Texas Supreme Court Uses "Common Sense" to Avoid Lender's Forfeiture on Home Equity Loan Violation

Texas has some of the strongest homestead protections in the country.   It was also one of the last states to allow home equity lending.   When it reluctantly amended its Constitution to allow home equity lending, it included some draconian provisions for lenders who didn't follow the rules, allowing forfeiture of principal and interest in some cases.   A lender's failure to provide a timely release after the borrower repaid the loan sparked a spirited disagreement among the Texas Justices as to whether to apply the Constitutional provision as written or to use common sense.   In a 7-2 decision, "common sense" and the lender prevailed. Garofolo v. Ocwen Loan Servicing, LLC., No. 15-0437 (Tex. 5/20/16).    You can read the opinion here and the dissent here.

What Happened

Teresa Garofolo took out a home equity loan for $159,700 in 2010.   She paid the loan off in April 2014.   While the lender recorded a release of lien, it did not provide her with a recordable release as required her loan documents.    She made demand upon Ocwen to provide her with the required paperwork.   When they failed to comply within sixty days, she filed suit in federal court seeking forfeiture of all principal and interest under the Texas Constitution.    The District Court dismissed the case.   When Ms. Garofolo appealed to the Fifth Circuit, the circuit certified two questions to the Texas Supreme Court:

 (1) Does a lender or holder violate Article XVI, Section 50(a)(6)(Q)(vii) of the Texas Constitution, becoming liable for forfeiture of principal and interest, when the loan agreement incorporates the protections of Section 50(a)(6)(Q)(vii), but the lender or holder fails to return the cancelled note and release of lien upon full payment of the note and within 60 days after the borrower informs the lender or holder of the failure to comply?

(2) If the answer to Question 1 is “no,” then, in the absence of actual damages, does a lender or holder become liable for forfeiture of principal and interest under a breach of contract theory when the loan agreement incorporates the protections of Section 50(a)(6)(Q)(vii), but the lender or holder, although filing a release of lien in the deed records, fails to return the cancelled note and release of lien upon full payment of the note and within 60 days after the borrower informs the lender or holder of the failure to comply? 

The Majority Opinion

The majority held that the Texas Constitutional provisions did not create substantive rights but merely set forth the conditions under which a creditor could have the right to foreclose a lien upon a homestead.   

Our initial inquiry is whether these terms and conditions amount to substantive constitutional rights and obligations. In concluding they do not, we first observe that section 50(a) does not directly create, allow, or regulate home-equity lending. Nowhere does it say all home-equity loans must include the constitutional terms and conditions, nor does it prohibit loans made on other terms. It simply describes what a home-equity loan must look like if a lender wants the option to foreclose on a homestead upon borrower default.

As to constitutional rights, section 50(a) creates but one: freedom from forced sale to satisfy debts other than those described in its exceptions. The delineation of home-equity lending terms and conditions serves only to set the boundaries of that constitutional right. The relevance of those terms and conditions is therefore contingent on the fundamental guarantee of section 50(a)—that the homestead is protected from forced sale “except for [a home-equity loan] that” includes the terms outlined in section 50(a)(6)(A)–(P) and “is made on the condition that” it also include the provisions set forth in section 50(a)(6)(Q)(i)–(xi). Those terms and conditions are not constitutional rights and obligations unto themselves. They only assume constitutional significance when their absence in a loan’s terms is used as a shield from foreclosure.

Majority Opinion, p. 6.   The majority went on to state that the constitutional protections did not apply because Ocwen did not seek to foreclose.

If Ocwen sought to foreclose on Garofolo’s homestead after she became delinquent in her payments, she could stand on the constitutional right to freedom from forced sale if her loan failed to include the release-of-lien requirement or forfeiture remedy. But that did not happen. Garofolo made timely payments and satisfied the balance in full. Ocwen never sought to foreclose, and there is no constitutional violation or remedy for failure to deliver a release of lien. Section 50(a) simply has no applicability outside foreclosure.

Majority Opinion, pp. 6-7.   Thus, the majority answered the first certified question "no."

