With more and more frequency, compliance lawyers find themselves advising their consumer lending clients not only about whether the client's practices are consistent with regulators' interpretations of the laws and/or regulations they administer, but also about the risk that implementation of those practices will result in the client being sued, either in individual or class actions, and how best to avoid or limit that risk. The reason for this is the general increase in litigation, particularly class action litigation, being pursued against consumer lenders over the past several years.

The year 2001 followed this trend, with a continuing high level of class action and individual cases filed against those engaged in residential mortgage lending and other forms of consumer lending. This Article discusses a sampling of the resulting decisions during 2000 and 2001, broken down by subject matter, with an emphasis on mortgage-related litigation. Cumulatively, they illustrate the breadth and the detail of the issues being examined, the creativity of lawyers in fashioning new and challenging arguments, and the fact that, overall, lenders seem to be faring rather well in terms of the judicial response. Still, the result is something almost akin to a comprehensive new judicial regulatory system, with well-established mortgage practices being subjected to detailed examination and controversies being resolved on the basis of new legal minutia. In some important ways, it is a far cry from traditional mortgage litigation, perhaps reflecting the increased federal presence in this area of law.
 

AMTPA/Preemption

There is a line of recent cases in which plaintiffs allege that the lender violated a state law fee limitation and the lender attempts to defend itself by asserting that the state law limitation in question is preempted by the federal Alternative Mortgage Transactions Parity Act (AMTPA). n1

Consumer FIN. L.Q. REP. 129 (2000).

The leading case in this area is National Home Mortgage Ass'n (NHEMA) v. Face, n2 decided in February 2001 by the U.S. Court of Appeals for the Fourth Circuit. In this case, the Fourth Circuit affirmed a lower court judgment in favor of the plaintiff, a trade association representing the interests of home equity lenders. n3 That lower court decision had declared that a Virginia law limiting the charging of prepayment penalties by non-depository lenders was preempted by AMTPA for loans meeting the definition of an "alternate mortgage transaction" (e.g., adjustable rate mortgage [ARM] and balloon loans). n4

A similar decision, captioned Shinn v. Encore Mortgage Services, n5 was rendered by a New Jersey federal district court the previous year. That decision, however, was in the context of a class action filed on behalf of individual ARM loan borrowers forced to pay prepayment fees following early pay-offs of their loans. n6 Currently pending in a New Jersey state court is a variation of the Shinn complaint, filed by the same lawyer, which involves balloon loans. n7

Discounted Packages/Upcharges

These cases examine whether the practice of upcharging for settlement services obtained from third party providers or offering discounted packages of settlement services from affiliated providers violates section 8 of the Real Estate Settlement Procedures Act (RESPA). n8 The most recent of the "upcharging"cases is Echevarria v. Chicago Title & Trust Co. n9

In Echevarria, plaintiffs alleged a violation of RESPA section 8(b) because the defendant, Chicago Title and Trust Company ("Chicago Title"), collected recording fees in excess of the charge imposed by the county recorder's office and pocketed the difference. The U.S. Court of Appeals for the Seventh Circuit affirmed the lower court's decision dismissing the plaintiff's  RESPA, as well as state law, claims. n10 Despite opinion letters and other informal statements issued by the U.S. Department of Housing and Urban Development (HUD) to the contrary (which the court said it was "extraordinarily reluctant" to follow), n11 the court concluded that for a violation of section 8(b) to occur, a third party must share in the unearned fee. n12 The court then found that Chicago Title did not share the unearned fee with a third party in that case. n13

Other courts have struggled with this issue before Echevarria. Another recent example is an Illinois district court which in Christakos v. Intercounty Title Co. n14 granted class certification in an upcharge case. The plaintiffs in Christakos alleged that their duplicate payment of a fee to both Intercounty Title ("Intercounty") and Mellon Mortgage Company ("Mellon") to record the cancellation of their paid-off mortgage violated section 8 of RESPA. (Intercounty never recorded the release of the Mellon mortgage and only refunded the amount it collected from the plaintiff after the plaintiff had initiated the action.) The court determined that although Mellon may have "unwittingly" shared in the total charge paid by the plaintiff, that charge represented a fee to Mellon for recording of the release and a fee to Intercounty in return for no services actually performed. n15 The court viewed the plain language of RESPA as being broad enough to cover a situation where a borrower pays two amounts to two parties for the exact same service, one of whom performs the service, and the other of whom receives the unearned fee while providing no service whatsoever. n16

