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Is eRecording Secure? Recognizing the Risks, Deflating the Myths

Posted in Collateral, Kentucky Law

When it comes to the electronic recording and notarization of documents, Kentucky has historically been on the outside looking in, while neighboring states have embraced the efficiency and cost-saving benefits of eRecording. But that may soon change: Kentucky is on the verge of passing legislation that would adopt the key provisions of the Uniform Real Property Electronic Recording Act (URPERA) and Revised Uniform Law on Notarial Act (RULONA). If the bill passes in 2018, Kentucky will allow eRecording for real estate documents (currently prohibited under Kentucky’s non-uniform UETA, KRS 369.103(2)(c)) and eNotarization). While Kentucky has gradually warmed to the idea of eRecording, some remain skeptical of the e-trend, fearing it may expose consumers to new security risks and hazards.

On the one hand, an appreciation of potential security risks is a good thing, given the challenges in implementing new eRecording and eNotarization systems. Any computer-based system comes with hazards, from data corruption and recovery issues to malicious software and rogue hackers. A private eRecording software company could inadvertently allow unintended access to customers’ documents, hire inadequately trained individuals, or even suffer employee malfeasance. Any county clerk or office currently eRecording relies on that company’s network security, file and folder organization systems, and recovery capabilities (or lack thereof).

On the other hand, these potential security risks tend to be overstated. Unlike digital medical records, with the privacy concern of exposing personal health information, land records are public. The fraudulent recording of mortgages and deeds is the concern with eRecording. Electronic documents, however, are arguably much less susceptible to fraud than their paper counterparts, and just as secure if not more so. As the Property Records Industry Association (“PRIA”) explains, certain protocols and encryption algorithms protect digital documents. Paper submissions lack these protections. With eRecording, an audit trail allows the document to be traced from the moment it is scanned, through the entire recording process, and back again to the submitter. Paper documents do not have an audit trail.

Moreover, eDocuments contain metadata that provides details about who accessed and e-signed it, when they accessed it, and where. So the document’s distinct audit trail also ties to the individual signing it, whereas paper documents can be more easily forged or manipulated.  By adopting URPERA, Kentucky will enhance the security of real estate transactions.

Besides improving the accuracy of the documents themselves, eRecording also imposes enhanced vetting for signors. Recording clerks are not capable of verifying the information set forth in an instrument, or the identity of the person in front of them, but with the dawn of eRecording, submitters must now enter agreements with private companies, set up an electronic payment system, and receive authorization to install the software, which creates electronic footprints that can be traced back to perpetrators of fraud. eNotarization similarly helps filter out perpetrators, whose ability to fraudulently record real estate instruments largely depends on the notary. In order to commit recording fraud, the culprit must find a conspiring notary willing to assist in the fraud, or a notary known to lack due diligence when confirming identities, or else must risk using false identification. eRecording skeptics also frequently express concerns about “robo-signing” – a signor’s failure to conduct the necessary investigation before attesting to a document – which they fear will run rampant in a digital world. The risk of robo-signing, however, is reduced with the new legislation because it will now require notaries to maintain journals whether the notarization is electronic or manual.

As PRIA notes, the risks of eRecording are “similar to those inherent in the paper recording process,” but “are not necessarily a function of how the document was received or recorded.”  While certain risks of eRecording exist, its use helps reduce fraud and improve verification accuracy. Fraud and imprecision in the recording process may not be eliminated entirely, but can be lessened through Kentucky’s adoption of URPERA and RULONA.

Kentucky To Consider E-Recording Reforms

Posted in Collateral, Kentucky Law

The past two decades have seen a paradigm shift in the way states sign, record, and notarize documents. Once hindered by paper document and “wet” signature requirements, the modern recordation process in many states has evolved to allow recording of real estate records electronically. States first began adopting laws to equate “e-signatures” with pen-and-paper signatures in the mid-1990s, and in 1999, the Uniform Law Commission created a model state law – the Uniform Electronic Transactions Act (UETA) – to broadly accept all forms of e-signatures. The next year, Congress passed the Electronic Signatures in Global and National Commerce Act (E-SIGN) to nationalize the use of e-records and e-signatures.

