CrunchedCredit : Capital Markets Finance and Real Estate Attorneys

The Cherryland case (discussed here and here) concerns one lender’s enforcement of a non-recourse guaranty pursuant to which the guarantor agreed to be personally liable in the event the borrower failed to maintain its status as a single purpose entity (which included an agreement by the borrower to remain solvent). As you might have guessed by now, the borrower failed to make payments due under the loan and the lender foreclosed, leaving a $2.1 million deficiency. The lender sued the guarantor for the deficiency, arguing that the borrower’s insolvency breached its single purpose entity requirements. A Michigan lower court agreed with the lender, finding the guarantor liable for the full amount of the loan under the guaranty as a result of the borrower’s inability to remain solvent. The Michigan Court of Appeals initially agreed with the lower court, noting that the failure of the borrower to remain solvent, regardless of the reason, was a violation of the single purpose entity requirements of the loan documents.

The guarantor appealed this ruling, and while on appeal, the Michigan legislature passed the Nonrecourse Mortgage Loan Act (the “Act”), a quirky bit of legislation which sought to protect guarantors from their own bad bargains. The Act provides, in relevant part, that a post-closing solvency covenant should not be used, directly or indirectly, as a nonrecourse carveout or as the basis for any claim or action against a borrower or any guarantor or other surety on a nonrecourse loan (with any such provision being deemed invalid and unenforceable).

With the Act then on the books, the Michigan Supreme Court remanded the Cherryland case back to the Michigan Court of Appeals, which overruled its prior ruling and found that, as a matter of public policy, a guarantor could not be liable to a lender as a result of a borrower’s insolvency. While any first year law student can tell you that invalidating a contract entered into by two sophisticated parties with a statute passed years after said contract is entered into raises numerous constitutional concerns, the Michigan Court of Appeals determined that the public purpose of averting “a broader economic problem of immense proportion in the interest of the public good” outweighed any such constitutional concerns. A more cynical blogger might interpret the legislation as protecting the very private interests of local landowners and developers at the expense of banks and investors (not always local) – but we won’t draw those same conclusions.

Where does this leave us? Prior to the Cherryland decision, there had been a string of recent cases in which courts either found or upheld recourse liability on the part of guarantors (discussed here) giving lenders confidence that their guaranty would be similarly upheld in court if the need for litigation ever arose. This decision has brought unwanted uncertainty to non-recourse lending as this case lays out a map to effectively undermine guaranties contracted between sophisticated parties. The Michigan Court of Appeal’s decision to affirm the 2012 legislation, which invalidates a guaranty made years prior to its enactment, may embolden other states to pass similar laws (protecting local guarantors and sponsors from the bad bargains they made in the boom years, and preventing lenders from exercising their contracted rights), which is something we should all pay attention to.

By: Matt Ginsburg and David Pildis
 

In its final rule, HUD set out a three pronged burden-shifting formula to determine whether FHA liability has been triggered.  First, the plaintiff has a burden to demonstrate that a practice has a discriminatory effect.  There is no requirement that the plaintiff prove discriminatory intent. Second, the burden shifts to the defendant to prove it had a legally sufficient justification for the challenged practice, which will require a showing that the challenged practice is (i) necessary to achieve one or more substantial, legitimate, nondiscriminatory interests of the defendant, and (ii) those interests could not be served by another practice that has a less discriminatory effect.  Third, the burden shifts back to the plaintiff, who may prevail by showing that another practice with a less discriminatory effect could be used.

HUD downplayed concerns that complying with the QM rule could cause lenders to be at greater risk of fair lending litigation on the grounds that their new rule does not change the substantive law recognizing discriminatory effects liability. Nonetheless, the banking industry is strongly opposed to this rule. HUD did not provide any comfort or safe harbors and instead chose to leave the question of “sufficient justification” to the courts.  This rule will only compound the concerns lenders must sort through as they work to develop underwriting practices to comply with the QM/ATR rules. Patrick Dolan, Robert Ledig, Thomas Vartanian and CrunchedCredit’s own Ralph Mazzeo have provided a summary and analysis of HUD’s new rule on behalf of Dechert’s Finance and Real Estate Group and Financial Services Group, which can be found here.

