Foreclosure Equity Stripping: Legal Theories and ...

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Foreclosure Equity Stripping: Legal Theories and Strategies to Foreclosure Equity Stripping: Legal Theories and Strategies to

Attack a Growing Problem Attack a Growing Problem

Prentiss Cox University of Minnesota Law School, [email protected]

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Foreclosure Equity Stripping:Legal Theories and Strategiesto Attack a Growing Problem

By Prentiss Cox

oreclosure equity stripping is the classic case of kicking someone who is down.The person perpetrating the equity strip-let's call this person the "acquirer"-targets homeowners who are in foreclosure and have equity remaining in the

property. Promising to "save" the home for the desperate homeowner, the acquireroffers refinancing or other assistance to "stop the foreclosure." For too many fore-closed homeowners, these promises end when the acquirer or the acquirer's confed-erates gain title to the property and take the homeowner's equity.

Prentiss CoxAssociate Clinical Professor of Law

University of Minnesota School of Law190N Mondale Hall229 19th Ave. S.Minneapolis, MN 55455612.625,[email protected]

This scenario is occurring frequently across the country as home prices have soaredin almost every market, creating substantial equity in homes and fodder for an indus-try that preys on homeowners who are unable to pay their mortgages. For many ofthese homeowners, foreclosure equity stripping completes the cycle started bypredatory lending tactics and undermines low-income homeowners' only grasp oneconomic security.

In this article I offer advocates for foreclosed homeowners an analysis of legal theo-ries and strategies to consider when confronting foreclosure equity stripping. I dis-cuss the genesis of the problem and the different forms that foreclosure equity strip-ping takes (I). I focus on three legal theories that lawyers representing victimscommonly use (II). And I catalog and briefly describe other statutory and common-law theories to consider in these cases (III).

I. Foreclosure Equity-Stripping Scams

Skyrocketing housing prices and high foreclosure levels, accompanied by growth inthe subprime lending market, have exacerbated the foreclosure equity -strippingproblem. Scams generally take one of two broad forms: fraud or reconveyance trans-actions.'

A. The Growing "Market" of Victims

That home prices have risen sharply in recent years is well known. The Office ofFederal Housing Enterprise Oversight reports that housing prices rose over 55 per-cent in the five-year period ending September 3o, 2oo5.2 In several regions theincrease during this period has been extraordinary-more than ioo percent in

1 My description of foreclosure equity-stripping schemes in this article is based on my review of documents and interviewsfrom over thirty foreclosure equity-stripping transactions in Minnesota, review of dozens of complaints and decisions fromother jurisdictions, and the National Consumer Law Center report, infra n. 82 Off ice of Federal Housing Enterprise Oversight. House Price Index for the Third Quarter of 2005, at 24(Dec 1, 2005),available at www ofheo.gov/media/pdf/3qO5hpi pdf

Clearinghouse REVIEW Journal of Poverty Law and Policy m March-April 2006

Foreclosure Equity Stripping

California, Hawaii, and the District ofColumbia, for example. 3

Less understood is that foreclosure ratesappear to have risen while housing priceswere escalating and stayed at high levelsdespite the supposed economic recovery.In 1986, o.26 percent of homes enteredforeclosure. The rate rose steadily, exceed-ing 0.40 percent for the first time in 1998.It peaked at 0.46 percent in 2ooi-2oo2 andhas since remained above 0.40 percent. 4

Either trend alone would likely result inmore homeowners who are in foreclo-sure and have substantial equity. Otherthings being equal, rising home priceswould mean that any given homeowner inforeclosure would have a greater chanceof having substantial equity, and higherforeclosure rates would mean more peo-ple in foreclosure at every level of equity.Together these trends result in a largernumber of distressed foreclosed home-owners with substantial equity and thus aripe and expanding market for theunscrupulous.

Subprime lending, which has explodedover the last decade, may be an importantcomponent connecting these trends.From 1994 through 2oo3, subprimeoriginations increased by over 9oo per-cent and amounted to more than io per-cent of all mortgage refinancing origina-tions by 2004. 5The foreclosure rate forsubprime loans has been estimated atmore than ten times the rate for con-forming loans. 6 The problem is not justthe increase in subprime loans but theaccompanying increase in the rate ofsubprime foreclosures, apparently as a

result of predatory practices. As onecommentator noted:

One might expect the number ofsubprime foreclosures to increaseas the overall number of sub-prime loan originations increase.Significantly, however, the growthof subprime foreclosures hassubstantially outstripped thegrowth of subprime originationsand the speed at which subprimeloans have gone into foreclosureshas also increased dramatically.These data suggest, at best, greatinefficiency in the subprimemortgage underwriting process;but, more troubling, they alsosuggest that predatory terms andpractices produce these rates offoreclosure. In Chicago, forexample, the proportion of sub-prime mortgage originationsincreased from 3% to 24%between 1991 and 1997; duringroughly the same period, howev-er, the subprime share of foreclo-sures increased from 1.3% to35.7%.7

B. Types of ForeclosureEquity-Stripping Schemes

Foreclosure equity- stripping schemesvary tremendously. A recent NationalConsumer Law Center survey of cases andwork in this area by state attorneys gen-eral, legal aid attorneys, and other con-sumer attorneys cataloged wide variationin how the acquirer obtains control of ahome and its equity. 8 The report found abroad range of local actors perpetrating

31d. at 15. Florida, Nevada, and Rhode Island have seen at least a 99 percent gain and twelve other states, including all

of New England, have seen gains of at least 60 percent. In the last year alone, house prices in Arizona rose over 30 per-cent, while eleven other states-including Idaho, Delaware, and Oregon-saw at least a 15 percent increase. Id.4

OFFICE OF POLICY DEVELOPMENT AND RESEARCH, U.S. DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT, U S HOUSING MARKET

CONDITIONS-3RD QUARTER 2005 at 74 (2005).

5ROBERTO G. QUERCIA ET AL., CENTER FOR COMMUNITY CAPITALISM, THE IMPACT OF PREDATORY LOAN TERMS ON SUBPRIME FORECLOSURES:

THE SPECIAL CASE OF PREPAYMENT PENALTIES AND BALLOON PAYMENTS 2 (2005), available at www.kenan-flagler.unc.edu/assets/doc-uments/foreclosurepaper.pdf.

61d.

7 Baher Azmy, Squaring the Predatory Lending Circle: A Case for States as Laboratones of Experimentation, 57 FLORIDA LAWREVIEW 295, 344 (2005).

8STEVE TRIPOLI & ELIZABETH RENUART, NATIONAL CONSUMER LAW CENTER, DREAMS FORECLOSED: THE RAMPANT THEFT OF AMERICANS' HOMES

THROUGH FORECLOSURE "RESCUE" SCAMS (2005) [hereinafter NCLC Report), available at www.consumerlaw.org/news/con-tentForeclosureReportFinal.pdf.

Clearinghouse REVIEW Journal of Poverty Law and Policy w March-April 2006


these schemes, with no national compa-nies engaged in systemic operations.

Acquirers can easily identify homeown-ers to solicit because the informationneeded is public record. Foreclosure fil-ings require some form of public notice.States that require judicial foreclosurecreate a courthouse file of potential tar-gets, while nonjudicial foreclosure pro-cedures typically require some form ofpublic notice, usually by advertisement.The other necessary element of thescheme is equity. Judicial filings or pub-lic notices of foreclosure are likely toinclude the amount of the underlyingmortgage in default and the amountrequired to prevent loss of the property.Nonforeclosing mortgagees and otherliens against the property also are mat-ters of public record.

1. FraudSome rescue scams are simple fraud orplainly deceptive trade practices, oftenagainst vulnerable homeowners. A com-mon transaction of this sort involves theacquirer obtaining a warranty deed to theproperty under the pretense of starting arefinancing or other deceptive represen-tation. The acquirer then files the deed,transferring ownership of the property tohimself or an associate, and moves toevict the foreclosed homeowner. A greatvariety of other types of simple fraud inthis area is seen as well. The following arethree examples: 9

In State v. Home Funding Corporation Jasonand Tanya Ruddy, a St. Paul, Minnesota,couple, owned a home worth about$145,000 with a loan of about $8o,ooo inforeclosure.' 0 The Minnesota attorneygeneral alleged that Home Funding toldthe Ruddys that it would refinance theloan, that a Home Funding representa-tive gave the Ruddys a business card stat-

ing "loan administrator," that HomeFunding sent an appraiser to the home aspart of the refinancing, and that HomeFunding fraudulently obtained a warran-ty deed from the Ruddys by telling them itwas paperwork to get the loan started.Without the Ruddys' knowledge, HomeFunding transferred the property to anassociate, Mr. Johnson, for $126,ooo.Home Funding told the Ruddys it com-pleted the refinancing without them. TheRuddys made a few payments to HomeFunding on what they thought was theirnew loan before receiving a "rent"demand from Johnson, whom they didnot know. Mr. Ruddy's employer helpedhim research county property records,leading to discovery of title transfers toHome Funding and then to Johnson.

In Rowland v. Haven Properties an elderlywidow owned a home in Chicago." Afterbeing inundated with foreclosure rescueoffers to help her -save her home," sheresponded to an offer stating that she hadbeen "heavily screened and pre-quali-fied!" and that the acquirer was "able to'quickly refinanc[e] homes out of fore-closure!"' Ms. Rowland attended whatshe thought was a refinance closing andunknowingly "sold" her house, valued at$245,000, for a $91,500 loan. Only laterdid she learn that she had allegedlybecome a renter in her home at a month-ly payment she could not afford.

