OCC Releases Final True Lender Rule

OCC Releases Final True Lender RuleOn October 27, 2020, the OCC released its final True Lender Rule. As discussed earlier on this blog, the OCC’s rule is designed to clarify the “true lender” doctrine, a legal test utilized by courts and regulators to determine whether a bank or its non-bank partner is the actual lender in a credit transaction. The true lender doctrine has caused uncertainty for banks, fintech companies, and other entities involved in the bank partnership model. The OCC’s final rule, which applies to national banks and federal savings associations, will provide some much-needed certainty in the space, and is a welcome first step in what will likely be a longer process of regulatory agencies accounting for modern lending practices.

The final rule tracks the OCC’s proposed rule, with one small clarification. After publication of the proposed rule, some commenters noted that the rule, as written, could cause problems in instances where more than one bank could be considered the “true lender.” For instance, if at origination one bank was the lender on the loan agreement and another bank funded the loan, under the language of the OCC’s proposed rule, both institutions could be considered the “true lender.” The OCC responded to this issue by drafting a new provision stating that if, on the date of origination, one bank is named as the lender in the loan agreement and another bank funds the loan, the bank named in the loan agreement is the “true lender.” Under the OCC’s reasoning, this approach allows customers to more easily identify the party responsible for the loan through reference to the loan documents themselves. Thus, under the rule, a national bank or federal savings association is considered the “true lender,” as opposed to its non-bank partner, if it is either (1) named in the loan agreement or (2) funds the loan, and if two different banks are involved in the credit transaction, the tie goes to the bank named on the loan agreement.

The final rule’s supplementary information also addresses commenters’ other concerns. For instance, several commenters expressed concern regarding the breadth of the rule, and asked that the rule be amended to clarify that the funding prong not include certain lending and financing arrangements, such as warehouse lenders, indirect auto lenders through bank purchases of retail installment contracts, loan syndication, or other structured finance. The OCC ultimately did not amend the final rule to make these clarifications, but it did note that the commenters were “correct that the funding prong of the proposed rule generally does not include these types of arrangements: they do not involve a bank funding a loan at the time of origination.”

Other commenters expressed concern that the final rule not displace other regulatory regimes – in particular, certain consumer protection regulations. For instance, one commenter suggested that the final rule would alter how account information in bank partnership arrangements is reported under the Fair Credit Reporting Act. Addressing these concerns, the OCC noted that the final rule “does not affect the application of any federal consumer financial laws,” including TILA, Regulation Z, Regulation X, RESPA, HMDA, the ECOA, or the FCRA.

While the proposed rule, which goes into effect 60 days after it is published in the Federal Register, is a welcome addition, we are certain it will be met with litigation by its opponents. Indeed, in September, the attorneys general of several states submitted a comment letter to the Acting Comptroller of the Currency Brian Brooks asking that the proposed rule be rescinded. Moreover, several states have sued the FDIC and the OCC over rules designed to provide a “Madden Fix,” a related problem facing fintech companies and entities involved in bank partnership arrangements. We anticipate litigation from state agencies challenging the OCC’s true lender rule and will keep our ear to the ground for any new developments.

What Does CA AB 3088 Mean for Mortgage Servicers?

What Does CA AB 3088 Mean for Mortgage Servicers?On September 1, 2020, California passed a new law titled the “COVID-19 Small Landlord and Homeowner Relief Act of 2020.” Although the majority of the new law addresses eviction issues between landlords and tenants, it imposes notable new obligations on mortgage loan servicers as well. This two-part blog series will address those changes. Part I will first address the forbearance notice requirements and a new borrower cause of action, and Part II will address the interplay of those requirements and the California Homeowners’ Bill of Rights (HBOR).

Forbearance Denial Notices Are Required

California now requires all mortgage servicers, including subservicers, to provide written notice to certain borrowers whose forbearance requests are denied between August 30, 2020, and April 1, 2021. The borrowers eligible for such notice must meet two criteria:

  1. Have been current on their mortgage payments as of February 1, 2020, and
  2. Be experiencing a financial hardship that prevents them from making timely payments on their mortgage, either directly or indirectly, because of the COVID-19 emergency.

Eligible borrowers are entitled to notice as to the “specific reason or reasons that forbearance was not provided.” The statute does not provide any timing requirements for giving such notice, which we presume was inadvertent.

Curable Denials

The statute further provides that, for any denials that are “curable,” the notice must explain any defects in the borrower’s request (an “incomplete application or missing information” are specifically called out in the statute). If the denial is curable, the borrower must be advised that they have 21 days to cure the identified defect. Upon submission of additional materials within 21 days, the servicer must accept the receipt of the renewed request and “respond” within five business days of receipt. Whether that response must include a final decision is not provided in the statute.

Which Loans Does This Really Impact?

