Venue rule does not automatically apply to confessed judgments in Pennsylvania

By Stephen J. Shapiro

In Midwest Financial Acceptance Corporation v. Lopez, the Superior Court of Pennsylvania held that the venue provisions in the Pennsylvania Rules of Civil Procedure do not automatically apply to confessed judgment proceedings. In so holding, the Court resolved a split of authority among Pennsylvania’s trial courts.

In Midwest, the defendant borrowers signed a promissory note in connection with a commercial loan that contained a standard confession of judgment clause:


When the borrowers defaulted on the loan, Midwest confessed judgment against them in the Allegheny County Court of Common Pleas, and then transferred the judgment to Centre County.

The borrowers filed a petition to strike the judgment in the Centre County Court of Common Pleas. Although they did not raise the issue in their petition, at oral argument the borrowers claimed that Midwest confessed judgment in the improper venue. The trial court agreed, holding that: (i) a judgment only can be confessed in a county in which venue would be proper under Pennsylvania Rule of Civil Procedure 1006, and (ii) Allegheny County was not a proper venue for Midwest’s confession of judgment proceeding under Rule 1006. Therefore, the trial court struck the confessed judgment.

On appeal, Superior Court reversed. The court first noted that, pursuant to Rule of Civil Procedure 1001, the venue provisions in Rule 1006 apply only to “civil actions,” which are defined as actions in assumpsit (contract), trespass (injury to person or property) and equity, as well as all other forms of action “which incorporate these rules by reference.” Confessions of judgment, the Court explained, are not “civil actions” within the meaning of Rule 1001 because: (a) confessions of judgment do not fall into one of the three enumerated categories of civil actions; (b) the Rules of Civil Procedure that govern confessions of judgment do not incorporate the venue rules; and (c) confessions of judgment “differ significantly both procedurally and substantively from the civil actions subject to the general venue rules.” Therefore, the court concluded:

[U]nless otherwise specified in the agreement, the general venue terms of Rule 1006 do not automatically apply to the initial filing of a judgment of confession, and cannot be used to strike an otherwise lawful confession of judgment that has been entered in strict compliance with a valid [confession of judgment clause].

The court also noted that, although the confession of judgment clause “[was] not a forum selection clause in the traditional sense,” it nonetheless authorized Midwest to confess judgment in Allegheny County. According to the court, by agreeing that “any attorney or the Prothonotary or Clerk of any court in the Commonwealth of Pennsylvania” could confess judgment against them in the event of default, the borrowers acknowledged that venue was proper in any county in Pennsylvania.

In addition, the court pointed out that the trial court deviated from the well-established rule that, on a petition to strike a confessed judgment, a court only may investigate whether any defects or irregularities in the confession appear on the face of the complaint and the exhibits attached to it. The court explained that the trial court’s reliance on factual allegations by the borrowers that were not in the complaint – such as the borrower’s allegation that they could not have been served in Allegheny County – was improper on a petition to strike. A debtor that wishes to dispute facts underlying a confession of judgment must do so by filing a petition to open the judgment, which is a different remedy, governed by different rules, than a petition to strike.

By limiting its holding to petitions to strike confessed judgments, the court did not say whether debtors can raise the venue provisions of Rule 1006 in a petition to open a confessed judgment. However, logic dictates that the holding in Midwest should apply equally in the context of a petition to open. The court held that confessions of judgment are not “civil actions” and, therefore, that Rule 1006 does not apply to them. It cannot be that a debtor can convert a proceeding that was not a “civil action” when initiated into one simply by filing a petition to open. Out of an abundance of caution, though, lenders may want to consider including explicit forum selection clauses that specify the courts in which the lender may confess judgment to reduce the risk of litigation on this issue.

A Lower Debit Card Interchange Fee Cap is Unlikely to Eliminate Durbin Amendment Fee Increases Plaguing Small-Ticket Merchants

By Stephen J. Shapiro

The Durbin Amendment to the Dodd-Frank Act required the Federal Reserve to ensure that debit card interchange fees are “reasonable and proportional to the cost incurred by the [debit card] issuer with respect to the transaction.” Therefore, the Federal Reserve issued regulations, which became effective on October 1, 2011, that capped interchange fees on debit cards issued by banks subject to the Durbin Amendment (those with more than $10 billion in assets). Under the formula in the regulations, the interchange fee for the average debit card transaction of $40 would not exceed 24 cents, which is about half the amount that issuers had charged for the same transaction pre-regulation.

