Wednesday, December 3, 2014

Procedural Issues Involved In Undoing Sale Leasebacks When Homeowner Files Bankruptcy After State Court Orders Eviction: Comply Or Seek To Waive Section 362(l) Tenant Certification Requirement, Res Judicata, Rooker-Feldman Doctrine

A 2007 court case decided by a U.S. Bankruptcy Court in Florida (In re Weinraub, 361 B.R. 586 (Bankr. S.D. Fla. 2007) illustrates some of the procedural hurdles that may face an attorney representing a homeowner in attempting to unwind/undo a predatory sale leaseback transaction.

In this case, the homeowner's bankruptcy attorney was retained very late in the game - the foreclosure rescue operator had already sued in state court and obtained a default final judgment of possession and a writ of eviction against the homeowner. The actual eviction, however, had yet to take place.

A summary of what next ensued to successfully prevent the eviction of the homeowners (the "Weinraubs") before it could litigate the merits of undoing the allegedly predatory actions taken by the foreclosure rescue operator ("Winston") follows:

  1. A Chapter 13 bankruptcy petition was filed on behalf of the Weinraubs, which immediately slammed the brakes on the eviction proceeding.
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  2. Also filed with the Chapter 13 petition was an adversary complaint (go here for the Adversary Complaint (in re Weinraub)), in which the Weinraubs challenged the validity of the ownership interest asserted by Winston in their home. According to the court:

    The basis for this claim is that Winston disguised a consumer credit transaction within a plethora of documents, which has been termed by Winston a "sale and lease back" agreement. The Weinraubs assert in their adversary complaint that the transaction really was a consumer credit transaction involving a loan of money and a security interest in their home. They further claim that such a transaction falls within the scope of the Truth In Lending Act, 15 U.S.C. § 1601 et seq. (hereafter "TILA"). The Weinraubs claim the transaction between them and Winston was part of a predatory lending scheme, to which they fell' victim. They further assert that this scheme would provide an unreasonably large and possibly usurious return to Winston. As such, the Weinraubs seek to exercise a right of rescission under TILA, among other remedies, arising under Title 15 of the United States Code and applicable Florida usury laws.
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  3. However, when filing their Ch. 13 petition, the Weinraubs failed to file a certification required (under Section 362(l) of the Federal Bankruptcy Code) of a debtor who is a tenant in a residential property. In lieu thereof, they requested emergency relief by filing a Motion to Waive Requirement of Section 362(l) and to Confirm the Automatic Stay is In Effect in an effort to immediately halt the eviction and allow them to litigate the merits of their claims (ie. recharacterization of the sale leaseback as a secured loan/equitable mortgage subject to the Federal Truth in Lending Act, and any associated usury claim).(1)
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  4. Failing to file the required certification resulted (by operation of §362(b)(22)) in the immediate removal of the protection of the automatic stay, which consequently allowed for the continuation of the eviction action where the landlord has obtained a judgment for possession before filing of the bankruptcy petition.
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  5. In response to the Weinraubs' motion, Winston asserted that, even if the court had the power to waive the tenant certification filing requirements, it should not do so, invoking both the doctrine of res judicata, and the Rooker-Feldman doctrine, essentially asserting that any Truth in Lending and usury claims should have been litigated in the earlier state court proceeding. His position was that, once the state court entered the default final judgment of possession and a writ of eviction against the homeowner, any claims the homeowners could have made were extinguished.
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Issues

1) Waiver of the tenant certification filing requirement under Section 362(l):

The court found that, in fact, it did have the power to waive this requirement and reimpose the automatic stay, It articulated two independent bases for doing so, the explanations for which are a little too long and esoteric to reproduce here, Accordingly, the reader is referred to the text of the court's ruling for the court's reasoning in waiving the tenant certification filing requirements.

