NO. 12-50064 IN THE UNITED STATES COURT OF APPEALS FOR THE FIFTH CIRCUIT

ELLERY G. PENNINGTON, et al Plaintiffs-Appellants v. HSBC BANK USA, N.A. et al Defendants-Appellees On Appeal from the United States District Court for the Western District of Texas, Austin Division No. 1:10-cv-785 (Hon. Lee Yeakel) BRIEF OF APPELLANTS

J. Patrick Sutton 1706 W. 10th Street Austin, Texas 78703 Ph (512) 417-5903 F (512) 355-4155 jpatricksutton@ jpatricksuttonlaw.com Attorney for Appellants ORAL ARGUMENT REQUESTED

CERTIFICATE OF INTERESTED PERSONS Undersigned counsel of record certifies that the following listed persons have an interest in the outcome of this case. These representations are made in order that the Judges of this Court may evaluate possible disqualifications or recusal. A. Parties: Ellery G. Pennington and Laura M. Pennington, a married couple residing in Georgetown, Texas Traci Smith, an individual residing in San Antonio, Texas Defendants-Appellees: B. Attorneys: HSBC Bank, USA, N.A. Wells Fargo Bank, N.A. Attorney for Plaintiffs-Appellants on appeal: J. Patrick Sutton 1706 W. 10th Street Austin, TX 78703 Attorneys for Plaintiffs-Appellants in the trial court: J. Patrick Sutton 1706 W. 10th Street Austin, Texas 78703 David M. Gottfried 1505 W. 6th Street Austin, TX 78703 Plaintiffs-Appellants:

Attorneys for Defendants-Appellees on appeal: W. Scott HastingsLocke Lord Bissell & Liddell LLP

2200 Ross Avenue Suite 2200 Dallas, TX 75201

B. David L. Foster Locke Lord Bissell & Liddell, LLP 100 Congress Avenue, Suite 300 Austin, TX 78701-4042

Attorneys for Defendants-Appellees in the trial court: Robert T. Mowrey Daron JanisLocke Lord Bissell & Liddell LLP

2200 Ross Avenue Suite 2200 Dallas, TX 75201

B. David L. Foster Amanda M. Schaeffer Locke Lord Bissell & Liddell, LLP 100 Congress Avenue, Suite 300 Austin, TX 78701-4042

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STATEMENT REGARDING ORAL ARGUMENT The central issue in this appeal involves the homestead protection provisions of the Texas Constitution art. XVI 50, a complex regime of rules that places onerous restrictions on home equity lenders and lending practices. Appellants believe the state constitutional provisions and their interpretive regulations are clear as they relate to this case, but the topic of home equity lending, and the strictness of the Texas constitutional home equity rules generally, are challenging and may raise questions as to the nature and consequences of the relief Appellants seek. Oral argument may be helpful to clarify why the Texas Constitutional scheme should be upheld despite the severe consequences for lenders for noncompliance. In addition, Appellee Wells Fargo has made policy arguments to the effect that it should be insulated from loan forfeitures where it sought to lower home equity borrowers' payments. Appellants request oral argument to address that issue.

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TABLE OF CONTENTS CERTIFICATE OF INTERESTED PERSONS ................................................. ii STATEMENT REGARDING ORAL ARGUMENT ........................................ iii INDEX OF AUTHORITIES ............................................................................... vii STATEMENT OF JURISDICTION .................................................................... 1 STATEMENT OF ISSUES ................................................................................... 2 STATEMENT OF THE CASE ............................................................................. 3 A. C OURSE OF PROCEEDINGS AND DISPOSITION IN THE COURT BELOW . ......... 3 B. S TATEMENT OF F ACTS .................................................................................... 6 1. Background and introduction ......................................................................... 6 2. The Pennington Texas home equity loan ....................................................... 6 3. The Smith Texas home equity loan ............................................................... 9 4. Wells Fargo's positions on Tex. Const. 50................................................ 11 SUMMARY OF ARGUMENT ........................................................................... 13 ARGUMENT AND AUTHORITIES ................................................................ 15 INTRODUCTION ................................................................................................ 15 ISSUE ONE: ......................................................................................................... 18 P ENNINGTON AND S MITH EACH STATE A CLAIM UNDER T EX . C ONST . ART . XVI 50( A )(6)(L) BECAUSE THEIR TPP AGREEMENTS WITH W ELLS F ARGOSET FORTH AN EXPRESS SCHEDULE OF INSUFFICIENT PAYMENTS THAT DID NOT PAY ALL INTEREST AS IT CAME DUE , EVEN IF THAT AGREEMENT IS CHARACTERIZED AS " TEMPORARY " OR " FORBEARANCE " IN NATURE . .......... 18

A. S TANDARD OF REVIEW AND APPLICABLE LAW . ......................................... 18 1. Motions to dismiss generally ....................................................................... 18 2. Rule of construction for Tex. Const. art. XVI 50 ..................................... 18iv

3. Substantive provisions of Tex. Const. art. XVI 50 ................................... 19 (a) section 50(a)(6)(L) scheduled installments ............................................. 24 (b) the 50 cap on principal ......................................................................... 25 B. T HE TRIAL PAYMENT PLAN VIOLATED SECTION 50( A )(6)(L) ................... 30 (1) Section 50 has no safe harbor for "temporary" schemes ........................ 31 (2) The asserted "safe harbor" is a foreclosure trap...................................... 34 (3) Lenders still have ways to help Texas home equity borrowers .............. 36 (4) Lenders have Section 50-permissible ways to unilaterally forbear from foreclosing .................................................................................................... 37 ISSUE TWO: ........................................................................................................ 41 W ELLS F ARGO NEGLIGENTLY MISREPRESENTED EXISTING FACT BY OFFERING THE HAMP PROGRAM TO T EXAS HOME EQUITY BORROWERS IN THE FIRST INSTANCE , SINCE BY W ELLS F ARGO ' S BINDING ADMISSIONS TO THE P ENNINGTONS AND TO S MITH , THE MODIFICATION RESULTING FROM THE SCHEME W ELLS F ARGO PROPOSED , BY GENERATING POOLS OF PAST DUE INTEREST THAT COULD NOT LEGALLY BE ROLLED INTO A RESTATED , INCREASED PRINCIPAL , WAS AT ALL RELEVANT TIMES " BREAKING THE LAW ." .................................................................................................................. 41 ISSUE THREE: .................................................................................................... 45 S INCE , BY W ELLS F ARGO ' S OWN ADMISSION , THE ONLY THING STANDING IN THE WAY OF THE PARTIES ' MUTUAL ASSENT TO ENTER INTO THE S MITH LOANMODIFICATION AGREEMENT WAS THE PRESUMED ILLEGALITY OF THAT AGREEMENT , THE PARTIES ' MUTUAL ASSENT SHOULD BE GIVEN EFFECT IF THE MODIFICATION WAS LEGAL . ....................................................................... 45

ISSUE FOUR: ....................................................................................................... 52 W ELLS F ARGO IS ESTOPPED FROM DENYING IT PROMISED A LOAN MODIFICATION TO S MITH IF ITS SOLE BASIS FOR THAT DENIAL WAS THAT THE MODIFICATION WAS ILLEGAL , BUT IN FACT THE MODIFICATION WAS LEGAL . ................................................................................................................. 52

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PRAYER ................................................................................................................ 56 CERTIFICATE OF SERVICE ............................................................................... 58 CERTIFICATE OF COMPLIANCE ...................................................................... 59

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INDEX OF AUTHORITIES Cases Am. Tobacco Co., Inc. v. Grinnell, 951 S.W.2d 420 (Tex. 1997) ................ 41 Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 127 S.Ct. 1955, 1966 (2007) ....................................................................................................................... 12, 29 Bosque v. Wells Fargo Bank, N.A., 762 F. Supp. 2d 342 (D. Mass. 2011) 45 Box v. First State Bank, 340 B.R. 782 (S.D. Tex. 2006) ............................... 34 Doody v. Ameriquest Mortgage Co., 49 S.W.3d 342 (Tex.2001) ................ 21 Fed. Land Bank Ass'n of Tyler v. Sloane, 825 S.W.2d 439 (Tex. 1991) ..... 41 Fix v. Flagstar Bank, FSB, 242 S.W.3d 147 (Tex. App.--Fort Worth 2007, pet. denied) ........................................................................................................ 27 Hawkins et. al. v. Wells Fargo Bank, N.A., Civ. Action No. 1:11-cv-00877LY (W.D. Tex. filed Oct. 6, 2011) ................................................................ 12 In re Adams, 307 B.R. 549 (Bankr. N.D. Tex. Jan. 26, 2004) ...................... 27 In re Cadengo, 370 B.R. 681 (Bankr. S.D. Tex. 2007) ................................. 21 In re Gulley, 436 B.R. 878 (Bankr. N.D. Tex. Aug. 23, 2010) .................... 39 In re Harmon, 444 B.R. 696 (Bankr. S.D. Tex. Feb. 17, 2011) ............. 23, 51 In re Katrina Canal Breaches Litig., 495 F.3d 191 (5th Cir. 2007) ............ 18 In re Lovelace, 443 B.R. 494 (Bankr.W.D.Tex. Jan. 28, 2011) ................... 18 Marketic v. U.S. Bank Nat. Ass'n, 436 F. Supp. 2d 842 (N.D. Tex. 2006) . 39 Martin-Janson v. JPMorgan Chase Bank, Civil Action No. 1:11-cv-584 (W.D.Tex. Jan. 11, 2012) ................................................................................ 54 McCallum Highlands, Ltd. v. Washington Capital Dus, Inc., 66 F.3d 89 .. 45 Packard v. OCA, Inc., 624 F.3d 726 (5th Cir.2010) ...................................... 18