In Jumper v. Hayes the plaintiff, a 68-year- old man on dialysis, alleged fraud inan action to clear title to his home inWashington, D.C., and obtain damagesagainst multiple people." Mr. Jumperand his wife, now deceased, had about$s8o,ooo in equity on a home worthabout $33o,ooo. They were in foreclo-sure when a realtor whom they trustedadvised them that they could not obtainrefinancing and should sell their home to

9 See generally Josiah Kibe, Comment: Closing the Door on Unfair Foreclosure Practices in Colorado, 74 UNIVERSITY OF

CoLORAoo LAW REVIEW 241 (2003) (offering a hypothetical example of a simple fraud equity-stripping transaction anddescribing equity-stripping problem in Colorado)

10state v Home Funding Corporation, No C4-03-7691 (Minn. Dist. Ct. Dakota County filed April 28,2003) On

December 23, 2005, the state received a judgment for $1,992,652 in restitution and $2,582,763 in civil penalties I was

involved in the prosecution of this case as lead attorney for part of the litigation and as supervising attorney for the case.

11Rowland v Haven Properties, No. 05cl 957, 2005 WL 1528264 (N D III. June 24, 2005) (rejecting motion to dismiss)

1 2jumper v Hayes, No. 04-ca-6241 (D.C. Super. Ct. filed Aug 2004)

Clearinghouse REVIEW Journal of Poverty Law and Policy * March-April 2006


obtain the equity. Defendant Hayes thensolicited them and promised what theJumpers were led to believe was a $15,000loan to bring their mortgage loan current.Ms. Hayes had them sign a deed transfer-ring sole ownership to her. Unknown to theJumpers, she used the deed to obtain firstone loan and then, four months later,another. After another three months, Hayesattempted to sell the house and evict Mr.Jumper, who learned for the first time thatHayes considered him a renter in his home.

2. Reconveyance TransactionsReconveyance transactions are probablymore prevalent and definitely harder todeconstruct for purposes of a lawsuit thatwill give the victim relief. The essence ofthese schemes is that the acquirerobtains title to the home in foreclosureand then "reconveys" possession and aninterest in the property back to thehomeowner, with the supposed goal oftransferring title back to the homeowner.The acquirer ultimately either completesthe reconveyance of the title back to theforeclosed homeowner or, probablymuch more commonly, evicts the fore-closed homeowner and sells the property.

Some simple fraud schemes may bereconveyance transactions on paper, butthe homeowner is unaware that any titletransfer has occurred. In this subsectionI analyze the more common problemwhere foreclosed homeowners under-stand that they have entered into a deal totransfer and then reacquire title. Thesetransactions vary widely in form, but thesolicitation, acquisition- reconveyance,and dispossession-eviction phases of thescheme often have common elements.

a. SolicitationAcquirers introduce themselves to fore-closed homeowners both through directmarketing and through mortgage brokers.

(1) Acquirer Direct Marketing

If these schemes have one common charac-teristic, it is the promise by the acquirer to"help stop the foreclosure" and "save" thehome. Often this representation is made in

a written solicitation sent to homeown-ers.13 Acquirers also make these claims innewspaper advertisements, telemarketing,and in-person solicitations of foreclosedhomeowners. A typical advertisementreads:

"Is Your Home In Foreclosure?We Can Help." "We Can Save YourProperty And Even Give YouCash In Hand." "We Can PayYour Mortgage For One Year AndAllowYou Time to Recover." "OurProgram Requires No DownPayment Or Up-front Cash." "WeAre The Experts And We HaveHelped Hundreds f Peple."14

A second primary marketing representa-tion is the bogus offer of refinancing. Asdescribed above, this representation oftenis used in simple fraudulent schemes toobtain title without the homeownersknowing that they have sold the home. Inother cases, a false promise of refinancingserves to lure the homeowner into a rela-tionship with the acquirer, who thenswitches the terms of the deal to a foreclo-sure reconveyance. One such tacticinvolves "running the clock." The acquirerleads the homeowner to believe refinanc-ing is in progress and then, near the end ofthe redemption period, tells the home-owner that the deal fell through. Theacquirer then offers the reconveyancescheme as the only option available.

Acquirers have accompanied these prom-ises with other representations. Acquirerspromote the notion that they have specialexpertise to deal with the complex prob-lems and anxiety created by foreclosureand often imply that the acquirer can offerthe homeowner a variety of options forresolving the foreclosure. One standardletter by an acquirer stated:

We look out for your interests.

We share vital facts about foreclosure.

We can stop the foreclosure process.

We can help you restore your credit.

We can help'you save your homestead.

13

See NCLC Report, supra note 8, at 57.

14Johnson v Home Savers, No. 04-5427 (E D.NY filed Dec. 14, 2004).



There are so many options foryou to choose from. Scheduleyour no hassle just plain factsconsultation today. Let us try andhelp you figure out solutions soyou can sleep at night. 15

In reality this list of options was allegedto have narrowed to one-a reconveyancetransaction that gave the acquirer title tothe property through a sham juniormortgage.16

Acquirers also rely on creating a sense ofurgency. Some foreclosed homeownersface loss of the home in weeks or days asthe foreclosure redemption periodcomes to an end, and thus the urgency isreal. In most cases, however, homeown-ers have sufficient time to sell the home,complete a loan restructuring, or evalu-ate other options.

Acquirers also have used affinity market-ing techniques-appeals to racial, reli-gious, or ethnic solidarity-to build afalse sense of trust. The NationalConsumer Law Center report offers anexample of a solicitation from an AfricanAmerican acquirer promising all theusual offers ("You can stop all the fore-closure stress today. We will lend you themoney for the foreclosure ... ") andhandwritten representations that includ-ed: "We tell you what they won't & helpyou. They can't stand to see young broth-ers doing what they do." 17

(Z) Mortgage Brokers

Acquirers also market themselves tomortgage brokers who deal with home-owners with subprime loans and offer afee for referring foreclosed homeowners.For homeowners who are unlikely toqualify for refinancing, the referral forthe reconveyance transaction gives themortgage broker an otherwise unobtain-able fee. Acquirers also can obtain busi-ness from mortgage brokers by payingreferral commissions in excess of thefees the mortgage broker could earn

through a refinance. Acquirers and bro-kers have participated jointly in theabove-described running the clockscheme, with the broker introducing theacquirer as a rescuer to the desperatehomeowner facing the end of theredemption period.

b. Acquisition and ReconveyanceI use the term "acquirer" to mean a per-son who solicits the foreclosed home-owner, acquires title to the property, andthen reconveys some interest to thehomeowner. In fact, many foreclosurereconveyance transactions are not sosimple; they involve intervening trans-fers of title and other interests. And aplethora of methods can be used toaccomplish the different interest trans-fers, depending on the limits and obliga-tions of state foreclosure procedures andindividual differences in the approach ofthe actors. In this subsection I brieflyaddress: () the conveyance of title fromthe foreclosed homeowner to the acquir-er; (2) the form of the reconveyance; and(3) other transfers of interest and actorsinvolved in the acquisition-recon-veyance process.

(1) Transfer of interest to acquirer.

Transfer of title from the foreclosedhomeowner has been accomplished byseveral methods, including () deedtransfer at the same time as a closing onthe reconveyance, (2) deed transfer priorto the reconveyance, (3) creation of amortgage interest, and (4) creation ofanother lien or judgment interest.

The easiest reconveyance transaction totrack by document trail is a closing atwhich the foreclosed homeowner trans-fers title to the acquirer and the acquirerreconveys an interest back to the fore-closed homeowner. More often, however,transfer of title to the acquirer appears tooccur before the execution of any interestback to the homeowner. In many cases,the acquirer simply presents the fore-

15State v HJE, No. 03-cv-05554 (D Minn filed Oct. 16, 2003)

16

1d.

17 See NCLC Report, supra note 8, at 54-62 (examples of written solicitations).


Foreclosure equity stripping

closed homeowner with a deed in favor ofthe acquirer. The foreclosed homeownerexecutes the deed; the acquirer records itand later reconveys an interest back to thehomeowner. Even when a closing occurs, itappears more common that the closing islimited to the conveyance to the acquirer,with the reconveyance transaction later".closing" in a separate, often informal,document signing. This "secret" secondclosing often is done to avoid drawing theattention of the mortgage lender makingthe loan to the acquirer. The transactionmay violate mortgage terms such as a "dueon sale" clause.

Acquirers also have gained title by usingmortgage or judgment interests acquiredduring the foreclosure procedure. Someacquirers give (or promise) $50 oranother small amount to the homeownerfor a junior mortgage on the home, thusenabling the acquirer to obtain title at theend of the foreclosure redemption peri-od. Of course, this is a risky strategy if notcarefully executed, as another juniorcreditor may gain title by paying all sen-ior lien holders. Acquirers also have"created" judgments that allow them toredeem and purchase existing juniormortgages, mechanic liens, or judgmentsas a means of obtaining title.