After Echevarria, HUD issued a Statement of Policy in which it officially took the position that section 8(b) prohibits all unearned fees, including where:
 

(1) Two or more persons split a fee for settlement services, any portion of which is unearned; or (2) one settlement service provider marks-up the cost of the services performed or goods provided by another settlement service provider without providing additional actual, necessary, and distinct services, goods, or facilities to justify the additional charge; or (3) one settlement service provider charges the consumer a fee where no, nominal, or duplicative work is done, or the fee is in excess of the reasonable value of goods or facilities provided or the services actually performed. n17

An allegation somewhat related to upcharging for settlement services concerns the offering of a discount for using one or more affiliated settlement service providers. The claim is that the availability of the discount has the effect of, at least financially, requiring the borrower to use the affiliated provider in violation of the RESPA section 8 affiliated business arrangement (AfBA) rules.  n18 In Geisser v. NVR, Inc., n19 for example, a Tennessee district court dismissed class action claims filed against national home builder NVR, Inc. ("NVR"). n20 The plaintiff, Dr. Sanford Geisser, had alleged that NVR violated the AfBA rules by "requiring" home buyers, including himself, to use NVR's affiliate mortgage lender and its affiliate closing agent. His basis for thisallegation was that NVR offered to pay part of his closing costs if he used both NVR affiliates. Dr. Geisser argued that this offer "economically coerced" him into using NVR's affiliates and thus constitutes a prohibited "required use" under RESPA's AfBA rule.

 

The judge in Geisser determined instead that NVR's offer to pay part of the plaintiff's closing costs represented an offer of a discount for a package of settlement services, which is specifically permitted under RESPA and Regulation X. n21 In reaching this conclusion, the judge was aided by the following HUD-mandated language in NVR's AfBA disclosure statement, which he iewed as sufficient to counter the plaintiff's claim that he was told he had to use the affiliates: 

Discrimination/Reverse Redlining

With national and local attention being focused lately on "predatory lending" practices, cases alleging discrimination, "reverse redlining," and related abuses, often asserted in defense to collection or mortgage foreclosure actions, appear to be increasing in frequency. One such case, and a very dangerous one for loan purchasers, is Associates Home Equity, Inc. v. Troup, n23 in which a New Jersey intermediate appellate court affirmed in part and reversed in part a trial court's dismissal on summary judgment of certain claims raised by the homeowners, Beat-rice and Curtis Troup ("Troups"). n24 The Troups had raised these claims in defense of a foreclosure action filed by the loan assignee, Associates Home Equity Services, Inc. ("Associates"). They asserted that: (i) their loan (a home improvement loan) was rescindable under the Truth-in-Lending Act (TILA); (ii) the rate and terms of the loan were "unconscionable" in violation of New Jersey's Consumer Fraud Act; and (iii) the loan was the result of certain "predatory" practices constituting "reverse redlining" in violation of state and federal anti-discrimination laws. n25

 

The appellate court's decision, issued on July 25, 2001, affirmed summary judgment for the defendant on the TILA claims, finding that all proper TILA disclosures, including a correct Notice of Right to Cancel, had been given. n26 The appellate court also agreed that the Troups' affirmative claims of discrimination were time-barred, because each of the state and federal anti-discrimination laws upon which the Troups relied had a two-year statute of limitation. n27 The appellate court, however, found sufficient evidence to raise a factual issue and to allow discovery to proceed on the Troups' other asserted defenses, as a matter of "recoupment," based on discrimination and unconscionability (recharacterized by the court as "reverse redlining" and "predatory lending"). n28 Such evidence included allegations that the Troups' home improvement contractor actively helped to arrange the loan they needed to finance those improvements, and that Associates, although a subsequent purchaser of the loan, approved the loan prior to closing. n29

