FYI: 9th Cir Limits "Public Injunction" Exception to Federal Arbitration Act

Reversing the lower court, the U.S. Court of Appeals for the Ninth Circuit recently ruled that putative class-action claims under California's Unfair Competition Law were subject to arbitration, where an arbitration provision in student loan agreements was neither substantively nor procedurally unconscionable, and plaintiffs' claims for injunctive relief did not fall within the "public injunction" exception to the Federal Arbitration Act's broad mandate to recognize arbitration agreements.  In so ruling, the Court reasoned that the requested relief related only to past harms and would not benefit the public at large, and thus did not fall within the exception. 

 

A copy of the opinion is available at:  http://cdn.ca9.uscourts.gov/datastore/opinions/2013/04/11/09-16703.pdf.

 

Plaintiffs, former flight-training students ("Students"), obtained loans from defendant bank ("Bank") to finance their tuition at a flight school that failed before they could graduate.   The promissory notes on the loans contained a prominent arbitration clause which expressly waived the right to litigate claims and contained a waiver of class-action arbitration.  The note also provided that Students had 60 days from the date of signing to opt-out of the arbitration provisions by so notifying Bank in writing. 

 

Alleging violations of California's Unfair Competition Law ("UCL"), Cal. Bus & Prof. Code §§ 17200-17210, based on Bank's supposed failure to include certain language in the note mandated by the Federal Trade Commission, Students filed putative class-action lawsuits in state court against Bank and another defendant (collectively, "Defendants"), seeking to enjoin them from reporting loan defaults to credit reporting agencies and from enforcing the notes against Students.   Defendants removed the case to federal court and filed a motion to compel arbitration.  The lower court denied the motion.  Defendants appealed.   

 

After Defendants filed their appeal, the lower court allowed Students to file a third amended complaint, but granted Defendants' motion to dismiss for failure to state a claim.  Plaintiffs appealed.

 

In this consolidated appeal, the Ninth Circuit vacated the dismissal of Students' claims and reversed the denial of Defendants' motion to compel.

 

As you may recall, the Federal Arbitration Act ("FAA") broadly recognizes arbitration clauses as "valid, irrevocable, and enforceable."  9 U.S.C. § 2.  The FAA also "preserves generally applicable contract defenses" by providing that arbitration agreements are "enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract."  Id.; see also AT&T Mobility LLC v. Concepcion, 131 S. Ct. 1740, 1753 (2011)("Concepcion")(holding that the FAA preempted California rule against class-action waivers).

 

Recognizing that state-law defenses to the enforceability of contracts, such as fraud, duress, or unconscionablity, also applied to arbitration agreements, the Ninth Circuit noted that under California law, contractual provisions that are both procedurally and substantively unconscionable are unenforceable.  Thus, applying this two-prong standard in light of Concepcion, the Court rejected Students' assertion that the arbitration clause's ban on class actions was unconscionable under California law, explaining that the argument that the ban on class arbitration was unconscionable under state law "is now expressly foreclosed by Concepcion." 

 

The Ninth Circuit also noted that nothing in the arbitration provision was substantively or procedurally unconscionable.  In so doing, the Court pointed out the relatively generous 60-day opt-out period as well as the prominent nature of the provision itself.  See Circuit City Stores, Inc. v. Ahmed, 283 F.3d 1198, 1199-1200 (9th Cir. 2002)(finding 30 day opt-out period sufficient amount of time).

 

Turning next to Students' request for injunctive relief, the Ninth Circuit noted that claims for "public" injunctive relief may be exempt from the FAA.  See Broughton v. Cigna Healthplans of California, 988 P.2d 67, 73, 78 (Cal. 1999)(holding that claim for damages was subject to arbitration clause, but that claims seeking relief enjoining future deceptive practices on behalf of general public were not arbitrable); Cruz v. PacifiCare Health Systems, Inc. 66 P.3d 1157 (Cal. 2003) (ruling that claims for monetary relief were subject to arbitration, because public benefit was merely "incidental to private benefits obtained" from the action, but that UCL claims seeking injunctive relief were for the benefit of general public and therefore not subject to arbitration).

 

Nevertheless, the Ninth Circuit held that Students' claim for injunctive relief in this case did not fall within the narrow "public injunction" exception to the FAA's rule that courts honor arbitration agreements.  Pointing out in part that Students specified in their complaint that Bank had withdrawn from the student loan business, the Court reasoned that, because the requested relief would thus only benefit the roughly 120 putative class members, and that "the injunctive relief sought . . . for all practical purposes, relates to past harms suffered by" them, their claims did not fall within the so-called "Broughton-Cruz" exemption to the FAA.