For government-backed loans subject to the CARES Act, the new law is practically irrelevant. The GSEs, HUD, and FHA have all been clear that no documentation is necessary for a borrower to request a forbearance; rather a borrower must only attest to a need related to COVID-19. Most importantly, servicer denials for CARES Act forbearances are virtually unheard of because the threshold is so low.

California’s new law is therefore targeted to privately held loans where the investor is not obliged to follow the CARES Act and is within its rights to request a financial package from a borrower seeking assistance. As discussed below, the new law both encourages such servicers to mimic the CARES Act for private loans while also giving them protections for enforcing their investor’s criteria that may deny forbearance requests.

CARES Safe Harbor

The new law provides that compliance with the CARES Act shall be deemed to be compliance with California’s law (see Sections 3273.10(d); 3273.11(b)). Similarly, a servicer who provides forbearance consistent with the CARES Act for a non-federally backed mortgage shall be deemed to be in compliance with the new law (see Sections 3273.10(d); 3273.11(c)).

This encouragement to mirror the CARES Act forbearances for privately held loans is tempered by California’s statement that the Legislature’s intent is for a servicer to “offer a borrower a postforbearance loss mitigation option that is consistent with the mortgage servicer’s contractual or other authority” (see Section 3273.12). This sentence is California’s sole acknowledgment that servicers may still apply their investor’s loss mitigation criteria to privately held loans, which may not include forbearances.

CARES Now Has a Cause of Action in California

The most notable mortgage-related change in the new law is the creation of a cause of action for a violation of the CARES Act, despite the fact that the CARES Act omits such a right. The state statute requires that a servicer “comply with applicable federal guidance regarding borrower options following a COVID-19 related forbearance” and then provides that “a borrower who is harmed by a material violation of this title may bring an action to obtain injunctive relief, damages, restitution, and any other remedy to redress the violation” (see Sections 3273.11(a); 3273.15(a)). A court is also permitted to award reasonable prevailing attorneys’ fees and costs to a borrower in any action based on a violation of the title in which injunctive relief against a foreclosure sale, including a temporary restraining order, is granted (see Section 3273.15(b)). A borrower may not be induced to waive her rights in this respect.

HBOR

In Part II to this blog, we will describe how California expanded the scope of loans to which the HBOR is applicable and detail how those changes may impact a servicer’s HBOR compliance.

Facilitating Ransomware Payments Entails Sanctions Risks, OFAC Warns

Facilitating Ransomware Payments Entails Sanctions Risks, OFAC WarnsThe Treasury Department’s Office of Foreign Assets Control (OFAC) issued an advisory on October 1, 2020, warning companies that engage with the victims of ransomware attacks that they run the risk of violating U.S. sanctions by facilitating ransomware payments. Ransomware attacks have increased in number and sophistication in recent years and have netted larger and larger payments from victims seeking to regain access to their digital systems and files or to prevent the threatened release of private information. The OFAC advisory cites FBI reports showing an annual increase of 37% in ransomware attacks and 147% in related losses from 2018 to 2019, and observes that payment demands associated with ransomware attacks have increased since the COVID-19 pandemic has forced businesses into greater reliance on online systems.

Individuals and entities behind or associated with ransomware attacks have been designated under various U.S. sanctions programs, including perpetrators and facilitators of attacks based in Iran, North Korea, and Russia. Companies that respond to ransomware attacks — including cyber-insurers, forensic investigation and response specialists, and financial services companies that facilitate ransom payments — face potential strict liability if their actions run afoul of applicable sanctions. OFAC may impose civil penalties even if the company in question did not realize it was transacting with a sanctioned individual or entity.

OFAC advises businesses that interact with ransomware victims to adopt or strengthen risk-based sanctions compliance programs that recognize and respond to sanctions risks presented by ransomware attacks. The existence and adequacy of such programs are  factors considered by OFAC in determining what, if any, penalty to impose for a sanctions violation. Further, the voluntary, timely, and complete report of a ransomware attack to law enforcement and full cooperation with law enforcement during and after the attack will be considered “significant mitigating factors” in OFAC’s enforcement decision if it turns out that sanctions were violated by the response to the attack.

Consistent with the official position of other federal agencies, OFAC considers payments to ransomware perpetrators to encourage criminal activity and to threaten national security. Therefore, OFAC will review applications for specific licenses involving ransomware attacks “on a case-by-case basis with a presumption of denial.”

