CODE ENFORCEMENT AND FORECLOSED PROPERTY REGISTRATION:

LENDERS’ (AND SERVICERS') EVOLVING AND

PERIPATETIC FORECLOSURE NIGHTMARE

Roger D. Schwenke

In the aftermath of the subprime mortgage meltdown, and in the context of the extensive array of foreclosures which have confronted property throughout the United States, cities and states have been left with a burden of dealing with dramatic increases in the number of foreclosed and abandoned blighted properties. It is outside the scope of these materials to analyze in any detail the consequences of rising foreclosures and abandonments on many American communities, but in general it has become "accepted wisdom" that abandoned properties substantially decrease the value of neighboring properties, which in turn has lowered the tax revenue cities, counties and other municipalities can collect. In other instances, abandoned property, especially abandoned homes, have become public nuisances such as fire hazards, or drug-growing and drug distribution locations, which can endanger the entire community.[1]

In response to this massive increase in abandoned, vacant and neglected properties linked to foreclosures and loan obligation defaults, cities, counties and states throughout the United States have developed a variety of approaches to try to force lenders to contribute to what are seen as the costs (both financial and societal) of often protracted foreclosure procedures. Even before the problems arising from the recent severe economic downturn, cities and counties had been confronted with properties which were unsafe or in need of maintenance or repair.

Until recently, the traditional governmental response was to rely on building codes in an effort to compel maintenance. Sometimes mortgage lenders and servicers were served with complaints and allegations that property had gone through foreclosure and was now in REO status. Governments argued that the lender, as the property owner, was responsible for the property. But where the property had been abandoned by its owner or was the subject of a foreclosure proceeding, the lender was not yet in possession of the property. In those instances, even though mortgagees often were named as defendants in housing court and other code enforcement cases, generally cities and counties did not attempt to impose liability upon lenders if such lenders were not yet in possession of the property. If the question came up about why the governmental entity was naming lenders as defendants (but then not aggressively pursuing recovery) -- which was a question which rarely arose – local government counsel would usually respond that lenders needed to be on notice of the governmental action since the lender’s rights could be affected, but also acknowledged that the city or county would not expect the lender to be responsible for violations occurring on a property the lender did not control.

As local governments confronted a massive increase in the magnitude, detriment and expenses arising from vacant properties, and while those same governments have seen their tax revenues drastically diminishing, they have become much more willing to expect mortgage lenders and servicers to contribute even before the lenders have a legal right to possession. Local (and sometimes even state) government has turned to new strategies and causes of action. These materials attempt a brief review of these evolving strategies, and include a prediction of some further techniques now under increasing consideration.

Vacant Property Registration

One of the newest approaches by local governments to address the problems posed by vacant and abandoned properties is the requirement that such properties by "registered" with the local government. Most such ordinances are applicable only to residential real estate. However, some – such as the Deerfield Beach ordinance discussed below - also include commercial properties. However, one of the problems with even those which claim to be applicable to “residential” properties is that the term frequently is defined to include “any property that contains one (1) or more dwelling units used, intended or designed to be occupied for living purposes”.[2] With such a definition, and even after review of the City’s list of “Frequently Asked Questions”, often it is unclear whether the registration and maintenance requirements apply to only homes, or also encompass apartment units, condominium or town home units and the residential parts of mixed use projects.

In 2006 the City of Chula Vista, California, became one of the first municipalities to pass an ordinance which required holders of troubled mortgages on property which was abandoned or vacant to register those locations, to pay registration fees and to post bond. The ordinance was adopted in July 2006 and took effect in October 2007.[3] At the time of its adoption, the ordinance was considered to be unique because it was based not only on the physical condition of the property, but also on what the City assumed to be the probable contractual provisions in the mortgages. The City assumed that the mortgages probably contained contractual covenants in the mortgage, often referred to as “abandonmentand waste clauses”, which authorize a lender (where a borrower has ceased making payments and has vacated an encumbered site) to access the property and to secure it from vandalism”. Under the ordinance, lenders must maintain the property which is undergoing foreclosure or which has been foreclosed. The registration requirement is triggered at the time of the first notice of default. When a notice of default is sent, the ordinance requires the lender to determine whether the property is vacant. If it is unoccupied, the lender must assure that the property is maintained, which often entails the retention of property managers.

