Undisclosed Settlements, Knowledge of Questionable Dealings, and Untangling a Messy Situation

In recent weeks, I have written about the rights of innocent victims of fraud and resolving unperformed settlements. This week, a recent case from an Washington appellate court raises questions about two related subjects: the effect of secret settlements on other parties to a case and when someone should know a transaction is questionable.

What Happened

 The Collingses owned a house in Redmond, Washington. In 2005, they suffered financial problems, and became concerned about their future ability to make payments. In 2006, they responded to an advertisement from City First Mortgage Services, a small lender based in Utah, for a program to help homeowners with credit problems.

Unfortunately, City First was not an honest dealer. When the Collingses applied, they were told by Gavin Spencer that their loan was approved, but closing was delayed several times. The Collingses called back, and Spencer told them that the loan had not been approved after all, and referred them to a manager for assistance. The manager, Paul Loveless, offered instead to buy the house from the Collingses and take a loan in his name. A loan officer, Andrew Mullen, arranged the sale and the loan. Loveless bought the house, which had about $133,000 equity, for $510,000, and leased it back to the Collingses at $2,970, with the Collingses getting the right to buy the house back in three years, at his purchase price of $510,000. The Collingses also obtained an agreement by Loveless not to refinance his loan. They paid Loveless a fee of $78,540 for this deal. (In other words, the Collingses agreed to pay Loveless a total of $185,460.)

In 2007, City First sold its loan, which eventually was bought by U.S. Bank.

In 2008, the Collingses received a foreclosure notice. When they investigated, they discovered that Loveless had refinanced his new mortgage in December 2006 and taken out a home equity line of credit, both of which were prohibited by the lease. He then defaulted on the refinance. When the Collingses complained, Loveless attempted to shake them down for more money.

In 2009, the Collingses sued City First, Loveless, Mullen, Spencer, and several others. U.S. Bank intervened, claiming that it was an innocent buyer and its rights should be honored over the Collingses’.

The court stopped the foreclosure. Everyone agreed that City First’s actions were an illegal scheme to skim off the Collingses’ equity in the house. The court ruled that Loveless’s interest was intended to be no more than a mortgage, and that as between the Collingses and Loveless, the Collingses had superior title except for any valid liens.

A jury trial was held in 2012 to determine whether City First, Loveless, Mullen, and Spencer were liable to the Collingses, and to make advisory findings for the court to use in determining whether the Collingses or U.S. Bank had better title. The jury awarded the Collingses $40,311 financial damages and $80,622 punitive damages against City First and Loveless, and $8,000 punitive damages against Mullen. (Washington usually doesn’t allow punitive damages, but the laws regulating credit services make an exception to this rule.)

Based on these findings, the court also ruled that the Collingses had better title than U.S. Bank and declared the U.S. Bank mortgage completely void.

Wait! What’s This Settlement?

 So far, it looks like a big win for the Collingses. Not necessarily so fast! The court also awarded the Collingses their attorney fees, and when their lawyer submitted his fee records, it came out that the Collingses and Mullen had settled for $500 before trial, with an agreement not to collect any judgment awarded against him. Mullen didn’t show up for trial, and instead the Collingses’ lawyer read his deposition to the jury. (It was a big fee award – over $600,000 in fees and over $40,000 in costs and expenses. The appellate court approved this award and awarded additional fees on appeal.)

City First argued, both in a motion to throw out the verdict and on appeal, that the secret settlement tainted the trial and that a new trial should have been held.

There is no dispute that courts do not like secret settlements. In both Washington and Oregon, however, they are generally legal. (In many states, they aren’t.)

In Oregon, government bodies aren’t allowed to make a secret settlement. Otherwise, if a party asks whether anyone else in the case has settled, the settlement has to be disclosed. Failure to disclose is treated as a violation of the pretrial discovery rules, which essentially means that only in cases of serious harm or intentional concealment will the court impose a serious sanction.

The Collings case raised the question, in Washington, of what happens when a secret settlement is discovered after trial. The court ruled that if the other parties’ ability to present their case was seriously harmed, the results of the trial could be thrown out. Because, however, everyone agreed at trial not to prepare a transcript of the closing arguments, and City First didn’t move to add a statement of what happened in closing argument to the record, the appellate court decided that it didn’t have enough to work with to decide whether City First was harmed. The ruling in favor of the Collingses was upheld.

One of the appellate judges disagreed, arguing that the jury instructions implied that Mullen was still in the case and that some of Mullen’s testimony hurt City First.

(The appellate court also ruled that there was enough evidence to hold City First responsible for Loveless’s and Mullen’s wrongdoing. This was important because Loveless had filed for bankruptcy.)

Should U.S. Bank Have Known There was Something Wrong?

 The next major question raised on appeal was by U.S. Bank. After ruling that the Collingses had the right to challenge the sale of Loveless’s mortgage to U.S. Bank because they had better title than Loveless, the real issue was whether U.S. Bank was an innocent buyer. If it was, it could argue that it should be allowed to get the benefit of its purchase.

Both Oregon and Washington require an innocent buyer to make a valuable payment for its interest, which wasn’t disputed. They also require the buyer neither to know or to have any notice that would lead it to know of a conflicting claim. That’s where U.S. Bank’s argument failed.

U.S. Bank had bought the refinanced loan and home equity line of credit from GMAC as part of a securitized loan package (the kind of deals that eventually led to the “toxic asset” crisis beginning in 2008). As part of the deal, it agreed to maintain database of loan records, and GMAC had a copy of Loveless’s original loan and mortgage. These documents referred to the agreement to lease the house back to the Collingses, with the right to buy the house back in 2009. They also included an agreement by Loveless not to take out a home equity line of credit. Based on that, the court ruled that U.S. Bank should have known what it was getting into.

Lessons Learned

 Disclosing settlements is often a safer approach to a case, but it might hurt claims against other defendants. There are also some laws in Oregon and Washington that may call for separating out the percentage of fault of a settled defendant from a damage award, so it’s not always a good idea to settle in the first place unless everyone settles. In general, if you have a claim against more than one defendant, talk to your lawyer about settlement strategy.

Also, if you manage to find yourself a deal like the Collingses, it’s a good idea to do what you can to protect yourself against shenanigans like Loveless pulled. The lease the Collingses entered into could have been recorded, which would have immediately notified any lender of the risks of refinancing. Checking the title from time to time also might be a good idea. The best defense, of course, is to investigate before you sign.

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