Today, many states have not merely achieved the visions of UETA and E-SIGN, but have surpassed them. Nearly all states have adopted UETA, but Indiana, Tennessee, and Virginia have also adopted the Uniform Real Property Electronic Recording Act (URPERA), a 2004 uniform law allowing clerks and recorders to e-record real property transactions and land records. In addition to URPERA (which, as of 2014, has been adopted in 28 jurisdictions), West Virginia, Nevada, and Pennsylvania have gone even further by adopting 2010’s Revised Uniform Law on Notarial Act (RULONA) allowing notaries to electronically perform notarial acts.

But Kentucky has remained stubbornly behind, one of only four states in which not a single county clerk will accept real estate recordings electronically. The primary reason is that Kentucky adopted a non-uniform version of UETA that excepts documents relating to real estate transactions. A second reason is the state’s county clerks have been suspicious that any sort of reform will result in more work, or lower fee income, or both.

Despite this stagnation, however, significant progress is being made in 2017, thanks to newly-created factions pushing Kentucky in the right direction. Recently, the annual Conference on the Law of Financial Institutions held at the University of Kentucky College of Law entertained a reform proposal that stressed the need for adaptation over resistance, and articulated the potential benefits of real estate e-recordings. The presentation urged banks and lawyers to (1) pursue legislation to remove Kentucky’s UETA real estate exemption; (2) adopt URPERA for its clarity and conformity with adjacent states; and (3) adopt RULONA to allow e-notarization and deter fraudulent “robo-signing.” In addition, the Kentucky Secretary of State’s Office recently commissioned an Electronic Notary & Recording Task Force. The first meeting of the Task Force, designed to review technologies, pursue the requisite legislation, and determine the best e-recording practices for Kentucky, is scheduled to occur later this month. The goal of the Task Force is to propose legislation for consideration by the 2018 General Assembly.

SCOKY Drops the Ball in Unifund

Posted in FDCPA, Kentucky Law, Usury

The Kentucky Supreme Court offered a new interpretation of Kentucky’s usury statute, KRS 360.010, in a collection case involving a credit-card receivable. Unfortunately, SCOKY interpreted a statute that did not apply.

Harrell, a consumer, had a credit card agreement with Citibank, N.A., a national bank with headquarters in South Dakota. The interest rate was 27.24%. Harrell defaulted, and Citibank charged off the debt, but later sold the account to a “debt buyer,” Pilot who later sold to Unifund. Unifund filed a collection action, seeking payment of the debt, and prejudgment interest at 8%, the statutory rate under KRS 360.010.

Harrell counterclaimed, arguing that when Citibank charged off the account, it waived its right to collect ANY prejudgment interest after charge-off. Harrell alleged that Unifund’s attempt to collect interest that it wasn’t entitled to was a violation of the Fair Debt Collection Practices Act.

SCOKY held that Citibank extinguished its right to statutory interest when it contracted with Harrell for an interest rate in excess of 8%. And it held that Citibank waived its right to prejudgment interest when it charged off the account.

First, Citibank is a national bank with headquarters in South Dakota. Under well-established law, a national bank may “export” the interest rate permitted in its headquarters state. South Dakota does not have a usury limit; hence the 27% interest rate for the credit card complied with applicable law. The credit card agreement had a South Dakota choice of law provision—Unifund’s problem was that it failed to produce the agreement. And prejudgment interest is a substantive legal right that parties can control by a choice of law provision. Unifund’s invocation of KRS 360.010 was bad strategy, and led SCOKY down a path it didn’t need to follow. The 27% interest rate would have been permitted for prejudgment interest under the applicable South Dakota law.