State Attorneys General Challenge FDIC’s Madden Fix

State Attorneys General Challenge FDIC’s Madden FixIn early August 2020, several state attorneys general filed suit against the Office of the Comptroller of the Currency (OCC) challenging the OCC’s proposed “Madden Fix.” Notably, while the Federal Deposit Insurance Corporation (FDIC) also issued their own Madden Fix, the agency was not named as a defendant in the initial lawsuit. As such, it is not surprising that a group of attorneys general, many of whom are involved in the suit against the OCC, have now filed a separate lawsuit challenging the FDIC’s Madden Fix. Specifically, on August 20, 2020, the attorneys general of California, Illinois, Minnesota, New Jersey, Massachusetts, New York, North Carolina, and the District of Columbia sued the FDIC in the U.S. District Court for the Northern District of California alleging that the agency’s rule “unlawfully extend[s] federal law in order to preempt state rate caps that would otherwise apply to . . . nonbank entities.”

This lawsuit, like its twin, can be traced back to the Second Circuit Court of Appeals’ decision in Madden v. Midland Funding. In Madden, the Second Circuit cast doubt on the valid-when-made doctrine, a legal concept that, for over a century, has allowed banks to sell, assign, and transfer loans freely. Under the valid-when-made doctrine, a loan is valid when it is created and remains valid when it is sold, even when the purchaser of the loan resides in a jurisdiction where the loan would otherwise be prohibited by state law. Following Madden, the banking and lending industry pushed for a “Madden Fix” by Congress and the prudential bank regulators. In June of this year, the FDIC issued a rule confirming that under section 27 of the Federal Deposit Insurance Act (12 U.S.C. § 1831d), if the amount of interest on a loan is permissible when it is made, it remains permissible despite the sale, assignment, or other transfer of the loan. Lenders saw this rule, along with the OCC’s Madden Fix rule, as a welcome first step in addressing the uncertainty created by Madden.

The lawsuit against the FDIC is largely identical to the suit against the OCC. In particular, the attorneys general contend that the agency’s rule violates the Administrative Procedures Act because the agency purportedly “ignored the potential for regulatory evasion and failed to explain its rejection of evidence contrary to its proposal.” The complaint also attacks the FDIC’s rulemaking as an allegedly impermissible attempt to use its regulatory authority to overturn the Second Circuit’s decision in Madden. There are some differences between this lawsuit and the OCC complaint. For instance, the FDIC suit invokes the language of the Federal Deposit Insurance Act itself, contending that the FDIC, through its rule, violates the act by attempting to extend federal preemption of state interest rate caps under Section 27 of the act to non-FDIC banks.

We are not surprised that the FDIC’s rule is facing a legal challenge, and we anticipate that the agency will vigorously contest these claims. However, this lawsuit adds to the current uncertainty surrounding the emerging fintech industry and bank-partnership model of lending. As we previously suggested in this space, there are practices that banks and non-bank lenders, as well as their fintech partners, can take to mitigate the risks posed by Madden and the True Lender doctrine – a related legal issue that lenders and their partners face during the process of launching innovative bank partnership efforts. Parties should carefully structure partnerships to reduce Madden and True Lender risk. In the meantime, we will continue to monitor this case, as well as the corresponding challenge to the OCC’s Madden Fix.

NYDFS’s New (and Expanded) Servicer Vendor Management Expectations

NYDFS’s New (and Expanded) Servicer Vendor Management ExpectationsOriginally proposed by the New York Department of Financial Services (NYDFS) in 2019 and constituting what the Mortgage Bankers Association has described as “the first major update to Part 419 since its adoption almost 10 years ago,” the new Part 419 of Title 3 of NYDFS regulations covers a range of significant issues impacting the servicing community. These changes include Section 419.11, which imposes significant vendor management expectations on financial services companies servicing borrowers located in the state of New York. With an effective date of June 15, 2020, time is of the essence for servicers to ensure their vendor management programs and processes meet NYDFS expectations.

Introduction

Over the past decade, most financial service companies have comprehensively overhauled their enterprise vendor management programs to conform with federal regulatory expectations, such as those promulgated by the Office of the Comptroller of the Currency, the Bureau of Consumer Financial Protection (CFPB), and the Federal Deposit Insurance Corporation. As federal regulators have adopted a somewhat less aggressive approach under the current administration, state regulators, particularly NYDFS, have moved to fill the vacuum. While Section 419.11 incorporates aspects of existing federal regulatory guidance, it also includes elements likely not already incorporated into existing servicer vendor management programs. As such, bank counsel as well as impacted subject matter experts within the organization, such as enterprise risk management groups and servicing teams on the business side, must develop and implement a holistic internal review program. Perhaps equally importantly, the organization must preserve appropriate supporting documentation in preparation for the inevitable NYDFS requests for information.

Applicability

Part 419 is intentionally designed to have extremely broad applicability and defines a “servicer” as “a person engaging in the servicing of mortgage loans in this State whether or not registered or required to be registered pursuant to paragraph (b-1) of subdivision two of Banking Law section 590.”  The definition of “servicing mortgage loans” is similarly broad and encompasses traditional mortgage servicing activity, reverse mortgage servicers, and entities that directly or indirectly hold mortgage serving rights.

