THE INABILITY TO PAY IS IMMATERIAL: ORCILLA LOWERS THE STANDARD

A 2016 California appellate court ruling, Orcilla vs. Big Sur, Inc., has introduced new uncertainty to the ever-more-complex arena of real estate investing. The ruling found that the original buyers of a property can challenge a foreclosure if the circumstances at the time of origination — in this case, the inability of the buyers to afford their payment — are deemed unconscionable.

What does this mean for the investor whose portfolio contains non-performing notes or the institutions that handle such loans? Read on to learn more about the Orcilla ruling and its potential impact on the real estate market.

A Brief Overview of the Orcilla Case

A company named Quick Loan gave the Orcillas, a couple with limited English comprehension, a refinance loan in 2006. The terms led to a monthly payment that exceeded the couple’s take home income by more than 30 percent. After an initial default, the foreclosing lender proposed a loan modification that increased the monthly payment by several hundred dollars. The second default resulted in the sale of the home to a third party, who eventually evicted the Orcillas. Meanwhile, Quick Loan had lost its license for using trustee money to purchase casino markers.

This cautionary tale of the pre-recessionary lending market and its most egregious practices would have come to nothing had the Orcillas not appealed when their initial claim was dismissed. In spite of the fact that they could not prove material damages, the appellate court ruled that the loan was so procedurally unconscionable that it met the standard for substantive unconscionability even though the Orcillas did not meet all of the elements of their claim.

The Possible Impact of Orcilla on the Real Estate Investment Market

The Orcilla case against the bona fide purchaser, Big Sur, is concerning for several reasons. First, the claim of substantive unconscionability rendered the fact that the Orcillas were not able to make good on the loan immaterial; in this ruling, procedural mistakes trump the debtor’s ability to pay. Second, the ruling overlooking existing laws designed to protect the consumer from fraud and opened the door to a much broader and ill-defined set of challenges.

Most importantly, though, the ruling sweeps aside the rights and protections of BFPs who act in good faith when taking over a defaulted loan. If the Orcilla ruling sets the precedent for other states, the foreclosure market will become a lot more uncertain; investors and lenders alike may become unduly cautious about investing in the scratch and dent market for fear of losing monies because of unknown irregularities in the original loan documents.

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