The regulations had an unintended consequence:  Merchants who sell small-ticket items actually saw their interchange fees increase. As explained in a paper by Zhu Wang, an economist at the Federal Reserve Bank of Richmond:

“Prior to the regulation, Visa, MasterCard, and most PIN networks offered discounted debit interchange fees for small-ticket transactions as a way to encourage card acceptance by merchants specializing in those transactions. For instance, Visa and MasterCard set the small-ticket signature debit interchange rates at 1.55 percent of the transaction value plus 4 cents for sales of $15 and below. As a result, a debit card would only charge a 7 cents interchange fee for a $2 sale or 11 cents for a $5 sale. However, in response to the regulation, most card networks eliminated the small-ticket discounts, and all transactions (except those on cards issued by exempt issuers) have to pay the maximum cap rate [of no less than 21 cents] set by the Durbin regulation. For merchants selling small-ticket items, this means that the cost of accepting the same debit card doubled or even tripled after the regulation.”

Shortly after the regulations went into effect, several merchant trade associations sued the Federal Reserve, arguing that the interchange fee cap was too high because the Federal Reserve did not properly implement the Durbin Amendment. Specifically, the Durbin Amendment identifies two categories of costs incurred by debit card issuers: (1) specified costs that the Federal Reserve could consider when setting the fee cap, and (2) specified costs that the Federal Reserve could not consider when setting the fee cap. In preparing the regulations, the Federal Reserve considered a third category of costs – costs not specified within either of the first two categories – and included some of those costs in the formula it used to calculate the fee cap. The merchants argued that, under the plain terms of the Durbin Amendment, the Federal Reserve only was permitted to consider costs within the first category when calculating the cap and, therefore, its inclusion of costs from the third category was improper and resulted in an inflated fee cap.

On July 31, 2013, the United States District Court for the District of Columbia agreed with the merchants and vacated the regulations in NACS v. Board of Governors of the Federal Reserve System. Among other factors that the Court offered in support of its conclusion, the Court mentioned the small-ticket merchant issue:  “By including in the interchange fee standard costs that are expressly prohibited by statute, the final regulation represents a significant price increase over pre-Durbin Amendment rates for small-ticket debit transactions . . . . Congress did not empower the Board to make policy judgments that would result in significantly higher interchange rates.”

The Federal Reserve has indicated that it intends to appeal the Court’s ruling, but assuming that the Federal Reserve eventually is required to lower the debit card interchange fee cap, the question becomes, will a lower cap fix the small-ticket merchant issue raised by the Court? Based on the analysis in Dr. Wang’s paper, probably not.

Dr. Wang explained that, pre-regulation, issuers were willing to reduce interchange fees for small-ticket transactions because those transactions acted as loss leaders. After the regulations went into effect, though, the economics no longer worked:

“Before the regulation, card networks were willing to offer discounted interchange fees to small-ticket merchants because their card acceptance boosts consumers’ card usage for large-ticket purchases from which card issuers can collect higher interchange fees. After the regulation, however, card issuers profit less from this kind of externality, so they discontinued the discounts.”

If Dr. Wang’s understanding is correct, a reduction in the interchange fee cap will not solve the small-ticket merchant problem. To the contrary, a reduction in the cap would make it even less likely that issuers will reinstate small-ticket merchant discounts because the reduced cap would further diminish the economic incentives that led issuers to offer the discounts in the first place. To be sure, lowering the fee cap will reduce the fees that all merchants – including small-ticket merchants – pay when compared to the fees changed under the existing regulations. However, fees will not return to the low levels small-ticket merchants paid pre-regulation (unless, that is, the cap for all merchants is lowered to the pre-regulation discounted rate for small-ticket merchants – a result that seems highly unlikely).

Dr. Wang’s report also exposes a potential flaw in the NACS Court’s analysis. The Court’s conclusion that the regulations did not adhere to the Congressional intent behind the Durbin Amendment because they resulted in increased interchange fees for small-ticket merchants suggests that it may have overlooked the economics upon which the small-ticket merchant discounts were based.

