a former borrower if that person is otherwise unwilling to leave.
An investor should build eviction costs into the budget from the beginning. It is advisable to hire an attorney for the first couple of evictions, after which an investor may be able to handle them solo. Never, however, attempt to conduct an eviction appeal to county court without an attorney.
Stopping a Foreclosure Sale
It is a myth that lawyers can wave a wand and, with a phone call or nasty letter, stop a foreclosure. Attorneys have no such power. It is a fact that foreclosure can be stopped, but the only sure way to do so is to file a lawsuit and successfully persuade a judge to issue a temporary restraining order prior to the foreclosure sale. After the sale occurs, the remedy that remains—a suit for wrongful foreclosure—is slightly different. Relief may be limited to a money judgment if the property was sold at foreclosure to a third party for cash (a bona fide purchaser or “BFP”). If a BFP is in the mix, the possibility that the property itself can be recovered by the borrower is near zero.
Clients will often report that they have been engaged in reinstatement negotiations with the lender, usually consisting of phone calls and messages, and ask if that is sufficient to avoid a scheduled foreclosure. The answer is a resounding no. Unless there is payment of the arrearage and a signed reinstatement agreement, the foreclosure will almost certainly go forward even if the client was talking settlement with the lender just the day before. Note that reinstatement agreements must be in writing and signed by both parties. Phone calls mean nothing in this business.
Borrowers occasionally assert that since a note has been sold multiple times, and the chain of transfers may be unclear, the foreclosing entity is not the lawful owner or holder of the debt. Unfortunately for this argument, the Property Code does not require the foreclosing party to first prove that it is either the owner or the holder of the note. EverBank, N.A. v. Seedergy Ventures, Inc., 499 S.W.3d 534 (Tex.App.—Houston [14th Dist.] 2016, no pet.). Nor does it do any good to claim that the deed of trust lien was not properly assigned; in Texas, the rule is that the mortgage follows the note. Texas courts liberally construe alleged clerical defects in favor of the noteholder.
Clients will sometimes state that they don’t want to sue the lender, they just want to get a restraining order to stop the foreclosure. The lawyer must reply “Sorry, it doesn’t work that way, you can’t split the two.” A restraining order is an ancillary form of relief, meaning that it arises from an underlying suit. In other words, there must be an actual lawsuit in place to provide a basis for requesting a TRO. Fortunately, the suit and application for the TRO can be filed simultaneously and a hearing obtained usually within a day or two.
There is an additional issue: a borrower must have grounds for legal action or possibly face penalties for filing a frivolous suit. Some clients have difficulty understanding this. “Why,” they ask, “can’t you just go and get a TRO for me?” The answer is that the lawyer must first file a lawsuit that contains some credible basis for relief and then make an argument with a straight face before a judge in order to get a TRO. Having said that, if such a credible basis exists, then obtaining a TRO should not be difficult although it will be only short-term in its effect—up to 14 days. It is much more of a challenge to convert the TRO into a temporary injunction after the TRO expires. The posting of a bond is also required.
A Pre-Foreclosure TRO is a Better Remedy
As a general rule, it is far better for a borrower to obtain a restraining order to stop a foreclosure than it is to bring suit after the fact. Texas law favors the finality of foreclosures, making wrongful foreclosure suits an uphill battle. If the property was sold to a third party who has no knowledge of any claims or alleged defects there is little chance that the borrower will get the property back. The third party is a protected BFP, and any remedy for the borrower will therefore likely be limited to monetary damages. Bottom line? If in doubt about whether or not a foreclosure is going to occur, one should file suit and attempt to get a temporary restraining order to stop it. “Wait and see” is the worst possible strategy in this case since it is always more difficult to correct the situation after the foreclosure sale has occurred. The judge will likely ask without much sympathy “Why, since you knew about these various alleged defects, did you not take action to stop the foreclosure?”
The key to a pre-foreclosure remedy is a temporary restraining order. A TRO is considered an emergency short-term measure necessary to avoid irreparable harm. Its purpose is to preserve the status quo (up to 14 days) until the court can hold a hearing to determine whether a temporary injunction (TI) should be granted. In re Newton, 146 S.W.3d 648, 651 (Tex. 2004). The TI—the second step in the process—goes further and freezes the current state of affairs until a trial on the merits can be held. See Civil Practice & Remedies Code Chapter 65 for the rules on injunctions.
So why don’t more people sue to stop a foreclosure? Money. A person in financial distress will have difficulty coming up with both cash for legal fees and money for the TRO bond. Here is the blunt truth: if a borrower or investor cannot readily write a substantial retainer check to an attorney for purposes of suing a lender, then that person probably has no business in the expensive world of litigation.