Specific NYDFS Vendor Oversight Expectations

At the outset, it is important for a scoping purpose to understand the nature of the vendors NYDFS expects to be covered under Part 419. Section 419.1 defines “third-party provider” as “any person or entity retained by or on behalf of the servicer, including, but not limited to, foreclosure firms, law firms, foreclosure trustees, and other agents, independent contractors, subsidiaries and affiliates, that provides insurance, foreclosure, bankruptcy, mortgage servicing, including loss mitigation, or other products or services, in connection with the servicing of a mortgage loan.”  This is a very broad definition that, as discussed below, occasionally appears to run counter to some of the granular requirements of Part 419.11, which seem designed to apply specifically to legal services provided by traditional default firms.

Part 419.11 opens with the mandate that regulated entities must “adopt and maintain policies and procedures to oversee and manage third-party providers” in accordance with Part 419. Accordingly, even before the subpart numbering begins, regulated entities have their first process-based takeaway: The regulated entity should review each specific, individual mandate in Part 419 and confirm that it is expressly covered in an applicable policy and procedure. This chart or other tracking document should be separately maintained by the regulated entity in case it needs to be provided or used as a roadmap in discussions with NYDFS.

419.11(a) – Subsection (a) itemizes the basic components NYDFS expects to see in an effective oversight program: “qualifications, expertise, capacity, reputation, complaints, information systems, document custody practices, quality assurance plans, financial viability, and compliance with licensing requirements and applicable rules and regulations.” The good news is that each of these elements likely is already covered under vendor management programs designed to satisfy existing federal regulatory requirements.

419.11(b) – An additional component of the 419.11 vendor oversight program is furnished in subsection (b), which states “[a] servicer shall require third-party providers to comply with a servicer’s applicable policies and procedures and applicable New York and federal laws and rules.” There are two elements to this expectation. First, the “shall require” requirement is likely addressed through contractual provisions in the underlying contract between the regulated entity and the vendor. Second, the regulated entity vendor management program will need to include validation of this contractual provision. Again, however, this likely is already part of the regulated entity’s vendor management program.

419.11(c) – It is a foundational principle of financial services vendor management that a regulated entity does not evade liability merely by outsourcing a function to a vendor. Subsection (c) then serves only as a reminder for those regulated entities that might have felt any inclination to forget that rule: “A servicer utilizing third-party providers shall remain responsible for all actions taken by the third-party providers.”

419.11(d) – One of the most significant elements of 491.11 is the disclosure requirement in subsection (d): “A servicer shall clearly and conspicuously disclose to borrowers if it utilizes a third-party provider and shall clearly and conspicuously disclose to borrowers that the servicer remains responsible for all actions taken by third-party providers.” Here is the first provision in 419.11 that may well touch on a gap that currently is not covered by most regulated entity vendor management programs. Unlike the previous subsections discussed, this is not an oversight expectation, but an affirmative disclosure expectation. There is little guidance as of yet on how and where these disclosures must be made, but servicers must act proactively and aggressively to develop a strategy that not only makes these disclosures, but also makes them “clearly and conspicuously.” Note that regulated entities also will be working to make the separate Affiliated Relationship Disclosure under 491.13(a), if applicable, which may be folded into the 491.11(d) disclosure.

419.11(e) – NYDFS further injects itself into the vendor management process in 419.11(e) where it not only identifies the expected frequency of vendor reviews (not less than annually), but also six specific components that must be included in the vendor due diligence. Note that some of the elements set forth, such as preparation of foreclosure and bankruptcy documents (subsection (e)(1)), original document practices (subsection (e)(4)) and sanctions and disciplinary actions (subsection (e)(6)), seem designed with law firms in mind and may not be applicable to more traditional, non-legal vendors. Regardless, those regulated entities with programs that allow for 18-, 24- or 36-month review cycles for low-risk vendors will need to reassess and recalibrate those schedules in order to meet the NYDFS yearly review cycle expectation.

In terms of who performs the review, subsection (e) makes clear that the review may not be performed by representatives of the business: “The review shall be conducted by servicer employees who are separate and independent of employees who prepare foreclosure or bankruptcy affidavits, sworn documents, declarations, or other foreclosure or bankruptcy documents.” While the wording of subsection (e) is somewhat awkward (again it seems to focus on law firms as vendors), the call for independence is not a new requirement; OCC 2013-29, for example, included a requirement for “independent reviews.” Most larger regulated entities will already have their vendor oversight programs performed by independent risk management personnel but, where an entity does not have such a group, it either will need to create one or hire an independent vendor, such as outside counsel, to perform the necessary work.