Pennsylvania’s Superior Court Holds That Loan Term Sheets May Be Binding Contracts

By Stephen J. Shapiro

A recent decision by Pennsylvania’s Superior Court contains a warning for lenders:  loan term sheets may be binding contracts. In County Line/New Britain Realty, LP v. Harleysville National Bank and Trust Company, County Line, a real estate development partnership, sought to borrow more than $12 million from Harleysville to develop several contiguous parcels of land into a commercial property that would be leased to retailers.

Harleysville’s loan committee approved the loan and emailed County Line a term sheet outlining the details of the loan that the bank had approved. In addition to the amount of the loan, the term sheet identified: “(1) the identity of the borrower and lender; (2) the loan and facility type; (3) the principal amount, purpose, and distribution of the loan; (4) the interest rates; (5) the term of the loan; (6) the manner of the repayment of the loan (amortization); (7) the collateral for the loan; (8) the penalty and fees for the loan; and (9) the guarantors.”

Ten days after County Line received the term sheet, one of its principals called the bank employee handling the transaction to accept the loan described in the term sheet. Harleysville then informed County Line that it had decided to pull the loan and would not proceed with it. County Line responded by filing a lawsuit against Harleysville, which led the bank to agree to reinstate the loan. However, as the parties proceeded towards closing on the loan, they had several disagreements about whether County Line had sufficiently complied with certain conditions for closing the loan.

Ultimately, the loan did not close and County Line sued Harleysville for, among other things, breach of contract. At the conclusion of a 10-day trial, a jury found that Harleysville had breached a valid contract between the parties and awarded County Line $3.6 million in damages.

Among several issues raised on appeal, Harleysville argued that the term sheet was not a binding contract. According to the bank, the term sheet described a proposed loan and was merely an “agreement to agree” at some later date to a definitive loan. Because, argued Harleysville, the term sheet did not evidence an intention by the bank to bind itself legally to the proposed loan; therefore, the term sheet was unenforceable.

Superior Court rejected the bank’s argument. First, the Court made clear that it “[did] not dispute Harleysville’s assertion that the parties intended to further formalize their loan agreement through eventual execution of a note, a mortgage, and other relevant loan documents.” However, the Court concluded that the contents of the term sheet were sufficiently detailed to “evidence a contract wherein Harleysville agreed to issue County Line the contemplated loan.” Therefore, the Court affirmed the judgment in favor of County Line.

In light of the outcome in the County Line case, before issuing detailed term sheets lenders in Pennsylvania should carefully consider whether they are willing to close on loans governed only by the provisions of those term sheets. When in doubt, lenders should consult with counsel to develop strategies to reduce the risk that loan term sheets will become binding agreements to lend.

The Future is Dim for Fair Lending Claims Based on a Discretionary Pricing Policy

By Stephen A. Fogdall

In Rodriguez v. National City Bank, the United States Court of Appeals for the Third Circuit just dealt a significant blow to classwide litigation of fair lending claims based on a bank’s “discretionary pricing policy.”  Such claims have been increasingly common in the aftermath of the 2007-2008 financial crisis.  These claims typically are based on the allegation that the bank gives its loan officers discretion to adjust a borrower’s interest rate or fees based on subjective factors independent of the borrower’s creditworthiness.  This discretion is alleged to result in minority borrowers paying a higher price for loans than nonminority borrowers.

Discretionary pricing claims are usually framed using a “disparate impact theory” under the Fair Housing Act or the Equal Credit Opportunity Act.  The viability of such claims has already been brought into question by the U.S. Supreme Court’s recent grant of certiorari in a case to decide whether the Fair Housing Act allows for disparate impact liability.  (For more discussion on that topic, click here.) Now the Third Circuit has ruled that such claims, as typically framed, cannot be brought on a classwide basis, even if they are otherwise legally viable.  In Rodriguez, the parties agreed to settle claims that the bank caused minority borrowers to pay more for loans than nonminority borrowers due to loan officers’ discretion to set points, fees and other charges.  The district court refused to approve the settlement, finding that certification was foreclosed by the Supreme Court’s decision in Wal-Mart Stores, Inc. v. Dukes, 131 S. Ct. 2541 (2011).  The Third Circuit granted the plaintiffs’ petition to appeal that ruling, but affirmed it.

