The U.S. Court of Appeals for the Fourth Circuit recently ruled that the federal Home Owners' Loan Act preempted a borrower's state-law claim of unconscionablity in the origination of her home mortgage loan, but that HOLA did not preempt her claim for fraud.
In so ruling, the Court reasoned that the unconscionablity claim was based on alleged acts that fell squarely within the realm of preempted loan origination activities, but that, because state regulation of deceptive commercial practices only incidentally affected lending and was thus outside the scope of federally-regulated banking activities, borrower's fraud claim was not preempted.
A copy of the opinion is available at: http://www.ca4.uscourts.gov/Opinions/Published/121181.P.pdf.
Plaintiff borrower ("Borrower") purchased a home on a land contract, and in an effort to obtain financing to pay off the land contract, contacted a bank for a different loan. The property appraiser allegedly appraised the home at a value substantially higher than its actual value, and the bank offered Borrower a mortgage loan for the full amount of the appraisal. The Borrower obtained an adjustable rate mortgage with an interest rate that could go up over 15%. Struggling to make her loan payments, Borrower ultimately declared bankruptcy.
Borrower later filed a lawsuit against the owner of the loan as well as the successor to the bank that originated the loan ("Originating Bank"; collectively the "Defendants"), alleging unconscionablity and fraud. With regard to the unconscionablity claim, the complaint alleged among other things that the loan was induced by an inflated appraisal and the terms of the loan were substantively unfair. As to fraud, Borrower claimed that Originating Bank misrepresented the value of her property for the purpose of inducing her into the loan agreement, that Borrower reasonably relied on the representation, and that she was harmed as a result.
The Defendants removed the case to federal district court and moved to dismiss. The district court dismissed each of Borrower's claims, ruling that they were preempted by the federal Home Owners' Loan Act. Borrower appealed.
The Fourth Circuit affirmed in part, reversed in part, and remanded.
As you may recall, HOLA's implementing regulation ("Regulation") provides that the Office of Thrift Supervision ("OTS") "occupies the entire field of lending regulation for federal savings associations." 12 C.F.R. § 560.2(a).
In addition, the Regulation provides that "federal savings associations may extend credit as authorized under federal law . . . without regard to state laws purporting to regulate or otherwise affect their credit activities . . . " and that "without limitation," states are preempted from regulating the following aspects of loans: "(3) Loan-to-value ratios; (4) The terms of credit, including amortization of loans and . . . . adjustments to interest rate . . . including the circumstances under which a loan may be called due and payable . . . . (9) Disclosure and advertising, including laws requiring specific statements, information, or other content to be included in credit application forms, credit solicitations, billing statements, credit contracts, or other credit-related documents . . . . (10) Processing, origination, [or] servicing . . . of . . . mortgages[.]" 12 C.F.R. §560.2(b).
Finally, the Regulation expressly provides that certain state laws, including contract and tort law, are not preempted "to the extent that they only incidentally affect the lending operations of Federal savings associations or are otherwise consistent with the purposes of paragraph (a) of this section." 12 C.F.R. §560.2(c).
Pointing out that the Regulation governed this case because it was in effect at the time Borrower entered into her mortgage agreement, the Fourth Circuit applied the preemption analysis set forth by OTS while keeping in mind that HOLA and the Regulation were not intended to preempt state laws providing the basic norms of commercial transactions. See 12 U.S.C. §§ 5412, 5413(abolishing OTS and vacating its regulations, but not retroactively).
Thus, in addressing the unconscionablity claim, the Fourth Circuit rejected Borrower's contention that the acts alleged in her complaint should be viewed as a whole, and that they demonstrated that she was unconscionably induced into an unfair contract. As the Court explained, the Regulation instead required an examination of each component of Borrower's unconscionablity claim and each of the acts she challenged fell squarely into Section 560.2(b)'s list of activities that states are preempted from regulating.
Specifically, in examining each aspect of the unconscionablity claim, the Fourth Circuit concluded: (1) the allegedly hurried closing fell within the bank's "[p]rocessing, origination, servicing . . . of mortgages"; (2) the allegation that the loan was induced by an inflated appraisal was governed by the Regulation's provisions governing disclosures and advertising and loan origination; (3) the allegation that the loan was unconscionable because the loan exceeded the value of Borrower's home came under the Regulation's "loan-to-value ratios" and "terms of credit" provisions; and (4) the claim that the adjustable interest rate feature of the loan was unconscionable was preempted by the Regulation's provision governing "terms of credit, including . . . adjustments to the interest rate."
The Court therefore ruled that dismissal of Borrower's unconscionablity claim was proper given that her allegations as to unconscionablity all fell under the list of preempted banking activities.
Turning to Borrower's fraud claim, the Fourth Circuit noted first that the Defendants mischaracterized the nature of the fraud claim by equating it to an allegation that they failed to disclose the loan-to-value ratio, which would be covered by the Regulation. Rather, in the Court's view, Borrower's fraud claim did not relate to the loan-to-value specifically, but to her being intentionally "misled regarding a component of that ratio," which, the Fourth Circuit concluded, fell outside the scope of the Regulation.
Next, having concluded that the fraud claim fell outside the scope of the Regulation, the Court sought to determine whether the fraud claim "only incidentally" affected Defendants' lending operations under Section 560.2(c). In so doing, the Court noted in part that HOLA did not preempt state tort law governing commercial transactions, including state laws regulating deceptive practices, and, quoting from an OTS Opinion Letter, noted further that, although "a state deceptive practices statute . . . 'may affect lending . . . [, a] general prohibition on deception should have no measurable impact on . . . lending operations.'"
Thus, the appellate court ruled that Borrower's fraud claim only incidentally affected lending and was therefore not preempted.
The Fourth Circuit also rejected Defendants' assertions that Borrower failed to state a claim for fraud or that she failed to plead it with sufficient particularity. Pointing out that Borrower alleged each element of fraud and with the requisite particularity and that Defendants were made aware of the particular circumstances constituting the alleged fraud, the Court ruled that Borrower's complaint properly stated a claim for fraud.
Accordingly, the Fourth Circuit concluded that the lower court properly dismissed the claim for unconscionablity on preemption grounds, but reversed its dismissal of the fraud claim.
Ralph T. Wutscher
McGinnis Wutscher Beiramee LLP
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