Second, SCOKY believed that Citibank, by charging off, “waived” its right to interest. Following the Sixth Circuit in Stratton, SCOKY interpreted Citibank’s action as a “knowing and voluntary relinquishment of a known right.” SCOKY believed that Citibank took to the action to avail itself of a tax deduction for bad debt. But in fact, Citibank was required to charge-off. Federal banking regulations require banks to charge-off debts that are unlikely to be collected, in order to ensure that the banks’ books accurately reflect their assets. Ignoring these rules risks a write-up by the bank examiner. There is nothing “voluntary” about it. Even the National Consumer Law Center has recognized that “charge-off” is an accounting function that does not affect the ultimate collectability of the debt.

Unfortunately, there is a developing split in the courts on this issue, and there is no guarantee the Sixth Circuit and SCOKY will get it right anytime soon. Certainly, debt-buyers are not the most sympathetic defendants, and the lure of lucrative FDCPA class actions is drawing the attention of consumer lawyers.

Comer Introduces Industrial Hemp Bill

Posted in Healthcare, Kentucky Law, New Rule

Hemp leaf

Kentucky Representative (and former agriculture commissioner) James Comer introduced new legislation (H.R. 3530) to reduce the burden of regulations and statutes applicable to industrial hemp, an industry which is growing by leaps and bounds in Kentucky.

Currently, the statute allows “pilot projects” and “research,” but the industry needs more clarity and certainty to encourage investment and growth. Potential industrial uses include lighter, stronger fibers for composite materials and plywood, as well as textiles, and the constituent chemicals and oils for medical, food, and cosmetic applications. The new act facilitates commercialization by taking the important step of removing industrial hemp containing 0.3% or less of the psychoactive ingredient THC from the Controlled Substances Act’s definition of “marihuana.” Additionally, the bill would allow research into hemp with as much as 0.6% THC, still far below psychoactive levels.

The new legislation is not without critics however. Some believe that industrial hemp should be removed from the enforcement jurisdiction of the Drug Enforcement Administration. In 2014, the DEA confiscated the first international shipment of hemp seed to Kentucky, resulting in court action. That case was settled, but without firm written rules, and some uncertainty about DEA’s enforcement intentions remains. And the bill continues unnecessary reporting of hemp crop locations to federal authorities.

Another concern is whether the bill unintentionally opens cannabidiol (“CBD”) processors to enforcement risk, as they may produce higher-than-permitted concentrations of THC as a temporary byproduct of CBD production. Although research is ongoing, some claim that CBD has many health benefits, including relieving pain, reducing anxiety, and treating arthritis. Critics hope that their concerns will be addressed by amendment.

Sponsors are optimistic that some form of the bill will be enacted by the end of the year.

Kentucky General Assembly Halves Judgment Interest Rate

Posted in Interest Rates, Kentucky Law

The Kentucky legislature amended KRS 360.040, which governs the interest rate on money judgments. Previously, money judgments bore interest at 12% – the new rate is 6%, which is more in line with other states.

Importantly for financial institutions, the new statute provides that if the judgment is based on a contract or promissory note that establishes an agreed interest rate, then the judgment will bear interest at that rate.  The new statute also specifically applies to prejudgment interest, as well as post-judgment interest.  It is not clear whether the new statute will affect SCOKY’s recent decision in Unifund, which found that a lender that charged-off a debt effectively waived its right to prejudgment interest.

The new statute went into effect on June 29, 2017.