2) Application of res judicata to bar Truth in Lending Act ("TILA") claims:

The court found that res judicata was inapplicable because the TILA claims were not compulsory during the state court proceedings. In that regard, the court stated:
  • The law is well settled that compulsory counterclaims, which are not raised in a prior proceeding are waived. See Montgomery Ward Dev. Corp. v. Juster, 932 F.2d 1378, 1380-81 (11th Cir.1991); See Yost v. American National Bank, 570 So. 2d 350, 352 (Fla.App.1990)(holding that under Florida law a failure to raise a compulsory counterclaim in the first lawsuit results in a waiver of that claim). Furthermore, in the Eleventh Circuit, when a federal court is determining the preclusive effect of a state court judgment it must look to the law of the state that issued the judgment for any preclusive effect. See Montgomery Ward Dev. Corp. v. Juster, 932 F.2d at 1380; Daniels v. Funding USA, Inc. (In re Daniels), 350 B.R. 619, 623 (Bankr.S.D.Fla., 2006). The Court notes that the Florida Rule of Civil Procedure 1.170(a) incorporates Rule 13(a) of the Federal Rules of Civil Procedure. See Montgomery Ward Dev. Corp. v. Juster, 932 F.2d at 1380.

    The crux of the issue thus becomes whether the TILA claims that the Debtors now seek to assert were compulsory counterclaims to the eviction proceedings that have been reduced to final judgment in state court. The Court holds that they were not.

    Most recently, this exact issue, under very similar circumstances, was decided by Judge Isicoff, in Daniels v. Funding USA, Inc. See Daniels v. Funding USA, Inc. (In re Daniels), 350 B.R. 619, 623 (Bankr. S.D.Fla., 2006). Judge Isicoff determined that just because TILA authorizes a borrower to raise TILA claims in state court, it is not required that the borrower do so. See id. at 625-26. The court in Daniels followed the determination in In re Tomasevic that TILA rescission claims go "to the making of the loan, rather than a dispute as to the obligations under the loan as was the issue in the state court foreclosure action. Because the claims are not the same, res judicata does not bar this Truth in Lending claim." In re Tomasevic 275 B.R. 86, 101 (Bankr.M.D.Fla.2001). This conclusion has been reached in courts all around the country.

    Notably in Brady v. C.F. Schwartz Motor Co. Inc, the district court concluded that the sole connection between the TILA claim and the debt claim is the execution of the sale contract. Resolution of the debt claim, however, does not bear a logical relationship to the resolution of the Plaintiff's TILA claims because the validity or enforceability of the underlying sales contract does not affect Defendant's compliance or non-compliance with the TILA disclosure requirements. Brady v. C.F. S[c]hwartz Motor Co. Inc., 723 F.Supp. 1045, 1050 (D.Del. 1989); accord Walker v. Contimortgage (In re Walker), 232 B.R. 725, 734 (Bankr.N.D.Ill.1999).

    The above findings are also supported by Florida state court decisions. Although it does not appear that any state court has addressed this precise issue. One case that has come close is Whigum v. Heilig-Meyers Furniture Inc. In that case the court deemed actions on a debt to be permissive counterclaims to an action under Florida Consumer Collection Practices Act. See Whigum v. Helig-Meyers Furniture Inc. 682 Sold 643, 646 (Fla.Dist.Ct. App.1996). The court in reaching its conclusion noted that: (i) the Florida rule of Civil Procedure 1.170(a) was identical to Fed.R.Civ.P. 13(a); (ii) the policies in the federal consumer statutes are generally the same as those in the Florida statutes; (iii) the characteristics that determine whether a counterclaim is permissive or compulsory "dictate [the] conclusion that the proposed counterclaim is permissive." See id. at 646-47 (citing as support cases that held "that an action on a debt was not a compulsory counterclaim to an action under the Federal. Truth in Lending Act."). Even though Whigum was not the identical procedural issue, it would stand that the similar result would be reached under Florida law for the issue of the nature of a TILA counterclaim with respect to a state court debt claim.

