A New York federal district court recently stayed a mortgage foreclosure action before it where a prior state court action filed by the borrower, regarding the validity of an acceleration of the mortgage, could have resulted in piecemeal litigation. Bank of America v. Sharim Inc., 10 Civ. 7570 (S.D.N.Y. 2010). Specifically, the court found that, notwithstanding the strong presumption against abstention, a stay of the federal action was warranted where proceeding with both cases potentially would result in duplicative efforts and inconsistent opinions, contested jurisdictional issues in the federal action would require discovery and briefing, and no federal law or policy was implicated in the federal action.

Background  

The mortgage loan at the core of this litigation involved a commercial building located in New York City. In 2007, the borrower, Sharim Inc. (“Sharim”), granted a mortgage on that property to secure a $22 million refinancing pursuant to a mortgage consolidation agreement (the “Mortgage”). Bank of America, the lender, was the latest in a series of trustees administering the Mortgage.

In 2009, Sharim fell behind in its monthly mortgage payments, and several times requested a voluntary restructuring from the lender and the regular servicer. Sharim contends that the regular servicer was initially receptive to the restructuring but, when CW Capital Asset Management LLP (“CW Capital”) stepped in as special servicer, restructuring the loan no longer was an option. Rather, on July 15, 2010, CW Capital issued a default notice and demanded a payment of over $1.4 million, which included both default interest and late charges dating back to 2009. On July 28, 2010, Sharim paid the full amount under protest. Bank of America accepted the payment, but refused to return the Mortgage to non-default status unless Sharim paid an additional $292,837, which included a $220,000 reinstatement fee and other charges. When Sharim refused to pay on the grounds that the payment of such fees was not required by the loan documents, Bank of America accelerated the loan.

In response, Sharim commenced a state court action against Bank of America seeking a declaratory judgment that (a) Sharim had cured the defaults set forth in the default notice and that the Mortgage should be returned to non-default status without further payment; (b) Bank of America is not entitled to the reinstatement fee; (c) Sharim is not obligated to pay default interest and late charges prior to April 2010 because they had been waived, reversed, and/or never charged; (d) the loan cannot be accelerated; (e) the acceleration notice is not effective; and (f) Bank of America did not have the right to foreclose on the Mortgage due to the improper assignment thereof. In addition, Sharim requested injunctive relief preventing Bank of America from acting on the notice of acceleration and from continuing to charge default interest during the pendency of the action.  

On the basis of diversity jurisdiction, on October 4, 2010, Bank of America filed a federal foreclosure action against Sharim. In response, the state court stayed the state court action for 45 days to allow Sharim to file a motion for a stay or abstention of the federal foreclosure action, which the defendants in that action filed on November 16, 2010.  

Applicable Law

A federal court’s abstention from exercising jurisdiction is generally disfavored. According to the U.S. Supreme Court, “[a]bstention . . . is the exception, not the rule,” and is limited to a few exceptional circumstances where federalism is implicated, or “in situations involving contemporaneous exercise of concurrent jurisdictions, either by federal courts or by state and federal courts.” Colorado River Water Conservation Dist. v. United States, 424 U.S. 800, 813-16 (1976).

When state and federal proceedings are parallel, the Colorado River test addresses six factors: “(1) the assumption of jurisdiction by either court over any res or property; (2) the inconvenience of the federal forum; (3) the avoidance of piecemeal litigation; (4) the order in which the jurisdiction was obtained; (5) whether state or federal law supplies the rule of decision; and (6) whether the state court proceeding will adequately protect the rights of the party seeking to invoke federal jurisdiction.” According to Nat’l Union Fire Ins. Co. of Pittsburgh, Pa. v. Karp, 108 F.3d 17, 22 (2d Cir. 1977), cases are parallel when they “are essentially the same; that is, there is an identity of parties, and the issues and relief sought are the same.” As held by the Supreme Court in Moses H. Cone Mem’l Hosp. v. Mercury Constr. Corp., 460 U.S. 1, 21 (1983), a federal court will exercise abstention only when “the parallel state-court litigation will be an adequate vehicle for the complete and prompt resolution of the issues between the parties.”

