Mortgage groups sue California over zombie seconds law

A coalition of lenders, servicers and lienholders are challenging a new state law on zombie seconds, arguing it will increase the cost of financing and limit homeowners' access to equity. 

The California Mortgage Association and 11 other plaintiffs sued California Attorney General Rob Bonta in September, asking a federal judge to halt enforcement of the state's legislation on secondary liens and to rule it unconstitutional. Gov. Gavin Newsom signed the law in question, Assembly Bill 130, in June as part of a larger budget bill.

AB 130 defines certain lienholder conduct as unlawful, which according to plaintiffs gives borrowers grounds to avoid creditors' legal remedies including nonjudicial and judicial foreclosures. Some of the plaintiffs, including three lenders under pseudonyms, say they've already experienced borrowers invoking the law and hindering their debt collection efforts.

"As enacted, AB 130 will cause lenders to forgo extending junior credit secured by residential properties at the current velocity," said Bradley Laddusaw, president of the CMA, in a joint press release. "This will destabilize real estate financing and prevent consumers and small businesses from obtaining loans to meet housing, renovation, and business needs."

A Republican state senator in June also raised the question whether the law would "do away with second mortgages," according to a floor debate reported by the Daily Journal. A representative for Bonta's office didn't return a request for comment Tuesday morning.

The lawsuit represents a first, prominent challenge to state legislation which is emerging in the wake of a defanged Consumer Financial Protection Bureau. Other mortgage laws signed by state legislatures this summer include a foreclosure protection bill for zombie seconds in Connecticut. 

So-called zombie seconds have also been a headache for both lenders and borrowers in recent years, as consumers have sued creditors and Massachusetts forced a servicer in a settlement to erase $10 million worth of mortgage debt. 

Why mortgage players don't like the new California law

The bill allows a subordinate lien to become unenforceable if the lienholder engages in certain actions, including:

• Failing to communicate with a borrower for 3 years; 
• Not sending monthly mortgage statements as required by law;
• Omitting notices of ownership or servicing transfer; 
• Issuing a tax document that suggests the loan has been written off or exonerated.
  

Before initiating a foreclosure, the current servicer has to certify under oath that none of those "unlawful" practices had occurred, a difficult requirement for lienholders, the lawsuit states. Plaintiffs suggest federal law also already provides for remedies for such failures by servicers. 
The suing parties include the California Credit Union League, the United Trustees Association which includes title company employees, individual investors and default services providers. One of those individual investors, who inherited subordinate liens her late husband purchased, said the law forced her to restart foreclosure proceedings on a certain property, allowing the senior lienholder to leapfrog her and foreclose first. 

Another lender, which wants to proceed under a pseudonym as to not hinder their ability to enforce junior deeds, said the law creates compliance traps for loans "serviced through standard software" which doesn't issue statements when accounts are repaid. That scenario means the lender can't certify that every required statement was sent.

The restrictions around second liens diminishes the value of investors' secured interests, and discourages the issuance of junior liens "by rendering them effectively unenforceable for minor technical issues," the complaint reads.

The mortgagees also suggest first-time homebuyers may not be able to obtain "carryback" second mortgages for down payments or home improvements because of the heightened regulatory burdens.