The U.S. Court of Appeals for the Sixth Circuit recently reversed the lower court's grant of summary judgment in favor of a mortgage broker, lender, appraiser, and others, ruling that a borrower alleged sufficient facts regarding loan origination fraud to raise genuine issues as to the proximate cause of his financial injuries in an action under the federal RICO and Kentucky law.
In so ruling, the Court rejected the lower court's causation analysis that identified the high interest rate and terms of a negative amortization loan as the proximate cause of the borrower's injuries, rather than an allegedly false appraisal report that gave the illusion of substantial equity in the borrower's home.
A copy of the opinion is available at: http://www.ca6.uscourts.gov/opinions.pdf/13a0117p-06.pdf.
Plaintiff borrower ("Borrower") obtained two mortgage loans on his home in order to use the proceeds of the cash-out to build an addition to his house. One loan was a so-called option adjustable rate mortgage ("Option ARM") that gave Borrower the option of skipping principal payments and some of the interest for a certain number of years at the early stage of the loan repayment period. Generally, under the terms of this type of loan, the unpaid balance is added to the body of the loan, potentially resulting in negative amortization, and a principal balance that potentially exceeds the value of the real estate used to secure the loan.
To obtain the loan, Borrower met with defendant mortgage broker ("Broker") who arranged for an appraisal on Borrower's home. The appraiser that Broker used allegedly valued Borrower's home at twice the amount Borrower had paid to purchase the home, even though the house was allegedly worth much less. Based on the purported value of the home, Borrower qualified for a $500,000 loan, but Borrower declined, given his desire to borrow just enough to build the addition to his home and to refinance the two mortgages. Nevertheless, Broker and Borrower eventually agreed on a loan for a lower amount, and Broker submitted the loan application to defendant mortgage lender ("Lender"), which Lender approved primarily on the basis of the allegedly inflated appraisal.
Eventually, Borrower was unable to keep up with the payments on the refinance loan which had increased due in part to the adjusting interest-rate feature of the loan. With the house being worth much less than the appraisal had indicated and there being no equity in the home, Borrower declared bankruptcy and lost his home, allegedly because he was unable to sell his home at a price at which he could repay the loan.
Borrower filed a lawsuit in federal court, alleging claims under the federal Racketeer Influenced and Corrupt Organizations Act ("RICO"), Truth in Lending Act ("TILA"), and Real Estate Settlement Procedures Act ("RESPA"), as well as under Kentucky law for breach of contract, fraud, breach of fiduciary duty, and conspiracy. Seeking relief from the adjustable-rate mortgage, Borrower alleged that the defendants had engaged in a conspiracy, with the allegedly misleading appraisal at its center, to commit fraud in order to generate higher fees. Borrower alleged that the unfavorable terms of the Option ARM were never fully disclosed to him and that he suffered financial harm as a result of the alleged conspiracy to defraud him.
Broker and Lender both moved for summary judgment, which the lower court granted as to Borrower's RICO claims, the TILA claim, and the state law conspiracy claim. The lower court denied the motions as to the rest of the claims and ordered the parties to mediation, which produced a settlement agreement under which Borrower prevailed on the RESPA claim and the other claims were dismissed with prejudice, but not released.
Borrower appealed, challenging the lower court's grant of summary judgment as to his RICO claims and his state-law conspiracy claim. The Sixth Circuit reversed in part and affirmed in part.
As you may recall, RICO provides a private cause of action for "[a]ny person injured in his business or property by reason of a violation of" one of RICO's four criminal provisions and makes it illegal for an enterprise to engage in "racketeering activity," as defined by predicate acts including mail and wire fraud. See 18 U.S.C. § 1964(c), § 1962(c). In addition, RICO makes it illegal "for any person to conspire to violate any" of RICO's other criminal provisions. 18 U.S.C. § 1962(d).
