Banking & Finance Law Report

Federal Reserve Expresses Openness to Relaxation of HVCRE Regulations on Community Banks

Last year, as noted by this blog, the FDIC, OCC, and Federal Reserve imposed harsher capital requirements on certain “high volatility commercial real estate,” or HVCRE, exposures, in accordance with the Basel III international banking standards. These new requirements were opposed not only by the real estate industry but also by banking associations, particularly the Independent Community Bankers of America (ICBA). The ICBA argues that the Basel III rules were intended to apply only to large, internationally active banks, and that the rules place too great a regulatory burden on smaller institutions. A recent report by the Federal Reserve Bank of Philadelphia notes that CRE regulations disproportionately affect smaller banks, as “CRE represents approximately 50 percent of small bank loan portfolios, compared with just over 25 percent of large bank portfolios.” The report goes on to state that loans that might be classified as HVCRE under the new rules represent approximately 5% of total loans for the median commercial bank with total assets below $10 billion, “a modest, but certainly not insignificant, portion of small banks’ CRE portfolios.” Continue Reading

Ohio Revised Code §1301.401 – A Powerful Tool for Lenders with a Defective Mortgage

For years, it was generally accepted that mortgage creditors and bankruptcy trustees could assert the status of a bona fide purchaser and treat a defectively notarized mortgage as if that mortgage did not exist.  On February 16, 2016, our Supreme Court provided clarity regarding the legal effects of R.C. §1301.401 and provided protection to lenders regardless of whether their mortgages were defective.

In Re Messer, 2016-Ohio-510 was a referral to the Ohio Supreme Court from the Bankruptcy Court for the Southern District of Ohio.  Mr. and Mrs. Messer (the “Messers”) owned real property in Ohio.  In order to finance the purchase of the property, the Messers executed and delivered a mortgage to Mortgage Electronic Registration Systems (“MERS”) as nominee for M/I Financial Corp.  The mortgage was later assigned to JP Morgan Chase Bank, N.A. (“Chase”).  Although the mortgage was correctly signed by the Messers, the notary failed to certify the mortgage acknowledgment, although the notary did notarize other documents at the time of the closing.  The Franklin County Recorder accepted and recorded the mortgage on December 4, 2007.

On September 19, 2013, about six years after the defective mortgage was recorded, the Messers filed a Chapter 13 bankruptcy petition. The Messers scheduled the mortgage as the secured claim of Chase.

On December 20, 2013, the Messers filed an adversary proceeding against Chase seeking to extinguish the defective mortgage. Bankruptcy Judge Caldwell referred the state law questions to the Ohio Supreme Court for resolution.

The two questions for resolution were whether R.C. §1301.401 applies to all recorded mortgages in Ohio, and whether this statute provides constructive notice to the world of the existence and contents of a recorded mortgage that was deficiently executed under R.C. §5301.01. The Court answered each question in the affirmative.

The Court began its analysis by considering R.C. §5301.01(A) which sets forth the requirements for a mortgage in Ohio. The section states:

A *** mortgage *** shall be signed by the *** mortgagor ***. The signing shall be acknowledged by the *** mortgagor *** before a judge or clerk of a court of record in this state, or a county auditor, county engineer, notary public, or mayor, who shall certify the acknowledgement and subscribe the official’s name to the certificate of the acknowledgement.

Thereafter, the Court considered R.C. §1301.401 and concluded that it provides that the recording of certain documents provides constructive notice:

(B) The recording with any county recorder of any document described in division (A)(1) of this section *** shall be constructive notice to the whole world of the existence and contents of [the] document as a public record and of any transaction referred to in that public record, including, but not limited to, any transfer, conveyance, or assignment reflected in that record.

(C) Any person contesting the validity or effectiveness of any transaction referred to in a public record is considered to have discovered that public record and any transaction referred to in the record as of the time that the record was first *** tendered to a county recorder for recording.

(Emphasis added.)

The Messers made several arguments contending that R.C. §1301.401 was not applicable to rescue a defective mortgage which failed to comply with R.C. §5301.01(A). The Court rejected each argument.