Lis Pendens Saves Equitable Mortgage

Posted in Collateral, Foreclosure, mortgage

The Kentucky Court of Appeals recently affirmed in Brooks v. J.P.Morgan Chase Bank, N.A. that an equitable mortgage established in litigation has priority over a pendente lite mortgage.  The Lender filed an action to correct several deficiencies with its mortgage: (1) signed by husband but not wife; (2) unidentified preparer; (3) no scrivener’s statement; (4) blank legal description; and (5) original not recorded and lost.  The Lender sought to have a copy of the lost mortgage recorded.  Upon filing its complaint, the Lender recorded a lis pendens in accordance with KRS 382.440.  During the litigation, the borrower granted a Law Firm mortgage on the subject property.  The trial court held that the Lender’s resulting equitable mortgage had priority over the Law Firm’s recorded mortgage.  The appeal challenged the validity and priority of the respective liens.

While the Law Firm’s mortgage secured a debt for services, it was not a lien governed by the attorney lien statute, KRS 376.460. The statutory attorney lien attaches to sums recovered, but a client can grant a mortgage as additional security.  The Lender’s unrecorded copy of the mortgage failed almost every requirement of KRS 382.335.  While it could not be recorded, these defects did not invalidate the mortgage or the resulting equitable mortgage.  The Law Firm also challenged the Lender’s mortgage because it was granted to MERS.  Despite the involvement of MERS being commonplace and permitted by prevailing Kentucky law, the Brooks court still labeled the use of MERS as “controversial.”  But since the Lender possessed the original note, it could enforce the resulting equitable mortgage.

For priority, the Law Firm argued its lien was the only “lawfully recorded” mortgage. But the Lender had recorded a lis pendens the month before the Law Firm had taken its mortgage.  A prior equitable mortgage takes priority over a subsequent lien recorded with actual or inquiry notice.  While the lis pendens did not create a lien, it did provide notice.  As a pendente lite lienholder, the Law Firm could have no greater interest than the Lender.  Since the Lender’s predecessor had provided credit in exchange for a transfer of an interest in the property, it held an equitable mortgage despite the multitude of deficiencies in the mortgage itself.  The Lender’s equitable mortgage had priority over the Law Firm’s lien as the lis pendens resulted in the Law Firm’s lien being subject to the results of the litigation.

Brooks v. J.P. Morgan Chase Bank, N.A., 2017 Ky. App. Unpub. LEXIS 121 (Ky. Ct. App. Feb. 10, 2017).

The Power Of Three Overcomes A Putative Debtor Who Can Count To Twelve

Posted in Bankruptcy Trends

The Sixth Circuit BAP has reversed the denial of a motion to dismiss an involuntary petition.  A single petitioning creditor initiated the case of In re Zenga based on the putative debtors’ responses to interrogatories which identified 10 creditors.  The putative debtors sought to introduce evidence of additional creditors.  The bankruptcy court held the prior sworn statements estopped the presentation of contrary evidence.  With less than 12 creditors, Section 303(b)(2) permits a single creditor to file the involuntary petition.  The bankruptcy court entered the order for relief.

The applicable standard of review for the application of estoppel was not decided because the result was the same under a de novo or abuse of discretion review.  Since the numerosity requirement in the statute was not jurisdictional, equitable powers could be used to prevent a debtor from arguing it met the threshold.  The best interest of the creditor’s argument was not subject to a final order and not reviewed.  Siegel was not extended to prevent the use of equitable doctrines to overcome a numerical threshold.  For judicial estoppel—an oft-discussed concept—no court had relied on the sworn testimony of the number of creditors so it was inapplicable.  That left equitable estoppel.

To establish equitable estoppel, a party must prove “(1) misrepresentation by the party against whom estoppel is asserted; (2) reasonable reliance on the misrepresentation by the party asserting estoppel; and (3) detriment to the party asserting estoppel.”  There was no dispute as to the first two elements: (1) the putative debtors misrepresented that they only had 10 creditors besides the petitioning creditor; and (2) the petitioning creditor reasonably relied on that misrepresentation in commencing an involuntary bankruptcy proceeding.  But the bankruptcy court failed to make any findings on the detriment suffered by the petitioning creditor (and his attorney could not articulate any specific detriment).  The more appropriate remedy was having other creditors join in the petition as permitted by § 303(c), not estopping the putative debtors from presenting evidence of additional creditors.  The orders for relief entered by the bankruptcy court were vacated.

