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In Indiana, Failure To Comply With HUD Servicing Regulations Can Be A Defense To A Foreclosure Action

While not directly applicable to commercial cases, Lacy-McKinney v. Taylor, Bean & Whitaker Mortgage, 937 N.E.2d 853 (Ind. Ct. App. 2010) is worth mentioning here. If you are involved in residential mortgage foreclosures in Indiana, you should be aware of the Lacy-McKinney decision. The case addressed the question of whether a lender/mortgagee’s lack of compliance with federal mortgage servicing responsibilities may be raised as an affirmative defense to the foreclosure of an FHA-insured mortgage.

HUD language. The Lacy-McKinney note and mortgage, which were in default for non-payment, referenced the applicability of HUD regulations to the loan. The terms of the loan documents clearly spelled out that regulations limited the lender’s right to accelerate and foreclose. For example, the borrower claimed that the lender did not satisfy a HUD regulation requiring a face-to-face meeting before the filing of a complaint for foreclosure.

The issue. The main issue in Lacy-McKinney was: are the HUD regulations binding conditions precedent that must be complied with before a lender has the right to foreclose on a HUD-insured mortgage? (Please note that the quarrel over the condition precedent did not affect the validity of the mortgage, but only whether the lender had a right at the time to foreclose on the mortgage.)

First impression. The issue was one of “first impression” in Indiana – meaning that the legal question was entirely novel and could not be governed by any existing Indiana precedent. The opinion thoroughly outlined the background of HUD-insured mortgages and some of the applicable regulations. (Read the opinion for more detail.) The case also discussed other states’ positions on the issue.

Defense recognized. The Court concluded that an affirmative defense should be recognized for non-compliance with HUD regulations under the circumstances:

The above precedents, the language of the HUD regulations, and the public policy of HUD persuade us that the HUD servicing responsibilities at issue in this case are binding conditions precedent that must be complied with before a [lender] has the right to foreclose on a HUD property. As such [borrower] can properly raise as an affirmative defense that [lender] failed to comply with the HUD servicing regulations prior to commencing this foreclosure action.

Summary judgment reversed. The Court went on to hold that the trial court’s summary judgment in favor of the lender should be reversed. “The trial court erred in granting summary judgment in favor of [lender] on its action to foreclose on [borrower’s] HUD-insured mortgage without first determining that [lender] had complied with Subpart C – the conditions precedent to foreclosure.” The Court therefore remanded the case to the trial court for further proceedings – likely a dismissal of the case. Ultimately, the lender in Lacy-McKinney may win the foreclosure war, but the borrower won this battle.

Those who deal in this area, whether they be lenders, borrower or counsel, should be familiar with this case. The loan document provisions and regulations appear to be consistent with 2009 Indiana state and local law developments requiring pre-suit settlement conferences, etc. about which I discussed on March 15, 2009 and June 19, 2009. Depending upon the contents of the loan documents, HUD-related “i’s” need to be dotted and “t’s” need to be crossed before suit can even be filed.