Commercial Lenders Take Note: Insurance May Not Cover Fraudulent USDA Guarantees for Business & Industry Loans

Commercial Lenders Take Note: Insurance May Not Cover Fraudulent USDA Guarantees for Business & Industry LoansA Wisconsin federal court recently held that forged USDA loan guarantees did not trigger coverage under a bankers blanket bond held by Wisconsin-based Citizens Bank, resulting in a $15 million loss to the bank. Atlantic Specialty Insurance Co. issued the bankers blanket bond to provide coverage for losses stemming from certified securities or corporate, partnership or personal guarantees that were fraudulent, but the court determined that the bond did not cover counterfeit government-backed guarantees.

In 2013, Citizens invested $15 million in a pool of loans purportedly backed by USDA guarantees under the USDA’s Business & Industry guaranteed loan program. The loans were purportedly made to a variety of businesses, including a distribution center, an energy company, and several hotels. The loans, however, had been originated in the name of fictitious borrowers with fictitious collateral.  The USDA guarantees on the loans were forged by the originating lender as well, and Citizens discovered that the USDA had no record of the loans at all.

After learning of the forgery, Citizens filed a claim under its financial institution bond—also known as a bankers blanket bond. Citizens sought coverage under the provisions of the bond that covered losses stemming from forgery and alteration of certificated securities or corporate, partnership, or personal guarantees. Atlantic denied the claim, however, and Citizens filed suit in Wisconsin federal court to recover its $15 million in losses on the forged loans.

In the litigation, Atlantic maintained that the bond did not cover losses for counterfeit government-backed guarantees, arguing that the forged USDA guarantees did not fall under the definition of certificated securities or corporate, partnership, or personal guarantees. Citizens Bank, in turn, argued that the forged USDA guarantee agreements qualified as a certificated security because they met the class, obligation, medium, and issuance elements laid out by the terms of the bond. Citizens Bank also argued that the USDA acts as a quasi-corporation, triggering coverage under the bond for “corporate, partnership, or personal” guarantees.

The court, noting that neither party contemplated losses related to government-issued guarantees, sided with Atlantic. Specifically, the court found that the self-identified guarantees were not covered as a certified security, since the bond separately defined “certificated securities” and “guarantees.” The fraudulent USDA guarantees also were not covered as corporate, partnership, or personal guarantees, the court found, since the USDA is a government agency and not a corporation.

This decision illustrates a potentially costly oversight in insurance coverage for commercial lenders dealing in government-backed loans. In addition to implicating USDA guaranteed loans, other government-backed loans, such as loans backed by the U.S. Small Business Administration, could potentially be excluded from coverage with terms similar to Citizen’s bankers blanket bond. Commercial lenders should review the terms of their insurance coverage for potential gaps in coverage related to government-backed guarantees that may not fit within otherwise broad coverage.

Banks Should Prepare for Increased Collaboration between IT, Legal and BSA/AML Compliance Departments under New FinCEN Guidance

Banks Should Prepare for Increased Collaboration between IT, Legal and BSA/AML Compliance Departments under New FinCEN GuidanceLast month, the U.S. Treasury Department’s Financial Crimes Enforcement Network (FinCEN) issued an Advisory which provided substantial guidance to financial institutions regarding the scope of information that must be provided in Suspicious Activity Reports (SARs) arising from cyber-events, cyber-enabled crime, and cyber-related information under the Bank Secrecy Act (BSA).

When are financial institutions required to report cyber-events pursuant to the BSA?

Pursuant to the BSA and its implementing regulations, a financial institution is required to report any suspicious or attempted transaction involving $5,000 or more in funds or other assets. If the suspicious or attempted transaction involves a cyber-event, it now falls squarely within the reporting requirements under the BSA. Accordingly, cyber-events targeting financial institutions that could affect a transaction or series of transactions over the reporting threshold amount must be analyzed as a suspicious transaction.

In determining whether a cyber-event should be reported, a financial institution should consider all available information surrounding the cyber-event, including its nature and the information and systems targeted. Similarly, to determine monetary amounts involved in the transactions or attempted transactions, a financial institution should consider in aggregate the funds and assets involved in or put at risk by the cyber-event.

What cyber-related information must be included in a SAR?

When filing a mandatory or voluntary SAR involving a cyber-event, financial institutions should provide the following information:

  1. a description of the event to include information regarding the magnitude of the event;
  2. known or suspected time, location, and characteristic/signatures of the event;
  3. indicators of compromise;
  4. relevant IP addresses and their timestamps;
  5. device identifiers;
  6. methodologies used; and
  7. all other information the financial institution believes is relevant.

In addition, the Advisory explains that institutions subject to a large volume of cyber-attacks are permitted to report the cyber-events through a single cumulative SAR if the cyber-events are substantially similar in nature.