419.11(f) – Establishment of appropriate and effective lines of communication is captured in the two elements of subsection (f). The first requires the regulated entity to communicate appropriate point of contact information to all its vendors so that they “have appropriate and reliable contact information for servicer employees who possess information relevant to the services provided by the third-party provider.” The second sentence is specifically aimed at law firms and requires regulated entities to “ensure foreclosure and bankruptcy counsel have an appropriate servicer contact to assist in legal proceedings and to facilitate loss mitigation questions on behalf of a borrower.” The creation and maintenance of escalation contacts is not new and, again, this should be an area already covered by regulated entities. However, this provides an opportunity for regulated entities to ensure all contacts are current and properly documented.

419.11(g) – Another precept of effective vendor management is that issues identified during oversight activities be remediated and, where appropriate, that action be taken against the vendor up to and including termination of the vendor. This expectation is captured in subsection (g), which states simply “A servicer shall take appropriate remedial steps if a servicer identifies any problems through the review required by subdivision (e) of this section or otherwise, including terminating its relationship with a third-party provider.” Again, this should already be part of the vendor management program of the regulated entity and should not require significant structure revision of the existing program.

419.11(h) – Finally, subsection (h) returns to the issue of interactions with and oversight of counsel and “those with the authority to fully dispose of the case concerning foreclosure proceedings.” The policies to be developed by the regulated entity must address three points identified by NYDFS. Specifically, they must (1) address “how notice will be provided to foreclosure attorneys and trustees regarding a borrower’s status for consideration of a loss mitigation option and whether the borrower is being evaluated for, or is currently in, a trial or permanent modification;” (2) “ensure that its foreclosure attorneys comply with the requirements of New York Civil Practice Law and Rules Section 3408 with regard to mandatory settlement conferences in residential foreclosure actions;” and (3) “ensure that its foreclosure attorneys comply with all applicable legal requirements including all relevant Administrative Orders of the Chief Administrative Judge of the Courts of New York.” For those regulated entities that manage law firms in a workstream outside of their traditional enterprise risk management programs, the personnel involved in that workstream will need to ensure their program also meets NYDFS requirements.

Conclusion

Any financial services company that believes it is subject to the requirements of Part 419 should ensure that an appropriate working group has been created to review the applicable vendor management requirements of 419.11. Institutional change, particularly at the enterprise vendor management level, does not occur immediately. It will take time to identify the relevant internal stakeholders, review the specific requirements of 419.11, determine the policy, procedure, or operating tool gaps that need to be filled, develop the measures necessary to fill those gaps, and then obtain all necessary operational approvals to implement those measures. With 419.11 now effective, NYDFS is empowered to audit and inspect regulated entities to ensure compliance with existing federal regulatory requirements. Servicers that have not yet finalized their approach to 419.11 are encouraged to do so as soon as possible.

HUD Issues Final Rule on the Fair Housing Act’s Disparate Impact Standard

HUD Issues Final Rule on the Fair Housing Act’s Disparate Impact StandardOn September 3, 2020, the U.S. Department of Housing and Urban Development (HUD) issued its final rule on the implementation of the Fair Housing Act’s disparate impact standard. The Fair Housing Act (FHA) prohibits discrimination in many housing-related activities on the basis of race, color, religion, sex, disability, familial status, and national origin. For at least the past four decades, HUD and federal courts have read the FHA to prohibit “disparate impact” discrimination, which is conduct that, while not motivated by discriminatory intent, has a discriminatory effect. The final rule becomes effective 30 days from the date of publication in the Federal Register.

The path to the most recent disparate impact final rule has been long and circuitous. In February 2013, HUD codified its long-held view that the FHA bans disparate impact discrimination by issuing a rule entitled Implementation of the Fair Housing Act’s Discriminatory Effects Standard. That rule established a three-part, burden-shifting test to determine whether a housing practice that results in discrimination violates the FHA.

However, in 2015, the U.S. Supreme Court decided Texas Department of Housing and Community Affairs v. Inclusive Communities, in which a non-profit organization claimed that policies of the Texas Department of Housing and Community Affairs regarding the distribution of low-income housing development tax credits resulted in discrimination against African Americans in violation of both 42 U.S.C. § 1983 and the FHA. In Inclusive Communities, the Supreme Court did not rely upon HUD’s 2013 disparate impact, burden-shifting test. Rather, the court undertook its own analysis, resulting in standards that differed from HUD’s rule. While holding that the FHA prohibited disparate impact discrimination, the decision also established several guard rails designed to “protect potential defendants against abusive disparate impact claims.” For instance, the court held that a disparate impact claim cannot be sustained solely by evidence of a statistical disparity. Instead, the court enacted a “robust causality” rule requiring that a plaintiff show that a policy or procedure actually caused the disparity.

