THE“MORTGAGECRISIS”:HOWCURRENTCREDITWOESAFFECTYOUANDYOURCLIENTSLitigation and Dispute Resolution: New Cases, New CausesJimD.CooleyMeredithJ.McKeeWombleCarlyleSandridge&Rice,PLLCCharlotte,NC1TheCurrentLitigationEnvironmentqNewlegislationFederalandstateqIncreasedenforcementactivityFederalandstateCivilandcriminalpenaltiesqIncreasedlitigationBystatesAttorneysGeneralandregulatorsBylocalgovernmentsByprivateplaintiffs2NewLegislationqFederalHousing and Economic Recovery Act of 2008(signed7/30/08)Allows FHA to guarantee new loans for subprimeborrowersiflendersreducebalanceto90%ofhomevalueIncreasesconformingloanlimitsinhigh-costareasFirst-timebuyertaxcreditProvided basis for oversight and now takeover ofGovernmentSponsoredEnterprises(FannieMae,FreddieMac)HOEPAAmendments(generallyeffective10/1/09)Prohibits“unfair,abusiveordeceptive”lendingpracticesNew “higher-priced mortgage loan” regulations, includingconsiderationof“abilitytopay”Restrictionsonadvertising3456NewLegislation(cont.)qStateMortgageDebtCollectionandServicingAct(eff.4/1/08)FirsttimethatmortgageservicingsubjecttoNCregulationsUniquelanguagerequiresNC-specificproceduresNewpitfalls,shortfusesandpotentialforliabilityAmendedagainintheshortsessionof2008(H.B.2188)(eff.10/1/08)tobanyieldspreadpremiums(YSP)onall“ratespreadhomeloan”transactionsN.C.firststatetodoso.AmendmentstoN.C.MortgageLendingAct(H.B.2463)(eff.1/1/09)Comprehensiveregulationof“mortgageservicers”(definedtoinclude“receivinganyscheduledperiodicpaymentsfromaborrower,”includingescrowamounts)Servicersrequiredto:(i)belicensed;(ii)actwith“skill,careanddiligence”;and(iii)filefeescheduleswithCommissionerofBanksExpandslistof“prohibitedactivities”Requires 45-day pre-foreclosure notice to borrowers and gives Office ofCommissionerofBanks(“OCOB”)additionalpowerstosuspendforeclosurefor60daysForeclosure moratoria enacted in North Carolina and New York, and beingconsideredinmanyotherstatesThe new North Carolina servicing law imposes delays and additional procedures(e.g., in addition to the 45-day pre-foreclosure notice and OCOBs authority tosuspend foreclosure proceedings at any point in the process by 60 days, (notedabove),theEmergencyProgramtoReduceHomeForeclosuresAct(H.B.2623)(eff.11/1/08to10/31/10)givesOCOBauthoritytoextendtheforeclosurefilingdateupto30daysbeyondthedateestablishedinthepre-foreclosurenotice).Compare mandatory foreclosure mediation by judicial rule (Philadelphia Court ofCommonPleas;effectiveApril2008)7891011IncreasedEnforcementActivityqFederalcivilSECinvestigationsintopublicly-tradedcompanies(e.g.,9/3/08civilcomplaintagainsttwoCreditSuissebrokersseebelow)OTSAIGBank,F.S.B.FDICe.g.,investigationsofFremontandCountrywidehavebeenannouncedFTCpreparingsettlementswithloanservicersqFederalcriminalFederal-statetaskforcesformedinseveralcities(NewYork,Philadelphia,Atlanta,Dallas,LosAngeles)Firstindictments(securitiesfraud,wirefraud,conspiracy)unsealedinE.D.N.Y. on 9/3/08 against two former Credit Suisse brokers forallegedlydeceivingcustomersinthesaleofover$1billioninauction-rate securities by representing that the collateral of the loans