First, the Messers argued that R.C. §1301.401’s placement in the portion of the Revised Code relating to Ohio’s Uniform Commercial Code (“UCC”) means that the statute applies only to transactions governed by the UCC and does not apply to mortgages. The Court disposed of this argument noting that R.C. §1301.401’s clear and broad language indicates that it applies to “any document described in Division (A)(1)” of the section.  Further, the Court held that R.C. §1301.401(A)(1) clearly states that any document described or referred to in R.C. §317.08 is included in R.C. §1301.401.  Thus, the Court held that based on the unambiguous statutory language of R.C. §1301.401, this statute applies to all recorded mortgages in Ohio.

Not ready to surrender, the Messers argued that application of R.C. §1301.401 to recorded mortgages was inconsistent with R.C. §5301.25(A) and cannot provide constructive notice to a bona fide purchaser if the mortgage was not properly executed.

Again, the Court rejected this argument. The Court held that R.C. §1301.401 does not contradict R.C. §5301.25(A), but simply provides that the act of recording a mortgage provides constructive notice to the whole world of the existence and contents of the mortgage documents.

Finally, the Messers argued that, in enacting R.C. §5301.01(B) (providing for constructive notice for mortgages executed prior to February 1, 2002 and not acknowledged in the presence of, or not attested by, two witnesses) and R.C. §5301.23(B) (providing constructive notice where the mortgage document omitted the current mailing address of the mortgagee) show that if the General Assembly wished to create a constructive notice for deficiency-executed mortgages, it would have done so in R.C. Chapter 5301.

This final argument was also rejected by the Court. The Court stated that the existence of R.C. §5301.01(B) and R.C. §5301.23(B) does not preclude the General Assembly from recognizing other instances in which the recording of a deficiently-executed mortgage can provide constructive notice.

CONCLUSION

The Messer case is important because prior to the enactment of R.C. §1301.401, a defective mortgage was deemed not to provide constructive notice. See Rhiel v. The Huntington National Bank (In Re Phalen), 445 B.R. 830 (Bankr. S.D. Ohio 2011).  R.C. §1301.401 dispenses with the notion that a filed instrument is “not filed” if defectively executed.  Therefore, because the bankruptcy Trustee’s avoidance powers under 11 U.S.C. §544 are only effective if there is a lack of constructive notice, R.C. §1301.401 bars the Trustee from successfully defeating the interest of a mortgage lender whose mortgage is defectively executed, but nevertheless recorded.  This is great news for most lenders.

NCUA Approves Rules Easing Restrictions on Credit Union Commercial Loans

Last year, as discussed by this blog, the NCUA proposed a new set of regulations designed to ease restrictions on business lending by credit unions. These regulations would remove all prescriptive limits on member business loans (“MBLs”) and replace them with the fundamental principle that commercial loans must be appropriately collateralized.

The NCUA recently approved a final version of these regulations substantially identical to the proposed version. Most notable among the relatively minor changes from the proposed version:

  • The proposed rules loosened the limit on the aggregate dollar amount of commercial loans to a single borrower from 15% of the credit union’s net worth or $100,000 to 25% of the credit union’s net worth, provided that the additional 10% of the credit union’s net worth was fully secured at all times with a perfected security interest by readily marketable collateral. The final rules relax the limit even further by excluding from the limit any insured or guaranteed portion of a commercial loan made through a program in which a governmental agency insures or guarantees repayment.
  • Unlike the proposed rules, the final rules permit existing state rules to supersede Part 723 of the new rules if the state rules cover the same provisions as Part 723 and are no less restrictive. Any state rules previously approved by NCUA are grandfathered.

The new rules are set to take effect on January 1, 2017, except one. The existing rules require the principal of an MBL to provide a personal guarantee, or the credit union to seek a waiver from this guarantee obligation from the NCUA. This requirement will be abrogated 60 days after the new rules are published in the federal register.

Proposed Limitations On The Use Of Cognovit Notes

The Ohio General Assembly is currently considering a bill that would greatly restrict creditors’ ability to ask debtors to sign cognovit notes. A cognovit note allows a creditor, upon a debtor’s default, to enter judgment against the debtor without the usual notice or hearing.

