Bar News - May 17, 2013
Real Propery Law: Foreclosure Fight: Wielding the Covenant of Good Faith
By: Stephanie Bray and Dennis Labbe
A homeowner who receives a default or foreclosure notice may feel like homelessness is imminent. However, David need not feel intimidated by a Goliath-like lender because, when used correctly, a smooth stone and a sling may obtain the injunction necessary to stop the onslaught.
The homeowner in crisis may be able to arm his sling with one of the smoothest stones in the brook – the implied covenant of good faith and fair dealing, or simply "duty of good faith." The implied covenant that parties to an agreement will act in good faith and fairly with one another resonates with particular force for homeowners facing foreclosure at the hands of a lender who has turned a deaf ear to the homeowner’s pleas to consider alternatives.
Centronics Corp. v. Genicom Corp.
Retired US Supreme Court Justice David Souter, while a justice on the New Hampshire Supreme Court, penned the unanimous 1989 opinion in Centronics Corp. v. Genicom Corp, which defines the implied contractual obligation of good faith.
Centronics identifies three categories of contract cases in which there exists an implied duty of good faith: 1) standards of conduct in contract formation, 2) termination of at-will employment contracts, and 3) placing limits on discretion in contract performance. It is this third category of good faith that is most applicable to the homeowner’s battle against foreclosure.
Centronics articulates a four-step analysis for determining whether a party has breached his duty of good faith: 1) a degree of discretion in the agreement provides one party the power to deprive another of a substantial proportion of the agreement’s value; 2) in spite of such wide discretion, both parties intend to be bound by an enforceable contract; 3) the exercise of discretion exceeds the limits of reasonableness in depriving the other party of the substantial value of the contract; and 4) the cause of damage to the complaining party is an unreasonable exercise of discretion.
"Reasonableness" is a nebulous concept that begs the question of what exceeds its limits. A fact-specific inquiry is necessary. In Centronics, Justice Souter suggests the bounds of reasonableness should be shaped by identifying the "purposes of the contract," the parties’ expectations, and "community standards of honesty, decency, and reasonableness."
In 2009, the decision in Livingston v. 18 Mile Point Drive, Ltd. suggested more concretely that the actions of stonewalling, subterfuge, and evasion may exceed the limits of reasonableness. Where these actions evade the spirit of the bargain, or inhibit the other party’s performance of his obligations, such conduct may breach the duty of good faith.
An area rife for a finding of bad-faith conduct is a lender’s failure to properly consider an application for a loan modification. It is an all-too-common tale for homeowners seeking such loan modifications to submit application after application and never receive a definitive answer from the lender. When the homeowner with a pending loan modification application simultaneously receives a notice of foreclosure sale, she has been "dual-tracked." Evading a decision on the merits of a loan modification request and simply exercising the discretion to foreclose may be evidence of bad faith.
Good Faith and Fair Dealing in Mortgage Servicing
The Merrimack County Superior Court has recently applied the Centronics doctrine to a lender’s march to foreclosure. Johnson v. Deustche Bank National Trust Company, Trustee, preliminarily enjoined a foreclosure, as a means of enforcing the duty of good faith.
The Johnsons had entered into a mortgage contract with Deustche Bank’s predecessor. The loan was assigned to Deutsche, as part of a real estate investment trust that is governed by a Pooling and Servicing Agreement (PSA). When the Johnsons received a foreclosure notice, they promptly sought a modification of the loan, with assistance from a HUD-approved housing counselor. Deutsche’s loan servicer gave the Johnsons a one-line brushoff: "Unfortunately, the owner of your loan does not allow loan modifications."
The Superior Court examined Deutsche’s conduct under a Centronics analysis and found it wanting. The court found that:
The court was not persuaded by Deustche’s defense that the requested modification would be the second for the Johnsons, and that the PSA forbade second modifications. It noted Deutsche’s own argument that the Johnsons, as strangers to the PSA, cannot enforce its provisions, and concluded that "Deutsche cannot have it both ways." As strangers to the PSA, the Johnsons cannot have the PSA enforced against them.
- The language of the mortgage itself "conferred a certain degree of discretion when it comes to handling an event of default."
- The parties did not dispute that they intended to make a legally enforceable contract.
- Deustche’s refusal even to consider modification likely "exceeded the limits of reasonable discretion." The Court relied on affidavit testimony from the housing counselor that refusal to consider a modification, and proceeding directly to foreclosure, "would be contrary to reasonable standards in the residential lending industry" and "would be contrary to the purpose of the original loan and mortgage."
- Deutsche’s failure to exercise its discretion will be the cause of the loss of the value of the contract to the Johnsons.
Limits on Good Faith and Fair Dealing
The implied covenant of good faith and fair dealing, while versatile and powerful, is not without limits. The New Hampshire case of Olbres v. Hampton Co-operative Bank (1997) illustrates that the duty of good faith will not override the plain language of the contract.
In the same vein, courts that are asked to enjoin foreclosures are careful to remind borrowers that there is no generalized duty, even under the duty of good faith, to modify every residential mortgage.
Johnson v. Deustche Bank pointed out that "the implied covenant does not work to obligate lenders to restructure or modify the terms of a mortgage loan." Counsel for borrowers must instead "identify [a] particular grant of discretion in the mortgage that they believe was exercised unreasonably," the court said.
Abject refusal to exercise that discretion at all, in the form of refusing even to entertain a modification request, may breach the covenant. A bank’s alleged failure to properly to credit a borrower’s payments would also violate the covenant, as seen in a 2013 case from the US District Court, Galvin v. EMC Mortgage Corp.
Mortgage contracts repose all the power, and all the discretion, in the lender. However, for more than 20 years, New Hampshire law has recognized that with great power comes great responsibility. The beauty of the covenant of good faith and fair dealing is its simplicity: The party with the power and discretion must refrain from wielding them in a way that destroys the contract’s purpose and value and must instead behave in accordance with the community’s sense of decency. As long as it is not overused to rewrite the contract altogether, the doctrine, in the hands of a court of equity, is a versatile and effective method for curbing lender excesses.
Stephanie Bray is the project director for the NH Legal Assistance Foreclosure Relief Project and the managing attorney of NHLA’s Concord office. Dennis Labbe is a staff attorney on the Foreclosure Relief Project in NHLA’s Portsmouth office.