Default and Acceleration (Grace Periods, Cure Periods, Reinstatement, and Redemption)

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1 Default and Acceleration (Grace Periods, Cure Periods, Reinstatement, and Redemption) Default and Acceleration The first step in the foreclosure process is default and acceleration of the maturity of the debt Most notes give ME the option to accelerate the maturity of debt upon default [note 1, page 679] See Fannie Uniform Note, 6(C), page 1435 Upon acceleration, the entire balance of debt becomes immediately due and payable (all principal and any interest that has accrued but has not been paid) Acceleration is a practical precondition to foreclosure Mortgage lien can only be foreclosed once (because foreclosure extinguishes MR s title and also extinguishes the foreclosing ME s lien) It would make no sense for ME to conduct a foreclosure sale just to collect past due installments (the rest of the debt would remain unpaid, and the land would no longer be subject to a mortgage lien to secure that unpaid debt) Acceleration (in Context) Acceleration clauses can have different effects in different agreements/contexts E.g., in a lease, acceleration (if permitted) has the effect of accelerating the due date of all future rent payments under the lease (i.e., all future payments rent become due at once) E.g., in a mortgage, it does not accelerate future installments; instead, it accelerates the maturity (due date) of the unpaid principal balance

2 Problem Crouch s home is subject to mortgage held by Bank Under loan documents, his mortgage payment is due on the first of the month; it s now October 4, and Crouch hasn t made his payment for October Bank can t impose late fee unless Crouch s payment is more than 15 days late [RSMo (1)] Can Bank declare a default and accelerate Crouch s loan today (Oct. 4)? Grace Periods Loan documents can (but do not have to) allow a grace period before borrower goes into default and lender can accelerate E.g., Note in Graf provided a 20-day grace period (e.g., Borrower shall not be in default if payment is received within 20 days following the due date ) Does late fee clause create a grace period? Note: Late fee provision in loan documents does not create an implicit grace period for late payments If payment is due by 1 st of the month, and late payment is a default, a late fee provision does not create a grace period for nonpayment [See Fannie Note, 6(A), (B), p. 1435], it merely limits Lender s ability to impose late fee If default occurs, Lender can accelerate maturity of the debt even if late fee hasn t accrued yet unless loan documents explicitly provide Borrower with notice/cure period prior to acceleration Common law: after default, ME need not give MR notice (warning) and/or a right to cure default prior to accelerating the debt, unless required to do so by (a) a state statute or (b) the loan documents In commercial loan docs, notice/right to cure is not common for payment defaults, but is typically included for nonfinancial defaults Compare Freddie DOT [ 22, p. 1455]; ME must give MR notice and a 30-day cure period, as a precondition to ME s ability to accelerate the maturity of the debt

3 Graf v. Hope Building Corp. [p. 669] HBC owned land on which Graf held a mortgage Mortgage: entire balance can be accelerated if default continues uncured for 20 days (20-day grace period) July 1927 payment was too low (due to math error) HBC caught mistake but didn t correct it by oversight When grace period ran out, Graf accelerated; must Graf let HBC tender late payment and reinstate? Common law: once ME accelerates, MR can only redeem its interest by paying off FULL principal balance, unpaid interest, and costs of collection MR has no right to reinstate after acceleration unless (a) loan documents grant this right (e.g., Fannie Uniform Instrument) [ 22, pp ], or (b) state law grants this right (e.g., Cal. Civ. Code 2924c) After acceleration, more difficult for MR to prevent a foreclosure (the likelihood of a foreclosure probably increases) Is Graf s conduct here sensible? Why wouldn t/shouldn t Graf accept HBC s late payment and reinstate the mortgage loan? Should the court treat Graf s decision to accelerate and foreclose as unconscionable (and impermissible) on these facts? Why was this a 4-3 case? Graf majority: acceleration for untimely payment is not inherently unconscionable Court will not intervene absent fraud, bad faith, or unconscionable conduct [p. 671; Restatement 8.1] Cmt. e to Restatement 8.1 reinforces this view: important policy of predictability in mortgage remedies should avoid difficult and time-consuming judicial inquiries into such matters as the degree of mortgagor s negligence, the relative hardship that acceleration imposes, and other subjective concerns [comment e]