By: Laurie Nelson and Linda Ann Bartosch

Still pending are regulations that could likely have the consequence of restricting credit, such as the Consumer Financial Protection Bureau’s (the “CFPB”) ability-to-repay regulations incorporating the “Qualified Mortgage” (“QM”) standard which we have written about frequently including here and here as well as the interagency “Qualified Residential Mortgage” (“QRM”) exception to the risk retention requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) which we have also written about here and here. In addition, revised capital rules may mean that holding mortgage loans other than what regulators deem low-risk mortgage loans will trigger increased capital requirements for certain financial institutions. These developments may significantly reduce lender interest in originating non-traditional loans, which, in turn, may trigger disparate impact claims. Fitch Ratings said last week that “nontraditional mortgages, viewed as high risk by regulators, may be effectively eliminated from broad availability at regulated banks.”

This topic was just addressed in a Webinar presented by Dechert partners Ralph Mazzeo, Bob Ledig, Tom Vartanian and Ben Rosenberg titled “Living With the Consumer Financial Protection Bureau.” Nearly 200 people registered for the Webinar that covered such topics as: Understanding the CFPB: rulemaking vs. enforcement; Who does the CFPB have jurisdiction over?; CFPB and the mortgage industry; CFPB and fair lending; and CFPB enforcement considerations, including relationships with state attorneys general.

A quick tutorial on three theories of liability related to discrimination in lending:

1. Liability for overt discrimination in lending exists when a lender overtly discriminates on a prohibited basis (e.g., lender offers potential borrowers Mortgage Products X, Y and Z but offers a protected class of borrowers only Mortgage Product Y).

2. Disparate treatment liability results when a lender treats a minority applicant differently than a similarly situated majority applicant (e.g., lender denies or charges minority applicants more for mortgage products than similarly situated majority applicants).

3. Disparate impact liability can be triggered when a seemingly facially neutral policy or practice that is applied equally to all applicants disproportionately excludes or burdens certain persons on a prohibited basis (e.g., lender requires applicants to meet certain loan qualification criteria such as a minimum downpayment).

The law on disparate impact as it applies to lending discrimination is subject to continuing dispute and may ultimately require a Supreme Court ruling. What we know is that, under the view of federal regulators, evidence of discriminatory intent is not necessary to establish that a lender’s policy or practice that has a disparate impact is in violation of the Fair Housing Act or the ECOA. And we know that a policy or practice that has a disparate impact is not, by itself, proof of a violation because such policy or practice may be justified by “business necessity.” However, even with a business necessity justification, such policy or practice may still be a violation if some alternative policy or practice could serve the same purpose with less of a discriminatory effect.

This month, the DOJ entered into a proposed settlement with Luther Burbank Savings (“Burbank”) to resolve discrimination claims under the Fair Housing Act and ECOA after the DOJ alleged that Burbank’s minimum loan amount (generally $400,000) for single-family residential mortgage loans had a disparate impact on African-American and Hispanic borrowers that was not justified by business necessity.  Such settlements are not binding court precedent but they certainly have an effect on the policies of lending institutions. Another effect of such settlements may be that regulators and the CFPB may be more inclined to pursue disparate impact fair lending claims. See the recent “U.S. Department of Justice Turns Spotlight on Disparate Impact Discrimination Claims.”

Government actions that encourage or mandate restrictive lending standards have the potential to have a disparate impact on certain minority borrowers. Regulators may have to reconcile competing directives to lenders to maintain strict credit standards while avoiding or limiting policies that have a disparate impact. Institutions may find themselves in a difficult position between these two government objectives.

Lenders should carefully review their business justifications for lending policies that may have a disparate impact and consider whether there are acceptable alternatives that could have less of a disparate impact.

By Laurie Nelson

Under the new law, if a recorded mortgage fails to state the maturity date, the lien will automatically expire 10 years after the execution date of the mortgage (or if the mortgage does not state the execution date, the date the mortgage was recorded). Furthermore, any existing mortgage which is older than 10 years and fails to state a maturity date will be deemed to expire on July 1, 2012. Although the new law allows a holder of a mortgage to correct this issue by recording an affidavit in the county where the applicable mortgage is recorded, the affidavit must be recorded prior to the later of July 1, 2012 or 10 years following the execution date of the mortgage.

To the extent you have not already done so, if you are a holder or servicer, you should review your Indiana mortgages now to determine if the new Indiana mortgage law has an adverse impact on your existing mortgage liens. It's better to be safe than sorry. 