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Rice v. Metro Life Ins. Co., No. 02-09-028-CV, 2010 WL 3433058 (Tex.App. - Fort Worth Aug. 31, 2010, no pet.) ......................................... 52 Senter v. JPMorgan Chase Bank, N.A., 11-60308-CIV, 2011 WL 4089585 (S.D. Fla. Aug. 9, 2011) .................................................................................. 45 Smith v. JPMorgan Chase Bank, Nat'l Assoc., 2011 WL 5828927 ........ 12, 22 Texas Bankers Ass'n v. Ass'n of Cmty. Organizations for Reform Now (ACORN), 303 S.W.3d 404 (Tex. App.--Austin 2010, pet. granted) . 19, 25, 34 Thomison v. Long Beach Mortg. Co., 176 F. Supp. 2d 714 (W.D. Tex. 2001) vacated, CIV.A. A:00CA783JN, 2002 WL 32138252 (W.D. Tex. Aug. 9, 2002) .................................................................................................... 30 Wheeler v. White, 398 S.W.2d 93 (Tex. 1965) ................................................ 52 Statutes and Rules T.A.C. 153.11 .................................................................................................... 24 T.A.C. 153.14(2)(A) ............................................................................. 38, 39, 50 T.A.C. 153.14(2)(B) ......................................................................................... 28 T.A.C. 153.14(2)(C) ......................................................................................... 32 T.A.C. 153.3(2) ........................................................................................... 22, 27 T.A.C. 153.41 .................................................................................................... 27 T.A.C. 153.5 ...................................................................................................... 28 T.A.C. Chap. 153 generally ................................................................................ 19 Tex. Const. art. XVI 50(a)(6)(L) ............................................................ passim

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Other Authorities A Mortgage Tornado Warning, Unheeded, NYT, Feb. 5, 2012, at BU1 ..... 15 Home Equity Loans In Texas: Maintaining The Texas Tradition Of Homestead Protection, 55 SMU L. Rev. 157 (Winter 2002) .................... 20 In re Jones, 366 B.R. 584, 590-91 (Bankr. E.D. La. 2007) .................... 15, 16 Joseph Heller, Catch-22 ...................................................................................... 13 Office of Consumer Credit Commissioner, Home Equity Modification Interpretation Letter, Dec. 20, 2001 ............................................................. 33 Pitfalls (and Pratfalls) of Texas Home Equity Lending, 52 Consumer Fin. L.Q. Rep. 437, 442 ........................................................................................... 22 Still Mortgaging The American Dream: Predatory Lending, Preemption, And Federally Supported Lenders, 34 Cincinnati L. Rev. 1303 (Summer 2006) ................................................................................................................... 24 Taking Texas Home Equity for a Walk, But Keeping It On A Short Leash!, 30 Tex. Tech. L. Rev. 197 (1999) ...................................................... 20, 21, 23 Tex. Joint Regulatory Agencies, Home Equity Advisory Bulletin, April 2009 .................................................................................................................... 32 Where Agencies, The Courts, And The Legislature Collide: Ten Years Of Interpreting The Texas Constitutional Provisions For Home Equity Lending ......................................................................................................... 20, 21

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STATEMENT OF JURISDICTION Home equity borrowers the Penningtons and Smith appeal a final judgment from the United States District Court for the Western District of Texas, Austin Division. This court has jurisdiction pursuant to 28 U.S.C. 1291. This case was brought under 28 U.S.C. 1332(d), the Class Action Fairness Act, and relates to home equity loans issued to Texas borrowers. Proposed class action representatives the Penningtons and Smith appeal an order of January 12, 2012 granting Defendant Wells Fargo's and Defendant HSBC Bank's Rule 12(b)(6) motion to dismiss all of Plaintiffs' claims with prejudice and the final judgment entered consistent therewith.

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STATEMENT OF ISSUES Issue 1: Whether a written agreement prepared by a home equity lender that sets out a "temporary" schedule of insufficient payments for a pre-existing home equity loan violates Tex. Const. art. XVI 50(a)(6)(L) because those insufficient payments do not pay all interest coming due with each installment? Whether a borrower states a claim for negligent misrepresentation of an existing fact (as opposed to a nonactionable promise of future action) where it is alleged that a lender offered a type of home equity loan modification that, by the lender's own admission, violated Texas law at the time it was being offered? Whether there are issues of fact and law precluding dismissal as to the existence of a binding loan modification contract? It is undisputed that the borrower performed all her obligations under a contract for a loan modification. The borrower alleges that the lender's sole basis for not performing was its assertion that the object of the contract -- the loan modification -- was illegal. If the modification was legal, shouldn't the parties' thwarted mutual assent be enforced? Whether there are issues of fact and law precluding dismissal as to whether a promise to enter into a contract for a loan modification was made but then repudiated? The borrower alleges that the lender admitted that its sole basis for not fulfilling the promise was that the object of the contract -- the loan modification -- was illegal. If the modification was legal, shouldn't the borrower be allowed reliance damages?

Issue 2:

Issue 3:

Issue 4:

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STATEMENT OF THE CASE A. Course of proceedings and disposition in the court below. On September 30, 2010, Texas home equity borrowers the Penningtons filed suit in Texas state court for legal and injunctive relief to prevent loan servicer Wells Fargo and underlying lender HSBC Bank 1 from foreclosing on homestead property. (Doc. 1, r. 23). Defendants removed the suit on diversity grounds. (Doc. 1, r. 10). The Penningtons' subsequent amendments added named plaintiff Smith and additional allegations and claims, plus class action allegations, culminating in a Fourth Amended Complaint filed June 2, 2011. (Doc. 43, r.570). A fair reading of the complaint is that Wells Fargo's failure to recognize the onerous lender compliance rules that apply to Texas home equity loans led Wells Fargo to treat home equity loans the same way as garden-variety purchase-money mortgages for purposes of modifying those loans, thereby leading Wells Fargo to violate the Texas homestead protection laws in fundamental ways that trigger loan forfeiture. (Doc. 43, r. 578-579, 582). The complaint also asserted that, owing to Wells Fargo's failure to respect Texas home equity lending restrictions, Wells Fargo (1) made1

This brief refers to Defendants collectively as "Wells Fargo." 3

negligent representations to borrowers concerning the legality of home equity loan modifications (Doc. 43, r. 578, 585); (2) repudiated in-force modifications once it finally recognized the illegality (Doc. 43, r. 587); and (3) was estopped from denying modifications where borrowers had relied on the promises of modifications, (Doc. 43, r. 586). Wells Fargo moved to dismiss all claims and to stay the case pending resolution of the motion to dismiss. (Doc. 47, r.671). On August 23, 2011, the district court granted the stay over plaintiffs' opposition and referred the motion to dismiss to the magistrate judge. (Doc. 58, r. 787). When Plaintiffs became aware in September, 2011 of cases where Wells Fargo had permanently modified Texas home equity loans to include past-due interest in newly-stated principal, Plaintiffs sought leave to add additional named plaintiffs and claims and asked for a TRO to prevent Wells Fargo from taking certain steps as regards such borrowers. (Doc. 60, r. 931). The district court denied the requests on the basis that its prior stay applied to all case filings, not merely discovery. (Doc. 62). The additional parties filed their proposed class action separately thereafter. See Hawkins et al v. Wells Fargo, N.A., Civ. Action No. 1:11-cv-877-LY (W.D. Tex.) (filed Oct. 6, 2011).

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The magistrate issued a report and recommendation on December 22, 2011, recommending that all Plaintiffs' claims be dismissed. (Doc. 63, r.979). The R&R devoted relatively little discussion or analysis to Plaintiffs claims under the Texas Constitution, particularly the claim that the loan trial period payment plan -- as opposed to the permanent modification -- at issue violated the Texas Constitution. (Doc. 63, r. 98687). Those issues are at the heart of this appeal. On January 13, 2012, Plaintiffs timely filed objections as to dismissal of the state constitutional, breach of contract, negligent misrepresentation, and promissory estoppel claims. (Doc. 66, r. 1004). The borrowers included additional evidence for consideration with their objections, including a certified transcript of a recorded phone

conversation between Smith and Wells Fargo bolstering the claim that Wells Fargo assented to Smith's loan modification. (Doc. 66, r. 1016). On January 19, 2012, the district court, following a de novo review of the entire case file, approved the magistrate's report and recommendation without comment or changes and dismissed all claims with prejudice. (Doc. 67, r. 1030). Plaintiffs filed their notice of appeal on January 23, 2012. (r. 1037).