Similarly, under Kentucky law, a plaintiff must prove "an unlawful/corrupt combination or agreement between the alleged conspirators to do by some concerted action an unlawful act." James v. Wilson, 95 S.W.3d 875, 897 (Ky. Ct. App. 2002).
Focusing on whether the allegedly fraudulent appraisal was the proximate cause of the harm Borrower suffered, the Sixth Circuit addressed Borrower's contention that the lower court erred in finding that his financial injuries were unrelated to the allegedly inflated appraisal, but resulted instead from the high interest rate and unfavorable terms of the refinance loan. See Holmes v. Securities Investor Protection Corp., 503 U.S. 258, 265-68 (1992)(ruling that a plaintiff must plead and prove that the predicate acts alleged "not only [were] a 'but for' cause of his injury, but [were] the proximate cause as well.").
In so doing, the Sixth Circuit addressed the elements of "directness," "foreseeability," and whether the causal connection between the injury and conduct was logical and not merely speculative, and stressed that the appropriate inquiry in this case was not whether Borrower actually relied on the allegedly inflated appraisal, but whether the fraudulent scheme furthered by the appraisal proximately caused his financial injuries. Holmes, 502 U.S. at 268; Hemi Group, LLC v. City of New York, 130 S. Ct. 983, 989 (2010); Perry v. American Tobacco Co., Inc., 324 F.3d 845, 850-51 (6th Cir. 2003); Trollinger v. Tyson Foods, Inc., 370 F.3d 602, 614-15 (6th Cir. 2004).
Applying the "directness" standard and noting Borrower's allegations that: (1) Broker and the appraiser produced and sent through the mail a false appraisal of his home that inflated its value by over $100,000 to secure the high-interest loan; (2) the appraisal created the illusion that there was substantial equity in the home against which Borrower could borrower; (3) based on that illusion, Broker was able to convince Borrower to enter into the loan agreement; (4) the terms of which were not fully disclosed; and (5) the accruing interest and increasing balance on the loan caused Borrower to suffer financial injuries, the Court concluded that Borrower established a question of fact regarding causation, as it was "able to trace a straight line between the alleged fraud and the asserted injury."
Similarly, under the "proximate-cause" standard, which considers the foreseeability of the harm suffered and whether Borrower's theory of causation was "illogical or speculative," the Sixth Circuit concluded that Borrower raised a genuine issue of material fact in showing a connection between the alleged scheme to create an illusion of equity and the decision to obtain the Option ARM.
Taking the lower court to task for reaching the opposite conclusion as to causation, the Sixth Circuit noted among other things that the high interest rate and unfavorable terms that the lower court cited as the cause of Borrower's injuries were "more properly viewed as components of the alleged injuries rather than the proximate cause of such" and, further, that the appraisal was "a substantial factor in the sequence of responsible causation." See Cox v. Administrator U.S. Steel & Carnegie, 17 F.3d 1386, 1399 (11th Cir. 1994).
With regard to Borrower's state-law civil conspiracy claim, the Court noted that the claim consisted of two parts: (1) the alleged agreement between Broker and its principals to manufacture the false appraisals and (2) the alleged agreement between Broker and Lender to provide unlawful "kickbacks" in the form of yield spread premiums.
As to the first part, the Sixth Circuit disagreed with the lower court's conclusion that Borrower failed to show that the appraisal caused his injuries, thus ruling that Borrower had raised a sufficient question of fact as to causation to survive a motion for summary judgment. With respect to the second part, noting that the lower court did not rely "on its faulty proximate cause analysis," the Court agreed with the lower court that Borrower presented no evidence to establish that Lender and Broker agreed to commit an unlawful act, explaining that there was no indication of an illicit agreement between them, or any relationship other than within the context of the formal loan application process and payment of yield spread premiums.
Accordingly, the Sixth Circuit reversed as to the causation issue, but affirmed the lower court's grant of summary judgment in favor of Lender on the state-law conspiracy claim.
Ralph T. Wutscher
McGinnis Wutscher Beiramee LLP
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