Several years after Inclusive Communities, in June 2018, HUD issued an advanced notice of proposed rulemaking purporting to realign its disparate impact regulation to better match the Supreme Court’s holding. In August 2019, HUD issued the proposed rule, very similar to this recently released final rule, that sought to align HUD’s disparate impact analysis with the standards applied by the Supreme Court in Inclusive Communities. After more than two years, HUD finally issued the final rule.

Through its final rule, HUD aims to adopt the disparate impact analysis applied in Inclusive Communities. The final rule creates a new burden-shifting framework for disparate impact claims. Under the rule, a plaintiff must, as a threshold matter, sufficiently plead facts to support that a specific, identifiable policy or practice has a discriminatory effect, and that the challenged policy or practice was “arbitrary, artificial, and unnecessary to achieve a valid interest or legitimate objective.” The plaintiff must further plead that the challenged policy or practice has a disproportionately adverse effect on members of a protected class, that the specific policy or practice is the direct cause of the discriminatory effect (i.e., robust causality), that the alleged disparity caused by the policy or practice is significant, and that there is a direct relation between the injury asserted and the injurious conduct alleged.

If a court finds that a plaintiff sufficiently pleads facts to support each of the requirements above, HUD’s rule then provides the new burden-shifting test, which is summarized as follows:

  • The plaintiff must first show by a preponderance of the evidence that the challenged policy or practice has a disproportionately adverse effect on members of a protected class, that the specific policy or practice is the direct cause of the discriminatory effect, that the alleged disparity caused by the policy or practice is significant, and that there is a direct relation between the injury asserted and the injurious conduct alleged.
  • A defendant may then rebut the plaintiff’s allegation that the challenged policy or practice is arbitrary, artificial, and unnecessary by producing evidence showing that the challenged policy or practice advances a valid interest and is therefore not arbitrary, artificial, and unnecessary.
  • If a defendant rebuts a plaintiff’s assertion under (1) above, the plaintiff must prove by a preponderance of the evidence either that the interest(s) advanced by the defendant are not valid or that a less discriminatory policy or practice exists that would serve the defendant’s identified interest(s) in an equally effective manner without imposing materially greater costs or burdens on the defendant.

In addition, the rule lists a number of defenses that may be used during and after the pleading stage, including that the plaintiff failed to sufficiently plead facts to support the allegations and that the defendant’s policy or practice is reasonably necessary to comply with certain third-party requirements. In administrative cases, HUD will only pursue civil money penalties in a disparate impact case where the defendant has previously been adjudged within the last five years to have violated the FHA.

The language of the final disparate impact rule will not prove too surprising to anyone who has followed the rulemaking process. However, the theory of disparate impact liability has always been, and remains, complicated. Although the final rule appears to reduce the burden on defendants, it also provides additional layers of complexity through the new burden-shifting analysis. Thus, while the proposed rule is likely welcome relief to businesses that are vulnerable to disparate impact claims, it will likely not decrease the number of Fair Housing Act claims and may very well increase the costs to defend the claims.

Federal Agencies to Update Q&As Regarding Flood Insurance

Federal Agencies to Update Q&As Regarding Flood InsuranceIt has been nine years since the Interagency Questions and Answers Regarding Flood Insurance (Flood Insurance Q&As) have seen any revisions. But that’s all about to change. Under the National Flood Insurance Reform Act of 1994 (Reform Act), the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Farm Credit Administration, and the National Credit Union Administration (collectively, the Agencies) were required to revise their flood insurance regulations. In compliance with the Reform Act, the Agencies released a joint final rule in 1996. After promulgation of the joint final rule, commenters raised a number of diverse issues regarding the proposed rule. Thus, in 1997, the Agencies issued the Flood Insurance Q&As, which were last revised in 2011, to provide guidance for compliance with the new joint rule.

In late June 2020, the Agencies issued new proposed Q&As to “reorganize, revise, and expand” the guidance due to the substantial changes to flood insurance requirements under the Biggert-Waters Flood Insurance Reform Act of 2012, the 2014 Homeowner Flood Insurance Affordability Act, and the regulations issued to implement these laws. The revisions are meant “[t]o help lenders meet their responsibilities under Federal flood insurance law and to increase public understanding of their flood insurance regulations.” The “significant topics” addressed by the proposed revisions include “major amendments to flood insurance laws with regard to the escrow of flood insurance premiums, the detached structure exemption, and force-placement procedures.” Additionally, the Agencies are also proposing to reorganize the Q&As into “new categories by subject to enhance clarity and understanding for users, and improve efficiencies by making it easier to find information related to technical flood insurance topics.”