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B. Statement of Facts 1. Background and introduction Wells Fargo is one of the largest mortgage lenders and servicers in the U.S. Since the 2008 mortgage crisis, Wells Fargo has been servicing distressed loans and handling modifications and foreclosures. (Doc. 63, r. 980-81). It participated in the federal Home Affordable Modification Program ("HAMP"), under which it was obligated to identify loans subject to modification. Appellants the Penningtons and Smith are Texas home equity borrowers. (Doc. 63, r. 980). Wells Fargo services loans held by Appellee HSBC, a trustee for certain trusts that hold such loans. (Doc. 43, r. 575). Wells Fargo, as servicer for HSBC and other lenders, identified the Penningtons and Smith as candidates for the HAMP program. (Doc. 43, r. 578). 2. The Pennington Texas home equity loan The Penningtons purchased a home in 2002 and got an ordinary purchase-money mortgage. (Doc. 43, r. 579). In 2004, they got a home equity loan that replaced and paid off the original mortgage and added to the size of their loan principal. (Doc. 43, r. 579). In 2009, facing financial distress, the Penningtons sought a loan modification from Wells Fargo to reduce their monthly payments. (Doc. 43, r. 579). Wells Fargo required the

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Penningtons to cease making loan payments as a precondition to any loan modification. (Doc. 43, r. 578). Wells Fargo filed a judicial foreclosure action against Pennington in July, 2009 based on payments the Penningtons had missed at Wells Fargo's behest. (Doc. 43, r. 579). Non-judicial foreclosure is unavailable to lenders in the case of Texas home equity loans, but there are special expedited foreclosure proceedings available for such loans. Tex. R. Civ. Pro. 736. Wells Fargo employed that procedure to foreclose on the Penningtons in July, 2009. (Doc. 43, r. 579). In September, 2009, Wells Fargo offered the Penningtons a HAMP modification. (Doc. 63, r. 981). In October, 2009, it notified the Penningtons it had dismissed the judicial foreclosure. (Doc. 43, r. 600). The "trial period plan offer" ("TPP") initiating the HAMP modification process set out an express schedule of three successive $985.69 payments as one of several preconditions to a permanent loan modification. (Doc. 43, r. 580, 600, 612, 622). These payments were lower than the payments required by the home equity note and therefore insufficient to pay all interest and principal coming due under the note with each installment. (Doc. 43, r. 578, 580). The Penningtons made the three payments, but Wells Fargo kept the Penningtons in this "step one" process for an

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additional seven months, totaling ten trial period payments. (Doc. 43, r. 580, 599-607). During that time, Wells Fargo kept a separate accounting for the interest due under the original note, and applied late charges, later asserting as of late 2010 that the Penningtons were over $23,000.00 in past-due interest and late charges despite their having made all the TPP payments timely. (Doc. 43, r. 580, 605). During the period Sept. 2009-Sept. 2010, the Penningtons had many phone conversations with Wells Fargo representatives. They kept contemporaneous notes of their interactions with Wells Fargo, which appear in the record. (Doc. 43, r. 580; 599-614). Wells Fargo representatives stated as follows: On August 11, 2010, "Louella" in the "Loss Mitigation Department" told the Penningtons that "a new rule took effect in Texas that if there is any past due principle [sic] added to the balance, you are automatically disqualified for the HAMP loan." (Doc. 43, r. 605). On August 20, 2010, "Rhonda . . . said that now our loan had been denied due to the fact that our loan exceeds 80% loan to value. Rhonda transferred me to her supervisor, Tammy, who explained that there is a new rule that took effect June 2010 called the 'Texas Cash Out policy' that says they can not modify a loan if the amount owed exceeds the original amount borrowed." (Doc. 43, r. 606). On September 11, 2010, the Penningtons recorded that Wells Fargo's representatives "say [the "Texas Cash Out Policy"] is the reason for denial, even though we have never received a denial

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letter with this as the stated reason. This seems to be their back-up reason . . . ." (Doc. 43, r. 608). On September 17, 2010, the Penningtons recorded that "[t]he most common explanation [Texas Cash Out Policy] is that it means that the amount owed now exceeds the amount originally borrowed so therefore we do not qualify for a HAMP or inhouse modification." (Doc. 43, 614). Wells Fargo never gave the Penningtons a permanent loan modification. Wells Fargo kept them in the foreclosure process based on the interest arrears and late charges stemming from the agreed schedule of TPP payments, plus the payments the Penningtons skipped at Wells Fargo's behest. (Doc. 43, r. 580, 605-607). 3. The Smith Texas home equity loan Smith's events incept in September, 2010, around the time the Penningtons' attempts to get a loan modification from Wells Fargo were winding down. Smith was not late or behind on her home equity loan; she sought a way to reduce her payments. (Doc. 43, r. 581). Wells Fargo required her to cease making payments as a precondition to getting any modification. (Doc. 43, r. 581). Wells Fargo started her in the HAMP process in September, 2010 with a schedule of three express trial payments that were insufficient to pay all interest coming due with each installment. (Doc 63, r. 980-81; Doc. 43, r. 581-82). She made these insufficient payments. (Doc. 43, r. 582). In late February, 2011, Wells Fargo sent her a9

letter telling her "Congratulations!" (Doc. 43, r. 633). This letter enclosed the "Step Two" document, which was the actual modification agreement for a 40-year variable-rate loan incepting at 2% for 5 years. (Doc. 43, r. 640). The modification recited a new, increased principal balance of $621,908.18, an increase of $64,786 to principal. (Doc. 63, r. 642). Getting Wells Fargo's hearty "Congratulations!" on obtaining a loan modification came as no surprise to Smith, since she had spoken with Wells Fargo on the phone five week's prior and was given assurances she would be approved. (Doc. 66, r. 1016). The February, 2011 "offer" stated that "to accept" the offer, Smith was required to (1) return the enclosed agreement and (2) continue to make timely insufficient payments under the prior TPP agreement. (Doc. 43, r. 633). Smith accepted this offer in the relevant ways. (Doc. 43, r. 582). Smith began spending money on improvements to her home. (Doc. 43, r. 582). The district court concluded Wells Fargo did not sign the permanent loan modification. (Doc. 63, r. 774). Though not specifically alleged, Smith has never conceded that Wells Fargo did not sign or mail back the agreement. (Doc. 43, r. 582). On May 18, 2011, nine months after Wells Fargo's representatives had begun telling the Penningtons that loan modifications that increased

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home equity loan principal or exceeded an 80% loan-to-value ratio were impermissible under a "new rule," Smith received a call from Wells Fargo informing her that Wells Fargo would not honor the permanent modification. (Doc. 43, r. 582). According to Wells Fargo, this was not based on any failure by Smith to satisfy all the terms of the parties' agreement, but because, as the Wells Fargo representative stated, "there's nothing in the world [Wells Fargo] can do since [Wells Fargo] would be breaking the law." (Doc. 43, r. 582). The representative stated that Smith was the third borrower in a week to whom he had delivered the same news. (Doc. 43, r. 582). Wells Fargo thereafter indicated it would foreclose on Smith. (Doc. 43, r. 582). 4. Wells Fargo's positions on Tex. Const. 50 Because this case and the Hawkins proposed class action are related and were initially attempted to be combined through amendment, Plaintiffs believe the Court should be made aware of the positions that Wells Fargo has taken as to the meaning of Tex. Const. 50. When communicating to borrowers, Wells Fargo made both oral and written statements to the effect that loan modifications that increase principal or exceed an 80% loan-tovalue ratio are impermissible. (Doc. 59, r. 918, 929). However, in pending lawsuits, such as in its reply brief in its motion to dismiss in this case, and

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in its motion to dismiss in the Hawkins case now under advisement, Wells Fargo is asserting the opposite position, that such loan modifications do not run afoul of Section 50. (Doc. 53, r. 770); see Hawkins et. al. v. Wells Fargo Bank, N.A., Civ. Action No. 1:11-cv-00877-LY , Docket No. 17 (motion to dismiss of Nov. 29, 2011). Because of these inconsistencies in Wells Fargo's positions, Appellant borrowers seek to anticipate in this opening brief some of the arguments that Wells Fargo might make as to why its prior admissions to the Penningtons and Smith are either false as a matter or law, or else should not be given the Twombley presumption of truth for purposes of this appeal. See Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 127 S.Ct. 1955, 1966 (2007) (truth of allegations is assumed for purposes of Rule 12(b)(6) motion); Smith v. JPMorgan Chase Bank, Nat'l Assoc., 2011 WL 5828927 (applying Twombley to lender's admissions in section 50 case where lender admitted violation).

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SUMMARY OF ARGUMENT Under the Texas Constitution, an agreement that schedules home equity loan payments at an amount insufficient to pay all interest coming due is impermissible. When not cured timely, the defect renders the loan forfeit. Lender Wells Fargo's failure at the outset of the loan modification process to respect the distinction under the Texas Constitution between home equity loan modifications and ordinary mortgage loan modifications led Wells Fargo to issue illegal trial payment agreements to the plaintiffs. The insufficient payments scheduled under the trial payment agreements generated pools of past-due interest, creating a foreclosure trap of the type Section 50 is structured to prevent. Furthermore, because insufficient payments create a pool of past-due interest, modifications were rendered impossible for these borrowers at the very moment Wells Fargo was offering modifications, because the Texas Constitution has never allowed past-due interest to be added to principal through modification. Wells Fargo had thus put plaintiffs in a position of incurring past-due interest to qualify for a loan modification that could not be granted because of the existence of past-due interest. It's a catch-22. See Joseph Heller, Catch-22 (Simon & Schuster 1961) (maddening, self-

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contradictory logic prevented putatively crazy pilot from avoiding combat missions). Because Wells Fargo did not mention Section 50 to Appellant borrowers until after it had led them deeply into interest arrears, Wells Fargo violated Texas common law. First, it negligently misrepresented to home equity borrowers at the outset of the loan modification process the existing fact that a modification that rolled past-due interest into principal was permissible. Such modifications had been impermissible since 1987 and the advent of Texas home equity lending. Second, when Wells Fargo began expressly acknowledging that Texas home equity loans must be treated differently than ordinary mortgage loans, its response of slamming the modification door shut damaged Smith, who had already been given or promised a permanent modification. This resulted in either a breach of contract from the refused modification, or else Wells Fargo's being estopped from denying that it promised a modification, since Smith had reasonably and detrimentally relied on Wells Fargo's promise to complete the loan modification agreement.