A far more conventional use of fair lending laws to defeat collection efforts is to allege that the spouse of a borrower who qualifies individually for a loan was required to act as a guarantor or co-signor on the loan in violation of the Equal Credit Opportunity Act (ECOA). n30 This was precisely the argument raised by the defendant (an alleged guarantor on a business purpose loan made by the plaintiff to the defendant's spouse) in Boone National Savings & Loan Ass'n F.A. v. Crouch. n31 The defendant might have succeeded on this claim, had not the ECOA statute of limitations already expired. n32 But once again,  although the court dismissed her claim for damages under ECOA as untimely, it allowed her to assert the ECOA violation as a defense to the bank's collection action, i.e., as a matter of "recoupment," even though the limitations period had run. n33

Mandatory Arbitration

Recognizing the dangers of class action litigation, over the past several years many lenders have attempted to avoid this risk by inserting into their loan documents mandatory arbitration clauses (which typically, either expressly or by silence, prohibit class treatment of borrower grievances). Predictably, plaintiffs' counsel have fought hard to convince courts that such clauses should not be enforced. Despite some lower court successes, however, plaintiffs have generally been unsuccessful.

The most significant case in which plaintiffs fought to invalidate an arbitration clause in a consumer loan contract was Green Tree Financial Corp. v. Randolph. n34 In this case, decided December 11, 2000, the U.S. Supreme Court reversed the holding of the Eleventh Circuit Court of Appeals that an arbitration agreement, which was silent with respect to payment of filing fees, arbitrator's costs, and other arbitration expenses, failed to provide the minimum guarantees needed to ensure that borrowers could vindicate their rights under TILA. n35 The Supreme Court concluded that where a party seeks to invalidate an arbitration agreement on the grounds that arbitration would be prohibitively expensive, that party bears the burden of showing the likelihood of incurring those costs. n36 Because there was no showing on this point, the court concluded that the arbitration agreement was enforceable. n37 On remand, the Eleventh Circuit considered and rejected the plaintiff's alternative argument that the TILA creates a non-waivable right to class action relief. n38

Recent decisions issued by the U.S. Court of Appeals for the Third, Fourth, and Eleventh Circuits have rejected other arguments against arbitration clauses. In Bowen v. First Family Financial Services, Inc., n39 the plaintiffs alleged that their lender's requirement to sign an arbitration agreement before obtaining a consumer loan violated the ECOA. They argued that, because the arbitration agreement conditioned the extension of credit on the plaintiffs' agreement to forego their right to judicial remedies under the TILA, it violated section 1691(a)(3) of the ECOA. n40 That section prohibits discrimination against an applicant because the applicant has in good faith exercised any right under the Consumer Credit Protection Act, of which the TILA is a part. n41 The Eleventh Circuit affirmed the decision of the district court upholding the arbitration agreement, finding that the right to pursue TILA claims in a judicial forum, either individually or through a class, is waivable. n42

 

Similarly, in Johnson v. West Suburban Bank, n43 the Third Circuit reversed a Delaware district court's order denying the defendant lender's motion to stay the proceedings and compel arbitration. n44 The court found that the plaintiffs had agreed to binding arbitration and there was no congressional intent to preclude the enforcement of arbitration clauses in either the TILA or  the Electronic Funds Transfer Act. n45 Finally, in Sydnor v. Conseco Financial Services Corp., n46 the Fourth Circuit reversed a lower court order refusing to compel arbitration provided for in mortgage loan documents. n47 The lower court had found that: (i) plaintiffs did not knowingly and voluntarily waive their right to a jury trial; (ii) the arbitration agreement was unconscionable because of unknown fees and costs; and (iii) the arbitration clause was unenforceable because the plaintiffs alleged fraud specific to the arbitration agreement. n48 The Fourth Circuit disagreed, finding that: (i) the arbitration clause clearly stated that the plaintiffs were waiving their right to a jury trial; (ii) the Randolph decision requires more proof than plaintiffs produced that  arbitration was prohibitively expensive; and (iii) the plaintiffs' fraud claims applied to the contract as a whole, hence, they were properly to be decided by the arbitrator. n49

