Indiana Appeals Court: Failure To Comply With HUD Servicing Regulations A Valid Affirmative Defense In Foreclosure Action Involving FHA-Insured Loan

Lexology reports:

• In a recently-published case of first impression in Indiana, the Court of Appeals of Indiana has held that a lender’s failure to comply with HUD servicing regulations on an FHA-insured loan may be asserted as a valid affirmative defense to a mortgage foreclosure action.

• In Lacy-McKinney v. Taylor, Bean & Whitaker Mortgage Corp., 2010 Ind. App. LEXIS 2161 (Ind. Ct. App. Nov. 19, 2010), the appellate court reversed the trial court’s grant of summary judgment in favor of the lender, and remanded the matter for further proceedings to resolve the factual dispute over whether HUD’s servicing guidelines had been followed.

• In reaching its result, the court drew from reported cases in Illinois, New York, Florida, Pennsylvania and New Jersey which essentially conferred third party beneficiary rights on borrowers arising out of the HUD servicing regulations pertinent to FHA-insured loans.(1)

• It proceeded to hold that as a “condition precedent to foreclosure,” the lender was required to demonstrate its compliance with the HUD regulations regarding acceptance of partial payments (24 CFR § 203.556) and the face-to-face meeting protocols in default situations (24 CFR § 203.604(d)). Having found that a genuine issue of fact existed as to both, the appeals court held that summary judgment for the lender should not have been granted.

Attorney Joseph F. Zielinski of Indiana Legal Services, Inc., South Bend, Indiana, represented the homeowner in this case.(2)

For more, see Indiana Appeals Court allows HUD regulations to be affirmative defense to foreclosure (requires subscription; if no subscription GO HERE, then click appropriate link for the story).

(1) The Indiana appeals court made these observations regarding the out-of state cases:

• The rationale for allowing noncompliance with HUD servicing responsibilities to be used as an affirmative defense to foreclosure on an HUD-insured mortgage was set forth by the Illinois Appellate Court in Bankers Life Co. v. Denton, 458 N.E.2d 203 (Ill. App. Ct. 1983). There, a mortgagee filed a complaint seeking to foreclose on the Dentons‘ HUD-insured mortgage, which was in default. Denton, 458 N.E.2d at 206. In their answer, the Dentons raised the mortgagee‘s noncompliance with the HUD servicing responsibilities as an affirmative defense. Id. The trial court granted mortgagee‘s motion to strike the Dentons‘ affirmative defense and entered a judgment of foreclosure and sale against the Dentons. The Dentons appealed, contending that they could use noncompliance of HUD regulations as an affirmative defense to the foreclosure.

• After citing to the applicable mortgage servicing responsibilities, which included the requirement of a face-to-face meeting, the Denton court noted:
  
  It is evident from the language of the servicing regulations that the mortgagee must comply with these provisions prior to the commencement of a foreclosure proceeding. Therefore, . . . we believe that the failure to comply with these servicing regulations which are mandatory and have the force and effect of law can be raised in a foreclosure proceeding as an affirmative defense.
  
  While it is true that 24 C.F.R. 203.500 provides that a pattern of refusal or failure to comply with the servicing requirements will be cause for withdrawal of a mortgagee‘s approval to participate in the federal mortgage insurance program, we do not believe this to be an adequate remedy for the individual mortgagor. The legislative purpose of the National Housing Act . . . is to assist in providing a decent home and a suitable living environment for every American family. Thus, the primary beneficiaries of the act and its implementing regulations are those receiving assistance through its various housing programs. This would include the defendant as mortgagors of a H.U.D. insured mortgage.
  
  Therefore, in order to effectively insure that the interests of the primary beneficiaries of the H.U.D. mortgage servicing requirements are being protected, mortgagors must be allowed to raise noncompliance with the servicing requirements as a defense to a foreclosure action. H.U.D.‘s withdrawal of a mortgagee‘s approval to participate in the mortgage insurance program after repeated violations of the servicing requirements is a useless remedy for the individual faced with the immediate problem of the foreclosure action; an action which could possibly be avoided by . . . further efforts to arrange a revised payment plan.
  