Wrongful Foreclosure Suits
“Wrongful foreclosure” is not technically a proper cause of action under Texas law, at least not standing alone, so the plaintiff-borrower must specifically allege certain facts or defects in order to state a cause of action in state court. A suit for wrongful foreclosure may be maintained if there are grounds for alleging that the loan documents (e.g., the note and deed of trust) were defective in some way (e.g., if the notices leading up to the foreclosure were done or timed incorrectly or if there was some alleged impropriety in the sale itself); the property was sold for a grossly inadequate sales price; and (3) a causal connection can be shown between the defect and the grossly inadequate sales price. Martins v. BAC Home Loans Servicing, L.P., 722 F.3d 249, 253 (5th Cir. 2013), Sauceda v. GMAC Mortg. Corp., 268 S.W.3d 135, 139 (Tex.App.—Corpus Christi 2008, no pet.). “For a party to recover damages for wrongful foreclosure and breach of the deed of trust, he must show that he has suffered a loss or material injury as the result of an irregularity in the foreclosure sale. In general, this is shown where the actions of the lender or note holder have caused the property to be sold for a grossly inadequate price.” Wells Fargo Bank v. Robinson, 391 S.W.3d 590, 594 (Tex.App.—Dallas 2012, no pet.).
As a matter of practicality, wrongful foreclosure suits based on defective notice nearly always go nowhere. Most large lenders are represented by law firms who know quite well how to write proper foreclosure notice and demand letters. What about the argument that the notices were sent to the wrong address? Remember, in Texas the lender’s obligation is to send these notices to the borrower’s last address as shown in the lender’s files. The burden is on the borrower to “show that the mortgage servicer held in its records the most recent address of the debtor and failed to mail a notice by certified mail to that address,” which is a challenging burden to carry. Saravia v. Benson, 433 S.W.3d 658 (Tex.App.—Houston [14th Dist.] 2014, no pet.).
Another common borrower tactic is to demand that the plaintiff lender in a deficiency action produce the original note as a prerequisite to getting a judgment. In spite of the popularity of the “show-me-the-note” theory on the Internet, it is entirely ineffective in Texas, since under Texas law “the note and deed of trust are severable. . . . Although a mortgagee must give notice and follow other specified procedures, there is no requirement that the mortgagee possess or produce the note that the deed of trust secures in order to conduct a non-judicial foreclosure.” Morlock, L.L.C. v. Bank of New York, 448 S.W.3d 514 (Tex.App.—Houston [1st Dist.] 2014, pet. denied); also Martins, 722 f.3d at 255. In a digital world, there is diminishing sanctity and value to be found in a hard-copy document with an original wet-ink signature.
If any doubt remained that clerical defects and discrepancies do not void a foreclosure in Texas, then the door to that argument was nailed shut by Edwards v. Fannie Mae, 545, S.W.3d 169 (Tex.App.—El Paso 2017, pet. denied). In that case, the foreclosure documentation did not even reference the correct note and deed of trust. The court nonetheless dismissed such concerns because the property and the parties were the same and sufficient links existed to establish that the foreclosure should pass master. After all, the court reasoned, certain “inaccuracies in mass-produced loan documents and foreclosure paperwork” are inevitable.
If a wrongful foreclosure suit is being considered, it should be filed quickly so that notice of the suit (a notice of lis pendens) can be filed in the real property records. If the lender was the successful bidder, this notice may effectively prevent the lender from transferring the property to a BFP.
The action available under Property Code Section 51.004 (discussed above) is different from a wrongful foreclosure remedy per se. Relief is granted if the court finds that the fair market value is greater than the sale price, but only in the context of a deficiency claimed by the lender.
The cruel fact for borrowers is that wrongful foreclosure suits face challenges from the beginning. A plaintiff can realistically expect the following in a wrongful foreclosure lawsuit: (1) the lender will not rush to settle, since lenders pay high fees to large litigation firms to fight tooth and nail to avoid doing the right thing; (2) written discovery (interrogatories, requests for production, and requests for admission) from the plaintiff will be nearly entirely objected to by lender’s counsel, so extensively as to make the responses essentially useless (a deposition will therefore be required); and (3) lender’s counsel will remove the case from state court to federal court where judges are more conservative and lenders can use Federal Rule 12(b)(6) to dismiss the case.