The Importance of Collaboration between BSA/AML and IT Cybersecurity within the Institution

In order to ensure an institution has implemented a comprehensive threat assessment program and developed appropriate risk management strategies and responses to cyber-events, it is imperative that the essential departments, BSA/AML compliance, legal, cybersecurity and IT work hand-in-glove to identify, report, and mitigate cyber-events and cyber-enabled crime. Likewise, these departments should have a structured reporting and feedback loop system wherein they share information from across the organization, hold regular meetings to discuss issues, provide cross-training between departments and have written policies and procedures that facilitate cooperation. This type of internal cooperation will provide for more comprehensive, accurate and complete SAR reporting and is consistent with the underlying principal and primary goal of FinCEN’s Advisory to “help U.S. authorities combat cyber-events and cyber-enabled crime” targeted at financial institutions.

Servicers Beware: Courts Rule Non-Parties Cannot Invoke Jury Trial Waiver

Servicers Beware: Courts Rule Non-Parties Cannot Invoke Jury Trial WaiverIn Florida, courts routinely enforce jury trial waiver provisions found in loan agreements, which are generally valid and enforceable. This is true even with respect to fair debt actions. However, because there is generally a fundamental right to a jury trial, waivers of this right are strictly construed. As such, federal courts in Florida have consistently ruled in favor of borrowers holding that non-parties to a mortgage cannot enforce a jury trial waiver provision.

In a recent decision, the U.S. District Court for the Middle District of Florida aligned itself with its counterpart in the Southern District. The plaintiffs sued the bank alleging violations of the Florida Consumer Collection Practices Act (FCCPA) and the Telephone Consumer Protection Act (TCPA) and requested a trial by jury. The bank moved to strike the jury demand arguing that the plaintiffs waived their right to a jury trial by signing the mortgage, which contained a waiver provision.

Agreeing with the plaintiffs that the bank could not enforce the waiver because it was not a party to the mortgage, the court held that, “[g]iven the historical importance of the right to jury trial, and the general policy of ‘indulg[ing] every reasonable presumption against waiver,’” the bank failed to meet its burden in showing that the plaintiffs’ demand for jury trial should be stricken.

The U.S. District Court for the Southern District of Florida has issued several prior opinions with respect to a  servicer’s ability to enforce a jury trial waiver. The first such decision was issued in 2011. In that case, the plaintiffs sued the loan servicer alleging that the forced-place insurance premiums it charged to their mortgage loan accounts exceeded what the loan servicer actually paid because a substantial portion of the premiums were refunded to the loan servicer through various kickbacks and/or unwarranted commissions.

The loan servicer filed a motion seeking to strike the plaintiffs’ demand for a jury trial, arguing that the plaintiffs waived their right to jury trial by signing a mortgage containing a jury trial waiver. The court denied the loan servicer’s motion, stating the jury trial waiver in the mortgage “was part of a contractual relationship” and therefore could not be invoked by the non-party loan servicer.

Two years later, the district court again weighed in on the issue. In response to a loan servicer’s motion seeking to strike their jury trial demand, the plaintiffs contended that, because the waiver is contractual, it can only be enforced by parties to the contract. The plaintiffs argued that the loan servicer could not invoke the waiver because it was not party to the mortgage contract.

Agreeing with the plaintiffs, the court determined that because the waiver is part of a contractual relationship between the plaintiffs and the owner of the note and mortgage, and not between the plaintiffs and the loan servicer, the loan servicer could not enforce the waiver against the plaintiffs.

Most recently, in 2014, and relying on the two predecessor cases, the district court held that an otherwise valid jury trial waiver was unenforceable by the loan servicer because it was a non-party to the mortgage, and denied the loan servicer’s motion to strike jury trial demand.

Thus, it seems clear in Florida that servicers cannot enforce a jury trial waiver provision contained in a mortgage to which they are not a party. It remains to be seen, however, whether a servicer, who is also a creditor, has standing to enforce such a waiver. Further, courts have acknowledged that an owner and successor in interest of a promissory note may invoke the jury trial waiver provision contained in the related mortgage where the mortgage provided that the terms and covenants bind and/or inure to the benefit of the successors and assigns of the lender. However, given the strict standard in Florida, the language in mortgages should be carefully evaluated in an effort to confirm whether such successor language is included and applies.

No Free Houses—Florida Supreme Court Approves Fifth DCA’s Bartram Decision and Extension of Singleton v. Greymar

No Free Houses—Florida Supreme Court Approves Fifth DCA’s Bartram Decision and Extension of Singleton v. GreymarThe mortgage industry scored a significant victory last week when the Florida Supreme Court released its decision in Bartram v. U.S. Bank, N.A. broadly approving of the approach taken by the Fifth District Court of Appeal and other courts in addressing the application of the statute of limitations in the context of an action for foreclosure.

