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.
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.
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
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" 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
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.
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.
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
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.
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.
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]