A detailed recounting of one person's short sale experience and his rights under the FDCPA
Since the mortgage meltdown a few years ago, many Americans have been struggling with the fallout. Record numbers of foreclosures have occurred. Homeowners have worked to modify their loans, only to be stymied by the system. Banks and other mortgage holders seem, at times, indifferent to the problems the homeowner faces. Other times, it appears that lenders and banks are not indifferent; they are hostile to the plight of the distressed homeowner.
Bills.com received a personal testimonial from an individual homeowner, who tried diligently to work out a solution with his lender, attempting to negotiate a short-sale of his home. Bills.com feels that this individual’s well-researched, detailed recap of his experiences will provide some useful information to others who are going through the same or similar situations.
Pay close attention to the issue of how a deficiency balance can lead to a tax obligation, whether a non-recourse loan can lead to a deficiency balance that results in the issuance of a 1099-C for forgiveness of debt, and whether the bank violated the Fair Debt Collections Practices Act (FDCPA).
As you will read, the author only wanted to finalize the short sale and put the whole matter behind him, but was put through the ringer. Fortunately, he had the intelligence and stick-to-itiveness to fight for himself.
If every consumer were as well informed and thorough as our correspondent, fewer people would be taken advantage of.
The following is the letter that was sent to the bank’s legal counsel:
I am writing to request your office intervene in the negotiations concerning my short-sale transaction.
In late 2005, I purchased a home in California for approximately $500,000, obtaining financing from Wells Fargo Bank, N.A. (hereafter, “the Bank”), a subsidiary of Wells Fargo & Company. The financing for this purchase included two notes, the first note in the amount of about $370,000 and the second note in the amount of about $80,000. A second trust deed was executed simultaneously and recorded in California. In 2007, I moved my primary residence out-of-state, but retained the home in California, rented the home by way of a property manager and continued to service the debt until approximately one-year ago, when there was a several month gap in renters that removed the source of cash flow necessary for me to service my debt payments.
Over the past year, I have been in contact with the Bank on a continuous basis and, after much labor, have reached a tentative agreement with the representatives of the Bank responsible for servicing the first note to execute a short-sale with a third-party. This tentative agreement was reached a few weeks ago and, in brief, calls for an agreed-upon sales price of about $250,000, which the servicing division of the Bank has decided to split between the first note and the second note in a ratio of approximately 90 percent and 10 percent, respectively. I suspect that the reason for this ratio is due to the fact that both the first and second notes have already been sold to one or more GSEs (Government Sponsored Enterprises) and/or private MBS (Mortgage Backed Securities) entities.
The person within the Bank that represents the interests of the beneficial owners of the second note, Ms. Jane Doe, contacted me on July 1, 2010. During the course of these discussions, Ms. Doe explained that in order for the second note holder to agree to a short-sale I would need to make a “contribution” to pay off a portion of the balance of the second note that is not otherwise covered by the first note holder’s agreement to pay 10 percent of the total proceeds. Ms. Doe would not provide any guidance on the amount that I should contribute. However, she explained that it “only seems fair” for me to pay some contribution in exchange for the second note holder “forgiving” the unpaid balance of the note. Furthermore, Ms. Doe explained that if I do “contribute” a sufficient amount to persuade the second note holder to move forward with the short sale, I would nevertheless receive an IRS Form 1099-C, reflecting the balance of the second note that was “forgiven.”
After learning about the IRS Form 1099-C issue, I contacted my tax advisor, who then participated in a three-way teleconference with Ms. Doe on July 2, 2010. During the course of that telephone call, my tax advisor explained that the second note on my California home was subject to the California anti-deficiency statute. He then asked Ms. Doe why a borrower with no personal liability for a deficiency on a second note would agree to pay any amount in order to obtain approval for a short sale, when that same borrower could simply let the lender foreclose and exercise the power of sale under the deed of trust. Ms. Doe offered several justifications in response: (1) the Bank was forgiving the loan and (2) the Bank would not report the deficiency to the credit agencies in the case of a short sale. My tax advisor then inquired whether I would be given any assurances or recourse in the event the Bank did not appropriately report the short-sale to a credit agency. Ms. Doe explained that if a short-sale transpired and the credit reporting agencies reflected the transaction as a foreclosure, this would be an issue that I would have to take up with the credit reporting agencies.
The next topic of conversation during our teleconference was the issue of IRS Form 1099-C. My tax advisor questioned Ms. Doe as to why the bank would file this form if, in fact, the second note was a non-recourse liability and therefore could not be considered as having been forgiven as part of the short-sale transaction, as is made clear in Treas. Reg. §1.1001-2(c)(Example 8) and Rev. Rul. 90-16. Ms. Doe explained that she was not familiar with those rules but it was the policy of the bank to issue Form 1099-C even in all cases.
Potential FDCPA Violations
Based on my limited understanding, it appears to me that Ms. Doe’s actions appear to constitute a violation of both the federal Fair Debt Collection Practices Act (“FDCPA”) and California’s Rosenthal Fair Debt Collection Practices Act (“California FDCPA”). Let me explain.
