BY THOMAS K. STANDEN IV
With respect to the amount, timing and method used to assess and collect late charges, during the last 28 years as a Note Servicing Company, I bet we’ve seen them all. It doesn’t seem to make much difference whether the note was structured by a CPA, Attorney, Financial Advisor, Title Company, Real Estate Broker or a “do it yourself” seller carry back. There are almost as many variations as there are notes.
It is not my intention to present rules and regulations to drain you of creativity, but as Note Brokers and Note Buyers it just makes sense to know what the law and/or statute has to say about late charges, how much you can charge and how and when you can collect, and how it can affect the value of the note.
We service notes on a nationwide basis and realize laws differ somewhat from state to state. For the purpose of this article, please be aware that the laws referred to herein, are California Statues and for illustration only. Also, they are far from all inclusive. This would be a study in itself. We have found however, that most states have similar laws on the books. Therefore, when structuring, I would suggest you become familiar with the appropriate sections prior to finalizing and execution.
The California Business and Professional Code indicates a late charge can apply to any type of property. The amount charged on an Owner Occupied, one to four units is limited to 10% after 10 days. The late charge provision must be stated in the note and is limited by Statute. Additionally, you cannot assess a late charge unless you have provided a statement to the borrower identifying when the late charge will be assessed on a monthly basis for each payment.
To satisfy this requirement, payment coupons with such a statement can be used. When using payment coupons, a January-to-January method should be considered. This way you have a standard practice whereby you send an annual accounting statement for all activity of the account for the preceding year, the 1098 Interest Paid form along with coupons for the entire year.
When using payment coupons, they must comply with the “late charge” code sections and include the following: 1. A notice sent for each payment due, the date after which such charge will be assessed and, 2. The notice shall contain the amount of such charge or the method by which it is calculated.
Pyramiding late charges is prohibited. Pyramiding of late charges is where you charge more than one late charge for the same delinquent installment. California Civil Code Section 2954.4 prohibits the practice of pyramiding late charges. For example, if a borrow fails to make a timely payment in January, but makes the regular installment payment due in February, a lender cannot charge a late charge for February, even though the payment received in February would be applied towards the January payment and the February installment payment would still be due. Dragging that late charge into subsequent months as a penalty to the borrower would keep the borrower from getting ahead. A default interest rate is one that increases after a certain period of default, and a late charge is being charged would be pyramiding of late charges.
Late charges on balloon payments seem to surface as a “punitive penalty” occasionally. Clearly, the California Business and Professional Code prohibits such a practice except that a late charge that could have been assessed on a regular installment can continue to accrue for each month past the due date.
Another question that seems to frequently arise is: “When is the payment deemed received?” Much controversy exists in this area and many court cases exist. We suggest the following:
a. Do not require payment be made by mail only.
b. Your payment coupons should not contain a limited access mailing address, such as a P.O. Box otherwise you may be responsible for payments placed in the mail.
c. The date payments made by personal check is the date received provided you allow all methods of payment to be made. The mere act of depositing in the mail is not a payment made as supported by the Cornwell v. Bank of America”. See Cornwell.
d. The date payments were deposited in the mail for good funds (money order, cashiers check, etc.) is the date deposited in the mail.
The habitual, persistent absence of timely payments from an irresponsible Payor can drive you to drink (or at least up the wall) even when a late payment provision exists in the note. But the situation is exacerbated to total frustration and send us over the edge when no late payment provision exists in the note.
So, what can we do when considering that statutory limitations do, in fact exist?
First of all, when considering the purchase of a note, consider how the absence of a late charge in the note will negatively affect the value of the note. This should be a factor in the decision making process of how much to pay for the note or in some cases actually could be a determination of whether to buy it or not. As you know, yield is not the sole criteria.
Next, If you are structuring a note or providing consultation, be personally aware of the “rules of the road and not depend totally on others.
If you are nervous about an unlawful late payment provision in a note that you own and are collecting, you could consider modifying the note. The risk here is that it puts the Payor on notice and you in a potentially vulnerable position. But, maybe only you know that … there are ways you could do some creative negotiations in terms of mutual benefits.
If the borrower were continuously late making monthly payments, an option would be to make a report a national credit-reporting bureau. Problem here is, the reporting cuts both ways. The credit nick on the borrowers history could negatively affect the value of your note when and if you sell it.
Obviously, we are biased in our suggested solution to the problems of late payments. More Note Brokers and Loan Brokers than you may realize are taking advantage of the aggressive delinquency enforcement provided by a Professional Loan Servicing Company and the well of resources available to them. The entrance of a third party in the collection process typically causes an increase in the compliance with the provision of the note by the Payor.