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ARGUMENT AND AUTHORITIES INTRODUCTION There was a time when the courts viewed Wells Fargo's and other major lenders' sworn representations and handling of loans as "unassailable," but those days are gone. In re Jones, 366 B.R. 584, 590-91 (Bankr. E.D. La. 2007) supplemented, 03-16518, 2007 WL 2480494 (Bankr. E.D. La. Aug. 29, 2007) rev'd in part sub nom. Wells Fargo Bank, N.A. v. Jones, 391 B.R. 577 (E.D. La. 2008) and aff'd sub nom. Wells Fargo Bank, N.A. v. Jones, 391 B.R. 577 (E.D. La. 2008) (Wells Fargo's mortgage loan handling created "a tangled mess"); see, e.g., In re Wright, BR 08-02079, 2011 WL 6813179 (Bankr. N.D. Iowa Dec. 28, 2011); In re Taylor, 655 F.3d 274, 279 (3d Cir. 2011) (sanctions against HSBC); In re Wilson, 2011 WL 1337240 (Bankr.E.D.La. Apr. 7, 2011); In re Thorne, 2011 WL 2470114 (Bankr.N.D.Miss. June 16, 2011); In re Doble, 2011 WL 1465559 (Bankr.S.D.Cal. Apr. 14, 2011); see also Gretchen Morgenson, A Mortgage Tornado Warning, Unheeded, NYT, Feb. 5, 2012, at BU1 (casting doubt on mortgage industry veracity). It therefore does not stretch credulity to assert that Wells Fargo entered the Texas loan servicing market and mishandled an entire state's portfolio of loans, acting both for itself and for various mortgage-backed

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security investment pools fronted by entities such as Appellee HSBC. Wells Fargo failed to respect the critical distinction under Texas law between purchase-money mortgages and home equity loans. That failure led to a single illegal practice across the portfolio of home equity loans serviced by Wells Fargo: having Texas home equity borrowers make insufficient payments as a precondition to loan modifications, which in turn caused them to go into foreclosure because it had always been illegal for such modifications to be given so long as interest arrears existed. It is a bad outcome for everyone, including Wells Fargo, which becomes subject to outright forfeiture of these loans under the Texas Constitution, art. XVI 50(a) ("Section 50"). Tex. Const. art. XVI 50(a)(6)(Q)(x) (forfeiture and cure provisions). As the court in Jones stated: With each revelation, one hopes that the bottom of the barrel has been reached and that the industry will self correct. Sadly, this does not appear to be reality. This case is one example of why their conduct comes at a high cost to the system and debtors. 2011 WL 1337240 at 1 (Bankr. E.D. La. Apr. 7, 2011). Nevertheless, it may be temping, given the avalanche of foreclosurerelated claims being filed in state and federal courts -- many of doubtful legal merit or involving nothing more than cash-strapped homeowners'

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desire to hang on to their homes at any cost -- to sigh and view all such cases as being short on substance and long on hope. This is not one of the dubious cases. The facts are compelling and the unfairness obvious. Appellant borrowers the Penningtons and Smith skipped payments because Wells Fargo required them to as a precondition for a modification that was always impossible. The district court glossed over that fact. Then Wells Fargo put these borrowers into illegal payment plans that did not pay all accrued interest and principal, putting these borrowers still further in arrears. Only much later did Wells Fargo disclose to them it could never have modified their loans in the first place. The district court did not focus on that. Wells Fargo urged the district court to blame the Penningtons and Smith for this predicament. This Court should reject that invitation. The alleged violations of Texas constitutional and common law are weighty and substantial. Furthermore, Appellants believe the same violations affect thousands of home equity borrowers in Texas.

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ISSUE ONE: Pennington and Smith each state a claim under Tex. Const. art. XVI 50(a)(6)(L) because their TPP agreements with Wells Fargo set forth an express schedule of insufficient payments that did not pay all interest as it came due, even if that agreement is characterized as "temporary" or "forbearance" in nature. A. Standard of review and applicable law. 1. Motions to dismiss generally The court of appeals reviews de novo a district court's order on a motion to dismiss for failure to state a claim under Rule 12(b)(6). In re Katrina Canal Breaches Litig., 495 F.3d 191, 205 (5th Cir. 2007). The court accepts all well-pleaded facts as true, viewing them in the light most favorable to the plaintiff. Id. (fuller recitation of standard). 2. Rule of construction for Tex. Const. art. XVI 50 The home equity provisions of the Texas Constitution are construed strictly against lenders for the benefit of debtors and their homesteads. In re Lovelace, 443 B.R. 494, 498 (Bankr.W.D.Tex. Jan. 28, 2011) (summary of 5th Circuit cases) (large lender's lien was forfeited for Section 50 violation). If there is no Texas Supreme Court precedent on point, then the federal court must determine how the Texas Supreme Court, if presented with the issue, would resolve it. Packard v. OCA, Inc., 624 F.3d 726, 729 (5th Cir.2010). The Texas Joint18

Financial

Regulatory

Agencies'

interpretations of section 50, set out at T.A.C. Chap. 153, are entitled to deference by the courts. Cerda v. 2004-EQR1 L.L.C., 612 F.3d 781, 786-87 (5th Cir. 2010). However, any interpretation that renders protection of home equity borrowers "meaningless" gets no such deference. See Texas Bankers Ass'n v. Ass'n of Cmty. Organizations for Reform Now (ACORN), 303 S.W.3d 404, 412 (Tex. App.--Austin 2010, pet. granted) (invalidating state agency's technical interpretation of "interest" that allowed 3% cap on fees to be gutted, since the exception swallowed the rule); but see Cerda v. 2004-EQR1 L.L.C., 612 F.3d at 796 (5th Cir. 2010) (disagreeing with ACORN on underlying substantive issue). 2 3. Substantive provisions of Tex. Const. art. XVI 50 Because the district court's opinion does not dwell much upon Section 50, and because Section 50 is so central to the issues and contentions in this case, Appellants feel obliged to address it fully before arguing their specific contentions. Wells Fargo has admitted for purposes of this appeal many of the points made below, but Section 50 is sufficiently difficult to parse and absorb that Appellants hope the court will find the fuller discussion useful in deciding this appeal.

2

ACORN is now under advisement by the Texas Supreme Court (No. 10-0121). 19

An ordinary mortgage is used to purchase a home, and if the borrower defaults, the home is lost through foreclosure. Home equity loans are used for purchasing other things, like TV's and cars, but if the borrower defaults, it's not the TV or the car that get seized and sold -- it's the borrower's home. The home equity borrower puts his or her house at risk to buy consumer goods. In the process, an evanescent, intangible thing that fluctuates up and down all the time -- "home equity" -- gets monetized and turned into something tangible. It sounds risky for borrowers because it is. See generally Julia Patterson Forrester, Home Equity Loans In Texas: Maintaining The Texas Tradition Of Homestead Protection, 55 SMU L. Rev. 157, 160-64, 177-78 (Winter 2002); Charles C. Boettcher, Taking Texas Home Equity for a Walk, But Keeping It On A Short Leash!, 30 Tex. Tech. L. Rev. 197 (1999) (explication, pros, and cons); Graham, Ann, Where Agencies, The Courts, And The Legislature Collide: Ten Years Of Interpreting The Texas Constitutional Provisions For Home Equity Lending, 9 Tex. Tech. Admin. L.J. 69, 73 (Fall 2007). Texas has a long history of aggressive homestead protection, and it didn't legalize home equity lending until 1987. See Cerda, 612 F.3d at 786. And it did so not through regular session laws, but through amendment to the Texas Constitution. See Forrester at 169-170, 177. That fact alone

20

highlights the importance accorded homestead protection in Texas. Id.; see Boettcher at 267 (discussing significance of Section 50's placement in the Texas Constitution). The home equity amendment, Art. XVI 50(a), sets out onerous rules that are a "compliance nightmare" for lenders. Graham at 73-74. Lender violations left uncured entail loan forfeiture -- a financial "death penalty." Id. at 74; see In re Cadengo, 370 B.R. 681, 698 (Bankr. S.D. Tex. 2007) (loan forfeiture imposed) (citing Doody v. Ameriquest Mortgage Co., 49 S.W.3d 342, 34546 (Tex.2001)). Owing to the death-penalty financial risk, small or unsophisticated lenders need not apply. Boettcher at 263. But even big lenders get it wrong too, and they end up forfeiting loans. See, e.g., In re Lovelace, 443 B.R. at 500 (USAA sought amelioration of harsh result, but lost its lien). As a commentator has observed: Because Texas homestead laws are liberally construed by the courts to effectuate the purposes of the Constitutional protections, even the innocent failure to satisfy any one of these conditions, however insignificant it may appear in the context of the loan, presumably would be found to be fatal to the creation of a valid lien. Unlike a valid judgment lien that may subsequently attach to the real property constituting the homestead if the property loses its homestead character (e.g., through abandonment), a purported Equity Loan that fails to satisfy any one of the Section 50(a)(6) conditions under this rationale would be void and could never constitute a valid lien on the real property. Moreover, the courts would be expected to find that none of these conditions could be waived by the homeowner because each is constitutionally vested. In any21

