The finger in the dike: state and local laws combat the foreclosure tide.

• Author: Walsh, Geoff
• Position: Consumer Law Symposium

1. INTRODUCTION

   The foreclosure crisis that began in 2007 has forced state and local governments to develop a first response capacity to meet a national crisis. States seeking to control foreclosures have always faced certain limitations in enacting laws that limit or impair contract rights. These limits arise primarily under the contracts clause of the United States constitution. other provisions of the U.S. Constitution, such as the Takings Clause, as well as terms of state constitutions may set additional limits. This article will examine the degree to which various constitutional provisions may limit the ability of states to control mortgage foreclosures. overall, my conclusion is that under their police power, states have broad authority to limit enforcement of mortgage obligations. This article will trace the history of state laws that have sought to alleviate the harsh effect of foreclosures in the past, beginning with the significant controversies that arose over state foreclosure laws during the Great depression of the 1930s. Later sections will review trends in recent state legislation. during the current crisis, state and local efforts have focused on foreclosure mediation and conference laws, as well as laws to control servicer conduct, so as to encourage a full consideration of loss mitigation options. overall, I conclude that recent state laws enacted in response to the foreclosure crisis have been relatively mild and have not approached the true limits of states' authority to control mortgage foreclosures.

2. DEPRESSION-ERA FORECLOSURE LEGISLATION BY THE STATES--BACKGROUND

   During a period of eighteen months in 1933 and 1934, twenty-seven states enacted statutes designed to mitigate the effects of the mortgage foreclosure epidemic that was sweeping the country. (1) In February and March of 1933, Iowa and Minnesota passed the first such laws shortly after several thousand farmers stormed the opening legislative sessions in each state, disrupted proceedings, and demanded immediate foreclosure relief. (2) Before the enactment of the Minnesota law, the state's governor threatened to impose martial law over the deteriorating foreclosure climate and issued an executive order to sheriffs statewide to cease conducting foreclosure sales and evictions. (3) One commentator who was involved in drafting legislation at the Minnesota capitol at the time described the climate in the legislature as a "flood of bills" poured in:

   It was proposed, for example: that the courts be closed to all mortgage foreclosure proceedings for two years; that the power to foreclose by advertisement be abolished; that sheriffs be given the power to postpone foreclosure sales at their discretion; that the courts be given the power to continue all foreclosure proceedings for two years upon such terms as should appear to them to be appropriate; that the period of redemption be extended arbitrarily one year, or two; and that henceforth there should be no personal liability upon any note or debt secured by a mortgage after the mortgage had been foreclosed. (4) During 1933 and 1934 many states enacted statutes that actually achieved most of these objectives. State legislatures drafted these laws with care in hopes of surviving constitutional challenges. The statutes authorized stays of foreclosure proceedings and extensions of post-sale redemption periods, often lasting for several years. Borrowers were given the power to turn non-judicial foreclosures into judicial foreclosures. State legislation provided tools for courts to restrict the harshness of deficiency judgments. (5) Some prominent examples of these laws will be discussed below.

   1. Moratorium/Stay of Proceedings in Depression-Era Legislation

      Moratorium laws enacted during the thirties applied to both nonjudicial and judicial foreclosures. Yet, for the most part, these statutes were drafted carefully to incorporate judicial supervision over any stay of foreclosure. Almost uniformly, the laws imposed some form of payment obligation upon borrowers as a condition to the continuation of a stay.

      Several types of statutory schemes were typical. Most moratorium laws followed the examples of the four state statutes discussed below.

      1. The Iowa Moratorium Statute

         Iowa was and remains a judicial foreclosure state. its initial moratorium Statute--enacted in February 1933--authorized a borrower to apply to a court for an order continuing a pending foreclosure action until March 1, 1935. The statute gave courts the authority to prohibit entry of a foreclosure judgment while the stay remained in effect. The borrower had the right to remain in possession of the property during the stay period. However, the statute created a procedure for the courts to require the borrower to pay to the lender rents, income, and profits generated by the property while the stay remained in effect. A similar process applied to cases in which a foreclosure judgment had already been entered. In these cases the statute extended the state's post-judgment redemption period for two years, subject to similar payment conditions. The statute applied to mortgages executed before its enactment, as well as to pending cases.

