Emerging Common Law Theories of Imputed Liability for Predatory Lending
Southern California (909)890-9192 in Northern California(925)957-9797
While assignee liability and the holder in due course doctrine has tended to dominate both the academic discussion of and the state legislative agenda regarding secondary mortgage market liability, it is by no means the only body of law potentially relevant to the subject. Indeed, a relatively overlooked group of common law doctrines may in the long run hold more promise in creating a secondary market incentive to police predation by loan brokers, originators, and servicers.
In reading predatory lending cases, it becomes clear that the judiciary is uncomfortable apportioning liability for predatory lending exclusively through the addlepated federal and state patchwork of assignee liability statutes. Indeed consumers and some courts have groped for common law doctrines that might provide some remedy for the concerted wrongdoing of secondary market financiers of predatory lending. It is currently unclear whether these cases promise to congeal into a more unified and systemic response to securitization of predatory loans. However, at least three possible theories have emerged which have the potential to re-apportion liability for predatory lending amongst parties to a home mortgage securitization structure: aiding and abetting liability, civil co-conspirator liability, and joint venture liability.
I have researched these common law theories, focusing on the extent to which courts have and may continue to deploy them in predatory mortgage lending disputes.
1. Aiding and Abetting
It is a long standing common law principle that a business or individual can be held liable for aiding and abetting the wrongful acts of another. The Restatement of Torts (Second) suggests that, “for harm resulting to a third person from the tortious conduct of another, a person is liable if he … (b) knows that the other’s conduct constitutes a breach of a duty and gives substantial assistance or encouragement to the other so to conduct himself.” The alleged aider-abetter itself need not owe a duty of care to the victim. n368 And most courts agree that the alleged aider-abetter need not reap a personal financial benefit from the wrongful conduct to be held liable. But many courts consider financial gain by the alleged aider-abetter as evidence of knowledge of and/or assistance to the tortious behavior. Moreover, the alleged aider and abetter need not even posses a wrongful intent, provided that she knows the conduct in question is tortious. Courts are also amenable to use of the common law doctrine of aider-abetter liability to enforce statutes which do not by their own terms define or contemplate liability for aiding and abetting. While most aider-abetter liability cases involve allegations of fraud, some courts have been receptive to applying aider-abetter liability to unfair and deceptive trade practice claims as well.
A small, but growing line of cases apply aider-abetter liability to a variety of different parties involved in predatory lending. For example, in a payday lending case, the New York Attorney General’s office successfully argued that a bank criminally facilitated evasion of the state’s usury law by allowing a non-bank agent to originate, service, and retain an ownership interest in payday loans. A federal district court in New York denied a motion to dismiss an aider-abetter liability claim against a mortgage closing attorney, who allegedly claimed to represent the borrowers when in fact he did not. A Pennsylvania case held that a real estate appraiser was potentially liable for predatory lending related claims because she acted in concert with other defendants. And an Illinois federal district court case refused to dismiss a common law fraud claim against an assignee of a predatory mortgage based on the allegation that the assignee “knew of the fraud, but nonetheless funded the loan.”