A fee of $70 per property registration is required to be paid. According to the City, the fees initially had two purposes: to help Chula Vista gather property data and to provide a "big stick" that would force mortgage servicers to fix homes that were in disrepair. Chula Vista reported that in the first year of this ordinance the City raised $77,000 in fees and levied $850,000 in citations.[4] The Enforcement Manager for the City has also reported that some lenders and property servicers have resisted compliance with the requirements in the ordinance. In his Congressional statement he reported that he had received a call at home one weekend from someone he identified as a “high-level lending industry representative”, telling him that the manager was “making too much fucking noise” about the ordinance.[5]

The Director of Code Enforcement for the City of Chula Vista was asked in this same Congressional hearing to discuss the consequences of the "mortgage meltdown" on his and other communities. Here is how he responded:

“Although the collapse of the housing market and lending industry has been widely reported, the ripple out effect of the collapse has yet to be adequately addressed. There have been discussions on who is to blame and how to prevent this from happening again, but little attention has been paid to the true, innocent victims – the neighbors and local jurisdictions that are left to cope with and clean up the mess.

If a ship's captain recklessly pilots his ship into a hazard and spills oil, the damage isn't contained to just the ship. The oil spilled from that ship leaks into and spreads over miles of ocean, beaches and coastline. It seeps into every nook and crevasse. It covers every rock, every train of sand. It coats unsuspecting wildlife and damages the environment for decades to come. Such is the case with the record number of financially distressed properties (foreclosures) we are experiencing across the Nation.

The SS Mortgage has run aground at the hands of reckless captains. The crude oil of foreclosures and abandoned properties has leaked into and spread over the entire country, neighborhood by neighborhood. Unsuspecting residents are being covered in the oil of diminishing home values, blight and unmarketable real estate. They find themselves mired in a situation they didn't create and yet can't free themselves from.

With shipwrecks and oils spills, the damage can be minimized by fast action and containment. There are federal, state and local laws that require response crews be trained to react. There are action plans and drills to prepare for the worst. Even with this training and response, the impacts are only "minimized". The damage can't be undone. And when all is said and done, it can take decades to calculate the cost of response, containment and recovery. But, with a single spill, at least there is someone to hold accountable.

This is not the case in the situation we find ourselves now, this "mortgage meltdown". While ships’ holds were filled to overflowing with mortgages, some very questionable loading crews (brokers and originators) were hired in record number, and little, if any, thought was given to training response crews, preparing action plans and conducting drills. In short they didn't prepare for this disaster; they didn't feel they needed to. If a gallon or two of oil sloshed over the gunwales there would be someone there to scoop it up. In real estate terms, you could always "flip it", sell the house or mortgage, and save yourself from the "spill". You could, that is, until too much of the oil spilled over at once and there was no one there to scoop it up anymore. [6]

Chula Vista is not alone in the adoption of such ordinances. A national property maintenance firm called “Safeguard Properties” maintains an online database of vacant property regulations throughout the United States. [7] The chief executive officer of Safeguard, Alan Jaffa spoke on these issues at a February 2012 Mortgage Bankers Association conference. Based on the Safeguard database, he reported that in the past six months the number of municipal ordinances requiring owners, lenders and mortgage servicers to register vacant or foreclosed properties has risen over 50% to 980. What he referred to as “the troubled-home epicenters of California and Florida,” each had passed more than 100 such ordinances.[8]

One analysis of such ordinances observed that although such ordinances vary based on local political and economic “realities”, there are common themes and issues addressed in all jurisdictions:

“The primary aims of the ordinances include finding a cost effective means to track property vacancy (and any ill-effects that may be triggered), to finance the administration of vacant property monitoring, to ensure efficient enforcement of building codes and other health and safety regulations at or near vacant properties, and to provide authority to collect penalties to address violations. Enforcement is delegated to existing code enforcement departments or task forces assembled for this purpose.”[9]

There are a variety of approaches to vacant or foreclosed property registration. Some jurisdictions have the registration requirement triggered by vacancies of particular lengths of time; others trigger the requirement upon a specific event such as the initiation of a foreclosure action. Foreclosure-related registrations typically trigger a mandatory inspection of the property and establish the possibility of fines and penalties for un-remediated violations. Most such ordinances are predicated on the vacant status of the property – e.g., that it is not being used. However, there are some alternative approaches which instead focus on the identity of the user. For instance, an ordinance adopted by the City of Red Bud, Illinois applies only to lenders that come into possession of a site as a result of a borrower’s default.[10]

One recent article analyzing and critiquing various approaches for governmental response to vacant and abandoned properties identified five different kinds of ordinances and statutes:

  • Regulation Triggered by Vacancy
  • Regulation Triggered by Initiation of Foreclosure Process
  • Requirement of Registration upon Foreclosure Sale
  • Requirement of Insurance on Vacant Properties
  • Special Assessments Depending on Structure Characteristics or Length of Vacancy

The article includes with each category a listing of citations to illustrative ordinances or statutes.[11]

One of the most unique features of this new wave of vacant property ordinances is the imposition of financial liability on the mortgagee on the theory that the mortgage has the contractual (if not statutory) right to manage and control the property once there has been a default.

