Forbearance Agreements Must Meet the Statute of Frauds
A borrower obtaining relief from a lender in the form of an agreement to forbear from exercising the lender's rights and remedies under security instruments, or as to the timing or amount of payments or other modifications of loan terms, must assure that any such relief is agreed to in writing and is duly executed by the lender or an authorized agent of the lender. Where the initial discussions as to such relief, forbearance or modification are with a servicer, as will often be the case with respect to a securitized loan, the formal agreement must either be executed by the current holder of the loan or the authority of the servicer executing the formal agreement on behalf of the current holder must be confirmed.
The California Court of Appeal recently held, in Secrest v. Security National Mortgage Loan Trust, that a forbearance agreement comes within the statute of frauds and, therefore, must be in writing and subscribed by the party or parties to be charged. Though the holding in Secrest involved a residential loan, the requirements of the case apply with equal force to a commercial transaction. In light of the prevalence of commercial mortgage-backed securities loans over previous years, the case also serves as a reminder that agreements of the servicer either need to be within the authority of the servicer or need to be executed by the party or parties holding the loan instruments.
Prior to this ruling, the California courts had not found a forbearance agreement to be an instrument which required the formalities necessary to meet the statute of frauds. In fact, as noted in the court's ruling, "Miller & Starr California Real Estate Digest" states that "An oral agreement not to foreclose the lien of a mortgage or deed of trust, if given for consideration, is enforceable without any written confirmation by the beneficiary or trustee."
In Secrest, a residential borrower who had been in arrears on his mortgage on several occasions throughout the life of the loan negotiated a new forbearance agreement in January 2002. The draft forbearance agreement had errors, and the borrower had discussed correction of those errors with the lender's agent. Based on such conversations, the borrower had crossed out certain amounts within the forbearance agreement, executed and returned the forbearance agreement to the lender's agent and paid the initial payment required under the forbearance agreement. The lender's agent never completed the audit necessary to confirm the information noted by the borrower and never had the forbearance agreement finalized or executed on behalf of the lender. The borrower attempted to argue that, as a result of the lender accepting the initial payment, the lender was estopped from denying the effectiveness of the forbearance agreement. The court found that payment of money is not a basis for enforcement of an agreement that fails to meet the requirements of the statute of frauds, and stated that the borrower had an adequate remedy at law to recover any sums improperly retained by the lender.
The court relied upon Civil Code Sections 1698 and 2922. Civil Code Section 2922 requires that "A mortgage can be created, renewed or extended, only by writing, executed with the formalities required in the case of a grant of real property." Under Section 1698, "an agreement to modify a contract that is subject to the statute of frauds is also subject to the statute of frauds. On the basis of Sections 1698 and 2922, the court found that the forbearance agreement did modify the note and deed of trust and therefore had to meet the statute of frauds.
Borrowers who have reached an agreement with the lender or servicer on the terms of either a loan modification or forbearance should not make any partial payment or principal reduction payment until a fully executed forbearance or loan modification agreement has been executed by both parties. To the extent that the lender requires that the payment be made concurrently with the borrower's execution of the forbearance agreement and that the borrower execute the forbearance agreement first, the borrower or its counsel will want to deliver the forbearance agreement and payment to lender's counsel with instructions that the payment may not be released to lender until such time as the forbearance agreement has been executed by lender and an executed counterpart or countersigned original has been provided with authorization to release the same to borrower.
Where a requirement of the forbearance or modification agreement is the issuance of a title endorsement confirming the continued priority of the lien of the mortgage or deed of trust, the title company can act as an escrow holder for the payment and counterparts of the forbearance or modification agreement.
Borrowers are also advised to verify the authority of any servicer executing a forbearance or modification agreement. Such verification may require obtaining and reviewing the provisions of the servicing agreement, or, at a minimum, obtaining and relying upon a representation from the servicer that the agreement is within its scope of authority and is binding upon the lender.