The acquirer sometimes presents theentire transaction in the form of a writtencontract with the foreclosed homeowneroutlining the responsibilities of eachparty. These contracts usually specify thefees that the acquirer will obtain at dif-ferent points in the transaction.

(2) Reconveyance Interest

The form and terms of the reconveyancevary as well. The two common optionsthat acquirers use are reconveyance by acontract for deed and lease with a pur-chase option.18 In most states these twomechanisms have the advantage to theacquirer of allowing for rapid disposses-sion of any interest in the home on

default by the foreclosed homeowner-The contract for deed typically can becancelled within a short period. The pur-chase option of the lease is almost alwayspredicated on performance of the lease,thus allowing cancellation of the pur-chase option if the foreclosed homeown-er fails to make a timely rent payment.Both these options typically are struc-tured for a fairly short period before aballoon payment is due on the contractfor deed or the purchase option in thelease expires.

In the typical reconveyance transaction,the acquirer sets a repurchase price thatsubstantially exceeds the costs of acquir-ing the property but is below fair marketvalue. The foreclosed homeowner usuallypays rent or contract for deed paymentsthat exceed the acquirer's monthly carry-ing costs and almost always exceed themonthly payments that were due underthe mortgage in foreclosure. Thereforethe acquirer can profit from monthlypayments and the excess repurchaseprice should the homeowner actuallycomplete the terms of the reconveyanceand once again obtain title to the proper-ty. In Palmer v. Roberts, for example, theacquirer gave $95,000 in considerationto obtain title to the home and thenreconveyed it to the homeowner for$141,000, with monthly payments of over$s,!oo-more than the homeowner'sprior mortgage amount. 19

Acquirers have on occasion structuredother forms of the reconveyance, includ-ing life estates for elderly foreclosedhomeowners.

(3) Other Actors and Acquirer Mortgages

There also may be a transfer of title ormortgage interest prior to the grant of areconveyance interest to the homeowner.In this scheme, acquirers find investorsto whom they transfer title, either beforeor after the reconveyance. In other situa-tions the acquirer acts more like a bro-

181 use the term "contract for deed," which is synonymous with the following: installment land contract, long-term landcontract, installment sale contract, bond for deed, and land sale contract. See RESTATEMENT (THIRD) OF PROPERTY, MORTGAGES

§ 3.4 (1997).

19Palmer v Roberts, No. 04cv73635, 2005 WL 1631267, at *1 (E.D. Mich. July 6, 2005) (opinion and order denyingdefendant's motion for dismissal and summary judgment).



ker, bringing the foreclosed homeownerand the investor together to complete theentire acquisition and reconveyance. 2 0

Foreclosed homeowners often complainthat the investor is not made known tothem until the end of the process. Insome cases, the foreclosed homeownerlearns who actually took title only onbeing served an eviction notice.

A critical issue in dissecting many fore-closure reconveyance deals is the grant ofa mortgage by the acquirer (or investor).The financing that the acquirer orinvestor uses will determine when andwhether the acquirer obtains a mortgageand the form the mortgage takes. Someacquirers have sufficient assets, orfinancing in the form of a general line ofcredit, to complete the transaction with-out putting a lien on the home. Othershave a banking relationship with a finan-cial institution that understands that it isinvesting in a foreclosure reconveyancedeal and gives the acquirer a short-termmortgage. Some acquirers have no regu-lar source of financing and typicallyobtain mortgage refinancing at the timeof or prior to completing the recon-veyance. Others must rely on aninvestor's creditworthiness to obtain themortgage financing necessary to com-plete the transaction.

Tracking the proceeds of the mortgagefinancing also is important to understandthe transaction. Acquirers have obtained"front-end" payments that create positivecash flow for the acquirer at the beginningof the deal. For instance, when lenders pro-vide financing for 8o percent of the loanvalue, but the foreclosed mortgage andother liens and closing costs are less thanthis amount, there are proceeds to be dis-tributed at the closing. When the acquirertakes a deed to the property, uses the deedto complete the refinancing, and then latergrants a reconveyance interest to the fore-closed homeowner, the mortgage transac-tion is structured as a refinancing and theacquirer takes the closing proceeds as the

new "owner." When all the transactions(transfer of title to the acquirer, mortgagefinancing in the name of the acquirer,and reconveyance of interest to the fore-closed homeowner) occur simultaneous-ly at the closing, acquirers use a variety ofmeans to obtain some or all of the pro-ceeds, including (1) establishing a "saleprice" to the acquirer in the amount ofexisting liens against the property ratherthan fair market value, (2) creating a sell-er carryback note and mortgage (or atleast listing such on the HUD-1 (U.S.Department of Housing and UrbanDevelopment) financing statement), (3)assessing "fees" to obtain the proceeds,and (4) having the foreclosed homeown-er endorse the proceeds check to theacquirer following the closing. Thereremains the "back-end" payment whenthe acquirer obtains the remaining equi-ty in the property through eviction andresale.

21

Acquirers often use the same closingagent, title company, and mortgage bro-ker in repeated transactions. Given theoften specious nature of some aspects ofthe closing, this practice gives the acquir-er allies in convincing the foreclosedhomeowner that the transaction is beinghandled properly.

c. Dispossession-EvictionForeclosure reconveyance deals arealmost always straightforward equitylending. The acquirer seldom engages inany form of underwriting to determine ifthe foreclosed homeowner has the capac-ity to meet the obligations required tocomplete the reconveyance. Not surpris-ingly, as a result, the homeowner is oftenunable to meet the terms for recon-veyance and the acquirer takes posses-sion of the home. In some cases, acquir-ers design the plan to fail so that they cantake control of the property and liquidateremaining equity.

A lease can usually be terminated morequickly than a mortgage or even a con-tract for deed. A default on the lease also

2 0lnvestors' participation and culpability vary widely, from full participation in the sale and structuring of the deal to vic-timization by an acquirer who saddles them with a mortgage in excess of the property's value-and everything inbetween.

21The grant of a mortgage by the acquirer raises, for the foreclosed homeowner's attorney, legal issues that are beyond

the scope of this article,



allows the acquirer to terminate the pur-chase option. A few acquirers haveattempted to make transactions lookmore likely to succeed by initially placingthe rent or contract for deed payments inescrow, although this does little to help aforeclosed homeowner who must findsufficient funds to complete the purchaseoption or make the contract for deed bal-loon payment in order to regain title.

In the remainder of this article I identifyand analyze legal theories that advocates canuse to protect homeowners subject to fore-closure equity- stripping schemes and, inparticular, reconveyance transactions. I setforth three legal claims commonly used inforeclosure equity- stripping cases (II). Ibriefly catalog other statutory and com-mon-law theories to consider when advo-cating for foreclosed homeowners subjectto equity stripping (III). For the sake ofreducing a hopelessly complex subject to amanageable topic, the legal theories I pres-ent below are for the most part predicatedon the assumption that the transactioninvolves a single "acquirer" who is the pri-mary solicitor of the foreclosed homeownerand who takes title and completes thescheme by a reconveyance of an interest inthe home to the foreclosed homeowner.32

II. Primary Legal Theories toChallenge ForeclosureEquity-Stripping Transactions

Despite growing legislative interest, asof the end of 2oo5 only five states(California, Georgia, Maryland, Missouri,and Mirmesota) had legislation regulatingcertain purchasers of foreclosure proper-

ties or foreclosure consultants.2 3 A prac-

titioner confronted with a problem in one

of these states should determine if the lawapplies in the client's situation. In anyevent, three legal theories are commonlyused in foreclosure equity- strippingcases: (s) equitable mortgage, (2) theHome Ownership Equity Protection Act,and (3) state laws on unfair and deceptiveacts and practices.

A. Equitable Mortgage

The doctrine of equitable mortgageallows courts to look past the formal sale-reconveyance documents and, in certaincircumstances, to characterize the entiretransaction as a mortgage refinancing. Asuccessful equitable mortgage argumentcan offer several benefits to foreclosedhomeowners who enter into recon-veyance transactions.

1. Establishing anEquitable Mortgage

'"A court of equity will look to the substanceof the transaction over the form to ascertainthe intentions of the parties" in determin-ing whether to find an equitable mort-gage. 2 4 The parties' intent is the touch-stone, but "specific mortgage -negatinglanguage in conditional sale transactions"is not dispositive of intent. 2 5 Rather, inascertaining whether a transaction shouldbe treated as an equitable mortgage, courtshave looked to a variety of other factors asevidence of the parties' intent.

The Restatement of Property (Third) setsforth seven factors for consideration indetermining whether a reconveyance

2 2 Even if the facts confronting the practitioner differ from this model, the legal theories likely apply in some form, albeitwith different claims against different actors. In this article I do not address at least three types of other legal problemsthat often confront practitioners in foreclosure reconveyance cases. First, some foreclosed homeowners do not seek helpuntil they face eviction or imminent likelihood of such proceedings. This situation can raise the problem of how to assert,in a court whose jurisdiction is limited to determining the propriety of the eviction demand, the foreclosed homeowner'sclaim that the transaction should be rescinded. Second, and perhaps most important, a number of issues arise when theacquirer or investor grants a mortgage interest as part of the financing of the transaction-an interest that often precedesthe reconveyance interest of the foreclosed homeowner. The foreclosed homeowner then confronts the problem of inval-idating or coping with this mortgage interest. There also are concerns with fraud or breach of contract with the mort-gagee when the acquirer reconveys an interest to the foreclosed homeowner without the mortgagee's knowledge, Third,a recent trend is for acquirers to establish trusts to which the foreclosed homeowner transfers title and from which thehomeowner receives the reconveyance.