wasfederallyguaranteedstudentloanswhentheywereactuallybacked,inpart,bysubprimemortgagesandCDOs.12IncreasedEnforcementActivity(cont.)qStateOfficeofCommissionerofBanksConductsroutineexaminationofmortgagelenders.N.C.G.S.Section53-243.12(i)BringsdisciplinaryproceedingsundertheAdministrativeProcedureAct.N.C.G.S.Section53-243.12(withAttorneyGeneralsoffice)May require restitution to borrowers for violations of Chapter 24. N.C.G.S.Section53-243.12(j)JurisdictionofOCOBlimitedbyFederalpreemptiontostate-charteredinstitutionsSeethisyearsU.S.SupremeCourtdecisionin Watters v. WachoviaLook for battles over state power to regulate mortgage subsidiariesofnationalbanks13IncreasedLitigation:The“RadiatingRipplesofSub-PrimeLitigation”qClaimsagainstmortgageoriginatorsbyoronbehalfofborrowers“BottomUp”qClaimsarisingfromthesecuritizationprocessbyinvestors,byandagainsttrusts/underwritersandagainstoriginators,includinginsurers,astowhichgroupshouldbeartheultimateriskofdefaults“TopDown”qClaims involving collateral debt obligations (CDOs) against placementagents, portfolio managers, financial advisors, officers and directors ofCDOs, rating agencies, insurers, accountants and perhaps lawyers“BuyersBurnt”qShareholderandderivativeclaimsonbehalfofclassesofshareholdersofinvestmentbanks,mortgagecompanies,homebuilders,etc.More“BuyersBurnt”See Jayant W. Tambe, “The Radiating Ripples of Sub-Prime Litigation” in Those LowdownSubprimeandCreditCrunchBluesandWhatEveryBusinessLitigatorNeedstoKnowAboutThem(ABA,SectionofBusinessLaw,Aug.9,2008).14TheVarietyof“BottomUp”ClaimsqActionsbystatesagainstoriginatorsonbehalfofborrowers(parens patriae)alleging:DeceptiveadvertisingThatthefundamentalbusinessmodelofsomeoriginatorspromotesunfairanddeceptivepracticesqActionsbylocalgovernmentsagainst:AsinglelenderforreverseredliningCityofBaltimore“WallStreet”forcreatingapublicnuisanceCityofClevelandLenders which have already foreclosed, seeking demolition costs forabandonedhomesCityofBuffaloLenderswhoaretryingtoforeclose,seekinginjunctionstohalttheprocessCityofSanDiegoqActionsbyprivateplaintiffs:TohaltforeclosureprocessForbreachof“fiduciary”dutyFordiscriminatorypracticesTo enforce “suitability” standards contained in new HOEPA rule and NorthCarolinalaw15Bottom-UpClaimsbyStatesqActions by State Attorneys General against the largest(formerly)independentmortgageoriginator,CountrywideHomeLoansandsubsidiariesCalifornia,Illinois,Florida,Connecticut,WestVirginia,IndianaNationalAssociationofAttorneysGeneralanditsStandingCommitteeonConsumerProtectionprovideforumfordiscussionandcoordinationLook for greater coordination among state bank/mortgage companyregulators, especially as part of parallel proceedings involving theAttorneysGeneralqClaims by State Attorneys General framed primarilyaround “Little FTC”/unfair and deceptive trade practicestatutes16TheCaliforniaApproach:AttackingtheBusinessModelqClaims focus on the fundamental structure of the subprime,securitization business model as promoting unfair and deceptivetradepractices(UDTP).qUseofconspiracyclaimsjoinedwithUDTPclaims.qKeyAllegations:Easingofunderwritingstandardsandincreasinguseof“exceptions”tounderwriting.Useoflow-orno-documentationloans.Encouraging “risk-layering” by financing up to 100% of home