event, a constitutionally deficient lien cannot be estopped into existence. And, regardless of how inequitable it all may seem, lenders could expect no help from the courts in imposing a constructive trust or equitable lien in absence of compliance with constitutional and statutory requirements for fixing a lien on homestead property. J. Alton Alsup, Pitfalls (and Pratfalls) of Texas Home Equity Lending, 52 Consumer Fin. L.Q. Rep. 437, 442 (1998); see, e.g., Smith v. JPMorgan Chase Bank, Civ. Action No. C:11-cv-260, 2011 WL 5828927 at 1 (S.D.Tex. Nov. 21, 2011) (large lender forfeited loan) (no statute of limitations on non-existent lien); adhered to on reconsid. by Smith v. JPMorgan Chase Bank Nat. Ass'n, CIV.A. C-11-260, 2012 WL 43627 (S.D. Tex. Jan. 9, 2012) (interloc. appeal denied on statute of limitations issue because, based on 5th Cir. precedent, there was no ground for difference of opinion that lien was void ab initio). Section 50 is daunting on the page, and its provisions are confusingly stated as exceptions to the general rule that "forced sales" (i.e., foreclosures) are prohibited. However, this case mainly implicates two, simply-paraphrased aspects of section 50: 1. scheduled home equity loan installment payments must pay off all accrued interest as of each payment date, 50(a)(6)(L)); and 2. the principal amount of a home equity may never increase, for any reason, unless there's a repeat section 50-compliant lending event (i.e., a refinance), 50(a)(6)(F); 50(f); T.A.C. 153.3(2).

22

A section 50-compliant lending event, in turn, must comply with restrictions like: a maximum loan-to-value ratio of 80%, (50(a)(6)(B)); see Rivera v. Countrywide Home Loans, Inc., 262 S.W.3d 834, 840 (Tex. App.--Dallas 2008, no pet.); no more than one section 50 refinance per year, (50(a)(6)(M)); a formal closing at a title company or lawyer's office, (50(a)(6)(N)); and copious disclosures incorporating most of section 50 itself, (50(a)(6)(g)). The two paraphrased aspects of 50 paint the picture of a "paternalistic" constitutional scheme designed to prevent spiraling debt even if a borrower would prefer to be fed more credit from untapped home equity. Boettcher at 233; Forrester, 55 S.M.U. L. Rev. at 165. Section 50 does not give the courts discretion to "help" borrowers get more cash by bypassing the restrictions. See In re Harmon, 444 B.R. 696, 708-709 (Bankr. S.D. Tex. Feb. 17, 2011) (even though "sophisticated" attorneyborrower wanted the money and knew the loan violated Section 50, lender's chummy $177,715 "advance" violated Section 50, rendering loan forfeit); later unrelated proceedings at 2011 WL 1457236 (Bankr. S.D. Tex. Apr. 14, 2011).

23

(a) section 50(a)(6)(L) scheduled installments A home equity loan's installments must pay off a loan evenly and successively over time, such that the final installment looks much like all the others and ends the borrower's obligation. 50(a)(6)(L); T.A.C. 153.11; see Cerda, 612 F.3d at 791-92 (discussing subsection (L)). This prohibits balloon payments at the end of the loan term, for example, which are otherwise common in mortgage lending. T.A.C. 153.11(3). It also prevents lenders from luring borrowers into a debt spiral involving interest-only payments that do not pay off all accrued interest with each installment. Id.; see generally, Forrester. Such debt spirals involve the lender in refinancing the past-due interest, thereby allowing interest to earn interest. See generally Julia Patterson Forrester, Still Mortgaging The American Dream: Predatory Lending, Preemption, And Federally

Supported Lenders, 34 Cincinnati L. Rev. 1303 (Summer 2006). In that scenario, the borrower never pays down the principal, while the lender sees payments coming in that otherwise never would have. Those payments are pure gravy to a lender, since a quick, early default and foreclosure would have ended the payment stream from a distressed loan. See Forrester, 55 S.M.U. L. Rev. at 163-64.

24

(b) the 50 cap on principal As Wells Fargo stated to the Penningtons, the principal at the inception of a Texas home equity loan can never go up, only down, unless there is a new section 50 lending event. (Doc. 43, r. 605, 606, 608, 614). This, too, protects borrowers from spiraling home equity debt. The Smith loan modification settlement statement prepared by Wells Fargo illustrates what a violation of this rule looks like and in turn explains why Wells Fargo told Smith it was illegal. Principal increases by nearly $65,000 as a result of the payments Wells Fargo reduced or required Smith to miss, and the loan term is extended by a decade. (Doc. 43, r. 655); see generally, Alsup at 463 ("once a home equity loan, always a home equity loan" discussion). Past-due interest would have begun earning interest as new principal and for even longer than the original note term, undermining the protection afforded to borrowers of a cap on principal. See ACORN, 303 S.W.3d at 412 (requiring per diem interest and loan points to be included in 3% cap on expenses so that Section 50 borrower protections would not be undermined). If the rule were otherwise, Section 50(a)(6)(B)'s key limitation that the loan-to-value ratio cannot exceed 80% could be easily circumvented by something short of a section 50 refinance, such as a modification with

25

large increases to principal like Smith's. A high loan-to-value ratio is one of the most signification factors" in defaults and foreclosures. Forrester, 55 S.M.U. L. Rev. at 165. Wells Fargo cited the 80% rule to the Penningtons as a basis for denying them a permanent modification. (Doc. 43, r. 606). The record does not contain the appraisals that would illustrate the Smith modification loan-to-value ratio, but it's telling that the Smith modification omits to even address it. With such a large increase to Smith's principal in a declining real estate market, the 80% LTV requirement would pose a real hurdle to giving Smith a modification, which is presumably another reason why Wells Fargo backed out. That's a tacit recognition that Section 50(a)(6)(B)'s 80% rule has no teeth if a lender can get around it after initial issuance of the note by increasing loan principal immediately after without a full-blown refinance. There are other ways in which Section 50's provisions must be read together to prevent increases to principal through modification. If modifications like Smith's were permissible, the once-annual limitation on refinances (i.e., section 50-compliant lending events) of 50(a)(6)(M) would be meaningless: lenders could just stealthily keep feeding past-due interest into the note through serial back-door "modifications" that increase principal often and without formalities. See Fix v. Flagstar Bank, FSB, 242

26

S.W.3d 147, 152 (Tex. App.--Fort Worth 2007, pet. denied) (second loan violated Section 50 annual limitation). There would be no principled justification for limiting the number of modifications. Borrowers would pay interest on past-due interest because the past-due interest would be transformed into new principal time after time. It would be tantamount to loan-sharking. The agency interpretation addresses this problem head-on by providing that the principal as of the original loan date "determines the maximum principal amount of an equity loan." T.A.C. 153.3(2). That is, the principal as of the loan date is the maximum principal forever for that loan. Increasing home equity loan principal for any reason requires a Section 50 refinance, which in turn creates a new home equity loan. Section 50(f); T.A.C. 153.41; see In re Adams, 307 B.R. 549, 552-53 (Bankr. N.D. Tex. Jan. 26, 2004). The cap on principal ties into other provisions as well. Section 50(a)(6)(F) disallows "a form of open-ended account . . . under which credit may be extended from time to time." This section uses the loose phrase "a form of" to ferret out any arrangement under which a home equity borrower's principal grows from whatever cause but no section 50

27

closing was held. 3 The rule at T.A.C. 153.14(2)(B) provides that "the advance of additional funds to a borrower is not permitted by a modification," distinguishing between short-form agreements and fullblown section 50-compliant refinances, which are long and documentintensive. Finally, logic dictates that a state-constitutional scheme that straight-jackets home equity lending to prevent borrowers from taking on too much debt does not permit principal to increase with anything less than a fully section 50-compliant lending event. Otherwise, unpredictable kinds of additions to principal could remain under the radar, and the 80% LTV rule would be widely flouted. For instance, lenders might pile on various kinds of late charges or fees that otherwise would not be permissible additions to the original principal amount, or else would pierce the 3% cap on all such costs as benchmarked against the original principal. Section 50(a)(6)(e); T.A.C. 153.5. Wells Fargo may argue, as it has in the pending, related Hawkins proposed class action, that modifications that include past-due interest should be allowed if the borrower's monthly payment is thereby lowered, even if the LTV crosses the 80% threshold. To the extent this Court

3

Home equity lines of credit have their own set of rules. Such loans are not at issue here. 28

entertains this argument in light of the Twombley rule that Appellants' allegations must be taken as true, Appellants respond to it briefly here. The argument that lowered payments should be safe-harbored has a first-blush appeal until the broader implications become clear. Lenders could start sidestepping Section 50 routinely by feeding borrowers more debt but rigging the payments to be lower for a time. Home equity modification mills would spring up since Section 50 could be so easily circumvented. It's difficult to see how a court could fashion a rule or guideline to deal with all the permutations of loan terms that would increase loan principal yet lower the payment for some length of time. That seems to be what Wells Fargo is proposing, however. Under such a scheme, it's not just the 80% rule that could get undermined: the prohibition on balloon payments could also be undermined, as could any other provision of Section 50. Wells Fargo's argument is, precisely, that loan modifications that "recapitalize" past-due interest do not trigger Section 50 at all. Thus, merely by "modifying" a loan in such a way as to make the payment numerically lower for some span of time, a lender would be safe-harbored from the entire regime of onerous restrictions in Section 50.