In the case of my second loan, I am clearly insulated from any personal liability under the California anti-deficiency statute. See Cal. Civ. Code §580b; see also Brown v. Jensen, 41 Cal. 2d 193 (Cal. S. Ct., 1953). Nevertheless, in repeated telephone calls Ms. Doe has knowingly misconstrued this fact by suggesting that the Bank would be “forgiving” my loan in the course of any agreed-upon short-sale. Furthermore, either Ms. Doe or the Bank as a whole has knowingly attempted to misconstrue the nature of my loan by treating it as a recourse debt under federal tax reporting rules.
On this latter point, let me elaborate. Under Treas. Reg. §1.6050P-1(b)(2), a bank is only required to issue a Form 1099-C if one of eight identifiable events occurs. Each of those identifiable events requires either a “discharge” or a “cancellation or extinguishment” of a debt stemming from some external action. In the case of a purchase money note protected by Cal. Civ. Code §580b, however, it is impossible for a bank to discharge an obligation that the borrower does not bear. It is equally impossible for a bank to cancel or extinguish a debt in the context of “a receivership, foreclosure, or similar proceeding in a federal or State court . . .” (Treas. Reg. §1.6050P-1(b)(2)(B)) or “pursuant to an agreement between [the bank] and a debtor” (Treas. Reg. §1.6050P-1(b)(2)(F)) since the debt is already extinguished by operation of California law. Note, these are the only two of the eight identifiable events that could reasonably apply to the facts at hand.
In fact, this is not just my view. The IRS has clarified that a bank is not required to file a Form 1099-C in the case of a short-sale involving debt covered by the California anti-deficiency statute. This guidance came in the form of a 1994 Field Service Advice issued to the Los Angeles District Counsel, wherein the IRS National Office stated that “[i]f the debt was [covered by the anti-deficiency statute], and a foreclosure or a transfer of the property subject to the indebtedness occurred, the lender would be required to file Form 1099-A reporting the amount of debt satisfied ($290,000), and the gross foreclosure proceeds” in lieu of filing a Form 1099-C. See 1994 FSA Lexis 204 (November 15, 1994).
Thus, it is clear that a bank need not file a Form 1099-C in a short-sale if the borrower’s loan is subject to the California anti-deficiency statute. However, your representative contends that the bank will, in fact, file a Form 1099-C in my case, which would invariably lead me to believe, were I less informed, that my loan is a recourse loan and not covered by the anti-deficiency law.
You might be inclined to reply that a bank has the prerogative to issue a Form 1099-C even if it is not compelled to file. However, that is not necessarily true. At least one court has recognized that the filing of a Form 1099-C has the effect of “assigning the debts to the IRS, necessarily passing to the IRS any right to collect money from the debtors.” See In re: Crosby, 88 AFTR 2d 2001-5633. In the case of a loan covered by an anti-deficiency statute, the filing of a Form 1099-C not only potentially converts a nonrecourse debt into a recourse debt in the form of tax dollars owed to the IRS, but it also sends a message to a less-informed borrower that their loan is not covered by an anti-deficiency statute.
Obfuscating the status of a loan vis-à-vis the California anti-deficiency statutes is no trifling matter. In fact, it is a violation of the both the FDCPA and the California FDCPA. See 15 USC §§1692e(2)(A), (10). In fact, in December 2009, the United States District Court for the Northern District of California denied a defendant collection agency’s motion to dismiss a class action lawsuit involving FDCPA violations where the collection agency knowingly pursued collections on debts for which the borrower was not personally liable under Cal. Civ. Code §580b. See Herrera v. LCS Financial Services Corporation, 2009 U.S. Dist. Lexis 122775 (DC N. Cal. 12/22/09).
I believe that the facts of my case is similar to the Herrera case insofar as Ms. Doe has attempted to build the impression that my second note is a recourse debt by stating that the Bank is going to “forgive” the balance of the note and by saying that I “made a promise to repay the loan.” However, my case is actually more egregious than the Herrera case because the Bank has knowingly attempted to misconstrue the non-recourse status of my loan by indicating that it will issue a Form 1099-C in contravention to clear IRS guidance.
In short, I find it unconscionable that a bank would attempt to obtain inducement payments from borrowers by using form filing tactics and language to convey a view that a borrower’s loan is a recourse loan when in fact the loan is clearly not a recourse loan under California law. The contribution that Ms. Doe is seeking is, in this respect, akin to a bribe. However, I am not litigious and have no interest in pursuing a principled based legal action against the Bank. I simply want to transact this short-sale and move on with my life. As a result, I am willing to pay the Bank $500.00 as a “contribution” merely to dispense with this issue. But given Ms. Doe’s actions to date and the Bank’s general intractability throughout this process, I doubt this offer would be accepted without your office intervening. Therefore, I ask you to consider this matter and let me know as soon as possible if we can move on with this short-sale.
Here’s what transpired after I sent the letter:
- I faxed the letter to Ms. Jane Doe and sent the letter by regular mail to the general counsel
- The day after I sent the fax, my real estate agent got a call from Ms. Doe indicating $500.00 was acceptable. I’m pretty sure what transpired here was that she passed the letter up to her superiors and they probably got it in the hands of someone in the legal dept.
- About a month later I got a letter stating the letter was reviewed by "appropriate personnel" and confirmed a short sale approval had occurred.
- When the short sale occurred, I had to sign a form about getting a 1099-C. Clearly they did not pay attention to my educational letter – I think this form was just part of the “standard” form package.
- When tax time arrived, I received, as expected, 1099-C’s for both the first and second mortgages. All turned out well at tax time, although that is a complex story for a follow up article.