valuethroughuseof“piggybacks.”Usingpiggybackswithoutattentiontothetotalmonthlypaymentandunderwritingonbasisof“interest-only”payments.Otherallegationsrelatetodeceptiveadvertisingandthecreationofa“highpressure”salesenvironment.17181920ReliefRequestedqCivilPenalties($2,500-$10,000perviolation)qPreliminaryandpermanentinjunctionsagainstcontinuationofthepractices (but cf. more specific foreclosure injunctions under theMassachusettsapproach)qRestitutiontoborrowers“anymoneyorproperty,realorpersonal,whichmayhavebeenacquiredbymeansofunfaircompetition”-California Amended Complaint“.whosehomeswerelostduetoforeclosure.”-Illinois Complaint“notify every consumer . . . of the availability of restitution - Connecticut ComplaintqReformationorrecession“.rescinding,reformingormodifyingallmortgageloans.affectedbytheuseofthe.unlawfulactsandpractices”- Illinois Complaint - Connecticut Complaint21TheMassachusettsApproach:Halting(orSlowingDown)ForeclosuresqOn May 2, 2008, the Massachusetts Court of Appeals upheld apreliminaryinjunctionagainstCalifornia-basedFremontInvestment&Loananditsparentwhich:Restricts foreclosure against owner-occupied properties where themortgage loan is “presumptively unfair” under the states PredatoryHomeLoanPracticesAct.ProvidesadvancenoticetotheAttorneyGeneralbeforeitforeclosesonanyMassachusettsloanoriginatedandservicedbyFremont.Extends to any subsequent assignee of any Fremont residentialmortgageloan.OnappealtoMASupremeCourt.qOn June 3, 2008, the Massachusetts Attorney General obtained similar injunction against H&R Block, Option One Mortgage andAmerican Home Mortgage. The complaint adds claims of racediscriminationundertheFairHousingAct.2223Massachusetts v. Fremont Investment & LoanInjunction Decision Matrix for ForeclosureAGobjectswithin45daysAGdoesnotobjectwithin45AGobjectswithin30daysAGdoesnotobjectwithin30daysIsthemortgageloanowneroccupied?Isthemortgageloan“presumptivelyunfair”?(1)ARMteaserperiodof3yearsorless;(2)“Teaser”rate3%ormorebelowfullyindexedrate;(3)BorrowerDTIratioexceeds50%ifmeasuredatfullyindexedrate;and(4)LTVis100%,orprepaymentpenaltyissubstantialorextendsbeyondteaserperiod.FremontprovidesAGwith45dayswrittennoticebeforeforeclosure,identifyingwhyforeclosureisreasonableFremontandAGhave15daystoresolvedifferencesFremontmustobtaincourtorderCourtconsiderswhether(i)loanisactually“unfair”(i)reasonablestepshavebeentakento“workout”andavoidforeclosureand(iii)anyfairorreasonablealternativetoforeclosureexistsFremontprohibitedfrompursuingloanforeclosureFremontprovidesAG30dayswrittennoticeFremontmayproceedwithloanforeclosureNotGrantedGrantedNotresolvedResolvedYesNoNoYes(CourtesyofGreenbergTraurig,“Subprime&MortgageMarketsAlert,”May,2008)Is the mortgage loan “presumptively unfair”?(1) ARM teaser period of 3 years or less;(2) “Teaser” rate 3% or more below fully indexed rate;(3) Borrower DTI ratio exceeds 50% ifmeasured at fully indexed rate; and(4) LTV is 100%, or prepayment penalty issubstantial or extends beyond teaser period24TheMassachusettsApproach(cont.)qTheCityAttorneyofSanDiegohasrecentlytakentheMassachusettsapproach,seekingtoenjoinforeclosureactions (presumably limited to San Diego County) inPeople of the State of California v. CountrywideFinancialCorporation;BankofAmerica,etal.