Lenders should be aware of a recent Bankruptcy Court decision that barred a lender from obtaining certain costs when it did not comply with a notice requirement in a mortgage.

On June 5, 2014 the United States Bankruptcy Court in In re Demers, BR 13-11539, 2014 WL 2620961 (Bankr. D.R.I. June 5, 2014) ruled that it is inequitable to shift the costs of a creditor’s error in proceeding with the foreclosure process to the debtor when the creditor sent an unspecific and unclear notice and consequently was not entitled to proceed.

This case involved a debtor who objected to the costs included in a mortgage arrearage claim, specifically the inclusion of counsel fees, advertising costs, and title costs (together the “Disputed Charges”).

Donnalee Demers (“Demers”) signed an adjustable rate note (the “Note”) and secured by a mortgage (the “Mortgage”) on Demers’ real estate in Rhode Island. America’s Servicing Company (“ASC”) was the holder of the Note and the Mortgage. The Mortgage had a notice requirement that stated that in the event of Demers’ breach of the Mortgage, before accelerating the Note, ASC “shall” give Demers notice of, among other things, “the right to bring a court action to assert the non-existence of a default or any other defense of Borrower to acceleration and sale.” The Mortgage further provided that the Lender may charge Borrower fees, including attorneys’ fees. The Note also provided that the Note Holder has the right to be paid back for its expenses.

Demers defaulted on the Note in June 2012, and ASC sent her a notice of default in September 2012 (the “Notice”). The Notice did not inform Demers that she had a right to bring an action in court. In June 2013 Demers filed a Chapter 13 petition and five year plan to address the claims of her creditors. The issue in this case was whether ASC was entitled to recover the Disputed Charges as part of its claim despite its failure to comply with the notice requirement.

Demers argued that before ASC could accelerate the Note and commence foreclosure proceedings, it was required to provide Demers with a notice specifically stating that she had “the right to bring a court action to assert the non-existence of a default or any other defense.” She maintained that because the Notice did not so state, ASC did not satisfy the condition precedent to exercising the power of sale and should not be reimbursed for the Disputed Charges. The Court applied Rhode Island Law and explained that if Demers produced substantial evidence in support of her objection to ASC’s claim, then ASC would bear the ultimate burden of proving its entitlement to the Disputed Charges.

Demers based her claim only on the Mortgage notice requirement. ASC referred to both the Note and the Mortgage and argued that even if it failed to comply with the notice requirement, ASC is entitled to recover the Disputed Charges under the Note provisions that provide for reimbursement of fees and expenses. The Court reasoned that because the Note and the Mortgage were executed at the same time, they constituted one agreement and must be read together. The Court found the loan agreement between Demers and ASC was unambiguous, and held ASC’s compliance with the notice requirement was a condition precedent to its right to accelerate the Note and pursue foreclosure. The Court concluded that the Notice clearly did not comply with this prerequisite because it did not inform Demers that she had a right to bring an action in court. The Court also noted that even if it determined the loan agreement was ambiguous and open to multiple interpretations, the Court would still conclude that ASC was not entitled to recover the Disputed Charges because ambiguity in a contract must be construed against the drafter of the document and the contract implied a covenant of good faith and fair dealing.

The Court then rejected ASC’s four arguments in support of its recovery of the Disputed Charges. In response to ASC’s contention that the Notice was not required to mirror the exact language, the Court explained that under the agreement ASC was nevertheless required to expressly inform Demers of her right to bring an action in court. ASC’s second argument was that even if the Notice did not comply, ASC was still entitled to collect the expenses. The Court reaffirmed that any expense ASC incurred in connection with foreclosure proceeding were not rightfully incurred and could not be recovered. ASC then argued that the Notice’s failure to comply was a technical error that constituted a non-material breach of the Mortgage; however, the Court rejected this argument because it held that the notice requirement was a condition precedent, and ASC could not recover expenses incurred pursuing a right that was not yet ripe under the loan agreement. Finally, ASC asserted that Demers had actual notice of her right to bring a court action from her numerous prior notices. The Court pointed out that Demers received the latest notice four years before, and that prior notices are not relevant to whether ASC fulfilled its contractual obligations.

The Court concluded ASC did not meet its burden to establish its entitlement to the costs and consequently reduced ASC’s claim by the amount of Disputed Charges.

Lenders need to be mindful of this decision, and should take steps to ensure that they comply with specific notice provisions in loan documents.