4 The real hardship in Graf is a function of the economic circumstances of the time By 1930, crash had begun, real estate values were dropping HBC could have reinstated and made its monthly payments going forward, but it couldn t get refinancing to pay off the full balance (land values had dropped) Graf situation was somewhat analogous to the market for commercial real estate projects In 2012, though, many lenders chose NOT to start foreclosure ( extend and pretend ) Objective vs. Subjective Defaults Graf involves a payment default ( objective ) Sometimes, loan documents can also provide for subjective defaults, such as insecurity clause Under an insecurity clause, ME can accelerate the debt if ME deems itself insecure [p. 686] Most mortgages do not have insecurity clauses, but some do (esp. if loan in question covers all of a business s assets) Acceleration and Insecurity Exercise of an insecurity clause in any contract (incl. a promissory note) governed by UCC Under 1-309, Lender can accelerate based on an insecurity clause only if Lender in good faith believes that the prospect of payment or performance is impaired Under facts in Graf, a decision to accelerate based on an insecurity clause would likely have violated Freddie Mac v. Taylor Taylor (a soldier on duty in the Philippines) had made 4 mortgage payments more than 20 days late, but Lender had accepted them without objection Taylor mailed his Sept payment 28 days late By time Lender received it, the Oct payment was past due, so Lender returned the Sept payment Why did Lender do this? Would you have advised Lender to do this?

5 Courts have often held that waiver may prevent the lender from accelerating even when the loan documents seem to permit it [note 5, page 681] Classic example: lender regularly accepts payments 10 days late, w/out objection, then accelerates after next late payment Course of performance (acceptance of late payment) = waiver of lender s ability to demand timely performance in accordance with loan documents Lender in Taylor was concerned that further acceptance of late payments could lead to waiver 1-303(a). A course of performance is a sequence of conduct between the parties to a particular transaction that exists if: (1) the agreement of the parties with respect to the transaction involves repeated occasions for performance by a party; and (2) the other party, with knowledge of the nature of the performance and opportunity for objection to it, accepts the performance or acquiesces in it without objection (d). A course of performance... is relevant in ascertaining the meaning of the parties agreement, may give particular meaning to specific terms of the agreement, and may supplement or qualify the terms of the agreement (f)... [A] course of performance is relevant to show a waiver or modification of any term inconsistent with the course of performance. Would you have advised the Lender in Taylor to return the Sept payment (and all of the subsequent less-thancomplete payments) to the Borrower? If not, what would you have advised Lender to do differently? Lender should not return payment by borrower if that payment is an unconditional payment Risk of waiver can be managed by clear communication E.g., if Lender has already accelerated: Our acceptance of this untimely payment does not reinstate your mortgage, which is still in default. E.g., if Lender has not already accelerated: Our acceptance of this untimely payment has not cured your default and does not waive your obligation to make all future payments in a timely manner.

6 By contrast, Lender may reasonably reject and return any such payment that the Borrower makes that is conditional E.g., following acceleration, Borrower tenders check in the amount of three missed monthly payments Memo line, Borrower has written Reinstate Loan # If Lender accepts this check, court may conclude that Borrower tendered the payment on condition of reinstatement, and Lender accepted it on that basis Anti-Waiver Clauses Loan documents should, and typically do, contain anti-waiver clause Simple: Fannie Note 6(d), p. 1435: Even if, at a time when I am in default, the Note Holder does not require me to pay immediately in full, the Note Holder will still have the right to do so if I am in default at a later time. More comprehensive: [See in class handout] Enforceable as written, or can it too be waived? Every time Lender decides to accept an act of performance by Borrower that is not sufficient to cure a default, or forbears from exercising a remedy Lender could legally pursue, Lender should send a letter/notice to Borrower that: Recites anti-waiver provision in loan documents Clearly states that Lender s action does not cure Borrower s default, and Clearly states that Lender has not waived Lender s ability to enforce future defaults in strict accordance with the terms of the loan documents