2 3See infra II.A. 1

2 4Thomas C Homburger & Brian P Gallagher, To Pay or Not to Pay: Claiming Damages For Recharacterization of SaleLeaseback Transactions Under Owner's Title Insurance Policies, 30 REAL PROPERTY, PROBATE At. TRUST JOURNAL 443 (1995)2 5

RESTATENIEtT (THIRD) OF PROPERTY MORTGAGES § 3,3 cmt d (1997).

Clearinghouse REVIEW Journal of Poverty Law and Policy a March-April 2006614


transaction is an equitable mortgage. 2 6

The Restatement's comments and illus-tration make clear that foreclosurereconveyance is exactly the type of trans-action that falls within this doctrine andspecifically describe both sale-contract-for-deed deals and sale -leaseback-with-option arrangements as possible equi-table mortgages.2?7 One commentatorrecently identified fifteen factors thatcourts have used in construing equitablemortgage claims and noted that courtswere not consistent on which factorswere deemed relevant or how to weighthem.28

Foreclosure reconveyance transactionsfrequently contain the following factsthat can help establish an equitablemortgage: (1) the acquirer's statementsthat the purpose of the deal is to help thehomeowner save or stay in the home; (2)a substantial difference between theprice of the conveyance to the acquirerand the property's fair market value, anda difference between the repurchaseprice and market value; (3) retention bythe foreclosed homeowner not only ofpossession but also of the obligations andprerogatives of ownership, such as payingtaxes and insurance and being responsi-ble for repairs; (4) the complexity of thetransaction coupled with a substantialdisparity in sophistication of the parties;

and (5) a prior relationship between thehomeowner and the acquirer or associat-ed people regarding promises orattempts at a more traditional refinance.

Several courts have found an equitablemortgage in foreclosure reconveyancetransactions, including sale-leasebackdeals, or rejected judgment for thedefendant as a matter of law for thesetransactions.? 9 In the Rowland casedescribed above, the court rejecteddefendant's motion to dismiss the equi-table mortgage argument despite saledocuments clearly stating that the home-owner was selling and then leasing backthe home. In reaching this conclusionthe court particularly noted the unequalbargaining power of the parties. 3 o

Although especially well-suited to manyforeclosure reconveyance transactions.proving an equitable mortgage can be anuphill battle for the seller-grantee (theforeclosed homeowner in the context ofthis article). 3' Some courts require theseller-grantee to prove the existence ofthe equitable mortgage by clear and con-vincing evidence. 2 By contrast, underboth the Restatement and several statestatutes, the seller may use parol evi-dence to prove the true intent of thetransaction in the face of contrary writtendocuments.

3 3

2 6 1d. § 3.3(b). The seven factors are (1) statements of the parties; (2) substantial disparity between the value received bythe grantor and the fair market value of the real estate at the time of conveyance; (3) terms on which the grantor maypurchase the real estate; (4) grantor's retention of possession; (5) grantor's continued payment of real estate taxes, (6)grantor's postconveyance improvements to the real estate; and (7) nature of the parties and their relationship before andafter the conveyance. Section 3.2 of the Restatement is similar but deals with transfers of deed without the conditionalresale that is characteristic of a foreclosure reconveyance transaction.

2 71d., illus. 3-7.

28john C. Murray, Recharactenzation Issues in Sale-Leaseback Transactions, PROBATE ANO PROPERTY, Sept.-Oct. 2005, at 18-

19.

2 9See Brown v Grant Holding, 394 F Supp. 2d 1090 (D. Minn. 2005); James v Ragin, 432 F. Supp. 887 (WD N C 1977);

Hrubyv Larsen, No 05-894, 2005 WL 1540130 (D Minn. June 30, 2005) (unpublished) (granting preliminary injunctionto homeowner); Rowland v Haven Properties Limited Liability Company, No. 05c1957, 2005 WL 1528264 (ND III. June24, 2005) (memorandum opinion and order unpublished) (rejecting defendant's motion to dismiss); Gagne v Hoban, 159N.W.2d 896, 899-900 (Minn. 1968) (upholding lower court finding of equitable mortgage in a farm foreclosure recon-veyance); Smith v Potter, 406 So. 2d 1231 (Fla. Dist. Ct App. 1981).

30 Rowland, 2005 WL 1528264, at *3-5.

3 1Murray, supra note 28, at 19.

3 2RESTATEMENT (THIRD) OF PROPERTY- MORTGAGES § 3.3(b) (1997).

3 31d. § 3,3(a); see also Kibe, supra note 9, at 262 (collecting statutory cites)


toreciosure tquity btripping

2. Using the Equitable MortgageDoctrine to Help the ForeclosedHomeowner Recover Title

Establishing an equitable mortgageoffers the foreclosed homeowner severalbenefits. The obvious and direct resultwill be that the homeowner is held toretain title and gains the right to anotherforeclosure procedure. As an indirectresult, the homeowner may find it mucheasier to assert a variety of other claims,including usury and protection undervarious federal and state consumer cred-it statutes and state mortgage licensinglaws. 3 4

B. Home Ownership EquityProtection Act

The federal high-cost loan law, the HomeOwnership and Equity Protection Act(Hoepa), provides a useful tool in manyforeclosure equity-stripping cases. 3 5 Inmost such cases, whether your client hasa Hoepa claim will depend on whetherthe loan qualifies as a Hoepa loan-if itdoes, proving liability typically will beeasy. Hoepa then offers powerful statuto-ry remedies for the homeowner.

1. Qualifying as a Hoepa LoanA Hoepa loan is "a consumer credittransaction that is secured by the con-sumer's principal dwelling" that meetscost and annual-percentage -rate trig-gers. 3 6 Below I discuss several elementsof this definition in greater detail; I alsoaddress the requirement that the lenderbe defined as a "creditor" under Hoepa.

a. "Consumer Credit""Consumer credit" under Hoepa means"the right to defer payment of debt or toincur debt and defer its payment." 3 7 A

loan is likely to be consumer credit for

Hoepa purposes if the underlying trans-action is found to be an equitable mort-gage or if the transaction is a recon-veyance in which the returned interestinstrument is a contract for deed.

The "credit" definition presents more ofa concern when the repurchase part of areconveyance scheme is a lease withoption to purchase. Staff Commentary toRegulation Z, however, makes clear that alease can be a credit sale if the consumer"assumes the indicia of ownership." 3 8 Inmany lease options with these schemes,the consumer does exactly that-some-times agreeing to perform all mainte-nance, pay real estate taxes and home-owner's insurance, or assume similarownership obligations.

b. "Secured by the Consumer'sPrincipal Dwelling"

If the foreclosed homeowner can establishan equitable mortgage, the arrangementobviously will qualify as a transaction"secured by the consumer's principaldwelling." If an equitable mortgage is notestablished, or as an alternative argumenton motion, the transaction still might beconsidered as securing a consumer's prin-cipal dwelling. The language of Section16ow(aa) of Hoepa does not require that thecredit extended be a mortgage. In particu-lar, reconveyance deals in which the repur-chase is through a contract for deed likelyqualify. The Staff Commentary to Section!26.2(a)(24) of Regulation Z, which relatesto "residential mortgage loans," specifi-cally mentions contracts for deed as atype of loan secured by a dwelling. 3 9

Note that the definition of a 16 o2i(aa)loan also specifically excludes "residen-

3 4See infra III.A.4 (usury), II.B (federal consumer credit statutes including the Home Ownership Equity Protection Act

(Hoepa) and the Truth in Lending Act (TILA)), III.A.2 (state mortgage licensing laws), and Ill A 3 (other state consumer cred-it statutes).

3515 US.C. § 1639 (1994) The terms of TILA, Hoepa's statutory parent, 15 U.S.C. §§ 1601 (1976) et seq., are woveninto many Hoepa requirements. Both laws are implemented in Regulation Z, 12 C.FR § 226 (2001), with Hoepa regula-tions in Sections 31-32 and 34. For readers seeking a more nearly complete analysis of the basics of Hoepa and TILA, seeELIZABETH RENUART & KATHLEEN KEEST, NATIONAL CONSUMER LAW CENTER, TRUTH IN LENDING ACT (5th ed 2003)

3615 U.S.C. § 1602(aa) (1994).

3712 C.F R § 226.2(a)(12) (2001), which incorporates the term "credit" defined under 15 U.S.C § 1602(e) and 12 C.F.R§ 226.2(a)(14) (2001).

38Regulation Z, 12 C.FR. § 226.17 (2001) Official Staff Commentary § 226 17(a)(1)-7.

3 9Official Staff Commentary § 226.2(a)(24) n.5.



tial mortgage transactions," defined as "atransaction in which a mortgage, deed oftrust, purchase money security interestarising under an installment sales con-tract, or equivalent consensual securityinterest is created or retained against theconsumer's dwelling to finance theacquisition or initial construction of suchdwelling."4' The acquirer may argue thatthe reconveyance of the property includ-ed money for "acquisition" of the home,but the Staff Commentary specificallyrejects this notion, stating that "a trans-action is not 'to finance the acquisition'... if the consumer had previously pur-chased the dwelling and acquired sometitle."4 1

c. TriggersThe foreclosed homeowner also mustestablish that the loan meets one of theHoepa triggers of 8 percent of the loanamount in "points and fees" or an annualpercentage rate exceeding a comparableTreasury yield by 8 percent for a first lienloan. 4 2 In a reconveyance transaction,this problem usually can be analyzed inthree steps.