In the context of securitization of mortgage loans, the most emblematic recent aider-abetter liability case involves Lehman Brothers and First Alliance Mortgage Company. In In re First Alliance Mortgage Co., the Central District of California held that Lehman Brothers could be held liable for aiding and abetting fraudulent lending by First Alliance. Throughout the mid-to-late 1990s, a parade of state attorneys general, private consumers, and public interest organizations accused First Alliance of targeting senior citizens with misleading and fraudulent home refinance loans. Discovery revealed that Lehman Brothers was fully aware of these allegations. Nevertheless, Lehman Brothers extended First Alliance a large secured warehouse line of credit to initially fund predatory loans. After originating the mortgage loans, First Alliance then used Lehman Brothers’ services to securitize the loans for resale to investors on Wall Street. First Alliance used the proceeds of loans sold into securitization pools to pay down its line of credit, cover overhead costs, and initially reap handsome profits. First Alliance also retained the servicing rights to the loans, which gave the company the opportunity to make additional profits from servicing compensation paid by the trust, as well as other servicing related revenue, such as that gathered from late fees and refinancing delinquent loans. But, when predatory lending litigation brought by state attorneys general and the FTC (along with exposes in the Wall Street Journal and on national television) began to make First Alliance’s prospects look dim, First Alliance filed for bankruptcy. But before petitioning the bankruptcy courts for protection, First Alliance drew down 77 million dollars on its warehouse line of credit with Lehman Brothers. In bankruptcy proceedings, the bankruptcy trustee argued that because Lehman aided and abetted First Alliance’s fraudulent lending, Lehman’s security interest on the warehouse credit line should be equitably subordinated to other creditors, including First Alliance’s predatory lending victims. Ultimately the district court concluded that Lehman Brothers’ security interest would not be subordinated since the 77 million dollars Lehman had already coughed up had enriched the bankrupt company’s estate. But, before doing so, the court made clear that Lehman had aided and abetted fraud against the First Alliance’s customers. Given this finding, For their part, consumers involved in the class action have still not been compensated for fraudulent loans, many of which led to the loss of a family home. Lehman, which was a secured creditor, had its bankruptcy claim paid in full.
A second possible avenue of asserting liability for concerted wrongdoing in predatory lending securitization is civil co-conspirator liability. Generally a civil conspiracy is defined as “a malicious combination of two or more persons to injure another in person or property, in a way not competent for one alone, resulting in actual damages.” A conspiracy requires demonstration of an underlying unlawful act upon which the claim is based, as well as some form of combination or agreement between the co-conspirators.
It is well settled that where a conspiracy exits, liability for actions by one co-conspirator taken in furtherance of the conspiracy can be attributed to every co-conspirator, making each equally liable for the others’ acts. Courts treat parties to a civil conspiracy as joint tortfeasors with joint and several liability for all damages “ensuing or naturally flowing” from the act. Moreover, courts hold co-conspirators liable irrespective of whether they are the direct actor, and irrespective of the degree of involvement. n389 Courts distinguish co-conspirator liability from aider-abetter liability because, unlike a co-conspirator, an aider-abetter does not adopt as her own the wrongful act of the primary violator through concerted action or agreement.
Co-conspirator liability seems to have some promise in attributing wrongful actions of front-line players to behind the scenes financiers in securitization. In Williams v. Aetna Finance Company the Supreme Court of Ohio found a mortgage lender liable for fraud committed by a door-to-door salesman. The mortgage lender had an agreement to give the salesman a commission for loans he facilitated with the lender. The “pitchman” targeted neighborhoods with senior citizens who owned their homes free and clear, convincing them to borrow money for home repairs. The lender was liable for the pitchman’s behavior because it gave “access to loan money that was necessary to further his fraudulent actions against customers… .”
Other decisions have denied dismissal of civil co-conspirator liability claims for a range of mortgage lending industry participants, including brokers, home sellers, lenders, appraisers, and attorneys. In Herrod v. First Republic Mortgage, the Supreme Court of Appeals of West Virginia rejected the notion that the mere fact of securitization changes the application of co-conspirator liability rules, explaining that:
“[a] securitization model – a system wherein parties that provide the money for loans and drive the entire origination process from afar and behind the scenes – does nothing to abolish the basic right of a borrower to assert a defense to the enforcement of a fraudulent loan, regardless of whether it was induced by another party involved in the origination of the loan transaction, be it a broker, appraiser, closing agent, or another.”
While none of these cases involved extending liability to a seller, underwriter, or trustee in a securitization deal, the notion of a “pitchman” and a “financier” seems plausibly applicable to a lender and a seller or underwriter respectively. Although a pooling and servicing agreement will never explicitly say that an investment bank agrees to a deal despite an originator, broker, or servicer’s modus operandi of violating predatory lending laws, agreement can be shown through circumstantial evidence such as the financial incentives, available information, and tacit understanding amongst the parties.