The Supreme Court agreed that its reasoning in Singleton v. Greymar Associates, decided on res judicata grounds, extends to the application of the statute of limitations in mortgage foreclosure cases. Specifically, the Supreme Court concluded that the statute of limitations will not prevent a lender’s subsequent foreclosure action on a payment default occurring after the involuntary dismissal of the initial foreclosure action, so long as the subsequent action is filed within five (5) years of the post-dismissal default.

Numerous appellate and federal district courts laid the groundwork for the Supreme Court’s Bartram decision by taking a broad view of Singleton. For instance, in Deutsche Bank Trust Co. Americas v. Beauvais, a borrower challenged, on statute of limitations grounds, a second foreclosure action brought by the lender when the prior foreclosure action had been dismissed without prejudice due to the lender’s non-appearance at a case management conference.

The Third District held that “dismissal of a foreclosure action accelerating payment on one default does not bar a subsequent foreclosure action on a later default if the subsequent default occurred within five years of the subsequent action” because “despite acceleration of the balance due and the filing of an action to foreclose, the installment nature of a loan secured by such a mortgage continue[d] until a final judgment of foreclosure [was] entered and no action [was] necessary to reinstate it via a notice of ‘deceleration’ or otherwise.”

Similarly, the First District Court of Appeal held that an initial foreclosure action that sought acceleration which was dismissed with prejudice did not bar the bank from “instituting a new foreclosure action based on a different act or a new date of default not alleged in the dismissed action.”

In another case, after the bank voluntarily dismissed a prior foreclosure action without prejudice, the borrower sought to quiet title on the grounds that any recovery on the note was barred by the five-year statute of limitations. The borrower contended that the prior dismissal invalidated the note and thus barred any foreclosure suits for defaults on subsequent payments.

The United States District Court for the Southern District of Florida rejected the borrower’s argument, citing Singleton, and found that “[w]hile any claims relating to individual payment defaults that are now more than five years old may be subject to the statute of limitations, each payment default that is less than five years old … created a basis for a subsequent foreclosure and/or acceleration action.” As such, the court determined that the note and mortgage remained a valid and enforceable lien against the borrower’s property and did not, as a matter of law, constitute a cloud on title supporting a quiet title claim.

This analysis was embraced by the Middle District of Florida which agreed with the bank’s argument that there was a subsequent deceleration when the foreclosure action was dismissed for failure to prosecute, like was the case here, and, absent an effective acceleration, the statute of limitations would not expire until five years after the maturity date of the mortgage, when the final payment is due. The court reasoned that the analysis in Singleton regarding the application of the doctrine of res judicata was of “equal effect” to the statute of limitations issue.

Finally, in U.S. Bank National Association v. Bartram, the Fifth District Court of Appeal, relying on Singleton, held that a default occurring after a failed foreclosure attempt creates a new cause of action for statute of limitations purposes, even where acceleration had been triggered and the first case was dismissed on its merits, and a foreclosure action for default in payments occurring after the order of dismissal in the first foreclosure action is not barred by the statute of limitations provided the subsequent foreclosure action on the subsequent defaults is brought within the limitations period.

Agreeing with the reasoning of the appellate courts and the federal district courts, the Florida Supreme Court joined the chorus in Bartram and expressly held that its analysis in Singleton “equally applies to the statute of limitations context.”

The court stated that its ruling stemmed from its prior reasoning that a “subsequent and separate alleged default created a new and independent right in the mortgagee to accelerate payment on the note in a subsequent foreclosure action.” Therefore, the court concluded, “with each subsequent default, the statute of limitations runs from the date of each new default providing the mortgagee the right, but not the obligation, to accelerate all sums then due under the note and mortgage.”

Further, the court ruled that the statute of limitations would not continue to run after a dismissal, and thus the lender would not be barred by the statute of limitations from filing a successive foreclosure action premised on a “separate and distinct” default. Post-dismissal, the parties are simply placed back in the same contractual relationship as before, where the residential mortgage remained an installment loan, and the acceleration of the residential mortgage declared in the unsuccessful foreclosure action is revoked.

Bartram leaves several significant questions unanswered. Is it possible that there could be a different rule for voluntary dismissals? How does Bartram apply to mortgages with automatic, as opposed to optional, acceleration clauses? How do lenders account for time-barred installment defaults in calculating amounts due and owing?

Putting these questions aside for another day, Bartram is a big win for mortgage lenders which appears to have ended the debate over “free houses” in Florida.