(1) Do the repurchase charges meet either trig-ger? Consider whether the repurchaseportion of the transaction, standingalone, meets either trigger. As to theannual -percentage-rate trigger, notethat the base rate for determining thetrigger is the market rate for a Treasurysecurity with a -comparable period ofmaturity."4 3 If the repurchase isthrough a contract for deed with a bal-loon payment, or through an option torepurchase with a time limit, then thecomparable Treasury note rate shouldbe for this shorter period (and thuspresumably lower).

(:) Does the unified transaction meet thepoints-and-fees trigger? If the repur-

chase portion alone does not clearlymeet one of the two triggers, calculatepoints and fees by considering the saleand repurchase as one unified transac-tion. Add all the costs from the sale andrepurchase to see if point and fees total8 percent of the loan amount. Again, ifthe transaction is an equitable mort-gage, all costs can be aggregatedbecause the sale portion of the transac-tion is construed as providing a securi-ty interest for the repurchase "loan."Otherwise, the argument shifts towhether the sale costs are "points andfees" within the meaning of Section226.32(b). This section defines "pointsand fees" to include a noninterest"finance charge" as defined underSection 226.4; the "finance charge"includes "any charge payable directlyor indirectly by the consumer andimposed directly or indirectly by thecreditor as an incident to or a conditionof the extension of credit."4 4 The costsincurred by the foreclosed homeownerin the sale agreement certainly wouldappear to be incident to, or a conditionof, the overall transaction. 4 5

(3) Treat lost equity as a finance charge. Ifthe points-and-fees trigger is notestablished when the sale and repur-chase are considered components ofone transaction, determine whetherlost equity can be construed as afinance charge. Usually the acquirerstructures the deal to capture a profitby creating a difference between thehomeowner's "sale" price for theproperty and a much higher repur-chase price, in case the foreclosedhomeowner completes the repur-chase. This difference arguably is afinance charge. The definition offinance charge in Section ?26.4includes charges payable "indirectly"

4015 U.S.C. § 1602(w) (1994) and 12 CFR. §226.2(a)(24) (2001)

4 1Official Staff Commentary § 226.2(a)(24) n.5.

4212 CF.R § 226,32(a)(1)(i) (2001). The annual percentage rate must be in excess of 10 percent if the loan is a subordi-

nate lien. Id.

431d.

44/d. § 226.4(a)

4 5See NCLC Report, supra note 8, §§ 2.5,2, 2.5.3, 3.6 4 The definition of "points and fees" is broader than the rule for

which loan charges constitutes a finance charge Cf. 12 C.FR §§ 2264, 226 32(b)(1) (2001)

Clearinghouse REVIEW Journal of Poverty Law and Policy v March-April 2006


by the homeowner or imposed "indi-rectly" by the creditor. Because thelower sale price was a necessary predi-cate to the repurchase part of the trans-action, this lost equity can be held as anindirect charge that the foreclosedhomeowner pays to repurchase thehome. Whether this amount is charac-terized as points and fees or as "financecharge" probably will not matter onceit is determined to be a finance charge.In the latter case, this finance chargeamount added to existing interest pay-ments likely will cause an annual per-centage rate in excess of the trigger.

d. "Creditor"Hoepa imposes requirements only on a"creditor"-one

(A) who regularly extends consumercredit that is subject to a financecharge or is payable by written agree -ment in more than 4 installments(not including a down payment), and(B) to whom the obligation is initial-ly payable, either on the face of thenote or contract, or by agreementwhen there is no note or contract.4 6

(W "Regularly Extends Credit"

Compared to the Truth in Lending Act(TILA), Hoepa substantially relaxes thestandards for who qualifies as a personregularly extending credit.47 UnderHoepa, one is a creditor if "in any 12-month period, the person originatesmore than one credit extension that issubject to the requirements of§ z6.3g orone or more such credit extensionsthrough a mortgage broker."4 8

In some cases it may be easy to determinethat the transaction was accomplishedthrough a traditional mortgage broker,thus making it unnecessary to discoverany other loan transactions conducted bythe acquirer. Other cases may haveinvolved an intermediary between theacquirer and the foreclosed homeowner,but that this person acted as a mortgagebroker is less clear. Hoepa andRegulation Z do not define "mortgagebroker." A federal district court recentlyissued a preliminary injunction andfound that a person who acts to assist atraditional refinance in the beginning ofa transaction is a broker for Hoepa pur-poses even if the eventual transactiontakes the different form of a recon-veyance deal. 4 9

If the transaction was not "through amortgage broker," the foreclosed home-owner must meet the alternative defini-tion: that the acquirer conducted at leastone other Hoepa transaction not througha mortgage broker "in any 1z-monthperiod" or otherwise meets the generaldefinition of regularly extending creditunder TILA.5 ° Many acquirers do notengage in a large number of transactions,or at least their other transactions may bedifficult to find and classify as an exten-sion of Hoepa credit. Conducting discov-ery or searching public records to locateother deals in which the acquirer took aninterest in real estate, and investigatingthose transactions, may be necessary.

(2) "To Whom the Obligation IsInitially Payable"

4615 U S.C. §§ 1635 (1995), 1639 (1994), 1640-41 (1995), 12 C.FR 226.2(a)(17). See also 15 U.S.C. § 1602(f ) (1994).

The language referring separately to high-cost loans in the definition of "creditor" in 15 U.S. C. 1602(f) (1994) arguably

changes and loosens the two-part requirement in the former part of this subsection. This argument was expressly reject-

ed in Viernes v. Executive Mortgage Inc., 372 F Supp. 2d 576 (D. Haw. 2004).

4 7The general TILA requirements are stated in note 3 to 12 C.FR. § 226,2(a)(17): the person must have extended credit

either more than twenty-five times in the preceding (or current) calendar year or more than five times for transactionssecured by a dwelling in the preceding (or current) calendar year.

4812 C FR. § 226.2(a)(17) n.3 (2001).

4 9Hruby v. Larsen, 2005 WL 1540130 (D. Minn. 2005). The court relied on a dictionary definition of a mortgage broker

as "[a]n individual or organization that markets mortgage loans and brings lenders and borrowers together" in reaching

its result BLAck's LAw DICTIONARY 206 (8th ed. 2004). Many states, including Minnesota, define mortgage broker in a

licensing statute, although nothing requires a court to use this definition for Hoepa purposes.

5 0See supra note 47 The language "in any 12-month period" is broader than the temporal reference for determining

creditor status for non-Hoepa TILA loans. Whether one could successfully argue the literal translation of this provision Is

unclear -e.g., that two such Hoepa loans in a twelve-month period three years ago are sufficient to bring the iender

within the TILA definition of creditor, or if the two loans must be within the current twelve-month period

Clearinghouse REVIEW Journal of Poverty Law and Policy u March-April 2006


Advocates must identify correctly the partywho is potentially liable as a creditorunder Hoepa. The definition of "creditor"is restricted to the person "to whom theobligation is initially payable." In particu-lar, under Hoepa, the repurchase seller,not the acquirer, is the proper party in areconveyance transaction where these twoactors are different, that is, where theacquirer obtains title and then flips theproperty to an "investor" or other personwho takes title and acts as the reseller ofthe house to the foreclosed homeowner. 5 1Once the appropriate creditor is deter-mined, Hoepa has special assignee liabili-ty provisions that make most assigneesalso liable for all conduct and omissions ofthe creditor, including but not limited toHoepa violations.59

2. Hoepa LiabilityUnless the acquirer is sophisticatedenough to structure the transaction care-fully, a transaction that qualifies as aHoepa loan likely violates Hoepa. Forforeclosed homeowners, Hoepa offersthree types of protection: (1) additionaldisclosures beyond TIA requirements,(2) prohibited loan terms, and (3) prohi-bitions on ancillary conduct related tothe loan.53 In equity- stripping cases theadvocate should generally focus on

* the additional disclosure requirements, 5 4

" the prohibition against balloon pay-ments within the first five years,55

" the prohibition on extending creditwithout regard to the homeowner'sability to pay the loan obligation,5 6 and

* the limits on use of proceeds to pay ahome improvement contractor.57

3. Hoepa RemediesA Hoepa violation gives the homeownermost of the same remedies that are avail-able in any TILA case, including actualdamages, attorney fees, and a statutorypenalty of $?oo to $2,oo0.5 8 Hoepa pro-vides an important remedy of "an amountequal to the sum of all finance chargesand fees paid by the consumer, unless thecreditor demonstrates that the failure tocomply is not material."5 9 In some equi-ty-stripping transactions, this remedymakes it possible to recover money orcancel indebtedness sufficient to allowthe homeowner to recover lost equity orobtain legitimate refinancing or both. Allof these remedies are available only if thehomeowner files an action within therestricted limitation period of one yearfrom the date of the violation. 6 o

The other important remedy availableunder Hoepa is the right to rescind theloan. This right is available if the creditorviolated the disclosure and limitationrequirements in Section 226.32 but notthe conduct prohibitions in Sectiona26.34. 6While rescission is a powerfulremedy, rescission in foreclosure recon-veyance transactions often presents the

51See supra I.B.2.b.3. In this situation the acquirer might be characterized as a mortgage broker for purposes of deem-ing the investor a creditor under Hoepa.