    Based on the above, the Court adopts the determination in Daniels and finds that Weinraubs TILA claims, were not compulsory counterclaims. Therefore, they are not barred by res judicata.
3) Application of the Rooker-Feldman doctrine to bar TILA claims:

The court found that Rooker-Feldman was also inapplicable to the Weinraubs' TILA claims, articulating three separate reasons for doing so. Again, the court's basis for arriving at its conclusion is a bit too long and esoteric to be set forth below (and again, the reader is referred to the text of the court's ruling for the court's full rationale), but in a nutshell:
  1. The court cited persuasive precedent from the 9th Circuit Court of Appeals for the proposition that Rooker-Feldman does not apply where "the federal plaintiff does not complain of a legal injury caused by a state court judgment, but rather of a legal injury caused by an adverse party ..." [citations omitted].
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  2. The Weinrebs' TILA claims were not inextricably intertwined with with the default state court eviction proceeding, thereby failing to meet Rooker-Feldman's "inextricably intertwined" test.
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  3. The court found that Rooker-Feldman was inapplicable to bankruptcy courts, again citing 9th Circuit precedent, stating:

    The Ninth Circuit has found "two particularly notable statutory exceptions" to Rooker-Feldman, "First a federal district court has original jurisdiction to entertain petitions for habeus corpus . . . Second, a federal bankruptcy court has original jurisdiction under which it is empowered to avoid state judgments, to modify them, and to discharge them." Noel v. Hall, 341 F.3d 1148, 1155 (9th Cir.2002)(internal citations and quotation omitted); accord Gruntz v. County of Los Angeles (In re Gruntz), 202 P.3d 1074, 1079 (9th Cir.2000)(conducting an extensive analysis of the reasons why bankruptcy proceedings are exempt from Rooker-Feldman).
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For the court ruling, see In re Weinraub, 361 B.R. 586 (Bankr. S.D. Fla. 2007).

Go here for the Adversary Complaint (in re Weinraub) and here for the Motion to Waive Requirement of Section 362(l) and to Confirm the Automatic Stay is In Effect.

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Miscellaneous Side Notes
  • This case should serve as a reminder of the importance of seeking out competent counsel long before the foreclosure rescue operator goes to court and gets an eviction judgment. It's tough enough to undo these predatory transactions without also having to neutralize the effect of such a judgment.
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  • Ultimately, the court never addressed the merits of this case; the parties appear to have reached a mediated settlement, according to the docket report in the adversary proceeding. A review of the documents included with the Motion to Waive Section 362(l) reveals that the sale leaseback transaction was consummated in July, 2005, when the real estate market was at its peak. Presumably, there was quite a bit of equity in the property at that time. This bankruptcy case commenced in September, 2006, and the litigation went into 2007, at which point the real estate market had already stalled and had begun to tank. Presumably, by this time, the equity in the home existing at the time the transaction had been consummated had pretty much evaporated, thereby making a mediated settlement the easiest and most expedient way for the parties to settle their differences.
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  • The court ruling is silent as to whether the Florida state court proceeding was conducted in a court of general jurisdiction (ie. circuit court), or a court of limited jurisdiction (ie. county court), where residential tenant evictions are commonly litigated. If the eviction proceeding was brought in a court of limited jurisdiction, said court would not have had jurisdiction to hear cases where title to property is an issue (ie. recharacterizing a sale leaseback as an equitable mortgage and thereby establishing the homeowner victimized by the predatory deal as the true owner of the property (and the foreclosure rescue operator as a mere mortgagee), as well as TILA and usury claims. See, for example, Hewitt v. State, 101 Fla. 807; 135 So. 130 (Fla. 1931):.
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    When, in proceedings in the county judge's court to recover possession of land as from a tenant, a pleading is filed which puts in issue the title or boundaries of the land in controversy, 
    it becomes the duty of the county judge to dismiss the cause for want of jurisdictionBarrs v. State, 91 Fla. 30, 107 So. 249; Welch v. State, 85 Fla. 264, 95 So. 751; State v. Philips, 64 Fla. 105, 59 So. 241; South Florida Amusement & Dev. Co. v. Blanton, 95 Fla. 885, 116 So. 869. Prohibition is the defendant's remedy where the county judge does not dismiss an action for unlawful possession of lands when a plea tenders an issue as to the title of the landState ex rel. v. Hutchins, 135 So. 298, decided at this term.
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  • A review of the sale leaseback transaction documents filed with the Motion to Waive Section 362(l) reveals that the eviction proceeding was, in fact, brought in a court of limited jurisdiction (ie. a Florida county court), which does not have jurisdiction to hear or decide cases when title to property is placed in issue. (In this case, the homeowner default in the case and, consequently, the county court judge presiding over the eviction action was unaware of the true nature of the foreclosure rescue transaction involved). Had had the Weinraubs asserted this fact in the bankruptcy proceeding, addressing the foreclosure rescue operator's res judicata and/or Rooker-Feldman claims would probably have been obviated.
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  • Florida law is clear that when a sale leaseback is deemed to be an equitable mortgage, traditional landlord tenant rules don't apply. That doesn't mean, however, that a foreclosure rescue operator won't go into court seeking an eviction, anyway (vs. foreclosing), counting on the financially distressed homeowner to fail to respond to the eviction complaint (as was done in this case). It's up to the homeowner to show up in court and assert the appropriate defenses, claiming the deal was an equitable mortgage, usurious loan, and/or allege TILA violations. Since the homeowners didn't show up in court to defend against the eviction, the foreclosure rescue operator initially got away with obtaining an eviction judgment in state court.  See Florida Law Governing Landlord-Tenant Evictions, Ejectments Not Applicable Where Title Is An Issue In Connection With Sale Leaseback Foreclosure Rescues, Similar Scams; Evidentiary Hearing To Determine True Owner Required Before Compelling Payment Of Past Due Rent Into Court Registry & Awarding Possession; Foreclosure Proceeding Required To Oust Occupant.
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  • Note that paragraph 6 of Florida Statute Sec. 501.1377 now creates a rebuttable presumption that any foreclosure rescue transaction (a term of art that is specifically defined in the statute) involving a lease option or other repurchase agreement is an equitable mortgage under section 697.01, Florida Statutes. This law (passed subsequent to the ruling in this case) is part of the The Foreclosure Rescue Fraud Prevention Act of 2008, passed by the Florida legislature in response to the need to protect homeowners at risk of losing their homes to foreclosure or for non-payment of taxes, and who may be vulnerable to fraud, deception, and unfair dealings with foreclosure-rescue consultants or equity purchasers. See also, Florida Foreclosure Rescue Conveyances With Buyback Right To Be Treated As Equitable Mortgages Unless Established Otherwise.
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Footnote