Filing a Collection Suit? The Statute of Limitations for the Forum State May Not Be the Correct Limitations Period

Filing a Collection Suit? The Statute of Limitations for the Forum State May Not Be the Correct Limitations PeriodDebt collectors filing suit often assume that the forum state’s statute of limitations will apply. However, a string of recent cases suggests that may not always be the case. The Ohio Supreme Court recently determined that, by virtue of Ohio’s borrowing statute, the statute of limitations for the place where the customer submits payments or where the creditor is headquartered may apply Taylor v. First Resolution Inv. Corp., 2016 WL 3345269 (Ohio Jun. 16, 2016). As noted below, however, Ohio is not the only jurisdiction to reach this conclusion.

Given the increasing number of courts and regulators that consider the filing of a time barred lawsuit to be a violation of the FDCPA, entities filing collection lawsuits should closely review trends related to the statute of limitations in each state and accurately track the statute of limitations applicable in each jurisdiction.

Analysis of Taylor v. First Resolution Inv. Corp.

In 2001, Sandra Taylor, an Ohio resident, completed a credit card application in Ohio, mailed the application from Ohio, and ultimately received a credit card from Chase in Ohio. By 2004, Ms. Taylor had fallen into default and the debt was charged off by Chase in January 2006. The debt was sold in 2008 and then again in 2009 before being sent to a law firm to file a collection suit. The debt collector in Taylor, First Resolution Investment Corporation (FRIC), ultimately filed suit on March 9, 2010, in Summit County, Ohio. While FRIC initially obtained a default judgment, that judgment was vacated two months later, and Ms. Taylor asserted several affirmative defenses, including a statute of limitations defense and counterclaims based upon alleged violations of the Fair Debt Collection Practices Act (FDCPA) and the Ohio Consumer Sales Practices Act (OCSPA) for filing a lawsuit beyond the limitations period.

After FRIC dismissed its claims without prejudice, the trial court granted summary judgment in FRIC’s favor on Ms. Taylor’s claims. The trial court held that FRIC did not file a complaint beyond the statute of limitations because Ohio’s six or 15 year statute of limitations applied to FRIC’s claim and the complaint was filed within six years of Ms. Taylor’s breach.

The case was ultimately appealed to the Ohio Supreme Court. After noting that Ohio law determines the statute of limitations because it is the forum state for the case, the Ohio Supreme Court proceeded to analyze whether Ohio’s borrowing statute applied to the case. Ohio’s borrowing statute mandated that Ohio courts apply the limitations period of the state where the cause of action accrued unless Ohio’s limitations period was shorter. As a result, Taylor hinged upon a determination of where the cause of action accrued.

The Ohio Supreme Court ultimately held that the cause of action accrued in Delaware because it was the location “where the debt was to be paid and where Chase suffered its loss.” This determination was based on the fact that Chase was “headquartered” in Delaware and Delaware was the place where Ms. Taylor made all of her payments. Because the Ohio Supreme Court held that the cause of action accrued in Delaware, FRIC’s claim was barred by Delaware’s three year statute of limitations and as a result FRIC potentially violated the FDCPA by filing a time barred lawsuit.

Unfortunately, the Taylor court did not address a number of key questions. For instance, the court’s decision to apply Delaware’s statute of limitations turned on the fact that it was the place where Chase was “headquartered” and where Ms. Taylor was required to submit her payments. The court did not, however, indicate which of these facts would be determinative in a situation in which the place of payment and the creditor’s headquarters are different—the language the court used regarding the place where Chase “suffered its loss” suggests that headquarters should be the determining factor, but that is not overtly stated in the opinion. To the extent the place of payment drives the analysis, the court did not offer any insight into how it would handle a situation in which a customer submitted payments electronically—presumably, this suggests that courts should look to the place where the creditor directs the borrower to mail payments. The court also did not provide any guidance as to how a creditor’s headquarters should be determined.

Growing Trend of Jurisdictions Using Borrowing Statutes

While Taylor may seem like an anomaly, the court in Taylor identified a number of other jurisdictions that apply a similar analysis. For instance, in Conway v. Portfolio Recover Assocs., LLC, 13 F.Supp.3d 711 (E.D. Ky. 2014), the District Court for the Eastern District of Kentucky held that, by virtue of Kentucky’s borrowing statute, Virginia’s statute of limitations applied because it was the place where the creditor “was located and expected to receive payment.” Similarly, in Hamid v. Stock & Grimes, LLP, 2011 WL 3803792 (E.D. Pa. Aug. 26, 2011), the District Court for the Eastern District of Pennsylvania determined that Pennsylvania’s borrowing statute required the court to apply Delaware’s statute of limitations because that was the location of the creditor’s post office box where it directed the customer to mail payments. And in Portfolio Recovery Assocs., LLC v. King, 927 N.E.2d 1059 (N.Y. 2010), the New York Supreme Court held that, as a result of New York’s borrowing statute, the Delaware statute of limitations applied because the creditor was incorporated in Delaware. As these cases demonstrate, there is a growing trend of jurisdictions utilizing borrowing statutes to apply the shorter statute of limitations of the forum state, the creditor’s headquarters, and the place where the creditor directs the customer to mail payments.