By:  Stewart McQueen

But faster than you could say “deficiency judgment,” it appears as if both rulings will be written off the books.  A mere 24 hours after we weighed in on the topic, the Michigan Senate introduced Senate Bill 992 – a bipartisan creation known as the “Nonrecourse Mortgage Loan Act” (click here for a full text of the bill).  Not only would the bill prevent any forward looking solvency covenant from being used as a non-recourse carveout going forward, it would also retroactively apply to all nonrecourse loans now in existence, and to any pending action for which appeal rights have not been exhausted (ie. Cherryland and Chesterfield).  The bill sped through both chambers of the legislature and is now only a few strokes of Governor Rick Snyder’s pen away from becoming the law of the land in the Great Lakes state. 

No doubt that investors and developers across the state are patting themselves on the back (though constitutional scholars - see Article I, Section 10, Clause 1 - may be cringing).  The strong and swift legislative response was the result of a determined effort by Michigan real estate heavyweights to offset the damage done by the courts.  Industry leaders and trade groups, all with much at stake, conferred with legislators and even drafted a letter to warn them of the destructive implications of the rulings – the prevention of future development and the continued weakening of the state’s economic recovery – as part of their ultimately successful lobbying effort in support of the bill.

So – at least for now – the effect of these cases may not be so remarkable after all.  Still, it remains to be seen how other states’ judicial and legislative branches will react if faced with a similar issue.  Luckily for the stunned recourse guarantors left to pick up the tab in Michigan, it looks like this one’s “on the house.”

By: Matthew Ginsburg and Eric Kotloff

While the stylized program analyzed by the CBO is not an analysis based on a legislative proposal (and instead is an analysis based on a CBO-developed probabilistic model of borrower behavior, estimated from the historical performance of GSE and FHA mortgage loans), the analysis, nevertheless, serves as a basis to assess whether (any similar) refinancing program would have a significant impact on the U.S. housing market.

The stylized program analyzed by the CBO is aimed at helping those distressed borrowers who do not qualify for the current federal refinancing programs (i.e., HAMP, HARP and the FHA) by loosening eligibility requirements. The thought is—loosen eligibility requirements (e.g., relax LTV tests, waive appraisal requirements, limit borrower income tests, include existing loans guaranteed by the GSEs and FHA, etc.) and more distressed borrowers will be able to refinance their mortgages and avoid default. After all, even those contestants who are not smarter than a fifth grader know that avoiding default is beneficial to both the distressed borrowers and the economy at large.

Under these loosened eligibility requirements, the CBO estimates that the program would cause 2.9 million mortgages to be refinanced, resulting in 111,000 fewer defaults on loans and an estimated savings for the GSEs and FHA of $3.9 billion on their guarantee exposure, and from the borrowers’ perspective, the estimate savings within the first year is estimated to be $7.4 billion. Wow—you say…things are looking good. But (and wait for it because it is a BIG BUT), the CBO estimates that federal investors in MBSs, including the Federal Reserve, GSEs and Treasury would experience an estimated loss of $4.5 billion. And, now for the BIG BUT, non-federal investors (i.e., everyone else involved) would experience an estimated loss of $13-15 billion.

All of this loss for what (here is where we feel a sense of déjà vu): 

• a program that doesn’t help delinquent borrowers (i.e., borrowers most likely to default)—actually, the program specifically excludes delinquent borrowers and borrowers that have been late for 30 days within the past year—and sounds a lot like the existing federal programs HARP and HAMP, which have been criticized for not helping enough borrowers;
• a program that will have a net benefit on the economy of about 0, as the losses to investors will negate the gains to borrowers;
• a program, that in the end, probably won’t reach too many distressed borrowers, because many borrowers that wanted to refinance and could, one way or another, have already done so (remember, mortgage rates have been historically low for a few years now);
• a program that may end up increasing the GSEs and FHA guarantee exposure, as lenders will likely not agree to refinance unless the “put back” options and standard reps and warrants about the loans themselves are eliminated; and
• a program that does nothing for borrowers with significant negative equity to reduce the incentive for “strategic” default or the susceptibility to delinquency caused by life or other economic realities (think unemployment rate 9.1%).
   

We want to see an end to borrower delinquency and foreclosure as much as the next guy, but creating another program that has about as much chance of success as the Cubs winning the World Series is not the direction in which our hopes should be pitched.

By: Krystyna Blakeslee and Devin Swaney