(July23,2008).qCf.Massachusettsv.Doherty:Statesuedwould-be“flipper”whodefaultedonmultipleloansallegedlyobtainedbysubmittingfalseinformation,therebydamagingnearbypropertyowners.25ActionsbyStateAttorneysGeneraland/orRegulators:WhatsNext?qSimilar actions against other lenders and by other AttorneysGeneralusingCaliforniaorMassachusettsmodel,orbothqEmergenceofaidingandabettingtheoriesinordertotrytodrawinaffiliatedpartiesupthechainqStepped-upenforcementagainstoriginatorsandservicersbystateregulatorsqPerhaps a coordinated effort at a global settlement betweenAttorneysGeneralandwhatisleftofsubprimeindustry(shadesofsettlementwithtobaccoindustry)26Bottom-UpClaims:ActionsbyLocalGovernmentsqSubprime mortgages as a public nuisance: City of Cleveland v.DeutscheBankTrustCompany,etal.CityclaimsthatWallStreetsecuritizersareprimarilyresponsibleforacycleofloanstounqualifiedbuyers,whichledtodefaults,whichledtoforeclosures,whichledtoabandonedhomes,depletionoftaxbase,andincreasedfireandpoliceprotection,therebycreatingapublicnuisance.qFailuretoupkeep:CityofBuffalov.ABNAMROMortgageGroup,Inc.Cityclaimsthatmortgageholderswhoforeclosedandthenwalkedawayfrom57foreclosedpropertiesshouldberequiredtoreimburseitfordemolitioncostsrangingfrom$16,000to$40,000each.27Bottom-UpClaims:ActionsbyLocalGovernments(cont.)qReverseredlining:Baltimorev.WellsFargoBankCity claims thatWells Fargo,thelargestmortgagelender in theCity, violated Fair Housing Act by targeting African-Americancommunitiesforsub-primeandotherpredatorylendingproducts.The“disparateimpact”ofthesepracticesareallegedlymanifestedby much higher foreclosure rates in the African-Americanneighborhoodsthaninwhiteneighborhoods.See Gotlieb and McGuinness, “When Bad Things Happen to Good Cities Are Lenders toBlame?”BusinessLawToday(July/August2008)13-17.28Bottom-UpClaims:PrivatePlaintiffsqTraditional disclosure-type claims (individual and class actions),whichattacktheoriginatorsdocumentationoftheloan,abound.TILA,HOEPA,RESPA,FACTA,ECOASomeaccompaniedbystate-lawadd-ons,suchas:UsuryMisrepresentation/fraudBreachofthedutyofgoodfaith/fairdealingUDTPqNewtheories(ornewvariationsonoldtheories)include:“Whoholdsthenote?”foreclosuredefense/offense“Specialrelationship”claimsDisparateimpactonminorityapplicantsthroughHMDAdata“Suitability” standard for high-cost loans (new North Carolina law,HOEPAregs.)29Bottom-UpClaims:“WhoHoldstheNote?”qInreForeclosureCases,CivilActionNo.07-CV-2282(N.D.Ohio):Federal judge dismissed foreclosures in scathing opinion afterDeutsche Bank was unable to prove it held the notes at the timeforeclosureswerefiled.Case reveals difficulties of presenting MERS (Mortgage ElectronicRegistrationSystem)andthetechnologyofthe“modern”mortgagemarkettoacourt.qWhittikerv. DeutscheBankNationalTrustCompany,(N.D.Ohio,filedFebruary7,2008):Follow-onclassactionagainstDeutscheBankforFDCPAviolationsandRICOviolationsarisingoutofInreForeclosure Cases. Action seeks appointment of a receiver forforeclosedproperties.30Bottom-UpClaims:SpecialRelationshipClaimsqTomlinv.DylanMortgageInc., 