3. Joint Venture
A final common law doctrine which may hold promise in creating greater accountability for structured financing of predatory lending is joint venture liability. A joint venture is an association of two or more persons designed to carry out a single business enterprise for profit, for which purpose they combine their property, money, effects, skill, and knowledge. Joint ventures arise out of contractual relationships, be they oral, written, express, or implied. While the precise formulation of elements varies, generally to form a joint venture:
 two or more persons must enter into a specific agreement to carry on an enterprise for profit;  their agreement must evidence their intent to be joint venturers;  each must make a contribution of property, financing, skill, knowledge, or effort;  each must have some degree of joint control over the venture; and  there must be a provision for the sharing of both profits and losses.
Where a joint venture does exist, courts generally rely on partnership law in judging the rights of the parties. Thus, courts hold joint venturers may be jointly and severally liable for debts of the venture including those incurred from tortious conduct. In general, a co-venturer is not liable for the willfully unlawful acts of another. But, where the unlawful act was within the actual or apparent scope of the joint venture, or where the co-venturer gave express or implied consent to the act, or even where the co-venturer failed to protect the victim from the act, he or she can be liable for the primary wrongdoer’s behavior.
As with aider-abetter and co-conspirator liability, a growing line of cases find co-venturer liability with respect to predatory lending allegations. For example, in George v. Capital South Mortgage Investments, the Kansas Supreme Court considered a large punitive damage award against a mortgage lender and an assignee. The case involved a defunct mortgage brokerage called Creative Capital Investment Bankers. The consumer-plaintiffs in the case hired Creative to assist them in obtaining a loan to purchase a home from a relative for $ 40,000. After swamping the family with a parade of silly and unnecessary documents, the mortgage broker obtained a signature on a loan contract with a principle of $ 60,000. The broker then instructed a closing agent to distribute less than the agreed purchase price for the home to the seller. The lender, who was apparently aware of the unusual terms, assigned the loan to a private individual at closing and gave the closing agent instructions to not inform the borrowers of the assignment. When the family learned that they had borrowed $ 20,000 that they never wanted nor received, they sued. Creative Capital did not appear at trial and the court gave the family a default judgment, which in all likelihood was uncollectible. Of greater import was the family’s claim that the lender and the broker were engaged in a joint venture to profit from the broker’s fraud and usury. At trial the jury agreed. On appeal, the Kansas Supreme Court found sufficient evidence to sustain the co-venturer verdict against the lender and assignee. The lender argued that it was a distinct corporation, located in a different state, and did not share office space, administrative services, or telephone lines. Looking past these arguments, the court pointed to frequent contact between the lender and the broker, as well as the lender’s insolvency in structuring the loan immediately preceding closing. The court sustained the jury verdict against the assignee by pointing to the undisclosed assignment at closing as evidence that the assignee was a participant in the joint venture. Moreover, the court pointed out that the fact that the assignee received much of the financial benefit from the unlawful charges suggested that the assignee had agreed to the joint venture.
While the George case did not involve securitization, there does not appear to be a principled reason why joint venture rules would be inapplicable to structured finance. In securitization deals, the pooling and servicing agreement is an explicit agreement to carry on an enterprise for profit by the different businesses involved in the conduit, including mortgage brokers, lenders, MERS, servicers, sellers, underwriters, trustees, and trusts, or an SPV taking a different legal form. Each of these parties fulfill a specific function within a structured finance deal and all have control over their own particular role. At least some of the parties in some cases agree to share in the losses and profits of the venture. For example, mortgage lenders frequently agree to repurchase non-performing loans from the trust.
Mortgage brokers are only paid if any given loan closes and conforms to the underwriting standards of the loan pool. Servicers agree that their fees are contingent on performance aspects of the loan, such as whether borrowers pay on time. Sellers and underwriters agree to accept the price they can receive from selling securities, which is in turn dependent on the reputation and behavior of the originators, brokers, and servicers. Trustees agree to share in profits and losses, since they accept compensation out of the proceeds of consumers’ monthly payments. And certainly a trust (or other type of SPV) itself agrees to share in profits and losses, given that trust income is completely dependent on performance of the loans it houses.