 
Private Mortgage Insurance/Captive Reinsurance Arrangements

Between 1996 and 1999, HUD issued informal interpretive letters concerning the permissibility of various arrangements involving private mortgage insurance (PMI), specifically "lender paid mortgage insurance," n50 "captive reinsurance," n51 "performance notes," n52 and "agency pool mortgage insurance." n53 Many of these practices were challenged in a series of cases filed in the U.S. District Court for the Southern District of Georgia. In June 2001, three of those cases--Downey v. Mortgage Guaranty Insurance Co.; Pedraza v. United Guaranty Corp.; and Baynham v. PMI Mortgage Insurance Co.--were settled (somewhat surprisingly, after the defendants won an important preliminary victory in court). n54 The plaintiffs had alleged in these cases that the defendant PMI companies violated section 8 of RESPA by providing pool insurance and/or other benefits to lenders at below-market prices in return for referrals of PMI business, and sought treble damages. n55

Under the settlement, the companies denied liability but agreed to establish a fund of approximately $ 46 million to be divided up between the various classes and subclasses, with subclass members generally eligible to receive approximately thirty-five dollars each. n56 Additionally, the companies will make payments aggregating several hundred thousand dollars to various charitable organizations. n57 Finally, the companies agreed not to engage in a number of activities that the plaintiffs had challenged, including: (i) issuing notes in which the interest rate can be adjusted based on the performance of mortgage insurance on specified mortgage loans originated by certain lenders and insured by one of the companies; (ii) adding new loans under a transaction that provides for a lender to assume specified PMI claim payment risks in return for payment of a fee to such lender in connection with PMI issued by one of the companies; (iii) providing agency pool insurance, except as in accordance with guidelines set forth in the settlement agreement; (iv) entering into a contract of reinsurance with a reinsurer affiliated with certain lenders, except as in accordance with guidelines set forth in the settlement agreement; and (v) providing services incident to underwriting mortgage loans to certain lenders, unless such services conform to certain requirements set forth in the settlement
agreement. n58

Rescission

The right to rescind mortgage loans provided in the TILA n59 has long caused problems for residential mortgage lenders and loan purchasers. In a 2001 case decision, however, Dailey v. Leskin, n60 the borrowers' efforts to rescind in defense of a mortgage foreclosure failed. n61 The borrower attempted to rescind a mortgage loan after having entered into a contract to sell her home. The TILA provides that the right of rescission expires "three years after the date of consummation of the transaction or upon the sale of the property, whichever occurs first." n62 Liberally interpreting this language to take into account Congress' probable concern that allowing a post-sale rescission would "cloud property titles and inhibit transactions," n63 the Florida intermediate appellate court held that the borrowers' right to rescind expired at the time the borrower contracted to sell the secured property, and that any notice of rescission sent during the time the contract for sale of the secured property was pending was ineffectual. n64

 

TILA/Acutal Damages

Because statutory damages are available only for certain TILA violations, n65 plaintiffs sometimes find themselves having to try to pursue actual damages in TILA class actions. A February 2001 decision by the U.S. Court of Appeals for the Eleventh Circuit in Turner v. Beneficial Corp., n66 makes such efforts much more difficult.

The facts in Turner were that the borrower attempted to recover actual and statutory damages based on a Truth-in-Lending disclosure statement that allegedly failed to reveal the true cost of financing of a satellite dish system, but which the borrower admittedly never read. After establishing that the allegedly improper disclosure did not provide the borrower with a right under the TILA to statutory damages, the lender argued further that because the borrower did not read the disclosure, it could not have been the cause of any actual damage suffered by the borrower.