(1) Section 11 U.S.C. § 362(l) requires a debtor who is a tenant in a residential property to file a certification with the bankruptcy petition that:
  • (A) under nonbankruptcy law applicable in the jurisdiction, there are circumstances under which the debtor would be permitted to cure the entire monetary default that gave rise to the judgment for possession, after that judgment for possession was entered; and

    (B) the debtor has deposited with the clerk of the court, any rent that would become due during the 30-day period after the filing of the bankruptcy petition.
In footnote (4) of the court's ruling, the court offered this observation that the homeowner could have filed the required residential tenant certification, asserting in the certification that the sale leaseback transaction was a disguised consumer credit transaction:
  • A possible alternative, other debtors may pursue when they may have a valid TILA claim, is to certify under § 362(l). Their certification would state that "the nonbankruptcy law applicable" in the jurisdiction would be TILA and the cure of the default would be rescission. If the transaction was rescinded, the entire default that gave rise to the judgment for possession would be cured.
Along these same lines, and in cases where the TILA does not apply to a sale leaseback transaction (ie. a non-homeowner occupied or other commercial real estate transaction), I suppose other alternatives would be to state that "the nonbankruptcy law applicable" is the state law on equitable mortgage (Sec. 697.01, Florida Statutes, and the case law thereunder), or the state law on criminally usurious loans (Sec. 687.071, Florida Statutes). Note that the homeowners in this case, in their Adversary Complaint and their Motion to Waive Section 362(l), make reference to both equitable mortgage/F.S. 697.01 and usury in the context of the Truth in Lending Act.

If the transaction is deemed to be an equitable mortgage, the cure would arguably be the recharacterization of "rent" as a loan payment assocciated with the equitable mortgage, and that the sole remedy for obtaining possession upon default would be for the foreclosure rescue operator, as a recharacterized equitable mortgagee, to initiate a foreclosure action, in the same way any other mortgagee would be required to.

If the transaction is found to be a criminally usurious loan, the cure would be that the entire principal and all payments due thereunder on the now-recharacterized criminally usurious loan would be rendered unenforceable pursuant to Sec. 687.071(7), Florida Statutes. abcd

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