Following this reasoning, at least one court has found a triable issue of fact on the question of whether a securitization pooling and servicing agreement created a joint venture with respect to predatory lending allegations. In Short v. Wells Fargo Michael Short alleged that employees of Delta Funding, a mortgage lending company, closed a mortgage loan on his home when they came to his house with a stack of documents for him to sign. Mr. Short alleged that Delta never provided him any copies of the loan documents, nor gave any explanation of them at the informal closing. Delta Funding sold Mr. Short’s loan along with many others into a trust pursuant to a pooling and servicing agreement with Wells Fargo, a national bank regulated by the Office of the Comptroller of the Currency, agreeing to act as trustee. Under the pooling and servicing agreement, Countrywide Home Loans, Inc. agreed to service the loans. Eventually Mr. Short alleged that Countrywide gave Mr. Short notice that he owed two payments on his loan in one month. After several unsuccessful (and no doubt frustrating) attempts to contact Countrywide’s customer service, Countrywide eventually informed Mr. Short that he also owed nearly a thousand dollars in attorneys’ fees and other penalties in addition to his regular payment, plus the still unexplained extra monthly payment – all immediately due by certified check. Mr. Short also alleged that Countrywide had charged him fees that were not authorized under West Virginia statutes. Eventually Mr. Short obtained counsel and sued. The federal district court reviewed the general principles of joint venture. Then, the court pointed out that the parties explicitly divided up the revenue from various fees in the pooling and servicing agreement. The court concluded that “taking the evidence in the light most favorable to the plaintiffs, it would not be unreasonable for a jury to conclude that Delta Funding, Countrywide and Wells Fargo entered into a joint venture.”
IV. The Consumer Protection Critique of Mortgage Securitization Law
A. Ambiguity: Consumer Protection Laws Presume an Antiquated Model of Finance
Perhaps the one uniform feature of predatory lending law is its failure to recognize and account for the complex financial innovations that have facilitated securitization structures. Most consumer protection statutes, including the TILA (1968), the FDCPA (1977), the ECOA (1974), the FHA (1968), and the FTC’s holder in due course notice rule (1975) all preceded widespread securitization of subprime mortgages by over a decade. While this time frame is not meaningful in itself, it hints at a fundamental structural problem in the law.
One would expect little controversy in a term as fundamental as “creditor.” But, the word suggests a unitary notion of a single individual or business that solicits, documents, and funds a loan. For example, under the TILA, a creditor is “the person to whom the debt arising from the consumer credit transaction is initially payable on the face of the evidence of indebtedness.” This definition is important since the private cause of action creating the possibility of liability under the act extends only to “any creditor who fails to comply” with the Act’s requirements. While this definition resonates with the notion of a lender as we commonly think of it, this notion is increasingly discordant with reality. In the vast majority of subprime home mortgage loans, most of the actual tasks associated with origination of the loan, including especially face-to-face communication with the borrower, are conducted by a mortgage loan broker.
Because brokers usually do not fund the loan, they are not the party to whom the loan is initially payable. The absurd result is that the federal statute which purports to promote useful and accurate disclosure of credit prices, does not govern the business or individual that actually speaks to a mortgage applicant. Rather, liability for the statute is confined to errors in the complex paperwork, which many consumers have difficulty reading, and which are typically ignored in hurried loan closings long after borrowers arrive at decision on which broker and/or lender to use. Arguably the credit advertising restrictions in Part C of the statute reach mortgage loan solicitations by mortgage brokers. But these provisions are quite limited in their substantive reach. For example, they never explicitly prohibit misleading advertising or even false descriptions of loans. And even if they did, the statute does not grant a private cause of action to sue for advertising violations anyway.
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Southern California (909)890-9192 in Northern California(925)957-9797