The full panel of judges of the Eleventh Circuit, reconsidering an earlier decision of a three-judge panel rejecting the lender's argument, affirmed the lower court's ruling that plaintiffs claiming TILA violations must prove "detrimental reliance" in order to recover actual damages, and found that class certification was therefore inappropriate in determining whether the individual plaintiffs were so damaged. n67 In reaching this conclusion, the Eleventh Circuit found significant that the legislative history of the TILA, although making clear that consumers could recover statutory damages without having to prove detrimental reliance, required a heightened showing of loss suffered because of reliance on inaccurate or incomplete disclosures to recover actual damages. n68

Unauthorized Practice of Law

Another claim being made by some plaintiffs' class action lawyers is that the practice of lenders charging for the preparation of loan documents constitutes an unauthorized practice of law. Such a claim recently succeeded in Dressel v. Ameribank. n69 The court found its definition of what constitutes "document preparation" in HUD's RESPA Special Information Booklet, n70 namely "a separate fee that some lenders or title companies charge to cover their costs of preparation of final legal papers, such as a mortgage, deed of trust, note or deed." n71 Neither the Booklet nor RESPA (or Regulation X), however, takes a position as to whether only lawyers may perform this service.

A similar case with a slightly different twist is O'Sullivan v. Countrywide Home Loans, Inc., n72 in which a Texas federal district court granted class certification of a complaint which alleged that the defendant lender engaged in the unauthorized practice of law and violated section 8 of RESPA in connection with an arrangement between the lender and its outside counsel. n73 Under the arrangement, the lender would pay compensation to its outside counsel for document preparation services, a portion of which it essentially recouped from the lawyer as payment for "facilities" provided by the lender to the lawyer for use in performing the document preparation services. n74

Usury

Another claim commonly being asserted by plaintiffs' lawyers is that the lender, in making a loan to the plaintiffs, violated the usury law of the state in which the plaintiffs resided. Over the past several years, many lenders have successfully defeated such claims by relying on the federal exportation doctrine, which allows the lender to charge and collect interest (including fees considered part of interest) as permitted by the law of the lender's home state.

Turning the tables on lenders' use of the exportation doctrine, the plaintiffs in Flannick v. First Union Home Equity Bank n75 filed a class action complaint against a national bank, First Union Home Equity Bank ("First Union"). The plaintiffs alleged that First Union violated North Carolina's usury law by charging interest on home loans to Pennsylvania residents secured by Pennsylvania properties between the date of settlement and the date the funds were ultimately disbursed to the borrower. n76 First Union is headquartered in North Carolina (which opted out of the Depository Institutions Deregulation and Monetary Control Act of 1980 [DIDMCA], n77 the federal law which preempts state usury limits on first-lien loans) and maintains no branch offices in Pennsylvania. It originated the loans to Pennsylvania residents through a loan production office located in Pennsylvania.

First Union moved for summary judgment, arguing that North Carolina's opt-out of the DIDMCA preemption only applied to loans made in North Carolina and that the plaintiffs' loans were made in Pennsylvania, where the borrowers resided.  (Pennsylvania did not opt out of DIDMCA.) Because First Union was only authorize  to do business in North Carolina and maintained no branch offices in Pennsylvania, however, the court concluded that the loan had to have been made in North Carolina and thus fell within North Carolina's DIDMCA opt-out. n78 The court also found that First Union did not "exist[]" in Pennsylvania under section 85 of the National Bank Act n79 and so was not entitled to "export" the law of Pennsylvania to North Carolina "simply by . . . [making] loans to Pennsylvania residents for the purchase of Pennsylvania property through its 'loan production offices.'" n80

Yield Spread Premiums

Probably the most significant claim made in class action lawsuits against residential mortgage lenders in recent years is that the lenders' practice of paying yield spread premiums (YSPs) to mortgage brokers in amounts derived from rate sheets constitutes the payment of illegal referral fees under RESPA section 8. Until June 2001, it appeared that lenders were well on their way to defeating these challenges, of which more than 150 were filed nationwide, n81 primarily by arguing that the nature of these cases was such as to be inappropriate for class treatment.

