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News & trends
May 2008 | Volume 44, Issue 5
Predatory-lending litigation looms
Allison Torres Burtka, Associate Editor
Amid the subprime mortgage crisis, many people across the country—with
both good and bad credit—have found themselves stuck with loans
that are not what they anticipated. Mortgage lenders and related
institutions are under intensifying scrutiny for a wide range of illegal
conduct, including misrepresenting loan terms, adding bogus
fees, inflating appraisals, committing securities fraud, and discriminating
against borrowers based on their race and gender. Lawsuits allege
violations of the Truth in Lending Act (TILA), the Fair Housing Act,
the RICO statute, and state consumer protection laws, to name a few.
Last year, 278 subprime-mortgage-related cases were filed in federal
court—with the number in the second half of the year nearly
twice the number in the first half—and that figure is likely
to continue growing, according to a report by Navigant Consulting.
Forty-three percent of those cases were borrower class actions, most
involving inadequate disclosure regarding option adjustable-rate mortgages
(ARMs) and discriminatory lending practices.
The option ARM has proved especially problematic. “It’s
a subprime product being marketed to everybody,” said Jeffrey
Berns, a Tarzana, California, lawyer, whose firm has filed 60 federal
class actions against major lenders over option ARMs. He noted that
these clients range “from doctors and lawyers to field workers.”
Option ARMs have adjustable interest rates and different monthly
payment options. For example, the monthly payment may be fixed for
the first few years, but the interest rate goes up beginning in the
second month. At that point, the interest being charged exceeds the
payment amount, so the difference is added to the principal owed—a
process called negative amortization. Many borrowers then owe more
than they thought they would.
“A significant number of people had better loans before getting
talked into these option ARMs,” Berns said. The loan documents
often say that the low initial rate may increase, but some documents
contain “statements that are outright lies,” he said.
Paul Kiesel, a Beverly Hills, California, lawyer, also represents
borrowers suing over option ARMs. His firm has filed 56 class actions,
most of which revolve around TILA violations, all on behalf of borrowers
who stand to lose their primary residences. He estimated that half
had loans with low interest rates before signing up for the option
ARMs. “They were eligible for far better mortgages than they
got,” he said.
If the terms are not adequately disclosed, a mortgage is rescindable,
but the general public may not be aware of that, Kiesel said. He and
his colleagues have built a consortium of firms to work together—which
is necessary because “we have taken on the largest lenders in
the United States, and they have unlimited resources,” he said.
“We are facing such an imminent threat” of people being
forced out of their homes that lawyers have a responsibility to take
on this type of litigation.
“It’s too early to get a sense of the direction”
the litigation will take, Kiesel said. He noted that some cases are
proceeding individually, but on a limited basis, “and those
cases are tough.”
Berns said that lawyers bringing class actions are now dealing with
motions to dismiss, as defendants argue for federal preemption of
state law (some cases allege fraud and breach of contract under state
law). Plaintiffs in these cases are likely to move for class certification
this summer, he said.
The Seventh Circuit is set to decide whether to certify a class in
a case brought by a couple who sued their lender for inadequately
disclosing the terms of their option ARM. (Andrews v. Chevy Chase
Bank, No. 07-1326 (7th Cir. argued Sept. 26, 2007).)
“This is the first case in which a circuit court has considered
an option ARM,” said Milwaukee lawyer Kevin Demet, who—along
with his brother Donal Demet—represents the plaintiffs.
A federal district court found in the plaintiffs’ favor and
certified the lawsuit as a class action, and Chevy Chase Bank appealed.
Bryan and Susan Andrews previously had a stable loan but were lured
into refinancing by “essentially fake low payments,” said
Donal. Borrowers often don’t realize that the loan goes into
negative amortization in its second month, he said.
“The problem is coming to a head now” because many of
these loans are reaching the point where the payment is recalculated
after a low, fixed rate for the first few years, Donal explained.
“Now is when they’re hitting the crisis stage.”
He added that Chevy Chase indicated it had about 8,000 of these loans
with the same type of disclosure.
“This case is significant because the mortgage banking industry
attempted to get Congress to ban class actions for rescission of mortgages
in 1995,” Kevin explained. “Congress gave the industry
greater tolerance for errors in TILA disclosures, but Congress declined
to enact the ban. Nevertheless, the industry has been filing briefs
in court suggesting that Congress adopted the ban.”
Class actions would better enable borrowers who have been misled
to get meaningful relief, plaintiff lawyers say.
Discriminatory practices
Some areas of the country have seen companies prey specifically on
borrowers who do not qualify for prime loans, lawyers say. Lawsuits
have accused lenders and brokers of targeting groups that they perceive
to be financially unsophisticated, such as low-income and minority
borrowers.
The problem is acute in Cleveland, where foreclosure rates are among
the highest in the country. Cleveland lawyer Edward Kramer and his
firm have more than 25 cases pending over predatory-lending practices,
most arising from foreclosure actions.
The traditional mortgage system “wasn’t working for the
poor or minority communities,” Kramer said, and that left the
door open for mortgage brokers to target vulnerable people. In some
cases, brokers looked for property owners cited for building code
violations (to identify people ordered to repair their homes or face
prosecution) and bought lists of people with delinquent hospital bills.