29

Wells Fargo may also argue that an increase to loan principal is not "new debt" in the one and only case of "recapitalized" past-due interest, since that money was already owed to lender. In essence, an expresslystated increase to principal in a loan modification document is not an actual increase to principal. Wells Fargo has no persuasive authority for this point, and its semantic slipperiness undermines Section 50 for the reasons argued above. See Thomison v. Long Beach Mortg. Co., 176 F. Supp. 2d 714, 718 (W.D. Tex. 2001) vacated, CIV.A. A:00CA783JN, 2002 WL 32138252 (W.D. Tex. Aug. 9, 2002) (fees are fees for the 3% cap of Section 50, even if the lender would like to avoid a forfeiture by employing "hair-splitting semantics"). B. The trial payment plan violated section 50(a)(6)(L) To rehearse, the TPP agreements set out a schedule of trial payments. (Doc. 43, r. 622). These did not pay all accrued interest coming due each month. The borrowers here made those payments and then some: the Penningtons paid for ten months, Smith for nearly that long. The district court ruled that "although the partial payments constituted less than the accrued interest and paid off no principal, these were plainly temporary payments to stave off foreclosure, and were not

30

themselves an extension of credit contemplated by section 50(a)(6)(L)." (Doc. 63, r. 986). The district court did not explain why "temporary" payments are safe-harbored to protect the lender, or what constitutes a "temporary" payment plan. It did not cite or apply the applicable strict standard of interpretation for section 50. It did not explain why the fact that the payments were not new extensions of credit (i.e., new loans) leads to the conclusion that they do not violate section 50. The district court erred in all these aspects of its analysis. (1) Section 50 has no safe harbor for "temporary" schemes One searches in vain for any safe-harbor in section 50 for "temporary" payments that otherwise run afoul of the rule that scheduled payments must pay all accrued interest and some principal. See generally, Cerda, 612 F.3d at 791-92 (examining subsection (L)). Since Section 50 sets out onerous provisions for the protection of homesteads, the absence of an express safe-harbor for temporary "arrangements" or "agreements" that don't pay all accrued interest is compelling evidence that there is none. See In re Box, 324 B.R. 290, 296 (Bankr. S.D. Tex. May 3, 2005) (what lender asserted to be Section 50 safe harbor was antithesis of same) (lender

31

lost lien). The only safe-harbor is for modifications 4 that pay off interest as it comes due. See Tex. Joint Regulatory Agencies, "Home Equity Advisory Bulletin," April 2009 ("2009 Bulletin") (Doc. 43, r. 626). The 2009 Bulletin states that "the parties should be able to modify a home equity loan by providing a new schedule of installments so long as the schedule provides for successive periodic installments." Id. However, the amount of those payments must still "equal or exceed the amount of accrued interest." Id. Thus, any agreed schedule of payments, whether "temporary" or for any other term, must pay off accrued interest or else the state-constitutional scheme is undermined. In this case, Appellant borrowers are not disputing that the payments scheduled by the original note complied with section 50. But the TPP expressly replaced that schedule with a different schedule. It's right there on the page. (Doc. 43, r. 622). This is presumptively a modification or agreement that runs afoul of section 50 precisely because it departs from the originally scheduled payments. Cerda, 612 F.3d at 790-91 (Section 50's provisions read together to enforce regular payments). T.A.C.

153.14(2)(C) ("A modification of an equity loan may not provide for new4

Use of the term "modification" in this context refers to the TPP agreement itself, not the "Step Two" permanent modification. Appellant Smith never made payments under the "Step Two" permanent modification since Wells Fargo repudiated it. However, Wells Fargo accepted and credited the borrowers' payments under the "temporary" TPP agreements. 32

terms that would not have been permitted by applicable law at the date of closing of the extension of credit."); see 2009 Bulletin; see also Office of Consumer Credit Commissioner, Home Equity Modification Interpretation Letter, Dec. 20, 2001 ("2001 Interpretation Letter"). 5 It cannot be the case, as the district court suggests, that a schedule of payments given to the borrower after closing is insulated from violation by virtue of the fact that the original schedule was itself legal. If that were true, the 2009 Bulletin, which speaks to modifications after closing and changes in payment amounts, unaccountably omits from its discussion a significant exception to everything it sets out. Furthermore, how does one distinguish "temporary" payment

schemes from any other kind? The TPP itself sets out a three-month trial period, but Wells Fargo accepted insufficient payments for ten months under that agreement. Is one of these temporary but the other not? Are both? Would two years' worth be "temporary?" Five years worth? What principled basis makes any term of insufficient payments exempt? Are the courts to write into the Texas Constitution a grid of permissible "temporary" payment parameters whereby unpaid interest can allowably accrue? If so, that would harshly interact with the prohibition on additions5

Accessed at http://www.occc.state.tx.us/pages/consumer/education/HE_mod_ltr.htm.

33

to principal through modification: it would place a judicial imprimatur on home equity loan "temporary" modifications that block borrowers from getting "permanent" modifications. See ACORN, 303 S.W.3d at 412 (court invalidated agency interpretive rule that favored lenders). There is no room in Section 50(a)(6)(L) for exceptions or safe harbors for reduced payments that don't pay all interest because of this inherent problem. This court must decline to rewrite Section 50. See Box v. First State Bank, 340 B.R. 782, 790 (S.D. Tex. 2006) ("The Bank's policy arguments are best addressed by revising the text and language, which cannot be done by federal bankruptcy or district courts."). (2) The asserted "safe harbor" is a foreclosure trap The facts of this case illustrate how a lender's safe harbor for insufficient payments would create a foreclosure trap rather than "staving off" foreclosure, as the district court wrongly concluded as a matter of law. The borrowers here were allowed to make insufficient payments that created pools of unpaid interest. Had these borrowers' loans been ordinary mortgage loans, Wells Fargo could have modified the loans to include all that past-due interest without fanfare. But, as already discussed -- and as Wells Fargo has admitted to Appellants -- you can't modify Texas home equity loans to increase principal; that requires a refinance. Wells Fargo

34

thus created a debt trap for the borrowers here by inducing them to incur arrears that couldn't be rolled into principal via the very loan modification being offered. Wells Fargo could have disclosed all this years before. Wells Fargo didn't tell the Penningtons until mid-2010 that the Texas constitutional provisions were "new" rules. It was not until many months later again, in mid-2011, that Wells Fargo told Appellant Smith that "there's nothing in the world [Wells Fargo] can do since [Wells Fargo] would be breaking the law." But the law hadn't changed since Smith and the Penningtons started the loan modification process with Wells Fargo. Wells Fargo could never have given Smith the loan modification whose terms Wells Fargo set out on paper and for which it gave her cheery "Congratulations!" It could never have given the Penningtons a modification that increased principal. Wells Fargo's action of putting these borrowers behind on interest trapped them. In summary, Wells Fargo acted wrongfully under the Texas Constitution in having Texas home equity borrowers make reduced payments as a precondition for a modification. Such "temporary" payments do not help "stave off foreclosure," as the district court concluded. They create unpaid interest pools that stand in the way of modification since the

35

unpaid interest cannot be added to principal. Wells Fargo's binding admissions to the Penningtons and Smith establish that. In reality, such payments are not, on reflection, "reduced" at all, since the borrowers are still incurring all the interest; they're just not paying it all as it comes due. (3) Lenders still have ways to help Texas home equity borrowers Wells Fargo may complain that lenders need freedom to "help" borrowers with "temporary" payment schemes. This argument conflicts with a regime of laws that permits of no exceptions and that is interpreted strictly to protect homesteads. Plus, as already shown, it is no help to borrowers to have pools of interest building up that can't later be added to principal with a modification. Finally, Wells Fargo's policy argument glosses over the fact that ordinary purchase money mortgages are not affected. In seeking to deflect attention from its own failure to respect the distinction under Texas law between the two different forms of lending, Wells Fargo again lumps them together. In fact, Wells Fargo has always been free to modify ordinary mortgages to increase principal. But Wells Fargo also has options for helping Texas home equity borrowers. It can just reduce the loan interest rate for a trial period, thereby reducing payments without unpaid interest piling up. See generally 2001 Interpretation Letter. Alternatively, the lender can forgive the unpaid36

interest. See generally 2009 Bulletin. As a last resort in cases where interest arrears exist, there can be a section 50-compliant refinance that rolls those into a new principal sum. Wells Fargo didn't offer that to Appellant borrowers. Indeed, Wells Fargo's statements to the Penningtons in mid-2009 and to Smith in May, 2011, while taken as true for purposes of this appeal, may in fact constitute actionable misrepresentations in themselves to the extent it is shown there was something Wells Fargo could have done. (4) Lenders have Section 50-permissible ways to unilaterally forbear from foreclosing A core problem with the trial payment scheme at issue here is that it's an explicit scheme by agreement on paper, where borrowers see a payment on the page that, to them, represents their obligation to the lender. Borrowers reasonably view that as the "scheduled" payment since the lender has agreed not to foreclose while payments are flowing. With a section 50 loan, however, the reduced payment is a trap, since the interest cannot get rolled up in the loan via modification. However, there can be situations where a distressed borrower is behind and has arrears but where the lender voluntarily chooses not to foreclose to allow the borrower to catch up. That is forbearance. You don't need a misleading schedule of reduced payments on paper to do that. That's37

a phone call or letter where the lender advises the borrower to get current or else prepare for foreclosure. There's no reason that kind of communication would run afoul of or implicate section 50. The borrower would at least have a keen appreciation of the risks. There can also be forbearance plans that set out an express schedule of payments that might pass muster under Section 50. These take as their premise that "forbearance" requires the borrower to make higher monthly payments for a time in order to catch up on past-due amounts. The past-due sum is ratably applied to a certain number of payments and is in addition to the regularly scheduled payment. Wells Fargo calls this a "repayment plan" on its web site. 6 This Court may take judicial notice that this practice constitutes mortgage loan forbearance and has nothing to do with payment plans that put a borrower further behind. Whether true forbearance plans violate Section 50 is not at issue in this case. Finally, Wells Fargo may attempt to argue that because the trial payment plan is not a "contract," it was not "agreed in writing by the borrower and lender" as stated in the interpretive rules. T.A.C. 153.14(2)(A). That's an upside-down way of reading Section 50, however. Section 50 places the burden on the lender to put modifications in writing

