Daily Development for Friday, May 12, 2000

By: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
randolphp@umkc.edu

Note that although the pronouncements of the Second Circuit are dicta, they are pretty clear statements of conclusion that ought to be influential in other settings.

BANKING; FIRREA; FDIC AS RECEIVER: EXEMPTION FROM PENALTIES: Under FIRREA, "fines and penalties" that would prime the mortgagee's interest against the property cannot be assessed against the mortgaged property during the period of time that the mortgage is held by the Federal Deposit Insurance Corporation as receiver, and can be avoided by a subsequent purchaser of the mortgage loan. But increased charges accruing when improvement assessments are not paid are not "penalties" within the meaning of FIRREA. (Dicta)

National Loan Investors L.P. v. Town of Orange and Water Pollution Control Authority, 204 F.3d 407 (2000).

The Town of Orange, Connecticut, assessed various properties with charges for the construction of new sewer lines. The owner elected to pay the cost in installments, which were subject to interest at the same rate as that paid on the bond that financed the project. The Water Pollution Control Authority also levied an 18% per year charge for unpaid amounts due under the assessment. The owner defaulted and the lender began a mortgage foreclosure. During the pendency of the foreclosure, the lender was taken over by the FDIC.

Several years later, the FDIC sold its interest in the mortgage by assigning the note and mortgage to the new investor. The investor challenged the imposition of the 18% assessment during the nearly four year period that the FDIC had held the loan. The district court found that the 18% assessment was a penalty which would be prohibited by FIRREA, except the court stated that the applicable provision of FIRREA only applied to the FDIC's interest as titleholder, not as mortgagee. Therefore, the court concluded that the assessment would remain.

The Second Circuit reviewed de novo the district court's interpretation of this provision of FIRREA (in particular, 12 U.S.C. Sec. 1825(b)(3)). The appeals court determined that the FDIC does enjoy the protection of this section of FIRREA even as mortgagee, since the statute did not speak in terms of particular interests in property but rather expresses the exemption from fines and penalties without qualification.

This arguably takes care of the FDIC position, but what about the ability of the FDIC's successor to defend against the assessments arising during the FDIC's possession? The court noted that the applicable section speaks in terms of the FDIC's liability and is ambiguous as to whether the penalties can accrue and be collected from someone else, such as the successor titleholder. But the court concluded that the policies of FIRREA compelled the conclusion that a successor would take free of the penalites accruing during the FDIC's ownership of the mortgage. The court reasoned that the benefit to the FDIC would be eliminated unless the freedom from penalties was passed on to a subsequent holder of the note and mortgage. If the freedom from penalties was not passed on, the FDIC would be paid less for assignment of the note and mortgage.

A third aspect of the analysis focussed upon whether the new investor would retain the FDIC's exemption from liability postforeclosure, once it had become the titleholder. The court noted that the Seventh Circuit had decided in RTC Commercial Assets Trust v. Phoenix Bond & Indem. Co.,169 F.3d 448, 458 (7th Cir.1999), that the penalties had been charged to the property itself, rather than being a personal liability of the successor titleholder. The court noted that the district court had agreed with this line of reasoning. The court also added, however, that the question was a close one and could be avoided on the record before it.

An added twist at the level of this appeal was an argument by the investor that since Connecticut is a "title state", the mortgagee acquired title subject to the payment of the loan, so that the FDIC also held title as a result of being named receiver for the original lender. The court noted that Connecticut's status as a title state might have some impact on the discussion but added that it was not clear what that impact would be.

In the end, and after an interesting review of the law, the court decided to leave many of the questions it had raised unanswered. The court noted that the investor had conceded at oral argument that it bore the burden of establishing at trial that the assessment was a penalty and that it had failed to meet that burden. The applicable Connecticut statutory provision characterized the 18% assessment as interest or as a tax, not a penalty. The statement from the Authority had termed it a penalty. The court stated that neither characterization was dispositive. Determination of whether this charge was a penalty was, the court noted, a federal question informed by state law. In reviewing the case law, the court agreed with a Connecticut state court opinion that such a charge was intended to "ensure that municipalities receive fair compensation for delayed payment of taxes in light of fluctuating market rates, inflation and collection costs." (Citation omitted), 204 F.3d 407, 412. Based on this analysis, the Court agreed with the Connecticut case's conclusion that the assessment was not a penalty.

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