UPDATE: Ninth Circuit Denies Rehearing of Bourne Valley Decision Holding Nevada HOA Super-Priority Lien Statute Unconstitutional

UPDATE: Ninth Circuits Denies Rehearing of <i>Bourne Valley</i> Decision Holding Nevada HOA Super-Priority Lien Statute UnconstitutionalThe Ninth Circuit denied the plaintiff’s request to rehear Bourne Valley Court Trust v. Wells Fargo Bank, N.A., in which the Ninth Circuit found NRS 116 to be unconstitutional on its face because the statute violates a first lien holder’s due process rights by impermissibly shifting the burden to mortgage lenders to affirmatively request notice of an HOA’s foreclosure proceedings. This case, which we have been following in a series of blog posts, has significant implications for numerous HOA super-priority foreclosure cases pending in Nevada’s federal courts between purchasers from HOA foreclosure sales who claim to hold title free-and-clear of the first lien holder’s deed of trust and lenders who assert that their deeds of trust remain valid.

The Ninth Circuit had already denied the plaintiff’s request to delay publication of the case, and now the case will not be re-heard. Specifically, two Ninth Circuit judges voted to deny the petition for rehearing filed by the plaintiff in Bourne Valley, while one judge voted to grant the petition. Two judges also recommended denying the petition for rehearing en banc, with one recommending rehearing. The order noted that the full court had been advised of the petition for rehearing en banc and that no active judge had requested a vote on whether to rehear the matter en banc. While the eventual decision by the Nevada Supreme Court in Saticoy Bay LLC Series 350 Durango 104 v. Wells Fargo Home Mortgage, N.A., No. 68630, which involves the same facial due process challenge considered in Bourne Valley, may ultimately affect how courts interpret Bourne Valley, the Ninth Circuit will not re-consider its decision in the case, which is binding precedent for the federal trial courts in the Ninth Circuit, including the federal trial courts in Nevada.

Don’t Roll the Dice: FinCEN Assesses Significant Penalties on Regulated Entity for Failing to Implement a Comprehensive AML Compliance Program

Don’t Roll the Dice: FinCEN Assesses Significant Penalties on Regulated Entity for Failing to Implement a Comprehensive AML Compliance ProgramThe U.S. Treasury Department’s Financial Crimes Enforcement Network (FinCEN) imposed a civil money penalty of $12 million against a Nevada based casino, CG Technology, L.P. (CGT) for alleged violations of the Bank Secrecy Act (BSA) on October 3, 2016. This action continues FinCEN’s recent trend of aggressive expansion and enforcement of anti-money laundering (AML) regulations and the BSA, and sends a clear message that regulated entities must implement comprehensive AML compliance programs in order to avoid running afoul of AML regulations.

What is an AML compliance program?

The BSA, among other things, requires certain regulated entities, including financial institutions, to develop and implement AML compliance programs reasonably designed to assure and monitor compliance with the BSA and its implementing regulations. At a minimum, a financial institution’s AML compliance program must include:

  • A system of internal controls to ensure ongoing compliance;
  • Independent testing of AML compliance;
  • Designation of an individual or individuals responsible for managing BSA compliance;
  • A comprehensive training program for appropriate personnel; and
  • A customer identification program.

How did CGT’s AML compliance program violate the BSA?

FinCEN determined that CGT, which operates a race and sports betting operation in Nevada and provides gaming technology to casino customers globally, willfully violated the BSA by failing to (1) implement and maintain an effective AML compliance program, (2) report suspicious activity, (3) report certain transactions involving currency in amounts greater than $10,000, and (4) keep appropriate records as required by the BSA and its implementing regulations.

Significantly, among other things, FinCEN also identified the following specific deficiencies in CGT’s AML compliance program:

  1. Failure to fully take into consideration the environment it was operating in and the potential AML risks associated with CGT’s business model;
  2. Failure to ensure that its AML program policies conformed to its actual business practice (g., accepting gaming account deposits via wire transfer);
  3. Failure to properly train its employees on BSA requirements; and
  4. Failure to implement proper audit, monitoring, and reporting procedures.

In sum, although CGT had an AML compliance program, it was not reasonably designed to detect and prevent illicit activities.

Lessons from the CGT enforcement action?

The latest FinCEN enforcement action makes it clear that what constitutes a proper AML program is different for each financial institution. Regulated entities must thoroughly consider—and re-evaluate—the environment around them to account for specific risks and develop a sound AML compliance program. It is not enough for regulated entities to simply have an AML program–the program must be tailored to an entity’s current business model. To that end, risk assessments must be structured to include a realistic assessment of products and services currently offered, customer demographics, and recent trends in suspicious activities. In addition, a comprehensive training program for appropriate employees must be developed and include periodic training and mechanisms to compel attendance of periodic training. Finally, AML program compliance auditing, whether performed internally or externally, must be performed in a thorough and independent manner.