5215 U.S.C. § 1641(d) (1994). See RENUART & KEEST, supra note 35, § 9.7.

5312 C.FR. §§ 226.32(c) (2001) (additional disclosures), 226.32(d) (loan terms), 226.34 (ancillary conduct).

5412 C.FR. §226.32(c) (2001). The face of the paperwork typically will establish whether the acquirer has complied withthese requirements.

5 51d. § 226.32(d)(1).

5 6/d. § 226,34(a)(4). The language of this section includes "a presumption that a creditor has violated this paragraph

(a)(4) if the creditor engages in a pattern or practice of making loans subject to section 226 32 without verifying and doc-umenting consumers' repayment ability." Many acquirers do not engage in any form of underwriting. The "pattern andpractice" requirement may be met by showing that the acquirer does not routinely collect from foreclosed homeownersany information about repayment ability.

5 71d. § 226.34(a)(1).

5815 U S.C. § 1640(a)(1), (2)(A), (3) (1995).

5 9/d. § 1640(a)(4).

6 01d. § 1640(e). But see RENUART & KEEST, supra note 35, § 9.6. 1.

6112 C.ER. §226.23(a)(3) n.48(2001), See RENUART & KEEST, supra note 35, § 9 5.9


roreumosure Equixy Ermpping

difficult issue of how to tender the bal-ance owed on the rescinded financing.6 2

4. TILA Violations and RemediesThe attorney for the foreclosed home-owner may also want to consider assert-ing a TILA violation, especially if thetransaction does not qualify as a Hoepaloan or if rescission would be a usefulremedy but is not available for the Hoepaviolation. If the foreclosed homeownercan prove that the transaction qualifies asa Hoepa loan, then the acquirer or otherpotentially liable person is a "creditor"for all purposes under TILA and the loanis likely subiect to TILA disclosurerequirements. 6 3 A TILA violation givesrise to a right of rescission with a three-year limitations period for the rescissionclaim. 6 4 If Hoepa does not apply, theforeclosed homeowner must establishthat the acquirer (or other person "towhom the obligation is initially payable")meets the more difficult general TILAdefinition of a creditor who "regularlyextends credit."65

C. State Unfair and Deceptive Actsand Practices Laws

To catalog the myriad misrepresentationsthat may occur during equity-strippingschemes is impossible. For the more bla-tant scams, a common-law fraud or stateunfair and deceptive acts and practices(UDAP) claim is obvious, such as when theacquirer tells the homeowner to signpaperwork in order to "start the refinanc-ing," but actually obtains and records adeed, and the homeowner is unaware of nolonger being the record owner of thehome. 6 6 In many reconveyance schemes,however, the deception is palpable but dif-ficult to articulate. In this section I brieflycover (1) framing the problem, (2) com-mon misrepresentations and deceptiveschemes, and (3) the defense of contrarywritten documents.67

1. Framing the ProblemPart of an effective UDAP or common-law fraud argument is offering a contextfor why this type of real estate transactionis unique and the deception egregious.Many judges instinctively look only at theface of the executed real estate docu-ments and dismiss a fraud or UDAPclaim. Framing the circumstances of thetransaction in compelling and sympa-thetic terms can establish that the equi-ties lie in favor of the foreclosed home-owner and can help overcome judicialinclination not to look beyond the docu-ments. Factors to consider are the fol-lowing:

m Acquirers Targeting Homeowners withEquity. These deals are schemes thatacquirers actively sell, not real estatetransactions the homeowner seeks out.The acquirers usually seek out home-owners with significant equity.

* Emotional Distress of Foreclosed orVulnerable Homeowners. In addition tosevere financial distress, many fore-closed homeowners experience unusu-al emotional distress related to the par-ticular home. It might be a familyinheritance where the homeownersraised or are raising their children andfear appearing to be failures to theirchildren. Homeowners might be thefirst in their extended family to ownproperty. People who are elderly, ill, ormentally disabled have been dispro-portionately victimized by theseschemes.

* Trust. Acquirers often consciously cre-ate and then misuse a sense of trust totake advantage of the homeowner. Thisis especially relevant when the caseinvolves affinity marketing, such asappeals based on shared faith or race.Some acquirers also routinely tellhomeowners that they once faced fore-

6 2 See RENUART & KEEST, supra note 35, § 6.8.

6315 US.C. § 1602(f) (1994); 12 C.FR 226 2 (a) (17) n.3 (2001).

64 5 U.S.C. § 1635 (a), (f) (1995).

6 55See supra II.B. 1 d.(1).

6 6 See, e.g., Eitcher v Mid America Financial Investment Corporation, 702 N.W.2d 792, 804 (Neb 2005)

671n some jurisdictions, unfair and deceptive acts and practices (UDAP) laws do not cover real estate transactions. SeeJONATHAN A SHELDON & CAROLYN L. CARTER, UNFAIR AND DECEPTIVE AcTS AND PRACTICES § 2 2 5 (6th ed 2004)



closure and are offering the transactionas a means of helping others facingforeclosure.

" Complexity. These transactions arecomplex even for many lawyers tounravel. Foreclosed homeowners, maybe less sophisticated than the averagehomeowner, and many are vulnerabledue to mental or physical incapacities.

* High -Pressure or Nonexistent Closing. Manyacquirers either fail to have a formal clos-ing or conduct a closing with an affiliatedor friendly closer who supports theacquirer's high-pressure tactics.

" Aura of Sham Transaction. There often issomething repugnant about the processthat acquirers use to complete the deal.For example, when the acquirer gets adeed and promptly transfers the propertyto an allied "investor" for a higher price,one can call this a "strip and flip." Howsuch an acquirer posed as a rescuer butintended only to take advantage of adistressed homeowner is worthdescribing to the court. That theacquirer learned the approach at a get-rich-quick seminar, that the initialintroduction to the acquirer was ahard-sell door-to-door solicitation,that the acquirer used a sham mortgageto take title, or that the acquirerassumed almost no risk are all factsthat can help frame the transaction interms sympathetic to the homeowner.

m Negative Effects on the Community.Taking advantage of foreclosed home-owners can exacerbate the negativecommunity effects from high foreclo-sure rates.

2. Common Representationsor Arguments

The following misrepresentations or decep-tive schemes have been alleged in multipleforeclosure equity- stripping cases:

S"'Save Your Home." This type of repre-sentation can be found false, deceptive,or misleading when the likely conse-

quence of the scheme is that the home-owner will lose all ownership interestand be evicted. Some important infor-mation to demonstrate includes thefollowing: (1) the acquirer engaged inno underwriting to determine whetherthe homeowner had sufficient incometo make the monthly payments; (2) thenet effect of the deal was a monthlypayment that exceeded the amount thehomeowner had previously beenunable to pay; (3) the acquirer hasbusiness plans or other informationaimed at investors that show an inter-est in gaining possession of the home;(4) the number of deals the acquirerhas entered and the outcome of thosedeals (e.g., few or no homeowners haveever been able to repurchase theirhomes from the acquirer); or (5) theacquirer's alacrity in evicting a fore-closed homeowner who is slightlybehind on payments. 6 8

* "Guaranteed Refinancing." Often theacquirer falsely promises to the fore-closed homeowner that the acquirerwill later provide or arrange the refi-nancing necessary to complete areconveyance.

* "Running the Clock" Refinance. Acquirersoften suggest that they are arranging arefinancing and then stall until thehomeowner has no option but to enterinto any sale-repurchase deal that ispresented at the last minute. Evidencethat may support this claim includesinstances where the acquirer (1) uses acompany name that suggests expertisein real estate financing (e.g., SmithHome Finance Corporation); (2)advertises the offer of refinancingassistance in the newspaper or in theinitial solicitation materials; (3) uses abusiness card that says "loan officer,""loan consultant," or the like; or (4)tells the homeowner not to talk to themortgage company or anyone else."Running -the -clock" also is a tacticthat occurs in cooperative ventures

6 8Traditional UDAP theories would apply to this claim, but so might a "false promise" common-law claim (or a statuto-

ry claim for states with a "consumer fraud act" version of a UDAP statute). False promise can be especially appropriatewhere the acquirer repeatedly makes false promises in the course of one or several transactions. See, e g., Motorola Corp.v. Uzan, 274 F Supp. 2d 481 (SD.NY. 2003); Chedick v Nash, 151 F3d 1077, 1081 (D.C Cir. 1998) (fraud by making apromise with lack of present intent to perform). Evidence of similar conduct can be admissible to prove intent. SeeJohnson v United States, 683 A.2d 1087, 1092-99 (D.C. 1996).



between acquirers and mortgage bro-kers who are paid for referrals. Whenthe acquirer offers compensation inexcess of that earned normally by amortgage broker, the broker has anincentive to let the homeowner believethat refinancing is proceeding and thento switch to the acquirer's foreclosurereconveyance offer when the redemp-tion period is nearing the end and thehomeowner has little or no choice.

