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Home Equity Lending Rules Clarified by the Supreme Court
Author: John M. Lynch & Grace Ann Gannon
Texas Supreme Court recently issued two landmark decisions addressing the home
equity provisions of the Texas Constitution. The cases are significant because
they reject what many courts and attorneys had considered to be
well-established constitutional interpretations.
Background: Consistent with Texas’s historically strong protections of the homestead, home equity loans secured by a borrower’s homestead were constitutionally prohibited in this state until 1997. When the legislature finally created exceptions to permit these types of loans, they imposed significant consumer protections on the processes for their origination and enforcement.
Among these protections is the Constitution’s command that home equity loans be made “without recourse for personal liability against each owner and the spouse of each owner.” These loans must also include a provision requiring the lender to “forfeit all principal and interest of the extension of credit” if the lender does not comply with its loan obligations and fails to correct its noncompliance within 60 days of being notified by the borrower. Finally, and perhaps most importantly, the Texas Constitution provides that “[n]o…lien on the homestead shall ever by valid unless it secures a debt described by this section”.
Prior to the Texas Supreme Court’s two most recent opinions, the most definitive interpretation of Texas’s home equity lending law had come from the United States Court of Appeals for the Fifth Circuit. In Priester v. JP Morgan Chase Bank, N.A., the court was presented with the question of whether a failure to comply with the terms of Article XVI, Section 50(a)(6) of the Texas Constitution in the origination of a home equity loan renders the lien securing that loan void or merely voidable. Priester v. JP Morgan Chase Bank, N.A., 708 F.3d 667 (5th Cir. 2013), cert. denied, 134 S. Ct. 196, 187 L. Ed. 2d 256 (2013). If the lien was deemed void, a cause of action based on the defect would not be subject to a statute of limitations and could be asserted at any time after origination.
The Fifth Circuit—issuing an Erie guess based on its interpretation of the Texas Constitution and existing case law—concluded that a failure to comply with the Texas Constitution renders the lien voidable. The court held that because the Constitution includes a “cure” provision permitting a lender to remedy a constitutional defect within 60 days of receiving notice from a borrower, a lien that fails to comply with Section 50(a)(6) is merely voidable, and is therefore subject to a four year statute of limitations running from the date of origination of the loan.
The Texas Supreme Court Speaks: The Texas Supreme Court was presented with this same question in Wood v. HSBC Bank USA, N.A., 14-0714, 2016 WL 2993923, (Tex. May 20, 2016). The borrowers in Wood brought suit against their lender and loan servicer, alleging that their home equity loan—which had closed more than eight years prior—did not comply with the Texas Constitution at origination. Both parties moved for summary judgment, and the trial court found in favor of the lender. The Court of Appeals affirmed, holding that liens securing constitutionally noncompliant home equity loans are voidable, and thus the residual four-year statute of limitations applied to bar the borrowers’ claims.
The Texas Supreme Court disagreed. Pointing to Tex. Const. art. XVI § 50(c)—which states that “[n]o… lien on the homestead shall ever be valid unless it secures a debt described by this section” (emphasis added)—the Court concluded that home equity liens securing constitutionally noncompliant loans are invalid until cured and thus not subject to the residual four-year statute of limitations. In reaching its conclusion, the Court rejected the Fifth Circuit’s theory in Priester that the existence of a cure provision in § 50(a) renders such liens voidable, not void. “A voidable lien,” reasoned the Court, “is presumed valid unless later invalidated.” And “[a] plain reading of the Constitution necessitates a finding that liens securing noncompliant home equity loans are not valid before the defect is cured.” Thus, no statute of limitations applies to a borrower’s request for cure or attempt to quiet title on constitutionally noncompliant home equity liens.
The Court Speaks – Part II: In Garofolo v. Ocwen Loan Servicing, LLC, the borrower sought to enforce the forfeiture provision of Section 50(a)(6), bringing suit in federal court based on her lender’s failure to provide her with a release of lien following satisfaction of her home equity loan as required by Tex. Const. art. XVI § 50(a)(6)(Q)(vii). She argued that her lender was required to forfeit all principal and interest paid over the life of the loan in accordance with Tex. Const. art. XVI § 50(a)(6)(Q)(x). After the district court dismissed her claims, the borrower appealed. The Fifth Circuit requested clarification by certifying the following two questions to the Texas Supreme Court:
(1) Whether the lender’s failure to deliver a release of lien amounts to a constitutional violation for which a constitutional forfeiture remedy applies; and
(2) If it does not, whether the borrower can seek forfeiture through her breach of contract claim absent actual damages.
The Supreme Court answered no to both questions. First, the Court concluded that the only constitutional right created by § 50(a)(6) is a defense to foreclosure where the loan is not compliant with the Texas Constitution. According to the Court, all other rights arising under Texas home equity loans are merely contractual rights. The Court held that the terms and conditions required in § 50(a)(6) for home equity loans are simply the terms and conditions that must be included in a home equity loan agreement for the loan to be foreclosure-eligible. Thus, while the failure to include a constitutionally mandated term or condition can be used as a defense to foreclosure, a lender’s failure to abide by those terms post-origination does not give rise to a separate constitutional claim.
The Court responded to the second question by concluding that a borrower can seek forfeiture through a breach of contract claim only if they show actual damages. The Court explained that a borrower whose home equity loan agreement includes the forfeiture provision required by § 50(a)(6)(Q)(x) may seek forfeiture through a breach of contract claim, but only if one of the six corrective measures outlined in § 50(a)(6)(Q)(x) would actually correct the lender’s failure to comply with its loan obligations, and the lender fails to perform the corrective measure within 60 days of being notified.
In reaching its conclusion, the Court pointed out that § 50(a)(6)(Q)(x)’s forfeiture remedy is only available to a borrower under certain circumstances—specifically, when a lender fails to correct its failure to comply by employing one of six specific corrective measures. Here, the lender’s failure to provide a release of lien could not have been cured by one of § 50(a)(6)(Q)(x)’s corrective measures, and thus the forfeiture remedy was unavailable. As stated by the Court, “If performance of none of the corrective measures would actually correct the underlying deficiency, forfeiture is unavailable to remedy a lender’s failure to comply with the loan obligation at issue.”
While the full ramifications of Wood and Garofolo have yet to be seen, these cases constitute a fundamental change in our understanding of Texas home equity lending law. Stay tuned for additional analysis from SettlePou’s attorneys regarding the litigation, lending, and title insurance impact of these decisions for the Texas mortgage industry.For more information regarding this case or any related issues, please contact John M. Lynch at firstname.lastname@example.org or Grace Ann Gannon at email@example.com.