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Jun 23, 2005

Lenders' litigation blues Robert M. Jaworski, Esq.compliance, lenders, brokers, litigation, fair practices Like the duty sergeant on the old television series Hill Street Blues, compliance counsel should be constantly reminding their mortgage lending clients to "be careful out there." Why? Because mortgage lenders and brokers of both conventional and sub-prime loans are increasingly becoming the targets of litigious attacks by borrowers, various consumer groups, and the plaintiffs' class action bar. Here is a summary of the types of attacks being mounted and some recent decisions. AMTPA/preemption Many lenders rely on the federal Alternative Mortgage Transactions Parity Act of 1982 (AMTPA) and implementing regulations of the Office of Thrift Supervision (OTS) as authority to charge prepayment fees upon early payment of adjustable-rate and/or balloon mortgage loans. This reliance has recently been deemed by two Federal district courts to be justified. First, in NHEMA v. Face, a trade group representing sub-prime lenders successfully challenged the Virginia banking regulator's declaration that the Virginia law limiting prepayment fees was not preempted by AMTPA. Second, in Shinn v. Encore Mortgage Services, a New Jersey Court dismissed a challenge to a creditor's assessment of a prepayment fee upon payoff of an adjustable-rate loan on the grounds that the New Jersey prohibition against prepayment fees was preempted by AMTPA. Both decisions are now on appeal. Arbitration The increasing use of mandatory arbitration clauses in consumer loan contracts has led to a proliferation of challenges to their enforceability. While lenders have been mostly successful in defeating these challenges, in Randolph v. Green Tree Financial Corporation, the Eleventh Circuit Court of Appeals refused to enforce an arbitration clause in a retail installment contract to finance the purchase of a mobile home, which was silent about filing fees and the applicable arbitration rules. The Court reasoned that to compel arbitration under such circumstances would defeat the remedial purposes of the Truth-In-Lending Act (TILA). The U.S. Supreme Court has agreed to provide the final word on this issue. Attorneys' fees In Turner v. First Union National Bank, the Supreme Court of New Jersey affirmed an appellate Court decision upholding a lender's right to charge first-lien residential borrowers for the cost of lender's counsel to review title and loan documents "prepared by or submitted by or at the direction of the borrower's attorney." This right, the Court held, applied regardless that the borrower was not represented at loan closing and that submission of the documents created no "extra work" for the lender. The Court also ruled that the New Jersey law prescribing the circumstances under which a lender could charge the borrower a fee for lender's counsel was preempted by OTS regulations. Flipping "Flipping" refers to the practice of some lenders repeatedly refinancing a customer's loan over a relatively short period of time, typically so that the customer can receive a small amount of "cash out" at the closing of each transaction. In one of the few reported cases dealing with this issue, the Court in Gonzalez v. Associates Financial Service Company held as a matter of law that origination fees, which were charged on both a second and a third refinancing closed within 15 months of the original loan and which were based on the entire amount refinanced, were neither fraudulent nor unconscionable. However, lenders should note that there was a strong dissent. Forced-placed insurance Most security instruments require the borrower to maintain insurance protecting the secured property and, in the event that the borrower allows the insurance to lapse, authorize the lender to purchase collateral protection insurance (CPI) and charge the borrower for the cost of such insurance. Typically, this cost is significantly higher than the amount borrowers would pay for their own insurance, and often, lenders earn commissions on the CPI they purchase. Such facts have created a fertile ground for lawsuits. An example of how dangerous these lawsuits can be is provided in Hall v. Midland Group, in which the Court approved of a proposed class action settlement on behalf of all mortgagors for whom Midland Bank forced-placed hazard insurance through insurance agencies owned by affiliates over the past 20 years. HOEPA In Williams v. Gelt Financial Corporation, the plaintiff obtained a first-lien balloon mortgage loan from the defendant-lender to pay off some prior debts, and then attempted to rescind by telephone two days later. Nevertheless, disbursements were made, apparently with the plaintiff's acquiescence. Three months later, the plaintiff lost his job and contacted the lender, whereupon the lender agreed to refinance the loan at a lower interest rate. Four months later, the plaintiff rescinded the second loan, claiming that he was never provided with copies of the loan documents. The first loan was covered by and found by the Court to be in violation of the Home Ownership and Equity Protection Act (HOEPA) because: (1) no HOEPA pre-closing "cooling off" notice was given to the borrower; (2) the Note contained a HOEPA-prohibited prepayment penalty provision; and (3) the TILA disclosure statement