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Can a Loan Modification Waive the Borrower’s Right of Reinstatement?

Loans secured by a deed of trust typically provide that upon default (commonly, missed interest payments) the lender may elect to “accelerate” the loan, making the entire balance of principal and interest due.

After acceleration, Civil Code section 2924c allows the borrower to cure the default, reinstate the loan, and avoid foreclosure by paying only the amount in default (instead of the entire loan) plus certain fees and expenses.

Under Civil Code section 2953, the right of reinstatement cannot be waived in any “express agreement made or entered into by a borrower at the time of or in connection with the making of or renewing of any loan secured by a deed of trust….”  (Emphasis added.)

How do these statutes apply to a loan modification?

A recent opinion from California’s First Appellate District — Taniguchi v. Restoration Homes LLC — provides guidance.

Facts: borrowers and lender agree to loan modification; borrower defaults

The borrowers obtained a $510,500 loan secured by a deed of trust.  After the borrowers encountered difficulty making the payments, the borrowers and lender negotiated a loan modification agreement.

The modification adjusted the principal amount, eliminated an adjustable interest rate rider, reduced the interest rate and monthly payment, and deferred until the maturity of the loan approximately $116,000, consisting of accrued and unpaid interest and principal, fees, and expenses.

The modification provided that failure to make the modified payments as scheduled would be an event of default, in which case the modification would be “null and void” at the lender’s option, and the lender would have the right to enforce the original terms of the loan.

The borrowers defaulted on the modified loan.  The lender recorded a notice of default.  The borrowers were informed that to reinstate the loan and avoid foreclosure, they would have to pay the four missed monthly payments under the modified loan plus late charges and fees (an amount totaling just over $15,000), plus all sums that had previously been deferred under the modification (more than $120,000).

The borrowers sued, alleging the lender violated their right of reinstatement under Civil Code section 2924c.

Trial court: summary judgment in favor of lender

The trial court granted the lender’s motion for summary judgment and dismissed the borrowers’ claims.

The borrowers appealed.

Court of Appeal’s Opinion: reversed; loan modification could not waive right of reinstatement

The Court of Appeal ruled in favor of the borrowers and reversed the trial court’s judgment.

On appeal, the borrowers argued that their right of reinstatement could not be waived because the modification constituted the “making” of a loan (because it capitalized new sums that were due – the deferred amounts from the original loan) or a “renewal” of the original loan (because it replaced the former loan with new contract terms).

The lender argued that the modification was neither a “making” of a loan nor a “renewal” of the original loan, and that the modification properly allowed the lender to enforce the original loan terms upon the borrowers’ default on the modification.

The Court of Appeal acknowledged the lack of authority on the issue, noting one treatise’s observation that: “Whether a loan that has been modified by the parties as part of a workout agreement is considered ‘made’ or ‘renewed’ is unclear.”  That treatise also suggested that while a very simple forbearance agreement might include valid waivers of the right of reinstatement, an agreement changing too many substantive terms — amounts due, rates of interest, or deadlines — might render waivers unenforceable.

The Court of Appeal agreed with the borrowers that because the modification added amounts to the existing loan (specifically, the accrued and unpaid interest), it could be characterized as the “making” or “renewing” of a loan, making any waiver of the right of reinstatement unenforceable under Civil Code section 2953.

Unlike a simple “extension,” which “gives the same instrument effect for an additional period,” the modification here was more like a “renewal” because it amended the original loan terms “considerably.”

As such, the right of reinstatement could not be waived.  The court held that the borrowers could cure their default by simply paying the missed monthly payments under the modification along with late charges and fees, but did  not have to pay all sums that had been deferred from the original loan.

Lesson

Courts will generally protect the borrower’s right of reinstatement under Civil Code section 2924c.  Under Civil Code section 2953, the borrower’s right of reinstatement cannot be waived in connection with the making or renewal of a loan.

The more a modification changes the loan’s substantive terms, the more likely the modification will be considered a making or renewal of a loan, rendering any waivers of the right of reinstatement unenforceable.