The Claims and Defenses

The federal court defendants argued that the state action and the federal foreclosure action are parallel proceedings, and that the six factors weighed in favor of granting a stay because the foreclosure action is governed exclusively by state law and thus implicates no federal policy. Bank of America, the plaintiff in the federal action, argued that the two proceedings were not parallel because the parties and claims in the two suits differed, some interested parties were not named in one of the suits, and Bank of America had not filed a state foreclosure action. Further, Bank of America argued that the federal court must exercise its jurisdiction because the federal case was a foreclosure action, and was thus a proceeding in rem.

The Court’s Ruling

The federal court found that the state and federal court proceedings were parallel because the “contending parties, underlying facts, and legal issues are essentially the same.” Further, the court found that both proceedings required a finding of “whether there was a default; if so, whether it was cured; [Bank of America’s] right to the reinstatement fee; and [Bank of America’s] right to accelerate the mortgage loan.” The court also found that the absence of any parties or claims in the state court action could easily be remedied simply by adding them to that action.

Regarding the application of the six-factor Colorado River test, the court found that the first factor, the assumption of jurisdiction by either court over any res or property, weighed in favor of denying a stay because it was “the first and only court to obtain jurisdiction of the res in this in rem proceeding.” Citing Moses H. Cone, 40 U.S. at 15-16, however, the court emphasized that no factor of the test was singularly dispositive and that a flexible analysis of the factors should be espoused.

Turning to the second factor, the inconvenience of the federal forum, the court found that this factor weighed against granting a stay because no inconvenience existed. The court found that the third factor, however, the avoidance of piecemeal litigation, weighed heavily in favor of granting the stay. The court specifically found that “[a]t best allowing both cases to proceed will result in duplicative and wasted efforts. At worst, doing so will lead to inconsistent decisions, binding on different parties, all of whom have an interest in the matter.” While Bank of America argued that these concerns were the doing of Sharim—for racing to the state courthouse when it could have anticipated the commencement of the foreclosure action—the federal court was not critical of Sharim’s approach, stating that the very purpose of declaratory judgment is to resolve a dispute at the very earliest point in time. Further, the court stated that Sharim had no duty to wait for Bank of America to file a foreclosure action and, moreover, that Sharim had a valid claim for reimbursement of any improper mortgage arrears that was requested by either Bank of America or CW Capital.

The court found that the fourth factor, the order in which jurisdiction was first obtained, also supported granting a stay. The court explained that while no decision on the merits had been rendered in the state court action, a motion for preliminary injunction had been fully briefed, and no progress had been made in the federal foreclosure action. The court, citing Will v. Calvert Fire Ins. Co., 437 U.S. 655, 663 (1978), held that a district court should also consider whether a matter can be resolved in a more expeditious matter in the state court action. Because the defendants challenged Bank of America’s assertion of diversity, and an asserted gap in title might prevent Bank of America from properly asserting standing, the court noted that the federal action would require preliminary discovery and briefing merely on whether subject matter jurisdiction existed.

Considering the fifth and sixth factors, whether state or federal law supplies the rule of decision, and whether the state court proceeding will adequately protect the rights of the party seeking to invoke federal jurisdiction, the court held that these factors also supported the granting of a stay. The court emphasized the fact that the foreclosure action involved property in New York and a mortgage loan that closed in New York and, as such, no federal law or policy was implicated. Citing Gen. Reins. Corp. v. Ciba-Geigy Corp., 853 F.2d 78, 82 (2d Cir. 1988), the court held that “[a]lthough the absence of federal issues does not require the surrender of jurisdiction, it does favor abstention where ‘the bulk of the litigation would necessarily revolve around state-law . . . rights of [numerous] . . . parties.’” Moreover, the court noted that there were no concerns that the state court would inadequately protect Bank of America’s rights. After considering all six factors, the court ultimately held that, despite the presumption against abstention, the factors supported granting a stay of the federal foreclosure action.

Conclusion  

In light of the heavy presumption against abstention in federal court, usually stays are granted only in exceptional circumstances. While generally these circumstances involve questions of federalism, the U.S. Supreme Court has also found that abstention is appropriate for prudential reasons when there is “contemporaneous exercise of concurrent jurisdictions” between federal courts or federal and state courts. Lenders bringing foreclosure actions in federal court should be aware of the potential for a stay being granted where there is a high risk of piecemeal litigation because of a pre-existing pending state court action. To reduce the risk of abstention, lenders should bring foreclosure actions in the federal court at the earliest point in time to escape competing with a previously filed state court action. Let the race to the courthouse begin!