2000NCBusinessCourt9:JudgeTennilledeclinedtodismissbreachoffiduciarydutyclaimagainstbroker,wherebrokerhadenteredintoexclusive3monthbrokerageagreementswitheachborrower.Cf.Hintonv.West(N.C.SupremeCourt1935):Mortgagorandmortgageeasa“relationofconfidence.”qRosev.SLMFinancialCorp.,CivilActionNo.3:05-CV-445(W.D.N.C.):UDTP,breachofcontractandbreachofgoodfaithandfairdealingclaimsagainstbrokerPlaintiffattemptstobroadenTomlintocreateafiduciarydutyarisingfromanon-exclusivebrokeragreement.qSmith v. GMAC Mortgage Corp., Civil Action No. 5:06-CV-125 (W.D.N.C.): UDTP, breach of fiduciary duty,breachofcontractandnegligenceclaims.U.S.DistrictCourtJudgeVorheesdenieddefendantsRule12(b)(6)motion,findingthatplaintiffhadsufficientlypledaclaimforbreachofafiduciaryduty“surroundingthemortgagor-mortgageerelationship” which may give rise to an extra-contractual duty to make timely payments fromescrowtoplaintiffshomeownersinsurancecarrier.qFiduciarydutybyconduct?Iannuzziv.WashingtonMutual(E.D.N.Y.August21,2008),asreportedonLaw.comDespite NY authority that the mortgage broker generally does not owe a fiduciary duty to acustomer,theU.S.DistrictCourtdenieddefendantsmotiontodismiss,findingthat“abrokermaytakeonafiduciarydutybyperformingtasksandobligationsbeyondthatofanindependentbrokeror traditional middleman,” and that plaintiff had alleged sufficient facts based on a “closerelationship”betweendefendantbrokerandtheplaintiffsfinancialadvisor.313233Bottom-UpClaims:DisparateImpactonMinorityBorrowersqMiller v. Countrywide Bank, et al. (D.Mass.): Putativeclassactionalleging:Pricing policy contains discretionary component to credit-based pricingpolicywhichallowsincreaseinfinancingchargesandinterestmark-ups.Whilerace-neutralonitsface,pricingpolicyresultedindiscriminatoryimpacton African-American applicants, based on data compiled pursuant to theHomeMortgageDisclosureAct(“HMDA”).(MotiontoDismissdenied7/30/08)qLewisv.AlphaMortgageandAmericanHomeMortgageServicing,Inc. (Baytown,Texas):ReverseredliningclaimsbyAfrican-AmericanhomeownerbroughtunderHOEPAandtheTexasConstitution,asreportedatLaw.comon9/5/08.34Bottom-UpClaims:TheEmerging“Suitability”StandardqArticulatedinrecentstateandfederallawsas“abilitytorepay”qNorthCarolinausurylaw,Chapter24,nowregulateshighercosthome loans, defined as “rate spread home loans,” at N.C.G.S.24-1.1F(eff.1/1/08)Lendermaynotmakea“ratespreadhomeloan”unlessit“reasonablyandingoodfaithbelieves.borrower.hastheabilitytorepaytheloan.N.C.G.S.24-1.1F(c)DetailedanalysisofabilitytorepayrequiredLimitedrightbylenderto“cure”andtoassertbonafideerrordefenseRemedies:ForfeitureofinterestinconnectionwiththeloanAnaffirmativerecoveryoftwicetheamountofinterestalreadypaidSimilarlawsareineffectinNewYork,MaineandMarylandqThenewHomeOwnershipandEquityProtectionAct(“HOEPA”)Rulesat12C.F.R. 226.135(eff.10/1/09)containsasuitabilitystandardsimilartoNorthCarolina.35Some(Obvious)DefensiveStrategiesqWhichforum?RemovalunderCAFAPreemptionCompellingArbitrationqOtherpartiesandclaims:Cross-claimsassigneeliabilityCounterclaimsborrowermisrepresentationsandfalsefinancialstatementsqBorrowermisconductdefensesUncleanhandsFraudIllegalityqClassactiondefensesSubprime loan transactions are complex with many players unfocused,“shot-gun”attacksbyplaintiffdestroypredominanceorcreatesuchamorassofsubclassesthattheactionbecomesunmanageableBorrower misconduct may result in predominance of questions affectingindividualclassmembersoverquestionsoflaworfactcommontotheclass36