* "Repurchase" Really a Lease (with orWithout Option). Acquirers may repre-sent that they will obtain refinancingfor homeowners or help homeownersretain ownership but then turn thehomeowners into renters in their ownhomes. Advocates can build a persua-sive UDAP claim centered on the factsthat the acquirer's representations ledthe homeowners to believe that theywould retain ownership and the actualdeal deprived them of ownership(except perhaps for an option to pur-chase). 6 9 This argument can be pre-sented as an alternative theory to anequitable mortgage claim that thetransaction is in substance a loan.

" Sham Mortgages. Many acquirers obtaintitle to the property at the end of theredemption period by creating a shammortgage, often $5o or $1oo, with theacquirer as the mortgagee. PossibleUDAP claims related to these mort-gages include claims that (i) theacquirer misrepresented to the home-owner the purpose and effect of themortgage (e.g., stating that "this is tostart your refinancing"); () the con-sideration for the mortgage was neverpaid; and (3) the sham mortgage wassigned along with other papers pre-sented to the homeowner and neveridentified as such or explained.

* Other Claims. Among the multitude ofother possible UDAP claims are false,

deceptive, or misleading statementsabout (1) the amount of monthly pay-ments due under a sale-repurchase (orleaseback); (2) the acquirer's assistanceto other homeowners in foreclosure: (3)the qualifications or certifications of theacquirer; (4) the purpose or effect of thedocuments in the transaction; (5) thecontents of the documents in the transac-tion (e.g., blank spaces filled in by theacquirer or a false statement that thehomeowner is not in possession of theproperty); (6) the amount or uses of themoney distributed to or for the allegedbenefit of the homeowner at closing(including false and misleading state-ments for the purpose of inducing thehomeowner to endorse closing proceedsto or for the benefit of the acquirer); and(7) the amount or nature of the fees in thetransaction.

3. Oral Misrepresentations Contraryto Written Terms

The most likely defense in foreclosureequity-stripping cases is that the acquirerproperly obtained and is following theterms of written contracts with the home-owner. Oral misrepresentations can beactionable, courts have repeatedly held,under state UDAP statutes in the face ofcontrary written representations evenwhen this defense operates to preclude acommon-law fraud claim. 70 The NebraskaSupreme Court rejected this defense in aforeclosure equity-stripping case. 7 '

Ill. Other Possible Claims AgainstParties Participating in theEquity-Stripping Transaction

Because of the wide variations in foreclo-sure equity- stripping schemes, the num-ber of other possible claims is nearlyendless. Below are brief descriptions ofclaims worth considering. Each has beenasserted in at least one foreclosure equi-ty-stripping case.72

6 9A related allegation might be that the acquirer promised a repurchase option but failed to deliver the option in the actualtransaction documents or that the acquirer offered an option to repurchase but on different and less favorable terms

70 Weigand v Walser, 683 N.W.2d 807 (Minn. 2004), see generally SHELDON & CARTER, supra note 67, §§ 4 2 15 2.4.2 15 4 (collecting cases).

7 1Eicher, 702 N.W2d at 804.

7 2Other legal theories that are not discussed in this section and may be of relevance include federal or state RICO (Racketeer

Influenced and Corrupt Organizations Act); common-law civil conspiracy; joint venture, intentional or negligent infliction of emo-tional distress, and common-law claims (some of ancient origin) related to the execution of the deed



A. Statutory Claims

Advocates should consider five possiblestatutory claims, federal and state,depending on the facts of the case, statelaw, and the client's needs.

1. State ForeclosureEquity-Stripping Laws

Of course, consider an action under statelaw if you are in a state that has a law deal-ing expressly with foreclosure consultingor foreclosure purchasing. Two states,Minnesota and Maryland, recentlyenacted similar laws directly addressingthe problems presented by foreclosureequity stripping.73 These laws compre-hensively regulate both "foreclosureconsultants' and "foreclosure pur-chasers." A foreclosure consultant underthese laws is a person who offers services,claims the ability to assist in stoppingforeclosure, or makes any of a variety ofsimilar representations.74

The foreclosure purchaser provisions ofthe Minnesota and Maryland laws aimdirectly at foreclosure reconveyanceschemes and define a "foreclosure pur-chaser" as a person who engages in fore-closure reconveyance transactions.75Among many other requirements andproscriptions, the laws prohibit the fore-closure purchaser from the following:entering transactions in which the fore-closed homeowner does not have a "'rea-sonable ability to pay" for the recon-veyance; failing either to reconvey theproperty or to pay the foreclosed home-

owner if proceeds from resale exceed acertain amount; and representing thatthe foreclosure purchaser is helping to"save the house" or making substantiallysimilarly representations. 76

Older state statutes exist in California,Georgia, and Missouri. Minnesota andMissouri modeled the foreclosure-con-sultant portions of their laws on California'sregulation of foreclosure consultants.California also regulates "equity pur-chasers."7 7 The California equity purchaserstatute primarily governs contract forma-tion, but it also shifts the burden of proof infavor of finding an equitable mortgagewhenever there is a foreclosure recon-veyance transaction.7 8 Although itsapproach is less comprehensive, Georgiahas incorporated into its state UDAP lawprovisions similar to those regulating equi-ty purchasers in California.79 Missouri, bycontrast, has a law with provisions similarto the foreclosure consultant portion ofCalifornia law.8 o

2. Unlicensed Real Estate orMortgage Origination Activity

An acquirer or associated parties often lackthe real estate or mortgage originator licen-sure required to complete the regulatedaspects of the transactions. 8 1 This unli-

censed conduct may give rise to a claim forviolation of the statute or might constitute aper se UDAP violation. 8

If the acquirer or other defendant islicensed, the advocate for the foreclosedhomeowner may consider the following:(1) an action under the licensure statute

73MINN. STAT. § 325N (2004); MD. CODE ANN., REAL PROP. §§ 7-301 to 7-321 (2005). I must note here that I was substan-

tially involved in drafting and lobbying for passage of the Minnesota law.

74MINN. STAT. § 325N01 (2004); MD CODE ANN., REAL PROP. § 7-301(b) (2005).

7 5MINN STAT. § 325N.10, subdiv. 4 (2004); MD. CODE ANN., REAL PROP. § 7-301(e) (2005).

7 6MINN. STAT, §§ 325N.1 7(a)(a), (b), (d)(3) (2004); MD. CODE ANN., REAL PROP. §§ 7-31 1(b)(1)(i), (b)(2), (b)(4)(iii) (2005).

7 7CAL. CIV. CODE §§ 2945-2945.11 (foreclosure consultants), 1695-1695.17 (equity purchasers) (2005).

78CAL, CIV. CODE § 1695.12 (2005).

7 9GA. CODE ANN. § 10-1-393(b)(20)(A) (2005),

8 0 Mo. ANN. STAT. §§ 407,935-.943 (2005).

8 1Ann Morales Olazabal, Redefining Realtor Relationships And Responsibilities. The Failure of State Regulatory

Responses, 40 HARVARD JOURNAL ON LEGISLATION 65 (Winter 2003) (noting that every state had a real estate licensing schemeby the end of the 1970s),

8 2 See, eg., Seligman v First National Investment Incorporated, 540 N E.2d 1057, 1064 (111, App 3d Div. 1989) See gen-erally SHELDON & CARTER, supra note 67, § 3 2,

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or for a per se UDAP violation based onviolation of the prohibitions or requiredconduct in the statute; (2) reporting theconduct to the licensing regulator; or (3)determining if a recovery fund existsthrough which to satisf any judgmentobtained in the action. t

3, Credit Services andCredit Repair Legislation

Acquirers often represent that their"services" or proposed actions helpimprove or at least avoid further deterio-ration in the homeowner's credit rating.Such claims may be actionable under thefederal Credit Repair Organizations Actor state credit services statutes. 8 4 Anadvantage of these laws is the generallysubstantial remedies and lengthy limita-tion periods. 8 5

4. UsuryStates typically allow regulated lenders tocharge a variety of rates, depending onthe lender and the nature of the transac-tions.8 6 Most states also have some formof general usury law, although the lawsvary tremendously in scope. 8 7 Thesegeneral usury statutes often cap rates atmuch lower levels than they allow regu-lated lenders to charge. In Minnesota, forexample, the general usury statute capsinterest rates as low as 6 percent com-pared to rate limits of about 2o percent ormore for most regulated lenders. 8 8 Inforeclosure equity-stripping cases, many

acquirers are not licensed lenders andthus may be subject to the stricter ratelimits of general usury laws. 8 9

5. Real Estate SettlementProcedures Act Antikickback

Acquirers often have various affiliates,such as mortgage brokers, to whom theymake payments that could be character-ized as compensation for referrals ratherthan services. Such payments might giverise to an antikickback claim under theReal Estate Settlement ProceduresAct.9' Unlike some other parts of thestatute, the antikickback provision con-fers a private right of action.91

B. Common-Law Claims

The five common-law theories belowhave been asserted in foreclosure equity-stripping cases.

1. UnconscionabilityA consistent characteristic of many fore-closure equity-stripping deals is that evencarefully documented transactions appearfundamentally unfair and shock the con-science. In these circumstances, advo-cates should consider claims of uncon-scionability. This equitable doctrinerequires consideration of the entirecourse of conduct underlying the transac-tion, including the process by which theparties entered into the deal and the termsand effect of the bargain. 9 2 The doctrine

8 3 See, e.g., MINN. STAT. § 82.43 (2004).

