Getting your player ready...
John Reinholdt II earlier this month was sentenced to 16 years in prison as the mastermind of a $3.4 million Ponzi mortgage scheme that defrauded lenders. But one unexpected legacy of Reinholdt’s scam is a court battle to determine whether loan servicers also are proxies for “lenders” in real estate transactions under Colorado law.
At the heart of the issue is this question: can a servicer- the company that collect the mortgage payments each month – be paid at a sale or refinance of a property as an agent of the actual lender? Or, is it required that the actual holder of the note be present at each real estate closing?
It may sound like an academic, technical distinction, but it is important, because it impacts about a half-million real estate transaction in Colorado each year.
Dishonest lender set off events
Two cases – with similar facts that originated with two of Reinholdt’s former companies, but with different decisions by lower-court judges – are now in front of the Colorado Court of Appeals. Both involved fraudulent loans by the Reinholdt family, which created lending companies with colorful names such as Jaguar, Ocelot and Dakota to rip off reputable lenders that were bilked after loaning money to them. In the two cases in question, Reinholdt’s companies were lent money by Citywide Bank, but when the properties sold or refinanced, Citywide was not paid.
Reinholdt, who could have faced up to 24 years in prison, was also fined $2.5 million to pay in restitution. His Lafayette-based company operated under at least 19 different names. He borrowed money from “warehouse” lenders at rates between 5 percent and 7 percent and then used the money to make subprime mortgages of at least 11.5 percent. The Ponzi scheme portion: He used the money raised from new warehouse lines of creidt to pay back previous lenders, in some cases. And, as these two cases demonstrate, in some instances he did not pay back the money he borrowed. He also acquired new loans using non-existent “straw buyers.”
This is what Colorado Attorney General John Suthers said when Reinholdt was sentenced: “Criminals that defraud Colorado banks drive up the cost of home loans and other credit for all consumers. This sentence underlines the excellent work my office does in handling mortgage-and lending-fraud cases.”
Fraud led to broader question
However, the damage done by Reinholdt’s felony violations of the Colorado Organized Crime Control Act, could end up having repercussions far beyond the original fraud, as bad as it was.
“We would never close anything ever again,” the president of a title company testified in one of the lower-court cases, if courts required a holder of the note to be present at a real estate closing.
“It gets very confusing these days,” said attorney Alan D. Sweetbaum, who is representing borrowers in the two cases in front of the Colorado Court of Appeals. Sweetbaum, a partner of Sweetbaum, Levin & Sands, P.C., won a case on the issue in Adams County, but lost another case in Jefferson County. Citywide Banks was the lender in both cases.
Mortgages frequently sold
“As you know, (mortgage) notes are often sold on the secondary market, sometimes two or three times,” Sweetbaum said. “And sometimes they are bundled with other notes and sold as packaged securities. In the old days, it was simple. The actual lender came to the closing and the parties exchanged the actual note.”
As far as the consumer is concerned, the servicer is the lender. It could be a big bank such as Wells Fargo, or, it could be a small company that is not a household name. Consumers often never know the identity of the real lender, or investor. The loan could have been broken into “tranches” – or slices – and sold to other investors, so the true ownership is difficult to determine. Indeed, such securitizing of mortgages helped fuel the worst economic crash since the Great Depression, when the housing market collapsed.
Things truly get messy when the servicer is engaged in fraud.
Dishonest Dakota paid, not Citywide
“Dakota Lending was dishonest,” Citywide’s attorney Richard B. Podoll wrote in an opening brief on one of the cases in front of the appellate court.
In that case, homebuyer Brenda Armijo bought a home in Thornton for $189,000 in May 2008, according to public records. She borrowed $151,200 as part of the transaction. She bought the home from RE Services LLC, which initially had bought the property for $94,280. Financing for that loan to RE Services came from Jaguar Mortgage Co., and the loan was later assigned to another Reinholdt company, Dakota Lending LLC. The note was then assigned to Citywide, which had provided the funding to Jaguar
When Armijo bought the home, proceeds were disbursed by Stewart Title and paid to Dakota, instead of Citywide.
“It (Dakota) took the money. The money never reached Citywide, the holder of the promissory note,” Podoll wrote in court documents. He noted that Stewart Title argued that the servicer is the agent of the bank, so it did not err in paying Dakota. But Podoll says the Uniform Commercial Code makes it clear that the payment must be made to the holder (of the note) and not a servicer.
Looming foreclosure
Armijo was current on all of her mortgage payments, but still was at risk of having Citywide foreclose on her home, because Citywide had not been paid. She could have lost her house even though she had never heard of Jaguar, Dakota, Reinholdt or any of his related companies.
“In a case like this, the bank is saying, under the UCC I still have a live note, and I never got my money, and I have to be paid,” said Sweetbaum, Armijo’s lawyer. “The poor borrower-owner, on the other hand, has paid 100 percent of what she owes, and now faces being foreclosed on by the lender. In this case, my argument is that the borrower paid, but paid the wrong lender.” It’s not right, he said, that a borrower should have to pay the mortgage off twice, if the borrower was not aware of fraud.