“Both groups needed quick money, so they could be tricked to
enter these predatory loan agreements,” he said.
“Many clients are unsophisticated—that’s part of
the problem,” Kramer said. “Mortgage brokers fill out
the applications 95 percent of the time.” He added that in some
cases, brokers actually gave borrowers money to make their financial
situation appear better than it was.
“We’re looking at a real fraud” that’s built
into the companies’ business models, Kramer said, “from
Wall Street down to the street soldiers, who are the mortgage brokers.”
He added that “on an individual basis, these cases have been
very successful.”
One case alleged that a lender and its agents engaged in predatory
and discriminatory practices by targeting women in the Cleveland
area.
“Defendants extract unconscionable and illegal fees from their
victims until there is no money left to extract; they then leave their
victims’ homes vulnerable to foreclosures, which the loans were
specifically designed to facilitate,” the complaint says. (Eva
v. Midwest Natl. Mortg. Banc, Inc., No. 1:00CV1918 (N.D. Ohio
filed July 27, 2000).)
The plaintiffs alleged that the defendants failed to explain the
loans’ basic terms, made little or no effort to verify the applicants’
ability to repay their loans, falsified applications, and conspired
to give kickbacks to other corporations—violating RICO, the
Fair Housing Act, Ohio antidiscrimination law, the Equal Credit Opportunity
Act, and TILA. The parties settled the case, and seven out of eight
homes were saved.
More recently, the Cleveland-based public-interest law firm Housing
Advocates, Inc., which Kramer directs, filed a complaint with the
Ohio Civil Rights Commission against Argent Mortgage Co. for racial
discrimination, claiming that the company offered loans that were
likely to result in foreclosure in mostly African-American neighborhoods.
The commission investigated and found that the evidence substantiated
the alleged discrimination claim. (Housing Advocates, Inc. v.
Argent Mortgage Co., (CLE)H4(38066)05212007, 05-07-0938-8 (Ohio
Civ. Rights Commn. Mar. 13, 2008).) A hearing is to follow.
Beyond borrowers
Municipalities themselves have sued lenders and related companies,
saying they have lost money protecting or demolishing foreclosed homes
and through lost tax revenue. Baltimore has sued Wells Fargo Bank
for predatory lending in black neighborhoods. Cleveland has sued 21
Wall Street banks under state public-nuisance law for funding the
lenders who engaged in predatory lending.
The complexity of mortgage securitization—determining which
company is doing what—makes things difficult for plaintiffs,
Kramer said, because “no one’s taking personal responsibility.”
A former regional vice president of Countrywide Financial Corp.,
the nation’s largest lender, has sued the company for firing
him after he pointed out its fraudulent practices. (Zachary v.
Countrywide Fin. Corp., No. 4:2008cv00214 (S.D. Tex. filed Jan.
17, 2008).)
Mark Zachary discovered that appraisers were being encouraged to
inflate homes’ values; loan officers were helping borrowers
submit applications with false information; and Countrywide was requiring
10 percent of its backlogged applications to be approved so that a
builder could start building homes under contract, even though the
applicants were not qualified. These were systemic company practices,
said Philip Hilder, a Houston lawyer who represents Zachary.
“Mark signaled the alarm that these practices shouldn’t
go on,” he said. The company fired him two weeks later.
Zachary sued for wrongful discharge and filed a whistleblower retaliation
complaint with the U.S. Department of Labor. His case serves as “a
snapshot of what is happening in the industry,” Hilder
said. “It exposes the root cause of what has led to the subprime
debacle.”
Countrywide’s practices have raised concern elsewhere. The
U.S. trustee for Florida has filed suit in bankruptcy court against
the company for “bad-faith conduct that abused the judicial
process.” The case seeks sanctions and injunctive relief. (Walton
v. Countrywide Home Loans, Inc., No. 08-6092 (Bankr. N.D. Ga.
filed Feb. 28, 2008).)
The complaint cites bankruptcy courts in North Carolina, Pennsylvania,
and Texas that have sanctioned Countrywide or its representatives
for their conduct. U.S. trustees in Ohio and Florida have filed similar
complaints. The Florida attorney general is investigating the company’s
business practices.
The Justice Department and the FBI are investigating Countrywide
for securities fraud, and both agencies are taking a closer look at
the rest of the mortgage industry as well. The Justice Department
is gathering evidence to decide whether to create a special task force
to investigate possible wrongdoing, and the FBI is investigating 17
firms for fraud.
Lenders also face lawsuits from shareholders, employees (alleging
that they were denied overtime pay or terminated without the requisite
advance notice, for example), and homeowners who say they have been
hurt by inflated home appraisals in their neighborhoods.
Kramer pointed to greed as the reason the subprime problem has grown
to its current proportions. Lenders have cut corners, and commercial
banks have agreed not to require verification of income, he said.
Berns said his office has taken more than 14,000 calls from homeowners.
“Not a day goes by that we don’t get a call from someone
losing their house,” he said.
“It’s not an easy situation,” Kramer said, but
“if we could get lawyers to take a case or two, we could have
a tremendous impact in the community.”
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