6

Accessed Jan. 31, 2012 at: https://www.wellsfargo.com/homeassist/repaymentplan. 38

and get them agreed to. See In re Gulley, 436 B.R. 878, 884-86 (Bankr. N.D. Tex. Aug. 23, 2010) (lender's failure to get borrower's agreement owing to fraud by borrower's son still required forfeiture of loan, though equitable subrogation applied to soften the blow). If Wells Fargo never "agreed" to the TPP but accepted borrower payments according to its terms, then the TPP violates section 50 for that reason alone. Section 50 must be read to protect borrowers, meaning that the risk of failure of mutual assent falls on the lender. See Marketic v. U.S. Bank Nat. Ass'n, 436 F. Supp. 2d 842, 852 (N.D. Tex. 2006) (lender "subtly misstated" Section 50 to place risk on borrower). Rule 153.14(2)(A) doesn't state that a "contract" is required, but merely a writing "agreed to" by both parties. That's so that the borrower understands what's going on, not so that the lender may be excused from misconduct by being cagey about signing things. In this case, the borrowers made reduced payments according to a written agreement supplied by Wells Fargo, and Wells Fargo accepted those payments. The mutually-agreed writing element is satisfied, but in any event the risk of failure of mutuality falls on Wells Fargo. In conclusion, any agreement, however styled and of whatever duration, that schedules home equity loan payments in amounts insufficient to pay all interest coming due is impermissible under section 50 as well as

39

inherently unhelpful and dangerous to borrowers. It does not "stave off" foreclosure since payments are not in fact "reduced" -- they are simply not being fully collected by the lender. Yet a lender is always free to unilaterally reduce the interest rate for any length of time, or to unilaterally refrain from foreclosure to allow a borrower to catch up, or to forgive past due interest so that a loan modification is possible.

40

ISSUE TWO: Wells Fargo negligently misrepresented existing fact by offering the HAMP program to Texas home equity borrowers in the first instance, since by Wells Fargo's binding admissions to the Penningtons and to Smith, the modification resulting from the scheme Wells Fargo proposed, by generating pools of past-due interest that could not legally be rolled into a restated, increased principal, was at all relevant times "breaking the law." The elements of a cause of action for negligent misrepresentation are: (1) the representation is made by a defendant in the course of his business, or in a transaction in which he has a pecuniary interest; (2) the defendant supplies false information for the guidance of others in their business; (3) the defendant did not exercise reasonable care or competence in obtaining or communicating the information; and (4) the plaintiff suffers pecuniary loss by justifiably relying on the representation. See Fed. Land Bank Ass'n of Tyler v. Sloane, 825 S.W.2d 439, 442 (Tex. 1991). A "false representation" is one of existing fact, not a promise of future conduct. Id. Silence where there's an obligation to speak can be a false representation. Am. Tobacco Co., Inc. v. Grinnell, 951 S.W.2d 420, 436 (Tex. 1997). The district court dismissed the negligent misrepresentation claim on several bases but rejected the claim for reliance-type damages solely on the sole basis that promises of future conduct are not actionable. (Doc. 63, r. 14-16 and 16 fn. 5). The Penningtons and Smith take issue with that41

portion of the district court's opinion that deals with the claim for interest arrears as damages for negligent misrepresentation. See Sloane, 825 S.W.2d at 442-43 (borrower expenses made in reliance on bank representation were recoverable). The district court didn't focus on the relevant misrepresentation. The borrowers are not arguing that the promise of a loan modification is the relevant "existing fact." Wells Fargo had discretion to grant or reject one. It's the legality ab initio of a loan modification that's the "existing fact" misrepresented by the TPP by omission. Wells Fargo's inducement to borrowers to enter into the trial payment agreement was that a modification was legal. That is a necessary implication and sine qua non of any offer to launch into a loan modification scheme, or else why would the parties bother? True, the interest arrears themselves hadn't arisen yet as the legal bar to modification, but they necessarily would: the offer was from the outset predicated on reduced payments. The false representation was not whether or a not a modification would in fact be granted at the end, but whether a modification was permissible from the outset. Wells Fargo impliedly represented it was, but then much later it admitted to the Penningtons and

42

to Smith -- after they had incurred large arrears -- it was not. Therein lies the misrepresentation of an existing fact. Consider what would have happened had Wells Fargo told borrowers at the outset that modifications that rolled past-due interest into principal were illegal. The question is absurd, since Wells Fargo shouldn't have identified Texas home equity borrowers as candidates at all. Any reducedpayment scheme that generated interest arrears was unfit for borrowers who couldn't legally obtain a modification to roll those arrears into principal. Even if Wells Fargo had made such an offer, it defies belief to think a borrower would entertain it for even a second. It would amount to an offer to get behind on loan payments for no reason, placing the borrower dangerously behind and subjecting the borrower to a balloon payment at the time of modification in order to catch up. Plaintiff Smith was never behind by a day until Wells Fargo offered her a HAMP program modification. There's no basis in the record to believe she ever would have gotten behind. The program, as implemented, forced her to incur arrears she didn't know would wreck any chance of a modification. In summary, the modification contemplated by the HAMP process was always illegal in the context of Texas home equity loans because any scheme of reduced payments creates interest arrears that cannot be

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included in a home equity loan via a modification. It was illegal in 2008, and it was illegal when Wells Fargo admitted the problem to the Penningtons in 2010 and to Smith in 2011. Wells Fargo therefore negligently misrepresented an existing fact at the outset, causing borrowers to get behind on their interest for the sake of a modification they could not have legally obtained.

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ISSUE THREE: Since, by Wells Fargo's own admission, the only thing standing in the way of the parties' mutual assent to enter into the Smith loan modification agreement was the presumed illegality of that agreement, the parties' mutual assent should be given effect if the modification was legal. Contracts require consideration to be enforceable, and a borrower's payments under a pre-existing loan, without more, don't equate to consideration under an agreement to modify the loan. See McCallum Highlands, Ltd. v. Washington Capital Dus, Inc., 66 F.3d 89, 93 opinion corrected on denial of reconsideration, 70 F.3d 26 (5th Cir. 1995) (discussing the Texas pre-existing duty rule and exceptions thereto) (citing Texas cases). Generally, issues surrounding whether the "Step One" TPP is a contract that can be breached have split the courts. See Senter v. JPMorgan Chase Bank, N.A., 11-60308-CIV, 2011 WL 4089585 (S.D. Fla. Aug. 9, 2011) (good recent summary). Some courts have said there's no consideration, since borrowers are already obligated to make payments. See id. Other courts have said that borrowers' other obligations under the TPP constitute consideration, but the courts in these cases do not squarely decide what the object of the contract is. See, e.g., Bosque v. Wells Fargo Bank, N.A., 762 F. Supp. 2d 342, 352-53 (D. Mass. 2011) (borrowers'

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payments and other actions constituted consideration supporting a contract) (citing cases). Appellants here argued below that their additional burdens under the TPP constituted adequate consideration, and they continue in that assertion for the same reasons discussed in Bosque. At a minimum, Appellants' burdensome efforts to meet all the requirements constitute a legal detriment. Id. The district court did not squarely pick a side, nor state whether the borrowers here gave consideration. It variously characterized the TPP as an "agreement" or an "arrangement" that gave Wells Fargo discretion whether to grant a modification. However, the district court seems to have embraced the idea that the TPP is, at a minimum, an agreement that obligated Wells Fargo "to consider modifying the loan and to provide a decision." See Bosque at 351-353. There are two possible contracts implicated by this case. The first is the TPP documentation, composed of the "Step One" documents. Appellants have referred to this as the "TPP" or "TPP agreement." (Doc. 43, r. 616). This is an agreement whose object, Appellants contended below, is a permanent loan modification, much as a contract for goods has space shuttle O-rings as its object.

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The other contract is the permanent loan modification itself, which bears the title "Step Two" and bears all the indicia of a permanent modification ready for recording with the county clerk once executed. (Doc. 43, r. 640). Smith received this document and executed it, but she never received it back signed by Wells Fargo. There is no allegation that the Penningtons ever received the "Step Two," but rather than Wells Fargo was obligated to provide it once the Penningtons satisfied all the conditions of "Step One." Smith's case should not have been dismissed even under the district court's own reasoning and determination of law. If the district court is correct as a matter of law that Wells Fargo was obligated to give Smith consideration and a decision, then that consideration should be the final word on whether there was a contract. If Wells Fargo's decision was in error as a matter of law because Wells Fargo got the law wrong, that too should be the final word since it suggests that nothing ever stood in the way of a contract. This Court therefore need not decide the question whether the form TPP agreements are contracts for everyone who got involved in the HAMP process. It need only decide whether an issue for the trier of fact exists surrounding Wells Fargo's consideration and decision as to borrower Smith's modification.