The Third Circuit’s analysis followed the Duke decision closely.  The Third Circuit emphasized that the plaintiffs were required to prove that Rule 23’s commonality requirement was satisfied notwithstanding that the parties had agreed to settle the case.  The plaintiffs argued that they had established commonality using a statistical analysis of loan data produced by the bank, which they said controlled for all “objective credit and risk factors impacting loan pricing” and showed that the discretionary pricing policy had a discriminatory effect.

The Third Circuit ruled that this statistical analysis (which was not in the record) could not establish commonality by a preponderance of the evidence, because it did not show “that there was a common and unlawful mode by which the officers exercised their discretion,” and therefore did not establish that the alleged discriminatory effect was tied to a specific policy of the bank.  Individual loan officers may have exercised their discretion based on factors that, while subjective, had nothing to do with a borrower’s race.  Moreover, the analysis was based on national data from tens of thousands of borrowers at 1,400 bank branches.  A “very significant disparity at one branch or region could skew the average, producing results that indicate a national disparity, when the problem may be more localized.”

In short, the Third Circuit concluded, “the exercise of broad discretion by an untold number of unique decision-makers in the making of thousands upon thousands of individual decisions undermines the attempt to claim, on the basis of statistics alone, that the decisions are bound together by a common discriminatory mode.”

The Third Circuit’s analysis leaves open the possibility that a plaintiff might be able to establish commonality by limiting the class to borrowers in a specific region, or at an individual branch, or perhaps even borrowers who obtained loans through a specific loan officer, and then demonstrating disparate impact using statistics for these borrowers alone.  However, plaintiffs and plaintiffs’ lawyers are unlikely to find claims this finely grained worth pursuing.  Thus, it is difficult to see a future for disparate impact claims based on a discretionary pricing policy following the Third Circuit’s decision in Rodriguez.

Lenders may be able to reduce litigation risk by obtaining express consent when a borrower pledges the assets of a wholly-owned subsidiary as collateral

By Stephen J. Shapiro

A recent decision by the United States Court of Appeals for the Third Circuit suggests steps that lenders who accept the assets of a borrower’s wholly-owned subsidiary as collateral should consider taking to reduce the likelihood of litigation in the event the lender must pursue the collateral. In Wachovia Bank National Association v. WL Homes LLC (In re: WL Homes), borrower WL Homes pledged the bank account of JLH, its wholly-owned subsidiary, to Wachovia as collateral on a loan. When WL Homes later filed a bankruptcy petition, Wachovia brought an action in the bankruptcy court for a declaration that its security interest in JLH’s bank account was enforceable. The bankruptcy court ruled in Wachovia’s favor because it concluded that JLH had consented to WL Homes’ pledge of its bank account, and the district court affirmed that part of the bankruptcy court’s holding.

On appeal, the Third Circuit began its analysis by setting out the circumstances under which a security interest in a bank account becomes enforceable under the law of California, which governed the action. Such a security interest becomes enforceable under California’s Commercial Code when, among other circumstances not at issue in the case, “the debtor has rights in the collateral.” A debtor is deemed to have rights in collateral that it does not own when the owner of the collateral consents to the debtor’s pledge of the collateral. Therefore, the issue before the Third Circuit was whether JLH had consented to the pledge of its bank account as collateral for the loan to WL Homes.

In its analysis of whether JLH had consented to the pledge, the Court focused on the fact that the CFO of WL Homes, who had negotiated and signed the loan agreement with Wachovia, also was the president of JLH. Therefore, the Court imputed knowledge of the loan to JLH and concluded that this knowledge manifested JLH’s consent to WL Homes’ pledge of its bank account as collateral. Because the Court deemed JLH to have consented to the pledge, it concluded that Wachovia had an enforceable security interest in JLH’s bank account.

Although the result in the WL Homes case is not surprising, the case suggests steps that lender can take to reduce the potential for litigation when accepting a pledge of non-owned assets from a borrower. Specifically, lenders should consider obtaining express written consent to the pledge from the owner of the asset, even if the owner is a wholly-owned subsidiary of the borrower. Such clear, written consent could dissuade opponents from litigating the enforceability of a lender’s security interest, thereby potentially sparing lenders from the expense of litigating the issue of consent.