         Under the Iowa statute, the borrower's initial eligibility for the moratorium was automatic. The lender had the burden of proof of showing that the borrower made the application in bad faith. in a later amendment, this burden of proof changed, and the law required that the borrower establish good faith as a condition to obtaining the stay. (6)

      2. The New York Moratorium Statute

         New York was another judicial foreclosure state that enacted a foreclosure moratorium statute during the thirties. New York's law also barred foreclosure of mortgages in default, but required the borrower to continue payment of interest and taxes. The law provided that a court would review the borrower's income and expenses related to the property every six months. At its discretion, the court could require the borrower to pay the lender any surplus income over and above what was needed to cover interest and taxes. Essentially, the statute provided for a moratorium only on the payment of the loan principal, with the borrower's payment of interest, taxes, and insurance a condition to continuing the suspension of foreclosure. (7) The court was authorized to terminate the stay upon the borrower's nonpayment of any amounts the court at its discretion had ordered to be paid to the lender. (8)

         In most cases the New York statute did not require that a court conduct any extensive evaluation of the borrower's income and expenses. The requirement to pay interest, taxes, and insurance focused on terms of the particular contract, and these amounts could be readily ascertained. The requirement that the borrower make payments to the lender out of surplus income left over after payment of interest, taxes, and insurance was adopted by a later amendment. This requirement became a factor for income-producing properties such as farms or buildings with rental units. The stay was granted automatically and continued upon compliance with payment terms. The New York statute did not incorporate any kind of "good faith" threshold for the borrower.

      3. The California Moratorium Statute

         Foreclosures in California during the thirties, as now, were primarily nonjudicial. california's moratorium statute functioned in much the same way as those in judicial foreclosure states. it authorized courts to stay judicial as well as nonjudicial foreclosures. The borrower petitioned a court for this postponement. (9) The petition for postponement could be filed at any time within ninety days after recordation of the notice of default. Also, at any time before expiration of the post-sale redemption period, the borrower could file a petition to extend the redemption period.

         Under the california law, the courts exercised their equitable discretion in granting stays. Granting a stay was not automatic, even upon compliance with set payment terms. The borrower's inability to pay was not in and of itself sufficient grounds for relief. (10) The burden of proof of showing a right to relief was on the borrower. The court had discretion to set amounts for payment to the lender as a condition to the granting and continuation of the stay. in setting a payment amount, the court could consider the value of the property and the income derived from it. At a minimum, the borrower was required to pay enough to meet obligations for upkeep, taxes, and insurance. The post-sale period of redemption could be extended on the same grounds and through a similar procedure. There were apparently few legal challenges to these exercises of the courts' traditional equitable discretion related to foreclosures. one commentator noted eight years after the statute's enactment that no trial court decisions related to granting, denial, or termination of a stay had ever been set aside on appeal. (11)

      4. The Minnesota Moratorium Statute

         Minnesota, another nonjudicial foreclosure state, enacted moratorium legislation during 1933. One aspect of the statute--its authority to extend post-sale redemption periods--became the subject of the leading U.S. Supreme court decision of the era upholding the constitutionality of state foreclosure moratorium legislation. (12) The Minnesota statute allowed a borrower to apply to a court for a stay of foreclosure for up to two years. As a condition to the stay, the court could require the debtor to pay the income derived from the property, or else pay a fair rental value for the property. The court granting the stay reviewed and approved the amounts to be paid during the moratorium period. At a minimum, the payments would have to cover taxes and insurance. The court could also require that any surplus income derived from the property be paid and applied to the debt. (13) The statute allowed courts to stay the redemption period following a sale for up to two years. All...