Once these new Q&As become final, they will supersede the 2009 and 2011 Q&As and supplement the Agencies’ other guidance or interpretations. The Agencies recently extended the comment period to the proposed Q&A revisions to November 3, 2020. In addition, the Agencies announced they will release another set of proposed Q&As regarding the private flood insurance rule, which provides that regulated lending institutions must accept a private flood insurance policy issued by an insurance company that meets certain conditions and provides flood insurance coverage at least as broad as the coverage provided under a standard flood insurance policy issued under the National Flood Insurance program for the same type of property. Over the next several weeks, we will address several of the proposed changes to the Q&As and the extent to which those changes impact flood insurance compliance of regulated institutions.

CDC Issues Eviction Moratorium, but Will It Survive Legal Challenge?

CDC Issues Eviction Moratorium, but Will It Survive Legal Challenge?The Centers for Disease Control (CDC) recently issued a sweeping moratorium on most evictions through the end of 2020 as a means to stop the spread of COVID-19, which will go into effect on September 4, 2020. According to government estimates, the order will cover up to 40 million renters nationwide. This unprecedented exercise of power, however, may not withstand the legal challenges that are sure to be brought by landlords and property owners.

The moratorium applies to residential properties nationwide and is available for tenants who earn no more than $99,000 in annual income for an individual or $198,000 for a couple. To halt an eviction, a covered tenant must provide notice to his landlord or the owner of the property under penalty of perjury that he cannot pay the full rent due to substantial loss of income and an eviction would likely render him homeless or force him to move into a “shared living setting.” The order does not provide any financial assistance or other relief for landlords and property owners.

The order is not clear as to whether it bars evictions of persons occupying properties that are owned by a mortgagee or third party after a mortgage is foreclosed. The order expressly states that it does not prohibit foreclosures on home mortgages, but the CDC stops short of saying that the order does not apply to foreclosed properties. The order defines “evict” as applying to an “owner of a residential property, or other person with a legal right to pursue eviction.” The order also refers ambiguously to “housing contracts” and “housing payments,” rather than exclusively dealing in terms of rental or lease agreements and payments. However, the moratorium only applies to “residential property,” which is defined as “any property leased for residential purposes”—arguably not applying to property occupied following foreclosure.

As a basis for this extraordinary exercise of power, the CDC’s order cites section 361 of the Public Health Service Act (PHSA). This provision allows the CDC to make and enforce regulations necessary “to prevent the introduction, transmission, or spread of communicable diseases from foreign countries into the States or possessions, or from one State or possession into any other State or possession.” The CDC’s order also cites 42 CFR § 70.2, a portion of the Code of Federal Regulations that allows the CDC to “take such measures to prevent such spread of the diseases [deemed] reasonably necessary” when the CDC determines that measures taken by any state are insufficient to stop the spread of diseases.

In the past, section 361 has been used to forcibly quarantine a nurse after caring for Ebola patients in Africa, regulate the sale of raw milk, and prohibit the sale of baby turtles, among other things. The CDC’s use of section 361 to prohibit evictions nationwide, however, is a magnitude beyond any previous exercise of power under this law.

When the CDC’s order is invariably challenged in courts, the order might be struck down for various reasons, including that the order violates the Administrative Procedures Act or violates the Constitution’s Takings Clause, Due Process Clause, Commerce Clause, or Contracts Clause. In the meantime, mortgagees proceeding with evictions risk violating the CDC’s order. Stayed tuned for further updates.

Tenth Circuit Agrees with the Fifth Circuit – Private Student Loans May be Dischargeable in Bankruptcy

Tenth Circuit Agrees with the Fifth Circuit – Private Student Loans May be Dischargeable in BankruptcyThe 10th Circuit has joined several circuit courts holding that private student loans are dischargeable in bankruptcy. In McDaniel v. Navient Solutions, a case of first impression in the 10th Circuit, the court concluded that an educational loan does not constitute “an obligation to repay funds received as an educational benefit” under Section 523(a)(8)(A)(ii) of the Bankruptcy Code. In Fall 2019, the Fifth Circuit in Crocker v. Navient Solutions similarly held that private educational loans are not statutorily excepted from discharge, absent undue hardship. In other words, they can be discharged like other debt. We previously blogged about the Crocker case, which was widely cited in the McDaniel opinion.

The McDaniel case involved a Chapter 13 filing where the debtors had eleven student loan accounts, owing approximately $200,000. The debtors’ confirmed Chapter 13 plan provided that “[s]tudent loans are to be treated as an unsecured Class Four claim or as follows: deferred until end of plan.” A standard discharge order was issued, and the case was closed. After the discharge, the McDaniels made approximately $37,000 in payments on the loans. The debtors subsequently reopened the bankruptcy case and filed a complaint against Navient seeking (i) a declaratory judgment that their student loans were discharged in bankruptcy and (ii) damages arising from discharge violations. On appeal, the court addressed (1) whether it was res judicata that the student loans were excepted from the discharge based on the confirmed Chapter 13 plan and (2) whether the student loans are non-dischargeable under § 523(a)(8)(A)(ii).