8415 U.S.C. §§ 1679-1679(j) (1996); for state statutes, see, e.g., OHIO REV. CODE ANN. §§ 4712.01-.99 (2006). For a com-

plete listing of state credit repair statutes, see ANTHONY RODRIGUEZ ET AL., FAIR CREDIT REPORTING, app. B.3 (Supp. 2005 ed.).

8515 U.S.C. § 1679g (1994) sets out credit repair remedies; these include a full refund of the greater of amounts paid or

actual damages, punitive damages, and attorney fees. State credit repair laws often have a right of rescission and incor-porate UDAP remedies. SHELDON & CARTER, supra note 67, § 5.1.2.2.3. The Credit Repair Organizations Act has a five-yearlimitation period; see 15 U.S.C. § 1679(i) (1996).

8 6See generally ELIZABETH RENUART & KATHLEEN KEEST, THE COST OF CREDIT. REGULATION, PREEMPTION AND INDUSTRY ABUSES ch. 9 (3d

ed. 2005).

87Susan Lorde Martin, Financing Litigation On-Line: Usury and Other Obstacles, 1 DEPAUL BUSINESS AND COMMERCIAL LAW

JOURNAL 85, 90-91 (2002) (stating that the typical elements of a usury claim are "(1) an agreement to lend money; (2) theborrower's absolute obligation to repay with repayment not contingent on any other event or circumstance; (3) a greatercompensation for making the loan than is allowed under a usury statute or the State Constitution; and (4) an intentionto take more for the loan of the money than the law allows").

88Compare MINN. STAT. § 334.01 (2004) and MINN. STAT. § 47.59, subdiv. 3 (2004).

89See, e.g., Browner v District of Columbia, 549 A.2d 1107 (D.C. 1988) (upholding criminal usury conviction for fore-

closure equity scam).

9012 U.S.C. § 2607 (2003).

9 11d. § 2614.

9 2See generally RESTATEMENT (SECOND) OF CONTRACTS § 208 (1981).

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has been successfully used by homeown-ers in mortgage transactions. 93

Most courts look at unconscionable con-duct in two parts: procedural and sub-stantive. Procedural unconscionabilityfocuses on the relative bargaining powerand fairness of the bargaining process,while substantive unconscionabilityrefers primarily to the reasonableness ofthe ultimate terms of the contract. 9 4

Most courts require a finding of uncon-scionability in both parts, although somecourts use a more flexible determinationbased on either part or a combination ofthe two. 9 5 Advocates for foreclosedhomeowners should also consider therelated doctrines of good faith and fairdealing and contend that the agreementis void as a violation of public policy.96

The factors that courts often use toevaluate an unconscionabilityclaim include gross disparity inthe values exchanged ... ; belief bythe stronger party that there is noreasonable probability that theweaker party will fully performthe contract; knowledge of thestronger party that the weakerparty will be unable to receive sub-stantial benefits from the contract;knowledge of the stronger partythat the weaker party is unablereasonably to protect his interestsby reason of physical or mental

infirmities, ignorance, illiteracyor inability to understand the lan-guage of the agreement, or similarfactors.97

These factors obviously favor many fore-closed homeowners who assert uncon-scionability. In particular, more difficultforeclosure reconveyance cases often pres-ent the second factor listed above-that theacquirer knows that the foreclosed home-owner has no reasonable probability of per-forming on the contract.

In Brantley v. Grant Holdings a federal dis-trict court enjoined eviction of a home-owner and found a likelihood that thehomeowner would prevail on an uncon-scionability claim in a failed recon-veyance deal.9 8 The court concluded:

[A] desperate, ill informed andpoorly represented owner, led tobelieve she is on the brink ofhomelessness, cannot be said tohave freely entered into anagreement that was entirely one -sided, offered her no reasonablehope of successful performanceand at the same time deprivedher of her equitable and statuto-ry rights of redemption. 9 9

2. Unjust EnrichmentThe elements of an unjust enrichmentclaim also can vary by state but generallyare "(1) at plaintiffs expense (2) defen-

9 3 Family Financial Services Incorporated v Spencer 677 A.2d 479 (Conn. App. Ct. 1996) Patterson v ITT ConsumerFinancial Corporation, 14 Cal. App. 4th 1659, 18 Cal. Rptr. 2d 563 (Cal. Ct. App. 1993); Williams v Aetna FinancialCompany, 700 N.E.2d 859 (Ohio 1998); Williams v First Government Mortgage and Investors Corporation, 974 F. Supp.17 (D.D.C. 1997), aff'd in part and remanded in part by 225 F3d 738 (D.C, Cir. 2000).

94For a general discussion and starting point distinguishing the concepts of procedural and substantive unconscionabili-ty, see JAMES J. WHITE & ROBERT S. SUMMERS, 1 UNIFORM COMMERCIAL CODE 208-33 (4th ed. 1995).

9 5See Maxwell v Fidelity Financial Services Incorporated, 907 P2d 51, 58-59 (Ariz. 1995) ("[W]e conclude that under

A.R.S. § 47-2302, a claim of unconscionability can be established with a showing of substantive unconscionability alone,especially in cases involving either price-cost disparity or limitation of remedies."). But see Harris v Green Tree FinancialCorporation, 183. F3d 173 (3d Cir. 1999) (recognizing courts generally require both procedural and substantive uncon-soonability before upholding a claim of unconscionability); see also Anderson v. Delta Funding Corporation, 316 F Supp.2d 554 (N.D. Ohio 2004) (finding procedural unconscionability alone insufficient to invalidate a clause on the basis ofunconscionability).

9 6 See RESTATEMENT (THIRD) OF PROPERTY (MORTGAGES) § 6.2 (1997) (citing RESTATEMENT (SECOND) OF CONTRACTS § 205 (1981)). Butsee Barasso v Rear Still Hill Road Limited Liability Company 81 Conn. App 798, 807 n. 5 (Conn. App. 2004). (noting that"special defenses and counterclaims alleging a breach of an implied covenant of good faith and fair dealing .. are notequitable defenses to a mortgage foreclosure" (internal quotation marks omitted)),

9 7RESTATEMENT (SECOND) OF CONTRACTS § 208 cmts. c-d (1981).

9 8Brantley v Grant Holdings, No. 03-6098 (D. Minn. Dec. 23, 2003) (order granting preliminary injunction)

9 9/d. at 17.



dant received benefit (3) under circum-stances that would make it unjust fordefendant to retain benefit without pay-ing for it."1 0 0 Often misunderstood,unjust enrichment and restitution aresynonymous and constitute a legal theoryof liability, not merely a remedy. The lawof unjust enrichment is designed for sit-uations in which a party takes a benefitwithout legal right and yet the aggrievedparty has no remedy at law.1 0 1 This canbe an excellent description of the eventsexperienced by a homeowner in an equi-ty- stripping case.

3. Breach of ContractReconveyance transactions can be basedon elaborate written contracts. Simplebreach of contract is a possible claimespecially when the acquirer has drafteda contract specifying all the terms of thereconveyance deal. These contracts canbe unusually complex, or just obtuse, andthis makes it more likely that the acquir-er has committed a material breach.Contract ambiguities, of course, will beconstrued against the acquirer as drafterof the agreement.

4. Title Claims: DeclaratoryJudgment; Quiet Title;Slander of Title; Injunctive Relief;Constructive Trust

A foreclosed homeowner who realistical-ly seeks to regain title to the home shouldprobably assert a claim that allows thecourt to transfer title to the homeowner.The appropriate claim will depend on thefacts of the case, the registration status ofthe property, and state law. Filing a noticeof lispendens or other formal recording ofan adverse claim also may be appropriateat the outset of many cases.

5. Breach of Fiduciary DutyAs noted previously, acquirers haveclaimed special expertise in dealing withcomplex foreclosure problems and alsohave attempted to elicit trust by the fore -closed homeowners. Advocates mayestablish that the acquirer's sales repre-sentations create a fiduciary duty by theacquirer to the foreclosed homeowner.

Foreclosure equity stripping is not new, butit appears to be on the rise as a result ofsoaring home values coupled with contin-ued high foreclosure rates. Generalizingabout appropriate legal theories for com-bating the problem is difficult because ofwide variations in how the schemes areconducted. Many cases involve simplefraud. More often, the homeowner know-ingly enters into a transaction structured asa foreclosure reconveyance. In these casesthe practitioner should first determine if astate law regulates these transactions. Nextthe practitioner should consider three legaltheories most commonly used in thesecases: equitable mortgage doctrine; Hoepa;and UDAP laws. Numerous other theoriesalso may be useful depending on the facts ofthe case and the needs of the homeowner.

Author's Acknowledgments

I wish especially to thank Elizabeth Renuartfor her careful reading and comments, JimSugarman for his contributions to the arti-cle, David Nardilillo for his excellentresearch assistance, and Dan Tyson and hiscolleagues for comments and ideas.

10 0 University of Colorado Foundation v American Cyanamid Company, 342 E3d 1298 (10th Cir. 2003)

10 1

See generally RESTATEMENT (THIRD) OF RESTITUTION AND UNJUST ENRICHMENT §§ 1-4 (Discussion Draft 2000)

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