It went on to answer the second question in the negative as well.   The majority said that while the loan documents contained the constitutionally required language about forfeiture of principal and interest, those provisions didn't apply to all violations of the loan documents.

Although the forfeiture remedy incorporated into Garofolo’s loan might be applicable to a lender’s failure to comply with some of her loan’s terms, it does not apply to a failure to deliver a release of lien. Accordingly, Garofolo must show actual damages to maintain her breach-of-contract claim or seek some other remedy, such as specific performance.

Majority Opinion, p. 8.  

So when would the forfeiture remedy apply?   Under the Texas Constitution, a lender must forfeit all principal and interest if it receives notice of a violation and fails to take one of the following actions within sixty (60) days:

(a) paying the owner an amount equal to any overcharge paid by the owner under or related to the extension of credit if the owner has paid an amount that exceeds an amount stated in the applicable Paragraph (E), (G), or (O) of this subdivision;

(b) sending the owner a written acknowledgment that the lien is valid only in the amount that the extension of credit does not exceed the percentage described by Paragraph (B) of this subdivision, if applicable, or is not secured by property described under Paragraph (H) or (I) of this subdivision, if applicable;

(c) sending the owner a written notice modifying any other amount, percentage, term, or other provision prohibited by this section to a permitted amount, percentage, term, or other provision and adjusting the account of the borrower to ensure that the borrower is not required to pay more than an amount permitted by this section and is not subject to any other term or provision prohibited by this section;

(d) delivering the required documents to the borrower if the lender fails to comply with Subparagraph (v) of this paragraph or obtaining the appropriate signatures if the lender fails to comply with Subparagraph (ix) of this paragraph;

(e) sending the owner a written acknowledgment, if the failure to comply is prohibited by Paragraph (K) of this subdivision, that the accrual of interest and all of the owner’s obligations under the extension of credit are abated while any prior lien prohibited under Paragraph (K) remains secured by the homestead; or

(f) if the failure to comply cannot be cured under Subparagraphs (x)(a)-(e) of this paragraph, curing the failure to comply by a refund or credit to the owner of $1,000 and offering the owner the right to refinance the extension of credit with the lender or holder for the remaining term of the loan at no cost to the owner on the same terms, including interest, as the original extension of credit with any modifications necessary to comply with this section or on terms on which the owner and the lender or holder otherwise agree that comply with this section . . . .

Texas Const. Art. XVI, Section 50(a)(6)(Q)(x).  

Garofolo argued that Ocwen could have cured the failure to provide the written lien release by paying her $1,000 under subparagraph (f).   The majority found that this would be a nonsensical cure since it would not address the actual violation.  

The unquestionably harsh forfeiture penalty is triggered when, following adequate notice, a lender fails to correct the complained-of deficiency by performing one of six available corrective measures. Ocwen argues forfeiture is simply inapplicable here because none of the six corrective measures addresses the failure to deliver a release of lien. Therefore, Ocwen could perform any or all of them yet still not correct the underlying deficiency. Garofolo argues, however, that performance of the catch-all remedy in subparagraph (f)—a $1,000 refund and an offer to refinance her loan—would have corrected the deficiency because Ocwen would have performed one of the measures required to avoid forfeiture. Of course, there was nothing to refinance—Garofolo had already paid off her loan—and a $1,000 payment would not buy her a document only Ocwen can provide. Nonetheless, Garofolo maintains that performance of subparagraph (f) was necessary to avoid forfeiture even if it completely fails to remedy or even address Garofolo’s actual complaint.

. . . Allowing lenders to avoid punishment by performing an irrelevant corrective measure at the expense of directly addressing the borrower’s complaint frustrates this intent. It follows that the six specific corrective measures exist to give lenders avenues to avoid forfeiture by fixing problems rather than furnishing technicalities that can be manipulated to avoid them.

Majority Opinion, pp. 10-11.  