The 10th Circuit summarily rejected the assertion that the plan established that the student loans were excepted from discharge because the plan contained no explicit statement or determination as to the dischargeability of the student loans. The 10th Circuit next tackled whether private educational loans are subject to discharge. Section 523(a)(8)(A)(ii) of the Bankruptcy Code provides:

(8) unless excepting such debt from discharge under this paragraph would impose an undue hardship on the debtor and the debtor’s dependents, for –

(A)(i) an educational benefit overpayment or loan made, insured or guaranteed by a governmental unit, or made under any program funded in whole or in part by a governmental unit or nonprofit institution; or

(ii)  an obligation to repay funds received by an educational benefit, scholarship, or stipend; or

(B) any other educational loan that is a qualified education loan, as defined in section 221(d)(1) of the Internal Revenue Code of 1986, incurred by a debtor who is an individual. (emphasis added)

Like the Fifth Circuit in Crocker, the 10th Circuit emphasized that exceptions to discharge should be interpreted narrowly in favor of the debtor. The court then walked through the various statutory canons to interpret the statute. The 10th Circuit focused on use of the terms “educational loan” versus “obligation to repay funds received as an educational benefit” and concluded that these clearly mean separate things.  The term “educational benefit” is more akin to the other terms in section (A)(ii) (scholarship and stipend) which “signify granting, not borrowing.” In the court’s view, normal speakers of English use the term “benefits” in the context of things such as health benefits, unemployment benefits or retirement benefits to imply a payment, gift or service, not something that needs to be repaid. If section (A)(ii) included repaying private student loans as an “educational benefit,” section (A)(i) would be redundant and contrary to the canon against surplusage. The court concluded that “an obligation to repay funds received as an educational benefit” signifies a conditional grant of funding for education – akin to a stipend and scholarship – as opposed to a loan of funds for education. In other words, “[s]ubsection (A)(ii) was designed to except from discharge grants of money that are tied to service obligations – a category wholly distinct from loans.”

Following the 2005 amendments to Section 523, commentators painted with a broad brush alleging that private student loans were now dischargeable. However, the McDaniel case reflects the growing trend permitting a debtor to discharge certain private student loans. Private student lenders and servicers should take particular note of this case as the latest chapter and prepare for similar challenges.

Agencies Offer Regulatory Assistance in Disaster Affected Areas

Agencies Offer Regulatory Assistance in Disaster Affected AreasOn the first day of National Preparedness Month, the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the National Credit Union Administration, and the Conference of State Bank Supervisors issued a joint statement recognizing the impact of Hurricane Laura and the California wildfires on the operations of financial institutions.

Through the joint statement, the agencies announced they will provide the following regulatory assistance:

  • Lending: The agencies advised that actions taken to alter the terms of existing loans in affected areas “should not be subject to examiner criticism” and that they “will consider the unusual circumstances these institutions face” in supervising any institutions that are affected by these disasters. The agencies recommended that modifications of existing loans should be evaluated individually, considering the circumstances of each borrower and loan, to determine whether such modifications would constitute troubled debt restructurings.
  • Temporary Facilities: Where regulated institutions face challenges in re-opening facilities after Hurricane Laura and the California wildfires, the agencies “will expedite, as appropriate, any request to operate temporary facilities to provide more convenient availability of services to those affected by these disasters.” Affected institutions may begin the approval process for temporary facilities through a phone call to their primary regulator.
  • Publishing Requirements: Because damage caused by Hurricane Laura and the California wildfires may affect compliance with notice requirements for branch closings, relocations, and temporary facilities, regulated institutions should contact their primary regulator if they experience difficulties in complying with publishing or notice requirements.
  • Regulatory Reporting Requirements: Any regulated institution that anticipates difficulty in complying with reporting requirements should contact the institution’s primary regulator to discuss. The agencies advised that they “do not expect to assess penalties or take other supervisory action against institutions that take reasonable and prudent steps to comply with the agencies’ regulatory reporting requirements if those institutions are unable to fully satisfy those requirements because of these disasters.”
  • Community Reinvestment Act (CRA): Financial institutions may receive CRA consideration for community development loans, investments, or services that revitalize or stabilize a federally designated disaster area.

National Preparedness Month is recognized each September to promote the importance of disaster planning. The theme for September 2020 is “Disasters Don’t Wait. Make Your Plan Today.” Through its website ready.gov, the Federal Emergency Management System provides a number of resources for families and communities, including suggested weekly activities. For example, Week 1 is “Make a Plan,” which encourages friends and family to determine how they will communicate before, during, and after a disaster considering the specific needs of their household.

Over the next several weeks, we will provide additional information about National Preparedness Month and steps financial institutions can take to make their own plan that addresses customer needs and regulatory requirements during disasters.

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