Current Ohio law, specifically Ohio Revised Code Section 2323.13, generally enforces cognovit notes, but Ohio courts will not enter judgment on a cognovit note unless the note contains specific disclaimer language clearly and conspicuously visible, warning the debtor that signing the cognovit note surrenders the debtor’s rights to notice and a court trial upon default.1  Additionally, cognovit notes are banned entirely in consumer transactions.2 Continue Reading

NCUA’s Proposed Rules Concerning Credit Union Commercial Loans

Credit unions’ ability to lend to businesses may receive a boost if proposed NCUA regulations are approved. Business loans are becoming an increasingly important part of credit unions’ operations. Total business loans at federally insured credit unions grew from $13.4 billion in 2004 to $51.7 billion in 2014, growing from 3% of all total credit union loans to 6.8% over the same period. As of 2014, 36% of credit unions offer business loans, the vast majority of which (76%) are held by credit unions with assets greater than $500 million.

However, certain business loans, termed “member business loans” (“MBLs”), are limited by statute and regulation. An MBL is defined as a loan through which the borrower uses the proceeds for commercial, corporate, agricultural, or other business purposes, excluding extensions of credit that:  Continue Reading

Ohio Financial Institutions Tax and National Banks

In September, at the request of an Ohio-based national bank, the Office of the Comptroller of the Currency issued an opinion challenging the application of the Ohio Financial Institutions Tax (FIT) to national banks with their principal office in Ohio.

The opinion held that the FIT contradicted a federal statute that provides a national bank should be treated as a state bank chartered by the state in which the national bank has its principal office when state taxes are assessed.

The challenger maintain that the FIT contradicted federal law because Ohio chartered banks have a tax credit against the FIT for regulatory assessments paid to the Ohio Division of Financial Institutions but the FIT does not provide corresponding credit for national banks. The OCC agreed.

The opinion concluded that:

“Ohio law provides that each bank organization organized under Title XI of the Ohio Revised Code may claim a non-refundable tax credit against the FIT for regulatory assessments paid to the Ohio Division of Financial Institutions. The law provides no similar credit for regulatory assessments paid by bank organizations not organized under Title XI of the Ohio Revised Code, and it provides no credit for assessments paid to other financial regulators.  Thus, the FIT provides a tax credit to Ohio-chartered state banks that is not available to national banks.  This arrangement does not treat a national bank with its principal office located in Ohio as if it were an Ohio-chartered state bank . . .”

A review of OCC letter and review of Ohio Revised Code (“R.C.”) Chapter 5726 dealing with the FIT suggests from a substantive standpoint, the Department of Taxation would likely argue that the sum of FIT paid by an Ohio-chartered bank (taking advantage of the deduction) plus the Ohio regulatory assessment on such bank is equal to the FIT on a similarly situated nationally-chartered bank, so the treatment of the two banks is the same. The counter-argument is likely that the Ohio regulatory assessment isn’t under the FIT and shouldn’t count when assessing the federal preemption of the FIT.

Procedurally, a nationally-chartered bank can file for a FIT refund under R.C. 5726.30 for taxes paid within the last four years. Ohio Taxation Form FIT REF would be used.  The form contains space for the reason.  The Tax Commissioner then must act under R.C. 5703.70 by allowing briefing and/or a hearing.  The Tax Commissioner could issue a refund as relief sought (unlikely) or issue a negative Final Determination.  The bank would then have 60 days under R.C. 5717.02 to file an appeal of a negative Final Determination with the Board of Tax Appeals.  Decisions of the Board of Tax Appeals may be taken to the Ohio Supreme Court.

Newly Effective HVCRE Loan Rules

Lenders who finance commercial real estate exposures should be aware of new regulations that impose harsher capital requirements on certain “high volatility commercial real estate,” or HVCRE, exposures. In June 2013, the FDIC, OCC, and Federal Reserve jointly approved proposed rules intended to implement new international banking standards, known as the Basel III Capital Accords, as well as establish new risk-based and leverage capital requirements for financial institutions, as required by Dodd-Frank. The rules have been in effect for all banks since January 1, 2015, having applied to the largest banks one year prior.

Under the rules, an HVCRE exposure is defined as “a credit facility that, prior to conversion to permanent financing, finances or has had financed the acquisition, development, or construction (“ADC”) of real property,” if it fails to satisfy any of the following three capital requirements: Continue Reading

Seriously Misleading UCC Searches

Determining whether a security interest is properly perfected by using a state’s online lien search may be leading you astray.