In a somewhat tortured paragraph, the majority reasoned that forfeiture is triggered when a lender fails to correct the deficiency by performing one of the required acts.   If the deficiency cannot be cured by performing one of the required acts, then the forfeiture provision does not apply.

The six corrective measures each present an avenue through which a lender might actually correct a deficiency. But as this case demonstrates, these corrective measures do not speak to every manifestation of a lender’s failure to comply with its obligations. Accordingly, a lender might actually correct a deficiency but fail to do so through performance of a corrective measure. For example, if Ocwen delivered Garofolo’s release of lien within 60 days following notice, it would have actually corrected its failure to comply but would not have done so “by” performance of a constitutionally specified corrective measure. See id. Should it suffer forfeiture? Garofolo argues it should, but this view ignores that forfeiture is available only when a lender fails to correct its “failure to comply by” performance of a specific corrective measure. See id. (emphasis added). If none of those measures actually correct the lender’s failure to meet its obligations, the lender cannot correct its failure to comply “by” performing one of them, and therefore forfeiture is simply unavailable. See id. (a lender “shall forfeit all principal and interest . . . if the lender or holder fails to comply with the lender’s or holder’s obligations . . . and fails to correct the failure to comply . . . by” performing a corrective measure (emphasis added)). Accordingly, if a lender fails to meet its obligations under the loan, forfeiture is an available remedy only if one of the six corrective measures can actually correct the underlying problem and the lender nonetheless fails to timely perform the relevant corrective measure.

Majority Opinion, pp. 13-14.   Thus, the majority concluded that the forfeiture provision didn't really apply because it didn't make sense in the context of the specific default.   Instead, the majority said that Garofolo's remedy was to seek traditional breach of contract remedies or specific performance.

The Dissent

The dissenting opinion accused the majority of re-writing the law to achieve what it considered to be "common sense."

I do not agree with the Court’s answer to the Fifth Circuit’s second question, and instead conclude that the parties’ agreement expressly gives the borrower a contractual right to forfeiture of all principal and interest paid upon the lender’s “failure to correct [a] failure to comply” with its obligations under the loan. Though the Court is concerned about such a “harsh forfeiture remedy,” it is the remedy the text requires and to which both parties agreed. To reach the opposite conclusion, the Court adds words to the parties’ contract and to the Constitution’s language, and rewrites both to achieve the result it believes “common sense suggests.” Although the Court’s result may comport with “common sense,” or at least with the Court’s view of “common sense,” it is not what the parties agreed to or what the Constitution requires.

Dissent, p. 1.   The dissent found that the Constitutional language was straightforward and required forfeiture.

Consistent with the first required condition, the lender and borrower in this case agreed to a security instrument that requires the lender to give the borrower a recordable release of lien within a reasonable time after termination and full payment of the loan.  And consistent with the second condition, the agreement requires the borrower to give the lender notice of the lender’s failure to comply with an obligation, allows the lender “60 days after receipt of notice to comply with the provisions of Section 50(a)(6),” and provides that “only after lender has failed to comply, shall all principal and interest be forfeited by Lender, as required by Section 50(a)(6)(Q)(x), Article XVI of the Texas Constitution in connection with failure by Lender to comply with its obligations.”

Dissent, p. 3.   The dissent went on to say that if the default couldn't be cured by performing one of the six required cures that forfeiture was mandated rather than excused.

The Court concludes that the security instrument does not require the holder to forfeit all principal and interest unless one or more of the six corrective measures listed in subsections (a)–(f) of section 50(a)(6)(Q)(x) would “actually correct the lender’s failure to meet its obligations.” The Court then concludes that the corrective measure in subsection (f), on which the borrower relies, would not have “actually corrected” the holder’s failure to deliver the release of lien, and it would therefore be “ridiculously futile” and “irrelevant” for the holder to perform subsection (f)’s requirements.  Because the security agreement only permits forfeiture “as required by Section 50(a)(6)(Q)(x),” the Court concludes that forfeiture is not available here.  I disagree for four separate reasons: (1) subsection (f) expressly provides that it applies if the corrective measures in subsections (a)–(e) will not cure the holder’s breach, so it must apply here; (2) subsection (f) “corrects” the underlying deficiency for purposes of avoiding forfeiture and motivates the holder to timely deliver the release of lien; (3) it is not “ridiculously futile” or “irrelevant” for the holder to perform the actions subsection (f) requires; and (4) even if the holder could not “correct” its breach by performing subsection (f)’s requirements, the agreement would expressly require forfeiture, not excuse it.