referenced only a security interest in "real property" despite the fact that a security interest was also taken in fixtures and rents. Specifically regarding the prepayment penalty provision, the judge found that the HOEPA prohibition trumps the authorization provided in OTS regulations implementing AMTPA. As to the second loan, the judge accepted the borrower's uncorroborated denial of receipt of the loan documents despite the borrower's signed acknowledgment of such receipt and the testimony of the settlement clerk that "it is her 'habit' to make sure that copies of documents are given at loan closings." Rescission was therefore permitted, with the lender becoming an unsecured creditor and responsible to pay statutory damages. Rescission Clay v. Johnson concerned three home improvement loans executed shortly after one another that were rescinded by the borrower more than two years later. The lender took no action to effect the rescission. The Court held that the borrower was not time-barred to recover statutory damages$2,000 per loanfor the lender's refusal to recognize the borrower's rescission rights and reasonable attorney fees, although the lender was permitted to recover the reasonable value of the home improvements financed by the proceeds of these loans. Suitability A dangerous line of cases suggests that lenders are responsible for ensuring that their borrowers are capable of repaying their loans. A good example is Williams v. First Government Mortgage and Investors Corporation, which involved a situation in which the plaintiff-homeowner, being unable to obtain a $1,400 loan to pay delinquent taxes, agreed to refinance his entire mortgage with the defendant-lender. The plaintiff ended up having to pay $100 per month more than before, leaving little more than $500 per month to buy necessities for himself and his dependants11 children and 23 grandchildren. The loan went into foreclosure, and the homeowner sued to rescind the loan and recover damages under the Washington, D.C. Consumer Protection Procedures Act (CPPA), alleging that the lender violated the CPPA by knowingly making a loan the borrower could not repay with any reasonable probability. The result was an $8,400 jury verdict, trebled under the CPPA to $25,200, and an award of $199,340 in attorneys fees. The lender appealed, alleging that the CPPA did not apply to this loan, which was made in Maryland by a Maryland lender, and that TILA preempted the CPPA. The Court rejected both claims. Usury In Cohen v. Eisenberg, the plaintiff committed to make a $120,000 "hard money" mortgage loan to the defendants at a 19.5 percent interest rate. The loan closed in the name of "American Universal Mortgage Banking, Inc." (American), and was immediately assigned to the plaintiff. The defendants defaulted and the plaintiff foreclosed, at which point the defendants raised the affirmative defense of usury. However, the trial Court dismissed the defendants' affirmative defense on the grounds that American was a "qualified creditor" under the Depository Institutions Deregulation and Monetary Control Act of 1980, which allowed it to charge interest at rates in excess of the state's usury limitation. However, the appeals Court reinstated the defendants' special defense, finding that American's participation in the loan was merely to enable the plaintiff to evade New York's usury law. Yield spread premiums With respect to the yield spread premium controversy, there is both good news and bad news for lenders. The bad news is Glover v. Standard Federal Bank, where class certification was granted based on the judge's finding that: (1) HUD did not intend by its March 1, 1999 Policy Statement to articulate the less stringent test adopted by other courts in the Minnesota district (and elsewhere); and (2) even if it did, such a test was arbitrary or capricious and, thus, could not stand. Similar bad news was provided in Heimmermann v. First Union Mortgage Corporation. The good news is that class certification was denied in several cases, including Lee v. NF Investments, Inc., Potchin v. The Prudential Home Mortgage Company, Inc., Golan v. Ohio Savings Bank, and Yasgur v. Aegis Mortgage Corporation. Additionally, following the denial of class certification in Yasgur, the district Court granted summary judgment in favor of the defendant-lender, applying the HUD test. Conclusion These cases illustrate the importance of knowledgeable compliance counsel in an increasingly litigious environment. They also teach that lenders and brokers should never underestimate the creativity and persistence of borrowers' counsel, and must go beyond mere compliance to develop and employ prudent and fair practices which consider and, to some degree at least, protect the interests of both parties to the transaction. Even then, some litigation may be unavoidable as even satisfied customers may take offense at demands to repay their loans. Robert M. Jaworski, Esq. is a partner with Reed Smith Shaw & McClay in Princeton, New Jersey and a former Deputy Commissioner of the New Jersey Department of Banking. He is also Chairman of the Consumer Finance Committee of the State Bar Association's Banking Law Section and a member of the Bank Lawyers Council of The New Jersey Bankers Association. He may be reached at (609) 520-6003 or E-mail [email protected].
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