In sum, FinCEN’s evaluation of CGT’s AML compliance program demonstrates that simply having an AML compliance program is not enough to avoid scrutiny. It is clear that regulators expect financial institutions to regularly take a hard, self-imposed look at their policies and procedures, and make appropriate adjustments in order to proactively ensure BSA compliance.

Ninth Circuit Denies Motion to Dismiss and Motion to Stay Publication of Decision Holding Nevada HOA Super-Priority Lien Statute Facially Unconstitutional

Ninth Circuit Denies Motion to Dismiss and Motion to Stay Publication of Decision Holding Nevada HOA Super-Priority Lien Statute Facially UnconstitutionalAs we have previously covered in a series of blog posts, the Nevada Supreme Court held in September 2014 that Nevada Revised Statute chapter 116 allows homeowners’ associations (HOAs) to non-judicially foreclose on homeowners who have overdue assessments, which may extinguish a first lien holder’s deed of trust. That holding, as well as the confusion leading up to it, has sparked thousands of quiet title cases in state and federal courts between purchasers from HOA foreclosure sales who claim to hold title free-and-clear of the first lien holder’s deed of trust and lenders who maintain that their deeds of trust remain valid.

The purchasers’ arguments received a serious blow on August 12, 2016, when the Ninth Circuit issued its decision in Bourne Valley Court Trust v. Wells Fargo Bank, N.A., holding NRS 116 to be unconstitutional on its face because the statute violates a first lien holder’s due process rights by impermissibly shifting the burden to mortgage lenders to affirmatively request notice of an HOA’s foreclosure proceedings. The opinion was designated for publication, which, unlike an unpublished disposition or order, would make it binding precedent for the federal trial courts in the Ninth Circuit (which includes all the federal trial courts in Nevada).

Not surprisingly, given the potential implications of the decision for numerous cases and properties, the Ninth Circuit’s opinion was quickly met with a petition for panel rehearing and petition for rehearing en banc, as well as a motion to dismiss for lack of jurisdiction, all filed by the purchaser, Bourne Valley. Bourne Valley also sought to stay publication of the opinion, filing an emergency motion to stay publication on August 15, 2016. Multiple entities, including purchasers from HOA sales and the Nevada Legislature, have also submitted briefs as amicus curiae.

In its motion to stay publication, Bourne Valley argued that publication of the decision should be stayed because (1) the Nevada Supreme Court was scheduled to hear oral argument in a similar case involving the constitutionality of NRS 116; (2) Bourne Valley was planning to file a petition for rehearing; and (3) Bourne Valley planned to challenge the jurisdiction of the federal courts. The motion to dismiss centered on Bourne Valley’s claims that there was a lack of diversity between the parties and that the borrower was not fraudulently joined to defeat diversity. Bourne Valley argued that the U.S. District Court of Nevada had erred by assuming jurisdiction of the matter and denying its motion to remand.

Last week, on October 18, 2016, the Ninth Circuit denied both Bourne Valley’s emergency motion to stay publication and its motion to dismiss for lack of subject matter jurisdiction. The Court did not provide the basis for the denials.

What, if anything, the denials may portend is unclear. At the very least, it seems likely that the Ninth Circuit’s final decision in the case will be on the merits of the constitutionality argument, rather than dismissing the appeal due to a lack of jurisdiction. The Court also does not appear to be concerned that publication of its decision will create a risk of inconsistency with the Nevada Supreme Court’s anticipated holding in the case that was recently argued before it. It is still unknown whether the Court will ultimately rehear the case; it is possible that the Ninth Circuit will vacate its initial decision and ultimately rule in favor of the purchaser. For now, though, the denials of Bourne Valley’s motions can be seen as a positive development for lenders and servicers, as the Bourne Valley opinion has survived these initial challenges.

D.C. Circuit Court Finds the CFPB Misinterpreted Section 8 of RESPA and Violated Due Process with Retroactive Application

D.C. Circuit Court Finds the CFPB Misinterpreted Section 8 of RESPA and Violated Due Process with Retroactive ApplicationThe D.C. Circuit Court issued its long-awaited opinion in PHH Corporation v. Consumer Financial Protection Bureau, No. 15-1177 (D.C. Cir., filed 2015) regarding the constitutionality of the Consumer Financial Protection Bureau’s (CFPB) single-director structure, and the CFPB’s attempted enforcement action against PHH Corp. (PHH) for alleged violations of the Real Estate Settlement Procedures Act (RESPA). While the biggest headline coming out of that decision is that the CFPB’s structure, as designed by the Dodd-Frank Act, was determined to be unconstitutional, the Court also issued significant opinions regarding statutes of limitations in administrative actions, and the CFPB’s attempt to retroactively apply a novel interpretation of Section 8 of RESPA. With regard to the last point, the D.C. Circuit held that the CFPB’s interpretation of Section 8 of RESPA was inconsistent with the statute’s text, and that retroactively applying that interpretation violated due process because it was in direct conflict with prior guidance issued by the Department of Housing and Urban Development (HUD).