Dissent, p. 4.    The dissent also appealed to Supreme Court Justice Antonin Scalia for the importance of reading the law as written as opposed to how the Court would prefer to read it.

A plain reading of the adopted language reveals the framers’ intent, but the Court rewrites this language to effectuate its own intent. The Court confuses the term “correct” with “cure,” adds the word “actually,” and renders inoperative the language that says subsection (f) applies if subsections (a)–(e) do not. The Court says “common sense suggests” its interpretation, but our assessment of “common sense” does not permit us to ignore the adopted language. ANTONIN SCALIA & BRYAN A. GARNER, READING LAW: THE INTERPRETATION OF LEGAL TEXTS 237 (2012) (noting that “judicial revision of . . . texts to make them (in the judges’ view) more reasonable” presents “a slippery slope”).

Dissent, p. 7.   The dissent also ridiculed the Court's futility analysis.

Applying its common sense, the Court concludes that lenders and holders who fail to deliver a release of lien as promised should not have to comply with subsection (f) to avoid forfeiture because paying the borrower $1,000 and offering to refinance the note would be “ridiculously futile” and “irrelevant.” Instead, the Court believes the language should permit the holder to avoid forfeiture simply by delivering the release of lien. In fact, under the Court’s construction, the lender can always avoid forfeiture when it fails to deliver a lien release, even by doing nothing at all, because the forfeiture remedy simply does not apply to a failure to deliver a release. But this is not what the text says.

In any event, the holder’s compliance with subsection (f) is not as futile or irrelevant as the Court suggests. While subsection (f) does not expressly or directly require the holder to “correct” or “cure” its failure to deliver the release of lien by actually delivering the release of lien, it serves to motivate the holder to avoid the failure in the first place, thus preventing the obligation to pay the borrower $1,000 and offer to refinance. Within sixty days of receiving notice that it has failed to deliver a release of lien, the holder must pay the borrower $1,000 and offer to refinance, or the holder is subject to forfeiture. If the holder pays the $1,000 and offers to refinance, but does not deliver the release of lien, it will avoid forfeiture but remain in breach of its obligation to deliver the release of lien.   Certainly, at that point, the borrower can sue for specific performance to obtain the release. Regardless, at a minimum, subsection (f) provides the holder a catch-all method to “correct” a failure to comply when the five other methods will not “cure” it, and by doing so motivates the holder to avoid the deficiency all together.

Dissent, pp. 8-9.   Thus, the two justices in dissent would have applied the forfeiture remedy against Ocwen.

What It Means

It makes for good theater to watch the Texas justices sparring over whether to apply plain meaning or common sense when the result would be to penalize a business interest and offer a windfall to a consumer.    It is remarkable that two justices on the all Republican court would stand for principle against a traditional Republican constituency.  

The dueling opinions also illustrate how difficult it is to apply plain meaning analysis.    Both sides made plausible arguments from the constitutional text.    However, the majority's resort to "common sense" suggests that they knew were drawing a fine distinction.

Notwithstanding the majority's tortured analysis, the opinion makes practical sense.   Failure to timely deliver a release is a minor inconvenience compared to the remedy of forfeiture of all principal and interest.    Prior to a loan being satisfied, the prospect of taking away a person's home provides a strong policy basis for imposing strict liability upon lenders who do not follow the law.   After the loan is paid, the lender no longer holds any significant power to harm the borrower.   Allowing forfeiture in this case could have chilled the market for home equity lending in Texas (although other cases allowing forfeiture have not).   As a matter of public policy, the decision was probably correct.   The big question is whether the majority had to butcher the text to get to "common sense."