Second and Fourth Circuits Consider the Scope of Reg. X’s “Catch-All” Provision

Business Litigation Update

Date: March 11, 2022

Introduction

In two recent decisions, the Second and Fourth Circuits weighed in on the scope of Regulation X’s (Reg. X) catch-all provision for notices of error (NOEs).

In January, the Second Circuit decided Naimoli v. Ocwen Loan Servicing, LLC, in which it held that the catch-all provision applies to errors based on the alleged mishandling of loan documents, including the loss of documents that ultimately resulted in the borrower’s inability to obtain a loan modification. Prematurely hailing Naimoli as a sweeping victory, consumers immediately began relying on Naimoli to argue that the catch-all provision applied to a myriad of issues not historically covered by the Real Estate Settlement Procedures Act (RESPA). In Morgan v. Caliber Home Loans, Inc., the Fourth Circuit held that correspondence related to the denial of a loan modification is a contractual issue not covered by the catch-all provision, a decision more in line with historical jurisprudence.

The decision in Morgan clarifies how narrow, and fact specific, the holding in Naimoli may be. Together, the two holdings may offer guidance for mortgage servicers regarding the future of NOEs under Reg. X, but they more likely signal that the issue is far from settled and that the scope of Reg. X’s catch-all provision will be litigated for years to come.

Background

Since 1990, the Real Estate Settlement Procedures Act (RESPA) has required mortgage servicers to provide timely responses to qualified written requests (QWRs), including those that set forth alleged errors relating to the “servicing” of their loans, a phrase RESPA limits to the receipt and application of payments or the provision of payments to the loan’s owner or third parties.

For years, courts consistently held that QWRs that claimed errors relating to issues such as loan origination or loss mitigation (i.e., those unrelated to the receipt and application of payments) did not pertain to servicing and were not covered by RESPA.

As part of Dodd-Frank, Congress gave the CFPB rulemaking authority under RESPA. In 2014, the CFPB enacted 12 C.F.R. § 1024.35 as part of Reg. X, RESPA’s implementing regulation, relating to NOEs. In a nutshell, on its face, the regulation states that the term “error” refers to certain covered errors and to “any other error relating to servicing.”

Since the regulation’s enactment, there has been a host of litigation on whether a NOE can now relate to issues beyond the traditional definition of servicing or if “relating to servicing” as set forth in the catch-all provision expands the scope to other areas, including loss mitigation.

The holdings have been inconsistent. Some courts have applied the traditional servicing limitation. Others have held that a NOE can relate to one of the specifically enumerated errors set forth in Reg. X, but have limited the catch-all provision to errors that fall under the traditional definition of servicing. Others have abandoned historical case law altogether and have relied on the catch-all provision to expand the scope of NOEs beyond those relating to the receipt and application of payments.

As evidenced by the decisions in Naimoli and Morgan, the issue is making its way to the Circuit Courts.

Naimoli

In Naimoli, the borrower applied for a loan modification and completed a trial period plan, but the servicer rejected the loan modification due to the originating lender’s failure to record the mortgage. The borrower re-executed the mortgage, but the servicer lost it. The servicer then denied Naimoli’s loan modification because the mortgage was not recorded.

The borrower sent an alleged NOE, claiming that the servicer erred by (1) failing to provide the loan modification; (2) failing to record the mortgage; and (3) rejecting her payments under the modification. The servicer refused to reconsider its decision.

Naimoli sued the servicer in the Western District of New York alleging, in relevant part, that the servicer violated RESPA by failing to correct the alleged errors. The district court granted summary judgment in favor of the servicer, holding that the asserted errors were “essentially challenges to the denial of [the borrower’s] loan modification,” and thus were not “covered errors” under Reg. X.

The Second Circuit reversed, holding that the servicer’s loss of the borrower’s documents and failure to record the mortgage were covered under Reg. X’s catch-all provision. Reasoning that the phrase “relating to servicing” was broad enough to encompass any error that has “some connection … to loan servicing,” the Second Circuit held that an error may be covered “if it relates to or is connected with either (a) the loan servicer’s receipt of payments from borrowers or (b) the loan servicer’s making of payments to the loan’s owners or third parties.”

According to the Second Circuit: (i) the errors asserted in the alleged NOE related to servicer’s receipt of payments as the servicer’s failure to record the re-executed mortgage made the borrower ineligible for the loan modification and reduced interest rate; and (ii) the errors concerned the servicer’s payments to the loan owner, as the failure to record the mortgage jeopardized the servicer’s ability to pay the loan’s owner in the event of foreclosure. The court limited its holding, though, explaining that “(a)ll parties agree[d] that a loan servicer’s failure to properly evaluate a borrower for a loss mitigation option is not a covered error under § 1024.35(b)” and that the servicer’s errors could be corrected without overturning the servicer’s decision regarding loss mitigation.

Morgan

In Morgan, a borrower applied for a loan modification and was placed on a trial payment plan. However, after the borrower made the modified payments pursuant to the trial plan, the servicer declined to authorize a final loan modification, citing the existence of a priority lien.

The borrower sent a letter claiming the loan modification was denied for erroneous reasons. The borrower ultimately received a loan modification, but the servicer refused to stop reporting adverse information regarding the borrower’s delinquent payments to the consumer reporting agencies. The borrower filed a putative class action claiming the servicer’s response violated RESPA, but the district court dismissed, holding among other things that the letter did not allege an error relating to servicing.

The Fourth Circuit affirmed. As the court explained, “correspondence limited to the dispute of contractual issues that do not relate to the servicing of the loan, such as loan modification applications, do not qualify as QWRs.” Because the borrower’s letter merely contested the denial of her loss mitigation application, it did not concern a “servicing error,” and was therefore not a NOE protected by RESPA or Reg. X.

Conclusion

Servicers have long argued that QWRs or NOEs regarding loss mitigation are not covered by RESPA. The Second Circuit’s reasoning in Naimoli (i.e., that the loss of the loan documents made the borrower ineligible for a loan modification or interest rate reduction and thus relates to “servicing”) certainly muddies the waters on this issue. While servicers may find some comfort in the Fourth Circuit’s decision in Morgan, one thing is clear – this issue is long from over and servicers should take a strategic approach in responding to correspondence that may (or may not) be considered a NOE.

FOR MORE INFORMATION

For more information, please contact:

Jessica E. Salisbury-Copper
937.443.6854
Jessica.Salisbury-Copper@ThompsonHine.com

Anna K. Stark
212.908.3928
Anna.Stark@ThompsonHine.com

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