This case reminds us that when seeking equity from a bankruptcy court, it is important to know the harm that has been suffered.  That and the power of three petitioning creditors is only necessary when there are 12 creditors.

Keepin’ It Classy: Court Certifies Class-Action for Alleged FDCPA Violations

Posted in FDCPA

Last week in Macy v. GC Services, the United States District Court for the Western District of Kentucky certified a class action involving the Fair Debt Collection Practices Act (“FDCPA”).  According to the plaintiffs, GC Services Limited Partnership violated the FDCPA by sending them debt collection notices which failed to specify that debt validation is only required if the customer disputes the debt in writing.

The Court rejected GC Services’s argument that a class is unascertainable. GC Services contended that the plaintiffs had not shown that every class member had “suffered an injury sufficient to confer standing.”  The Court noted that the “majority of courts” (not addressed in the Sixth Circuit) do not require the named plaintiffs in a class action to demonstrate that “each and every class member could satisfy an individualized standing inquiry” at the class certification stage.

After rejecting GC Services’s argument that the class was unascertainable, the Court found that the plaintiffs satisfied the following Rule 23(a) criteria: numerosity, commonality, typicality, and adequacy of representation.  The Court focused on the collective receipt of a similar allegedly deficient notices that put plaintiffs—and the putative class members—at risk of waiving the FDCPA’s protections.

The Court also concluded that the plaintiffs satisfied Rule 23(b)(3) because common questions of law and fact predominated over individual ones and a class action was the superior method for adjudicating the claims.  The Court declined to follow the United States District Court for the Middle District of Florida’s opinion which found that a class action was not the superior method for adjudicating the putative class’s claims in a case involving the same counsel and similar claims against GC Services.  The Florida court reasoned that the named plaintiff’s demand for statutory damages “gave rise to a potential conflict of interest because class members with actual damages would be precluded from recovering them in lieu of the nominal damages the court intended to award.”  The Macy court disagreed, noting that class actions are “designed to overcome the problem that small recoveries do not provide the incentive for any individual to bring a solo action” and, therefore, the possibility that the class members might recover a “paltry” sum did not dissuade the court that a class action was the superior method of adjudication.  The Court also noted that any class members with larger actual damages could opt out of the class action and pursue their claims in an individual action.

Finally, the Court denied GC Services’s request that it certify a nationwide class in order to avoid piecemeal litigation.  The Court based its decision on the fact that the FDCPA does not limit the number of class actions that may be filed against a single defendant, and plaintiffs are masters of their own complaints.

Junk Faxes Go to the Head of the Class (Action)

Posted in TCPA

In its latest “junk fax” case, the Sixth Circuit Court of Appeals reversed a district court’s denial of class certification and dismissal of a lawsuit alleging that Top Flite Financial, Inc., a mortgage company, violated the Telephone Consumer Protection Act (“TCPA”) by hiring a third party to send unsolicited fax advertisements on its behalf. See Bridging Communities, Inc. v. Top Flite Financial Incorporated, Case No. 15-1572, 2016 U.S. App. LEXIS 22297 (6th Cir. Dec. 15, 2016).

According to the complaint, Top Flite allegedly hired Business to Business Solutions (“B2B”), a well-known fax-broadcasting company, to send unsolicited fax advertisements to the plaintiffs and a class of similarly-situated parties without their consent or an established business relationship. The district court first denied class certification because individual questions of consent (a defense to the claims) precluded a finding of predominance under Fed. R. Civ. P. 23(b)(3). Then, after the plaintiffs failed to accept a Rule 68 offer of judgment from Top Flite, the district court dismissed the lawsuit as moot. The plaintiffs appealed both rulings.

