The Supreme Court Decision in Klem and Schroeder Impacting Foreclosures

Mar 13, 2013   Print PDF

By Thomas A. Lerner

On February 28, 2013, the Washington Supreme Court issued two en banc decisions with regard to nonjudicial foreclosures.  In each case, the Court emphasized the duty of the foreclosing trustee to have fealty to the fairness of the sale, both as to borrower and beneficiary.

In Klem v. Washington Mutual Bank and Quality Loan Service, 2013 WL 791816 (Wash. Feb, 28, 2013), the borrower suffered from dementia and became the subject of a guardianship.  The guardian secured a signed purchase and sale agreement to sell the borrower’s residence for about three times the debt owed against it, but closing was not scheduled to occur for a week or two beyond the scheduled foreclosure sale date.  Quality Loan Service (“QLS”) was the foreclosing trustee, and under instructions not to continue any sale in the absence of instructions from the Bank.  QLS referred the guardian to the Bank to try to obtain the Bank’s permission for a delay.  For reasons not apparent in the record, the Bank did not give QLS that direction, and the foreclosure sale proceeded.  Subsequently, the guardian sued Washington Mutual and QLS for the difference between the bank debt and the price under the purchase and sale agreement, and prevailed.

Reminding us that a deed of trust and the ensuing foreclosure are three party transactions (borrower, beneficiary and trustee), here is what the Court said about the trustee’s role (with footnotes and citations omitted):

Again, the trustee in a nonjudicial foreclosure action has been vested with

. . . incredible power.  Concomitant with that power is an obligation to both sides to do more than merely follow an unread statute and the beneficiary’s directions.  If the trustee acts only at the direction of the beneficiary, then the trustee is a mere agent of the beneficiary and a deed of trust no longer embodies a three party transaction.  If the trustee were truly a mere agent of the beneficiary there would be, in effect, only two parties with the beneficiary having tremendous power and no incentive to protect the statutory and constitutional property rights of the borrower.

We hold that the practice of a trustee in a nonjudicial foreclosure deferring to the lender on whether to postpone a foreclosure sale and thereby failing to exercise its independent discretion as an impartial third party with duties to both parties is an unfair or deceptive act or practice and satisfies the first element of the CPA.  Quality failed to act in good faith to exercise its fiduciary duty to both sides and merely honored an agency relationship with one.

The second case decided on February 28th by the Supreme Court:  Schroeder v. Excelsior Management Group, et al., 2013 WL 791863 (Wash. Feb, 28, 2013).  In Schroeder the ultimate issue was whether an owner of agricultural property could waive the agricultural exception to nonjudicial foreclosure under the Deed of Trust Act.  Phil Haberthur of Stoel Rives was performing the duplicate roles of trustee and lender attorney, as has been common practice, and indeed is a party to the lawsuit because of his role as Trustee.  In a footnote, the Court made the following comments, essentially highlighting the ruling in Klem:

The issue has not been briefed.  It is not before us, and we do not mean to imply any finding of improper action by the trustee.  However, we are uncomfortable reciting these facts without making an observation concerning the multiple roles played by Haberthur lest we seem to be tacitly approving of an attorney for a party acting as the trustee.  The deed of trust act does not specifically permit or prohibit an attorney for a party acting as a trustee but imposes a duty of good faith on the trustee that may, at least in contested foreclosure actions, be difficult for a party’s attorney to execute.  RCW 61.24.010(4).  We note the act specifically states that the trustee ‘shall have no fiduciary duty or fiduciary obligation to the grantor or other persons having an interest in the property subject to the deed of trust.’  RCW 61.24.010(3).  However, we also note this court has stated that to prevent property from being wrongfully appropriated though nonjudicial means and to avoid constitutional and equitable concerns, at a minimum, a foreclosure trustee must be independent and ‘owes a duty to act in good faith to exercise a fiduciary duty to act impartially to fairly respect the interests of both the lender and debtor.’  Klem v. Wash. Mutual Bank, No. 87105-1, slip op. at 20 (Wash. Feb. 28, 2013).  ‘The relationship between lawyer and client is a fiduciary one in which the lawyer occupies the highest position of trust and confidence.’  RPC 1.8 cmt 17.  ‘[A]ttorneys owe an undivided duty of loyalty to the client.’  Mazon v. Krafchick, 158 Wn.2d 440, 448-49, 144 P.3d 1168 (2006).  At the very least, on review, it makes it difficult to determine which of Haberthur’s acts were made in his capacity as trustee and which as counsel for the beneficiary.  Thus, we often simply say Haberthur instead of trustee or counsel.

The fact pattern in Schroeder is unusual.  For our present purposes, however, the Court made clear that a trustee may not foreclose on land which was principally used for agricultural purposes.  This is not news.  The Court went further and concluded that “the act of a loan servicer or other beneficiary to proceed with a nonjudicial foreclosure on land it knows or should know to be agricultural land in clear violation of the statute has the capacity to be unfair or deceptive” which gives rise to a Consumer Protection Act claim.  This places a higher burden on the beneficiary and the trustee to determine if the property is principally being used for agricultural purposes prior to commencing a nonjudicial foreclosure, rather than waiting for the borrower to raise the issue.  For the agricultural exception to apply, the property must be both principally used for agriculture on the day that the Deed of Trust is granted and still have that character at the time of the sale.  Thus, the inquiry that we need to make should not require considerable effort, but should become another item on the pre-foreclosure checklist.

In the same opinion, the Court reaffirmed prior decisions that construe the Deed of Trust Act in favor of the borrower, given the ease with which lenders can employ its tools without court supervision.

The Court concluded:

Under Washington’s deed of trust act, agricultural land may only be foreclosed judicially.  This requirement of the act may not be waived by the parties and agricultural land may not be foreclosed nonjudicially.  If the property in question was primarily agricultural at relevant times then the property must be foreclosed judicially and statutory provisions relating to enjoining a nonjudicial foreclosure sale are inapplicable.  We reverse the courts below and remand for further proceedings consistent with this opinion.  Among other things, Schroeder’s claims for damages must be reinstated and the trial court must hold a hearing to determine whether the property was primarily agricultural at relevant times; if it was, the nonjudicial foreclosure sale shall be vacated.

The remedy the Court chose—to vacate the sale—has no prior appellate decision where this remedy was afforded.  Even in Klem, the Court resolved the flaw in the sale by payment of damages.  If the property had been sold to a third party post-foreclosure, or to a series of third parties in succession, the impact of a flawed nonjudicial foreclosure will trigger serial additional litigation, which presumably will fall to the title insurers to bear.  The impact of this decision on the ability to insure title, and the cost of that title insurance on foreclosed property remains to be seen.

These are unusual fact patterns in these cases, but the routine fact patterns rarely rise to the appellate courts.