BY PAUL GOLDEN
This article appeared in the September Issue of New York Real Estate Law Reporter
On June 14, 2023, the Second Department decided Walsh v Ocwen Loan Servicing, LLC. The court, with little fanfare, appeared to rule that cooperative apartment owners are saddled with an unavoidable risk of loss.
That is, if a lender alleges that the owners have defaulted, and then conducts a nonjudicial foreclosure sale, the former owners are left with few remedies. Re-gardless of whether the owners were truly in default, and regardless of whether they were notified of the sale, they can lose their home — for good.
A co-op shareholder does not have the same protections that a traditional homeowner has. The owner of a house, for example, who defaults on a mortgage, would not lose the home in a foreclosure sale until and unless the lender con-ducted a judicial foreclosure action, and until and unless the homeowner had the opportunity to present defenses to the court, and then only if the court specified at the end that the foreclosure would take place.
Shareholders of co-ops do not have those protections. Shareholders do not use the mortgage system — they obtain loans which are secured by their shares. If a lender deems the shareholder to have defaulted, the lender can ultimately conduct a nonjudicial foreclosure sale. This is just as it sounds — the court is not involved at all.
In any event, Walsh concerned a couple that owned cooperative shares to their home, an apartment, for fifteen years. Their position was that their shares (and corresponding lease) were inexplicably sold at a non-judicial foreclosure sale on Jan. 29, 2019. The closing then took place on July 18, 2019. The couple only found out that their cooperative shares had been sold at a foreclosure sale when the successful bidder arrived at their doorstep and claimed that he was the new owner of those shares. That bidder eventually filed a holdover proceeding to evict the couple from their home.
In September 2019, the couple filed an action against Ocwen Loan Servicing, LLC (Ocwen), the alleged assignee of the underlying note. They claimed they were not in de-fault of their promissory note and security agreement, and that they were not even served with any no-tice about the auction.
In the context of their case, the couple moved for a preliminary in-junction, seeking, among other re-lief, to enjoin the eviction during the pendency of the action. In May 2020, Hon. Jimenez-Salta of the Kings County Supreme Court granted the preliminary injunction, based in part on her ruling that there were serious questions on whether plaintiffs were actually in default of the promissory note and security agreement. The successful bidder then appealed.
On appeal, there were two diametrically opposed ways of viewing property rights. The successful bidder argued that UCC 9-617(b) gave him absolute rights of ownership. Under that statute, after there is a sale, a “good-faith transferee” obtains full rights to the collateral “even if the secured party [i.e. the lender] fails to comply with this article ….” The couple, conversely, argued that UCC 9-617(a) applied – which indicated that a secured par-ty only disposes of collateral after a “default.” The couple argued that the Legislature sought to make sure, when they passed UCC 9- 617(a), that parties such as plaintiffs would have to be in “default” in order for the purchaser to potentially obtain rights. They also argued that, to allow them to lose their home even if they were not in default, would violate the Due Process clause of the New York Constitution.
The court did not explicitly discuss the meaning of “default” in the stat-ute. Instead, the court simply ruled that “Where, as here, a debtor pledg-es cooperative shares and a corre-sponding proprietary lease as secu-rity for a debt, article 9 of the UCC applies to the enforcement of the se-curity interest.” Then the court held that the plaintiffs had not established that “that the relief they seek, in ef-fect, to vacate the sale of the shares and proprietary lease following the closing, is available under article 9 of the UCC.” Therefore, it held that the plaintiffs’ remedy was to seek monetary damages against Ocwen. Finally, it held that plaintiffs were not entitled to a preliminary injunction.
There are several critical issues that arise from this order.
One is that, at least in the Second Department, it appears a potential bidder has relatively few worries about whether he or she will actu-ally obtain viable and enforceable rights, in a nonjudicial foreclosure sale, at least once the closing takes place. Therefore, theoretically, such bidders will be willing to offer clos-er to the full value of the shares in a nonjudicial foreclosure sale. This is potentially beneficial for a de-faulting shareholder; the higher the sales price, the less the debt to the lender. There is even a chance the defaulting shareholder could obtain proceeds, to the degree they exceed the sum owed.
Second, a shareholder’s rights are extremely precarious, especially if dealing with a lender that cannot handle accounting records or notic-es properly. In the lender makes a mistake about: 1) whether there was a default; 2) how and when to serve the borrower with notice about the alleged default; or 3) both, then the borrower may suddenly find he no longer owns the shares at all. In such a case, the borrower apparent-ly has few options except to seek relief against the lender. But the chance to potentially win a money judgment against a lender, years af-ter the sale, will be cold comfort to a person kicked out of his home.
Third, lenders should take ex-tremely strong precautions in mak-ing sure that their accounting re-cords are in order, and that they serve notices on an alleged default-ing debtor perfectly, and that all t’s are crossed and i’s are dotted.
Otherwise, the former debtor may be unable to vacate the sale, and will have no choice but to seek full relief against the lender.
Fourth, the courts may eventually need to further clarify how far the law goes. In an extreme case, one could have borrowed funds, but fully paid them back to the lender. In such a case, if the lender makes an incredible error, and “sells” these same shares to a high bidder, which were formerly a security for the debt, how would the court handle it? A bidder would point to the Walsh case and argue that there is no way to seek to vacate a sale of shares under article 9 of the UCC. But presumably, even an extremely cold-hearted court would not go that far.