Regarding predominance, the Sixth Circuit noted that “Rule 23(b) requires a showing that questions common to the class predominate, not that those questions will be answered, on the merits, in favor of the class.” Id. at *6 (quoting Amgen, Inc. v. Conn. Ret. Plans & Tr. Funds, 133 S. Ct. 1184, 1191 (2013) (emphasis added). In other words, even though individual proof may be involved, if the issues which are subject to generalized proof predominate, Rule 23(b)(3) will be satisfied. In the Court’s view, Top Flite’s speculation that some claimants might have given consent was insufficient to overcome the plaintiffs’ evidence that B2B had not contacted any of the claimants to verify consent before sending faxes.

The Sixth Circuit also reversed the district court’s mootness dismissal because the plaintiffs had failed to accept Top Flite’s offers of judgment. Before the district court, Top Flite relied on the Sixth Circuit’s opinion in O’Brien v. Ed Donnelly Enterprises, 575 F.3d 567 (6th Cir. 2009), for the proposition that unaccepted offers of judgment can moot a case and deprive a district court of subject matter jurisdiction. However, in between the time of the district court’s ruling and the Sixth Circuit’s review of the case, the Supreme Court ruled in Campell-Ewald Co. v. Gomez, 136 S. Ct. 663 (2016) that unaccepted offers of judgment do not moot a case. In light of Campbell-Ewald, the Sixth Circuit held that Top Flite’s rejected offer of judgment did not moot the lawsuit.

The case is remanded to the district court.

Still Not Valid When Made

Posted in Circuit Split, Interest Rates, SCOTUS

Last year, we posted about Madden v. Midland Funding, LLC, 786 F.3d 246 (2d Cir. 2015), where the Second Circuit Court of Appeals decided to ignore the “Valid When Made” doctrine.  This is the established common law doctrine that if a loan is non-usurious when made, it remains non-usurious when assigned to another creditor, even when the new creditor would not qualify for the lending authority exercised by the loan originator.  In its decision, the Second Circuit departed from precedent in the Fifth, Seventh, and Eighth Circuit Courts of Appeal.  Financial institutions buying and selling debt on the secondary market hoped that the United States Supreme Court would step in, reverse the Second Circuit, and endorse the “Valid When Made” doctrine.

The Supreme Court asked the Solicitor General to weigh in, which it did, in unusual fashion. It strongly criticized the Second Circuit decision as incorrect—but then recommended that the Court deny the petition. It pointed to the cases from the Fifth, Seventh and Eighth Circuits as correct interpretations of Section 85 of the National Banking Act, and relied on 1828 and 1833 Supreme Court cases confirming the “Valid When Made” doctrine.  But the Solicitor General said that there was no circuit split, because the Second Circuit decision was only interlocutory and could be corrected on remand!

Ultimately, the Supreme Court denied Midland’s petition, without comment. Midland Funding, LLC v. Madden, 136 S. Ct. 2505 (2016).  This result apparently leaves the Madden decision as binding precedent on federal courts that sit in New York, Connecticut, and Vermont.  In addition, a district court in the Third Circuit has apparently followed Madden in a “rent-a-bank” case brought by the Pennsylvania attorney general. Pennsylvania v. Think Finance, Inc., 2016 U.S. Dist. LEXIS 4649 (E.D. Pa. Jan. 14, 2016).  Besides the Fifth, Seventh, and Eighth Circuits, other courts of appeal have yet to weigh in.  The Solicitor General’s recommendation notwithstanding, it would have been desirable for the Court to correct the Second Circuit.

In July, Representative Patrick McHenry (R-NC) introduced a bill in Congress to address the uncertainty. The Protecting Consumers’ Access to Credit Act of 2016, H.R. 5724, would amend the National Bank Act and the Federal Deposit Insurance Act to provide that federal interest rate preemption applies “regardless of whether the loan is subsequently sold, assigned, or otherwise transferred to a third party.”  However, no congressional action has been reported on the bill since then.