CFPB’s Interpretation of Section 8 of RESPA

In the context of this case, Section 8(a) of RESPA prohibits “payment by a mortgage insurer to a lender for the lender’s referral of a customer to the mortgage insurer.” However, section 8(c) provides that “[n]othing in [Section 8] shall be construed as prohibiting . . . the payment to any person of a bona fide salary or compensation or other payment for goods or facilities actually furnished or for services actually performed” (12 U.S.C. § 2607(c)(2)). HUD, the federal agency responsible for enforcing RESPA prior to the CFPB’s formation, publicly interpreted this to mean that a “bona fide” payment is one that is consistent with the reasonable market value of the good or service.

The CFPB, on the other hand, took the opinion that a mortgage insurer’s payment for reinsurance is not “bona fide” if it is part of a tying arrangement. In other words, the CFPB took issue with the practice of referring customers to a mortgage insurer that would, in turn, purchase reinsurance from the lender. The Court bluntly noted that the CFPB’s interpretation “makes little sense,” that “Section 8(c) of RESPA specifically bars the aggressive interpretation of Section 8(a) advanced by the CFPB in this case,” and that “the CFPB’s interpretation flouts not only the text of the statute but also decades of carefully and repeatedly considered government interpretations” (PHH Corp. v. CFPB, No. 15-1177 at 74, 75, and 76).

Retroactive Application Violates Due Process

Next, the Court addressed the CFPB’s attempt to retroactively apply its new interpretation to PHH’s prior reinsurance arrangements. As mentioned above, when HUD was tasked with enforcing RESPA, it publicly issued opinion letters in 1997 and 2004 explaining that captive reinsurance arrangements are “permissible if the payments made to the reinsurer (1) are ‘for reinsurance services actually furnished or for services performed’ and (2) are ‘bona fide compensation that does not exceed the value of such services.’” (citing letter from John P. Kennedy, Associate General Counsel for Finance and Regulatory Compliance, Department of Housing and Urban Development, to American Land Title Association 1 (Aug. 12, 2004) (J.A. 259)). In essence, so long as any fee paid for reinsurance bears a reasonable relationship to the market value of that reinsurance, then it does not violate Section 8(a) of RESPA.

In 2015, once the CFPB was assigned to enforce RESPA, they determined that captive reinsurance arrangements were prohibited by Section 8 because the payment was part of a tying arrangement. Relying upon its new interpretation, the CFPB attempted to penalize PHH for conduct that occurred as far back as 2008. Citing numerous Supreme Court cases, the D.C. Circuit Court held that the CFPB’s retroactive application is prohibited by the Due Process Clause. Because HUD had previously issued widely relied upon guidance on this issue and the CFPB had never publicly changed course—which they are free to do—the CFPB cannot retroactively impose adverse consequences for an entity’s past conduct that was structured in reliance upon the government’s prior advice.

The CFPB argued that nothing about HUD’s prior opinions should have given entities a reason to rely upon them, noting that they were not reflected in a binding rule. The Court strongly rebuked the CFPB’s position with the following statement:

We therefore find this particular CFPB argument deeply unsettling in a Nation built on the Rule of Law. When a government agency officially and expressly tells you that you are legally allowed to do something, but later tells you “just kidding” and enforces the law retroactively against you and sanctions you for actions you took in reliance on the government’s assurances, that amounts to a serious due process violation. The rule of law constrains the governors as well as the governed.

After reiterating that the CFPB’s interpretation of RESPA is impermissible, the D.C. Circuit Court remanded the case so that the CFPB may determine whether the fees paid by any mortgage insurers were more than the reasonable market value to the reinsurer, subject to any applicable statutes of limitations.

Implications

In addition to being perhaps the strongest public rebuke of the CFPB’s authority to date, this holding reiterates and confirms that the CFPB is subject to prior agencies’ interpretations. The CFPB may adopt different interpretations of consumer financial laws, but those interpretations must be made public before an entity can retroactively be punished for actions that are consistent with the prior agency’s guidance.

Creditors and Debt Collectors Should Pay Close Attention to the CFPB’s Consent Order with Navy Federal Credit Union

Creditors and Debt Collectors Should Pay Close Attention to the CFPB’s Consent Order with Navy Federal Credit UnionThe Consumer Financial Protection Bureau (CFPB) announced a consent order with Navy Federal Credit Union (Navy Federal) on October 11, 2016. While financial institutions should always analyze CFPB consent orders closely and carefully scrutinize their relevant practices in light of the consent order, first-party creditors, debt collectors, and any financial institution that electronically restricts access due to a consumer’s default status should pay particular attention to this agreement.