Perfecting a security interest in collateral establishes the priority of the secured party’s claim to such collateral, providing the perfected secured party with an interest in such collateral superior to the rights held by most subsequently perfected security creditors or judicial lien creditors.  For most types of collateral owned by an entity, a security interest may be perfected by filing a financing statement describing the security interest with the secretary of state’s office in the state where such entity is formed.  A financing statement is a form of public notice intended to inform others dealing with such borrower (referred to as a “debtor”) that the debtor has granted a security interest in its assets.

The Uniform Commercial Code (“UCC”) dictates that a financing statement covering property owned by an entity debtor (as opposed to an individual) must identify the debtor by its exact legal name.  Nonetheless, to alleviate the otherwise disastrous consequences of harmless errors or omissions in a financing statement, the law provides that financing statements are effective (even with errors) so long as they are not “seriously misleading.” Continue Reading

STRUCTURED DISMISSAL OF CHAPTER 11 CASES AND THE INVOLUNTARILY SUBORDINATED CREDITOR: Official Comm. of Unsecured Creditors v. CIT Group/Bus. Credit Inc. (In re Jevic Holding Corp.), 787 F.3d 173 (3d Cir. 2015)

The United States Court of Appeals for the Third Circuit plays a uniquely important role in the development of the bankruptcy laws.  The liberal venue rule for bankruptcy cases set out in 28 U.S.C. § 1408 has led to the disproportionate filing of large and mega chapter 11 bankruptcy cases being filed in the District of Delaware.  The decisions of the Third Circuit are binding on the District Court and Bankruptcy Court for the District of Delaware.  Consequently, the decisions of the Third Circuit govern that disproportionate number of large and mega chapter 11 cases.  Furthermore, because the bankruptcy court decisions in these mega cases often involve greater dollar amounts, they are more likely to be appealed, which can result in the Third Circuit being one of the few circuit courts to address a given issue.

In Official Committee of Unsecured Creditors v. CIT Group/Business Credit Inc. (In re Jevic Holding Corp.), 787 F.3d 173 (3d Cir. 2015), the Third Circuit recently considered the propriety of a “structured dismissal” of a chapter 11 case that provided for a distribution of estate assets contrary to the distributional scheme set out in the Bankruptcy Code.  In Jevic, the debtor was woefully insolvent.  Its secured creditors were owed millions more than the value of the debtor’s assets.  The Official Committee of Unsecured Creditors, however, challenged the secured creditors’ claims on fraudulent conveyance and preference theories.  That litigation lasted for several years, and the Committee’s claim eventually survived a motion to dismiss the case.  At that point, the secured creditors, the debtor and the Unsecured Creditors’ Committee agreed to settle the litigation.  Under the terms of the settlement, nearly $4 million was made available to the Committee and a litigation trust, with those funds available for use in the pursuit of unrelated litigation in the bankruptcy case.  Any amount remaining after such litigation would be distributed to general unsecured creditors.  The claims against the secured creditors were dismissed with prejudice, and the chapter 11 case was to be dismissed.  Conspicuously absent from the parties who reached the settlement was a group of truck drivers who held an uncontested WARN Act claim against the debtor for its failure to provide the required statutory notice prior to closing the business.  A significant portion of that WARN Act claim was entitled to priority over the claims of general unsecured creditors under Bankruptcy Code § 507 (a)(4).  Nevertheless, the claim would not be paid under the settlement even though general unsecured creditors would receive at least a partial payment on their claims. Continue Reading

Sixth Circuit Re-Affirms There Is No Constitutional Right to Financial Privacy

In a decision issued May 21, 2015, the Sixth Circuit stayed its course in refusing to extend constitutional protection to encompass a right of privacy in financial records and, in doing so, retained its position as the most conservative of the federal circuits to have addressed this issue.

The case, Moore v. WesBanco Bank, Inc., Case No. 13-4477, 2015 U.S. App. LEXIS 8589, arose from allegations that a bank and an assistant county prosecutor violated plaintiff Moore’s Fourteenth Amendment right to substantive due process when the bank provided copies of two canceled checks drawn on his account to the prosecutor without insisting upon a subpoena or seeking his consent.  Both defendants denied that the bank provided Moore’s checks to the prosecutor.  The district court found no need to resolve the factual dispute because it concluded Moore had no constitutional claim based on prior Sixth Circuit precedent.  On appeal, the Sixth Circuit agreed and declined to revisit the issue of whether it should extend the right to informational privacy to financial records. Continue Reading

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