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Smith's facts, though unlikely to recur except in the context of Texas home equity loans, present as strong a case as can be imagined for arguing for the existence of a contract as regards the TPP under the district court's analysis. The parties had manifested mutual assent as evidenced by the facts that Smith had received the final loan modification paperwork, complied with all the final obligations, and sent everything back for Wells Fargo's signature. There was nothing left for Smith to do, and no obligations remaining for her to perform: she was just making home repairs while waiting for the signed modification to come back to her. Wells Fargo took no issue with any of her qualifications or the satisfaction of any TPP terms, thereby providing evidence of its assent. At the last hour, Smith alleges, Wells Fargo stated that nothing but illegality stood in the way of Wells Fargo signing the document and mailing it to her. The representative on the phone, following two years of processing, stated: "there's nothing in the world [Wells Fargo] can do since [Wells Fargo] would be breaking the law." If that statement is objectively false because wrong on the law, the parties' mutual assent should be given effect. One issue of fact thus determines whether was a meeting of the minds: whether Wells Fargo actually made the statement Smith alleges.

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This differentiates Smith's case from every other decided case involving HAMP. Therefore, if after remand the district court finds as a matter of law that the proposed modification (i.e., with past-due interest rolled into new principal) was legal under section 50, then there is an issue for the finder of fact whether Wells Fargo said what Smith alleges. If Wells Fargo did, there is a completed contract. Smith gets a legalized modification. That's a sensible result: at the risk of repetition, if the sole asserted basis for the "decision" Wells Fargo was obligated to make is a question of legality that can be objectively answered by the court, then nothing ever stood in the way of the modification. Removal of the irritant of illegality will allow both parties to enter into the contract they wanted to enter into. As to that legal determination under Section 50, Plaintiffs agree with Wells Fargo's assertions to the Penningtons in 2010 and Smith in May, 2011: it is all but impossible that the district court would determine that Section 50 permits past-due interest to be rolled into principal through a modification. In that event, Wells Fargo's decision to pull back proves to have been valid (even though the negligent misrepresentation remains). But at least the parties are entitled to learn if they are wrong about Section 50. This court should therefore reverse the dismissal of Smith's breach of

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contract claim and remand so that the district court can consider the above issues of fact (whether Wells Fargo said what Smith alleges it said) and law (whether the Smith permanent modification was illegal). 7 Even if the Court determines that the TPP is not a contract because not supported by independent consideration, the Court may still determine -- apart from the breach of contract claims -- that the TPP constitutes an illegal modification under Section 50. That's because, as already argued, the risk of failure of mutual assent to a Section 50-compliant modification falls on the lender. Appellants have argued that their TPP payments and Wells Fargo's acceptance of those payments without objection do constitute a mutual agreement within the meaning of Section 50 to modify the loan for the trial period. T.A.C. 153.14. The fact that these borrowers assented to an illegal payment doesn't mean Section 50 renders it legal by

It's a striking result if Plaintiffs are correct that the trial payment scheme itself violates the Texas Constitution, as argued in Issue I herein. In that event, invalidation of the lien had already occurred as of the inauguration of the trial scheme, and Plaintiffs had no obligation to continue paying their loans. See Smith void ab initio case. That would sidestep for these borrowers the problem courts have had in finding consideration on the part of borrowers in other HAMP cases. See Senter. In the unique case of Texas home equity borrowers who entered into TPP agreements, the borrowers gave as consideration payments that they were emphatically not already legally required to make, since the loans were rendered invalid by the illegal payment scheme. The practical effect of this is uncertain, since the constitutional violation either voids plaintiffs' loans or else requires the loans to be cured. Still, it could form the basis for additional damages or else inform the manner of cure.

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estoppel. See In re Harmon, 444 B.R. 708-709 (sophisticated borrower's complicity in impermissible practice didn't prevent forfeiture).

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ISSUE FOUR: Wells Fargo is estopped from denying it promised a loan modification to Smith if its sole basis for that denial was that the modification was illegal, but in fact the modification was legal. The doctrine of promissory estoppel is a substitute for consideration in that where a contract isn't formed, but one party has relied to its detriment on promises made by the other, reliance damages are still available. See Wheeler v. White, 398 S.W.2d 93, 97 (Tex. 1965). Promissory estoppel is in the alternative to breach of contract. See Rice v. Metro Life Ins. Co., No. 02-09-028-CV, 2010 WL 3433058 at 10 (Tex.App. - Fort Worth Aug. 31, 2010, no pet.). Wells Fargo is estopped from denying it promised Smith a loan modification even if it didn't complete the contract by sending the paperwork back signed. The promissory estoppel claim would, at a minimum, permit Smith to recover reliance damages for sums she spent to renovate her home after being reassured in January, 2011 that she would receive a loan modification, plus loan payments made from that time forward. Depending on what this Court views as the relevant time of the promise, it's possible that all her HAMP program payments would constitute reliance damages. Her expectation damages, in this case any

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savings achieved by reduced payments extending out into the future, would not be recoverable under Texas law. The district court dismissed the promissory estoppel claim on the basis that no promise was made, concluding there was no "guarantee" of a modification. On the TPP paperwork alone, the point is debatable. Plaintiffs believe there is ample basis for this Court to find a question of fact as to that. The TPP documents are full of conflicting statements as to what a borrower should expect, often sounding as though a modification is mandatory if the borrower complies with all her obligations. However, the district court did not discuss in any detail the Smith allegations, which squarely allege a promise, foreseeability of reliance, and actual reliance. The missing link in the district court's decision is that the only basis Wells Fargo asserted for denying Smith a modification was illegality. As a necessary corollary, Wells Fargo's statement to Smith on the phone in May, 2011 amounts to an admission that, but for the section 50 illegality, Wells Fargo would have given her a modification. If that illegality is removed as a basis for the denial of a modification by a finding of legality, Wells Fargo is estopped from avoiding the detrimental results to Smith of that promise.

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Other statements by Wells Fargo bolster this argument. Plaintiff Smith recorded Wells Fargo in January, 2011 promising the approval of the modification, at which time Wells Fargo gave no indication of illegality or any reason for Smith to worry that the "Congratulations!" that came five weeks later didn't confirm her belief. She began spending money on improvements to her home based on the January phone call and the February congratulations. As of early 2011, therefore, Wells Fargo was not mentioning illegality to Smith, but it is established for purposes here that it had already raised that issue with the Penningtons in August, 2010. Wells Fargo had begun stringing Smith along in September, 2010 after it already knew about its Section 50 problems. Nothing was left to be done after Smith sent back the Step Two paperwork except Wells Fargo signing it, which it had already said it would do and which it was obliged to do. Cf. Martin-Janson v. JPMorgan Chase Bank, Civil Action No. 1:11-cv-584 (W.D.Tex. Jan. 11, 2012) (alleged promise was not in writing, so promissory estoppel unavailable even though lender required borrower to get far behind on payments in reliance on promise of modification) (court required additional evidence to decide motion to dismiss promissory estoppel issues). Since, as discussed above, Wells Fargo's sole asserted basis for not granting a modification

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was that its terms would have violated the law, the written and oral communications must necessarily be viewed as a promise to grant a modification but for that illegality. As with the breach of contract claim, the Smith case for promissory estoppel rests on narrow and unique facts relating peculiarly to Texas home equity laws and Smith's paperwork being processed just as Wells Fargo was notifying borrowers of the effects of Section 50. It would be fundamentally unfair for Smith to be penalized for Wells Fargo's belated assertion of an illegality that had always been present and that Wells Fargo had known about for the duration of Smith's loan modification process.

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PRAYER For the reasons above, Plaintiffs-Appellants, Ellery and Laura Pennington, and Traci Smith, respectfully request this Court to reverse the judgment of the trial court and remand the case for further proceedings as argued for herein. Specifically, the claim under Tex. Const. art. 50(a)(6)(L) and the claim for negligent misrepresentation should proceed to trial. The alternative claims for breach of contract and promissory estoppel should be remanded for a threshold determination of law whether unpaid interest may be rolled into home equity loan principal without a Section 50 refinance. If it can, then those claims should proceed to trial since the sole basis for Wells Fargo's decision not to grant a permanent modification is invalid as a matter of law. However, if as a matter of law unpaid interest cannot be added to Texas home equity loans through modification, then Wells Fargo's stated basis for denying the permanent modification was valid. Assuming the district court was correct that Wells Fargo's agreement with Plaintiffs was only to give a decision as to modification, then the breach of contract and promissory estoppel claims do not survive.

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Respectfully submitted,

__________________________ J. Patrick Sutton 1706 W. 10th Street Austin, Texas 78703 Ph (512) 417-5903 F (512) 355-4155 A TTORNEY FOR A PPELLANTS

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CERTIFICATE OF SERVICE I hereby certify that the foregoing BRIEF OF APPELLANTS has been filed in the office of the Clerk for the United States Court of Appeals for the Fifth Circuit, and a true and correct copy of the same has been provided to counsel listed below in the manner indicated on this 8th day of February, 2012.

by ECF W. Scott Hastings Locke Lord Bissell & Liddell LLP 2200 Ross Avenue, Suite 2200 Dallas, Texas 75201 /s/ J. Patrick Sutton J. Patrick Sutton

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