FIRREA Does Not Deprive Courts of Jurisdiction to Rule on Affirmative Defenses to Foreclosure Actions, Holds Pennsylvania’s Superior Court

By Stephen J. Shapiro

The Superior Court of Pennsylvania held last week that federal law does not prevent courts from considering affirmative defenses to foreclosure actions brought by mortgage holders that have acquired the assets of financial institutions placed into receivership. In Sass v. AmTrust Bank, a homeowner refinanced her mortgage through AmTrust and, when she defaulted on the mortgage, AmTrust filed a foreclosure action. In her answer to the foreclosure action, the homeowner alleged that an employee of the closing agent selected by AmTrust absconded with a large portion of the loan proceeds and that AmTrust had failed to include in her loan documents certain disclosures required by federal law. Therefore, the homeowner argued as an affirmative defense, she was entitled to rescission of the mortgage. The homeowner also brought a declaratory judgment action against AmTrust, seeking a declaration that her mortgage was void ab initio. While the cases were pending, the FDIC put AmTrust into receivership, and Nationstar Mortgage acquired the rights to the homeowner’s loan.

The homeowner moved for summary judgment in both actions and, when Nationstar failed to respond to her motions, the trial court granted them. On appeal, Nationstar argued that the trial court lacked jurisdiction to rule on the homeowner’s motions because the Financial Institutions Reformation, Recovery, and Enforcement Act (FIRREA) deprived the trial court of jurisdiction to hear any action relating to the pre-assignment conduct of a depositary institution that was placed in receivership. Specifically, FIRREA provides that “no court shall have jurisdiction over . . . any claim or action for payment from, or any action seeking a determination of rights with respect to, the assets of any depository institution for which the [FDIC] has been appointed receiver…”  12 U.S.C. 1821(d)(13)(D). The Superior Court characterized Nationstar’s position on appeal as follows:  “Nationstar appears to argue broadly that under FIRREA, a successor institution assumes only the assets of its failed predecessor and that, consequently, the purpose of FIRREA to assure economic stability in the wake of bank failures is met only if the successor is insulated from loss occasioned by any of its predecessor’s conduct.”

The Court rejected Nationstar’s broad reading of FIRREA. Rather than analyzing the policy considerations upon which Nationstar based its interpretation of FIRREA, the Court instead focused on the plain language of the statute, which on its face divests courts of jurisdiction only over “claims” or “actions.” Under that textual reading of FIRREA, the Court held that the homeowner’s declaratory judgment action was indeed a “claim” relating to the assets of a depository institution over which FIRREA had divested the trial court of jurisdiction. Therefore, the Court vacated the trial court’s grant of summary judgment on the homeowner’s declaratory judgment action.

On the foreclosure action, however, the Court held that the homeowner’s affirmative defense of rescission was neither a “claim” nor an “action” that FIRREA deprived the trial court of jurisdiction to hear, but rather was a “response” to Nationstar’s foreclosure action. Therefore, Superior Court held, the trial court did not lack jurisdiction to decide the homeowner’s motion for summary judgment on her affirmative defense of rescission. Superior Court held that Nationstar had waived its right to challenge the trial court’s ruling on the merits because it had failed to notice its appeal in a timely fashion. Therefore, Superior Court affirmed the trial court’s summary judgment ruling invalidating the mortgage and dismissing the foreclosure action.

In its opinion, Superior Court did acknowledge the potential mischief a homeowner could attempt to sow by pleading as affirmative defenses what are, in actuality, counterclaims in an attempt to avoid the FIRREA bar. It noted though that courts must look past the labels litigants place on their purported defenses and instead “must consider whether the disputed assertion of a party’s pleading stems from the desire to establish a right to payment and collect on the resulting debt, or from an explanation of why the debt is not valid or collectible.”

UPDATE:  On February 5, 2014, the Pennsylvania Supreme Court denied Nationstar’s Petition for Allowance of Appeal from the Superior Court’s ruling.

The Enhanced Scrutiny of Class Definitions Under the Ascertainability Requirement: An Additional Hurdle for Plaintiffs or an Increased Burden for Defendants?

Schnader Alert by Theresa Loscalzo and Ira Neil Richards:

This Schnader Alert discusses recent appellate authority on class certification, describing how courts are taking a closer look at whether class members can be identified from the class definition the plaintiff proposes and from the records available to the parties.

Please click here to read the full Alert.

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