  Id. at 205.

***

• Following reasoning similar to that found in Denton, the states of Florida, Maryland, and New York have likewise held that HUD servicing responsibilities may be raised as an affirmative defense in foreclosure actions even though the regulations do not create a private right of action. See Cross v. Fed. Nat’l Mort. Ass’n, 359 So.2d 464 (Fla. Dist. Ct. App. 1978) (mortgagee‘s failure to provide defaulted HUD-insured mortgagor with notice required under mortgage servicing regulations was affirmative defense that precluded summary judgment in favor of mortgagee); Wells Fargo Home Mortg., Inc. v. Neal, 922 A.2d 538,547 (Md. 2007) (mortgagor may not wield HUD regulations as sword but may assert regulatory noncompliance as shield to foreclosure on HUD mortgage); Federal Nat’l Mortg. Ass’n v. Ricks, 372 N.Y.S.2d 485, 497 (N.Y. Sup. Ct. 1975) (mortgagors may interpose as first defense, failure of mortgagee to comply with provisions of HUD Handbook).

• Some courts have styled a mortgagee‘s noncompliance with HUD regulations as an equitable defense (unclean hands and failure to do equity). See e.g., Heritage Bank, N.A. v. Ruh, 465 A.2d 547 (N.J. Super. Ct. Ch. Div. 1983) (courts may exercise equity power in refusing to grant foreclosures when mortgagees have flagrantly disregarded forbearance or casting); Fleet Real Estate Funding Corp. v. Smith, 530 A.2d 919 (Pa. Super. Ct. 1987) (summary judgment in favor of mortgagee reversed upon finding that court could exercise equity powers to restrict foreclosure by mortgagee who had not followed or applied forbearance provisions of the HUD regulations and Handbook). We find it problematic to treat such noncompliance merely as an equitable remedy. If noncompliance with HUD regulations is merely ―unclean hands,‖ a court may be precluded from requiring compliance in cases where the mortgagor is also deemed to have unclean hands. See Ruh, 465 A.2d at 558 (court of equity, fulfilling reasons and objects for its existence may, in furtherance of natural justice, aid one who is comparatively more innocent). Hence, the equitable approach is limited in its ability to promote a mortgagee‘s compliance with HUD regulations. Instead, we agree with the reasoning of Denton and view the affirmative defense of noncompliance with HUD regulations as the failure of the mortgagee to satisfy a HUD-imposed condition precedent to foreclosure.

• To hold that compliance with these regulations is not an affirmative defense, as Taylor-Bean suggests, would circumvent the public policy of HUD. The New Jersey Superior Court described this policy as follows:
  
  
  Families who receive HUD-insured mortgages do not meet the standards required for conventional mortgages. It would be senseless to create a program to aid families for whom homeownership would otherwise be impossible without promulgating mandatory regulations for HUD-approved mortgagees to insure that objectives of the HUD program are met. Foreseeable obstacles to these families‘ maintaining regular payments, such as temporary illness, unemployment or poor financial management, should be handled with a combination of understanding and efficiency by mortgagees or servicers. Poor servicing techniques such as computerized form letters and unrealistic forbearance agreements as were used by Associated defeat the purpose of the National Housing Act and the HUD program. The prevention of foreclosure in HUD mortgages wherever possible is essential. The HUD program‘s objectives cannot be attained if HUD‘s involvement begins and ends with the purchase of the home and the receipt of a mortgage by a low-income family. Id.
  
  Associated E. Mortg. Co. v. Young, 394 A.2d 899, 906 (N.J. Super. Ct. Ch. Div. 1978).

(2) Indiana Legal Services, Inc. is a nonprofit law firm that provides free civil legal assistance to eligible low-income people throughout the state of Indiana.