Note that other grounds for suit may be available to a plaintiff borrower, including breach of contract, common-law fraud, statutory fraud, negligent misrepresentation, and violations of either the federal or state debt collection practices acts. The typical wrongful foreclosure suit may recite such causes of action in addition to allegations of procedural defect and inadequate sales price. These sometimes work if the lender’s misbehavior is egregious. By contrast, allegations of deceptive trade practices under the DTPA will likely fail, since a “person cannot qualify as a consumer if the underlying transaction is a pure loan because money is considered neither a good nor a service.” Fix v. Flagstar Bank, FSB, 242 S.W.3d 147, 159 (Tex.App.—Fort Worth 2007, pet. denied).
Removal of a Wrongful Foreclosure Case to Federal Court
Removal of the case by the defendant-lender to federal court is allowed if there is a federal question (which there nearly always is) or if diversity exists (if the amount in controversy exceeds $75,000 and the parties are from different states), which is also common. The reality is that much if not most Texas home mortgage litigation of any significance now takes place in federal court. As noted above, removal facilitates the use of federal Rule 12(b)(6), which has been effectively weaponized by lenders as a means of getting rid of plaintiffs who allege lender misconduct. The standard applied is whether or not borrower’s complaint fails “to state a claim upon which relief can be granted.” Since such dismissals happen often, federal district court has effectively become a graveyard of wrongful foreclosure cases that were initially filed in state court.
Removal to federal court can also create complications for the attorney representing the borrower, who may be accustomed to practicing in state rather than federal court. Even if licensed in federal court (not all lawyers are), an attorney may be reluctant to switch venues since federal practice has become more of a specialty in recent years. Often, therefore, the plaintiff must go through a change of lawyers as a result of the removal.
The deadline for lender’s counsel to remove a case to federal court is 30 days after the lender is served.
Prolonged Negotiations for a Modification
Clients often report that they were engaged in prolonged negotiations to modify their existing loan prior to the foreclosure sale. Of course, these communications were usually conducted by phone and there is no signed written agreement binding the lender to stop the sale, so there is likely no basis for a wrongful foreclosure suit. Do lenders pursue this strategy intentionally, so as to make it appear that they are willing to be reasonable, when in fact it is in their interest to foreclose instead? Opinions vary. In 2018, Wells Fargo—already in the midst of scandal as result of creating millions of fake accounts, assessing unfair mortgage fees, and charging customers for car insurance they did not request or need—admitted that it had wrongfully foreclosed upon hundreds of borrowers, citing a software error.
If the parties make an agreement to hold off on a scheduled foreclosure, then that should be evidenced by a signed forbearance or standstill agreement. Without such a signed agreement, there is very little to keep the lender from proceeding to a foreclosure sale while still negotiating with the borrower or the borrower’s attorney. An email exchange should not be relied upon for this purpose. In any case, modifying a loan that exceeds $50,000 is subject to the statute of frauds and requires a signed writing.
What a Lawyer Needs from a Client Wanting to Foreclose
First and foremost, the lawyer needs to see the foreclosing client’s deed, note, and deed of trust. Most foreclosures that arrive in law offices involve documents that the attorney did not personally write. Anyone could have written them, including the client himself (there are lots of DIY real estate investors out there who, by and large, are their own worst enemies when it comes to legal documentation). So the documents must be evaluated first. Are they legally valid? Were the deed and deed of trust recorded? Who is the current owner and holder of the note, and does the holder have possession of the original? Is there a guarantor? Have there been any modifications, express or implied, since the original note was executed? What are the timeline requirements for notice of default and opportunity to cure? Who is the trustee named in the deed of trust, and will a substitute trustee have to be appointed? Has the borrower filed bankruptcy? What is the exact nature of the default (monetary or technical)? Does the property itself have any legal issues (e.g., environmental)? Are there other liens against the property, and how does the client’s lien rank among these? Is there the possibility of an IRS lien? If so, a title report should be ordered. Has the client already given some sort of notice? Notices given by clients who have not yet consulted an attorney can be problematic at best (and have to be re-done with correct notices) or, at worst, may contain offers of settlement that might (or might not) have been accepted by means of the parties’ course of conduct. All of these factors must be scrutinized before an attorney should even consider accepting a foreclosure case. Accordingly, every foreclosure case should begin with a consultation that includes a thorough document review.
Information in this article is provided for general educational purposes only and is not offered as legal advice upon which anyone may rely. The law changes. Legal counsel relating to your individual needs and circumstances is advisable before taking any action that has legal consequences. Consult your tax advisor as well since we are not tax practitioners and do not offer tax advice. This firm does not represent you (i.e., no attorney-client relationship is established) unless and until it is retained and expressly agrees in writing to do so.
Copyright © 2023 by David J. Willis. All rights reserved worldwide. David J. Willis is board certified in both residential and commercial real estate law by the Texas Board of Legal Specialization. More information is available at his website, http://www.LoneStarLandLaw.com.