CFPB Applies FDCPA Restrictions via UDAAP

In the consent order, the CFPB indicated that Navy Federal:

  • Threatened legal action or wage garnishment unless the consumer made a payment even though Navy Federal rarely took legal action;
  • Threatened to contact the consumer’s commanding officer when it had no intention to do so; and
  • Made representations to consumers regarding the impact on the consumer’s credit score of paying or failing to pay the debt when Navy Federal had not analyzed the particular consumer’s credit history to validate those assertions.

These allegations are common in enforcement actions involving the Fair Debt Collections Practices Act (FDCPA).  See 15 U.S.C. § 1692e (“The threat to take any action that cannot legally be taken or that is not intended to be taken.”); July 2013 Bulletin on Representations Regarding the Effect of Debt Payments on Credit Reports and Credit Scores. The CFPB, in this consent order, however, indicated that these actions constituted “unfair, deceptive, or abusive” acts or practices (UDAAP) under the Consumer Financial Protection Act of 2010 (CFPA).

The CFPB’s use of UDAAP in this instance demonstrates the importance of FDCPA compliance for first-party creditors, as the CFPB has shown on numerous instances that it views conduct that would otherwise violate the FDCPA as a UDAAP. See, e.g., July 2013 Bulletin on UDAAPs (indicating that the CFPB views “empty threat” type allegations as UDAAPs). This will be even more important once the CFPB issues its new debt collection rules implementing the FDCPA. As a result, first-party creditors, like third-party debt collectors, should pay close attention to the CFPB’s debt collection proposal.

CFPB Ignores a Contractual Provision to Find a UDAAP

In the consent order, the CFPB also indicated that Navy Federal’s threats to disclose the debts to consumers’ military commanders constituted a UDAAP because Navy Federal was not authorized to disclose the debt to the consumers’ commanding officer. In doing so, the CFPB ignored a provision in the consumers’ account agreements that authorized this practice because the provision “was buried in fine print, non-negotiable, and not bargained for by consumers.”

The CFPB clearly believed this was an important point to make, as it had already established the conduct at issue was a UDAAP. Nonetheless, the consent order provided no guidance as to what constitutes “fine print” or how a financial intuition should structure its agreements to avoid similar results in the future. Additionally, given that virtually no contractual provisions in credit agreements are negotiated and bargained for by consumers, the implications of this consent order could be extremely broad. Under this line of reasoning, the CFPB could invalidate almost any provision.

Electronic Access Restrictions

The CFPB also addressed Navy Federal’s practice of freezing consumers’ electronic access and disabling electronic services after consumers became delinquent on credit accounts. The CFPB claimed that Navy Federal’s electronic access restriction was unfair to consumers because it was likely to cause injuries to consumers, the injuries were not reasonably avoidable, and the injuries were not outweighed by any countervailing benefit. The CFPB appeared to take issue with Navy Federal’s practice of applying the restriction at the member level by freezing the consumer’s access for all accounts even though the delinquency was only related to the credit account.

Financial institutions, however, should be careful about interpreting this consent order too narrowly. For instance, while the CFPB’s statement of its claim targeted Navy Federal’s specific electronic access restrictions, it is not hard to envision the CFPB claiming electronic access restrictions based upon default status constitute UDAAPs. For instance, the CFPB noted that Navy Federal’s restrictions:

  • Prevented consumers from “managing their accounts online;”
  • Prevented consumers from “accessing online or mobile platforms to check account balances;” and
  • Prevented consumers from “adding travel alert[s] to the consumer’s account through mobile platforms.”

Any electronic account restriction that limits a consumer’s ability to view account information and manage their account online arguably presents these same issues. Moreover, while the CFPB focused on the fact that the injuries were not reasonably avoidable because Navy Federal did not clearly disclose the policy when consumers opened accounts or before they became delinquent, a clearer disclosure may not have ultimately resolved the issue, as the CFPB may have simply said the disclosure was too “fine print” or non-negotiable. Plus, in the past, the CFPB has indicated that this prong may be satisfied simply by the fact that the practice is common in the industry. See CFPB Exam Manual, p. 175 (“[I]f almost all market participants engage in a practice, a consumer’s incentive to search elsewhere for better terms is reduced, and the practice may not be reasonably avoidable.”).

In light of the Navy Federal consent order, financial institutions should take a close look at their policies, practices, disclosures, and exceptions to electronic access restrictions tied to default status. While it is clear that access restrictions at the consumer level rather than the account level are problematic, it may have much broader implications and may be a shot across the bow to the financial industry concerning electronic access restrictions.

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