Last June, Adams County District Court Judge Charles Scott Crabtree ruled in favor of Armijo and now the case is in front of the Colorado Appellate Court. The Land Title Association of Colorado filed a brief of Amicus Curiae, sometimes called a “friend of the court” filing, on behalf of Armijo. The LTAC, with more than 50 member title companies, estimated that title companies close more than 500,000 real estate loans and purchase transactions in Colorado annually.
Payoff statement crucial
“To close those transactions, title companies, borrowers, purchasers and lenders rely on payoff statements,” the LTAC said in its court filing. “Generally, payoff statements are obtained from the party to whom the borrower has been making the loan payment. More and more frequently that party is a servicing agent for the holder of the note secured by the lien Title companies and their customers need to be able to rely on payoff statements provided by the servicing agents who have been collecting loan payments. Requiring original promissory notes as a condition for a loan payoff would adversely impact the closing of real estate transactions in this State.”
It claimed that Citywide erred by blaming Stewart Title for paying Dakota, instead of Citywide. The association argued that the payoff to the bank’s loan servicing agent “constituted a payoff to Citywide.”
The LTAC goes on to say that is “standard practice” at Stewart Title, as well as for the entire title insurance industry, to rely on “payoff statements from institutional lenders, such as Dakota.” It noted that Dakota collected monthly payments of principal, interest, taxes and insurance and issued 1098 tax forms to borrowers. Dakota also could declare defaults and foreclose on deeds of trust on behalf of Citywide. The LTAC also said that Citywide did not insist that its original note be presented at the closing, prior to filing the lawsuit.
Also at the trial, attorney Robert “Bo” Edwards testified that because loans are constantly being assigned and re-assigned, it is more practical for a title company to determine who is getting the mortgage payments, rather than determining who actually owns the note.
Original notes rarely produced
Edwards testified that he has been involved in thousands of closing, and “almost never sees the original note, unless the lender is a private lender. Promissory notes are now bundled and could be off-shore.” He added it may be impossible to even locate the original note. He went on to testify that it is “hard to get investors to find the notes and, if located, get them to the closing. Most will not part with the note. Many lenders do not understand Colorado’s deed of trust release system.”
However, another attorney, Willis Carpenter, testified “a title company takes a risk of paying the wrong party without determining the holder of the note.”
Carpenter’s testimony also played a role in another case, in which the judge ruled in favor of Citywide.
In that case, Gregory Frankel obtained an $82,000 loan for a foreclosed property, which he planned to fix and sell. Jaguar Mortgage Co. made the loan.
Later, Frankel planned to refinance the mortgage into a more favorable interest rate. Frankel’s mortgage broker engaged Austin Title to conduct a title search.
During the search, Austin Title discovered the original Frankel-Jaguar promissory noted had been assigned from Jaguar to Ocelot and from Ocelot to Citywide.
Austin then asked Frankel to whom he sent his monthly mortgage payments and he said Ocelot. Austin Title then contacted Ocelot, requesting a payoff letter.
“Unfortunately for Frankel, the principals of Jaguar and Ocelot turned out to be criminals,” according to court documents. “Rather than direct the payoff funds to Citywide,” it mailed the payoff check to Ocelot, which “then used the funds for their own benefit. As a result, Citywide has never received funds to pay of Frankel’s note, and the note remains unsatisfied.”
Loans won’t close if original notes needed
In court documents, Frankel’s attorneys argue that because many “modern home mortgages are assigned, sold or securitized, it has become impractical to require the holder of a note to be physically present at a real estate closing.” The president of Austin Escrow and Title LLC, Kim Austin, testified that if it had to present the original note at a closing, it would be the end of the current way of closing loans: “We would never close anything again.”
Risky to pay off servicer
But Citywide “countered Ms. Austin’s doomsaying” with the testimony of attorney Willis Carpenter, according to documents. Carpenter testified that the “payment rule’s death are greatly exaggerated.” Carpenter’s opinion is that “real estate closing agents who depart from the strict requirements of the payment rule do so at their own risk,” as he had also testified in the Armijo case.
An executive from Citywide also testified that the bank had never authorized Ocelot to accept payoff funds.
Jefferson County Judge Dennis Hall concluded that evidence presented at the trial did not establish Ocelot as an agent for Citywide. Therefore, Austin Title’s payoff funds to Ocelot do not constitute payment to Citywide, Hall ruled.
“The “payment rule,” while perhaps no longer consonant with present commercial practices, remain the law in our state,” the judge ruled. “Closing agents who act in a manner inconsistent with the rule do so at their own peril. The responsibility for Frankel’s misfortune, therefore, lies with Austin Title, and not with Frankel or Citywide.”
Now, it is up to the Colorado Appellate Court to sort everything out. Stay tuned.