Then, on June 15, 2001, the U.S. Court of Appeals for the Eleventh Circuit issued its decision in Culpepper v. Irwin Mortgage Corp. (Culpepper III). n82 In Culpepper III, the Eleventh Circuit upheld class certification of a YSP case based on its interpretation of the first part of the two-part test established by HUD in its March 1, 1999 Broker Fee Policy Statement to determine the legality of YSP payments under RESPA (Policy Statement). n83 That interpretation was that a YSP is illegal if it can be demonstrated that the YSP, considered apart from any other compensation the broker might receive in the transaction, was not paid specifically in return for service. n84 Because the plaintiffs were then able to convince the court that such a result could follow from evidence--common to all class members--suggesting that whether a YSP is paid and how much of a YSP is paid depends entirely on whether the loan is above par and by how much, the court concluded that class treatment was appropriate. n85

All was not lost for lenders, however, as HUD subsequently issued a new Policy Statement correcting the Eleventh Circuit's misinterpretation of HUD's two-part test. n86 This clarification by HUD could prove to be the "silver bullet" that lenders have been looking for to shoot down plaintiffs' YSP class action claims.

 

Finally, a variation of the typical YSP allegation, recently raised in a Washington federal district court, may still present problems for lenders. In Bjustrom v. Trust One Mortgage Corp., n87 the plaintiff alleged that the defendant, Trust One Mortgage Corp., violated RESPA by charging origination fees on FHA mortgage loans in excess of one percent. n88 The plaintiff provided evidence in the form of regulations, directives, and other authority which supported the plaintiff's assertion that the total origination fees that a lender can charge and collect on an FHA loan may not exceed one percent of the principal amount of the loan. n89 In granting class certification, the district court acknowledged that most courts interpreting the HUD Policy Statement had concluded that claims of RESPA violations for paying YSPs were no longer susceptible to class-wide certification. n90 The court felt that this case was distinguishable because none of the plaintiffs in those cases challenged the YSPs on the grounds that they violated the FHA one percent limitation or argued that the charging of a YSP was unreasonable because the aggregate fees charged exceeded the one percent limitation. n91

Despite losing this battle, however, Trust One eventually won the war when, on October 26, 2001, it obtained summary judgment in its favor. n92 The district court found that, based on HUD's tacit acceptance of YSPs disclosed over many years on millions of HUD-1 Uniform Settlement Statements, the FHA one percent origination fee cap was not intended to include back-end compensation such as YSPs. n93 The court therefore dismissed the previously certified contract class as well as the RESPA sub-class, but implored HUD/FHA to issue an official statement on the issue (presumably a Mortgagee Letter) and suggested that the Court of Appeals immediately review its ruling. n94
 

Conclusion

Overall, and despite continuing challenges on the litigation front, the consumer lending and servicing industry seems to have prevailed on some fundamental issues, and has also established significant favorable precedent on a number of issues. But the cost has been (and continues to be) high, in terms of legal costs and compliance burdens. At some level these costs will be borne by society, to a degree by borrowers, and probably even more so by subprime borrowers. It is a legitimate policy issue to contemplate whether these sorts of lawsuits represent an optimal use of the resources of such borrowers.

Endnotes

n1 12 U.S.C. || 3801-3806 (2000); see generally Scott D. Samlin, AMTPA--The Federal Alternative Mortgage Transaction Parity Act (Parity or Parody?), 54

n2 239 F.3d 633 (4th Cir. 2001), cert. denied, 122 S. Ct. 58 (2001).

n3 See NHEMA v. Face, 64 F. Supp. 2d 584 (E.D. Va. 1999), aff'd, 239 F.3d 633 (4th Cir. 2001).

n4 Id. at 586.

n5 96 F. Supp. 2d 419 (D.N.J. 2000).

n6 See id. at 420.

n7 See Glukowski v. Equity One, Inc., No. GLO-L-872-01 (N.J. Super. Ct. Ch. Div. filed May 17, 2001) (on file with The Business Lawyer, University of Maryland School of Law).

n8 12 U.S.C. || 2601-2617 (2000).

n9 256 F.3d 623 (7th Cir. 2001).

n10 See id. at 630.

n11 Id. at 628-29.

n12 See id. at 626-27.

n13 See id. at 626.

n14 196 F.R.D. 496 (N.D. Ill. 2000).