The registration fees and potential enforcement fines and penalties vary widely among these ordinances. In contrast to the $70 fee charged by Chula Vista, Minneapolis requires vacant property owners that are found guilty of code violations to pay a substantial fee, which has increased from $2,000 annually to $6,000. However, to minimize the economic impact and provide an incentive for rehabilitation, the Minneapolis ordinance also adopted a "waiver" provision, which permits owners to postpone payment of the fee if they agree to enter into a Restoration Agreement with the City and bring the property up to code in a timely manner.[12]

A recent Florida ordinance illustrates the various issues and elements that are usually a part of such ordinances. The Deerfield Beach, Florida vacant property registration ordinance is triggered by a declaration of mortgage default:

Section 34-100 Registration of Abandoned Real Property,

(a) Any mortgagee who holds a mortgage on real property located within the city shall perform an inspection of the property that is the security for the mortgage, upon default by the mortgagor, prior to the issuance of a Notice of Default. If the property is found to be vacant or shows evidence of vacancy, it shall be deemed abandoned and the mortgagee shall, within ten (10) days of the inspection, register the property with the City Manager, or his or her designee, on forms provided by the City. A registration is required for each vacant property as well as improved property.

(b) If the property is occupied but remains in default, it shall be inspected by the mortgagee or his designee monthly until (1) the mortgagor or other party remedies the default, or (2) it is found to be vacant or shows evidence of vacancy at which time it is deemed abandoned, and the mortgagee shall, within ten (10) days of that inspection, register the property with the City Manager, or his or her designee, on forms provided by the City.

(c) Registration pursuant to this article shall contain the name of the mortgagee, the direct mailing address of the mortgagee, a direct contact name and telephone number or mortgagee facsimile number and e-mail address and, in the case of a corporation or out-of-area mortgagee, the local property management company responsible for the security and maintenance of the property.

(d) An annual registration fee in the amount of $150.00, per property, shall accompany the registration form(s).

(e) This article shall also apply to properties that have been the subject of a foreclosure sale where the title was transferred to the beneficiary of a mortgage involved in the foreclosure and any properties transferred under a deed in lieu of foreclosure/sale. [13]

Not surprisingly, lenders have sought to have ordinances of this type struck down as unconstitutional or in violation of the rights of a mortgagee under state judicial foreclosure statutory provisions. A recent decision by U.S. District Judge Ponsor in the District Court for Massachusetts considered arguments raised by a group of banks which held mortgages on residential property in Springfield, Massachusetts. They argued that the maintenance and registration requirements imposed under an ordinance which went into effect on December 13, 2011[14] were invalid under and preempted by Massachusetts foreclosure statutory provisions, violated the Contracts Clause of the U.S. Constitution, constituted an unlawful tax because of the ordinance’s cash bond requirements, were arbitrary, resulted in an unconstitutional taking, and violated procedural and substantive due process.[15]

The Court rejected all of the lenders’ arguments and granted the City’s Motion to Dismiss, or in the Alternative, for Summary Judgment. With respect to the arguments that the ordinance was unconstitutional because it was arbitrary, a taking, and violated due process, the Court’s opinion observed that the Plaintiffs had not even “made any arguments in support of these claims.” As a result Judge Ponsor considered each of these arguments only briefly, and then concluded that the Court would deny all of these constitutional claims. The reasons why the Court rejected the other bank arguments and granted the City’s Motion to Dismiss are clearly seen in the opinion’s comments on the argument that the ordinance impaired the banks’ contractual rights and in the opinion’s Conclusion:

“According to the ordinance’s stated purpose,

[u]nsecured and un-maintained vacant properties and foreclosing properties

present a danger to the safety and welfare of public safety officers, the public,

occupants, abutters and neighbors, and as such constitute a public nuisance.

This section is enacted to promote the health, safety and welfare of the public,

to protect and preserve the quiet enjoyment of occupants, abutters and neigh-