 

The Ninth Circuit thus concluded that absent from this case was the concern present in both Broughton and Cruz that a public benefit could be frustrated if arbitrators were entrusted to administer a public injunctive remedy.  Noting Students' concession that the alleged UCL violations already ceased, the small size of the affected class, and the lack of any prospective benefit to the public, the Court determined that the arbitration clause was enforceable.

 

Accordingly, the Ninth Circuit remanded, instructing the lower court to compel arbitration of Students' claims.

 

 

 

Ralph T. Wutscher
McGinnis Wutscher Beiramee LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct: (312) 551-9320
Fax: (312) 284-4751
Mobile: (312) 493-0874
Email: RWutscher@mwbllp.com

 

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FYI: Cal App Ct Holds CA Late Fee Limit for Brokered Loans Implicitly Incorporated, But Preempted Under NBA and HOLA

The California Court of Appeal, Second District, recently held that, although California's limitation on late payment charges was implied into all mortgage loans negotiated by licensed mortgage brokers regardless of whether the loans were extended by entities exempt from such limitation, the borrowers' breach of contract claims against loan servicers that had taken over the servicing of the loans were preempted by the National Bank Act and the Home Owners' Loan Act. 

 

A copy of the opinion is available at:  http://www.courts.ca.gov/opinions/documents/B236455.PDF

 

Plaintiffs borrowers ("Borrowers") obtained home mortgage loans that were secured by deeds of trust and negotiated by mortgage loan brokers with different state-regulated mortgage bankers or finance lenders.  The mortgage notes expressly permitted late fees to be applied only once to an overdue payment, but all the loans had a grace period of at least 10 days before late fees were assessed.  

 

Defendants federal loan servicers ("Servicers") took over the servicing of the loans and, when Borrowers failed to make their payments when due, assessed late fees.  Servicers applied the late payments to the past due installments in the order they became due, even though certain payments had been made within 10 days of scheduled installments.   The Servicers' method of applying late fees resulted in Borrowers' failure to pay subsequent installments on time, and in successive late payments and fees.  One of the Servicers was subject to the National Bank Act ("NBA"), and the other to the Home Owners' Loan Act ("HOLA").

 

Plaintiffs sued the Servicers for breach of contract, asserting that each loan implicitly incorporated the requirement in Section 10242.5 subdivision (b) of California's Real Estate Law, that a payment made within 10 days of the due date of an installment must be applied to that installment.   Plaintiffs thus alleged in part that Servicers breached the terms of the loans they serviced by applying payments made within 10 days of scheduled installments to past due installments.   Plaintiffs also asserted causes of action for unfair business practices under California's Unfair Competition Law, unjust enrichment, and declaratory relief. 

 

Servicers demurred.  The lower court sustained the demurrers and dismissed the putative class action lawsuits, reasoning that Servicers were exempted from the 10-day payment rule and that federal law preempted the breach of contract claims.  The lower court also ruled that the unfair business practices claims and requests for declaratory relief failed for the same reasons, and that relief for unjust enrichment was unavailable because of the express contracts.  Plaintiffs appealed, and the cases were consolidated.  The Appellate Court affirmed.

 

As you may recall, Article 7 of California's Real Estate Law governs loans made or negotiated by mortgage loan brokers.  See Cal. Bus. & Prof. Code § 10240 et seq. ("Article 7").  Among other things, Article 7 limits the charge of a late payment to 10% of the installment due, and provides for a 10-day grace period.  See Cal. Bus. & Prof. Code § 10248.3.  Moreover, a late payment fee may be charged only once for the same late installment, and a payment made within 10 days of a scheduled installment's due date must be applied to that installment.  Cal. Bus. & Prof.  Code § 10242.5 subd. (a), (b) ("Section 10242.5").  See also Cal. Bus. & Prof. Code § 10245 (providing that Section 10242.5's late fee limitation applies to broker-negotiated loans regardless of loan amount). 

 

In addition, although California law excludes certain entities, such as banks, savings associations, and servicers, from the definition of a mortgage loan broker, and therefore exempts them from certain requirements associated with mortgage loans, mortgage loan brokers are expressly prohibited from negotiating loans with late fees other than those specified in Section 10242.5.  See Cal. Bus. & Prof. Code §§ 10133.1, subdiv (a); 10245; 10248.1.

 

Moreover, under regulations now superseded, the Home Owners' Loan Act preempted state law by providing that "federal savings associations may extend credit as authorized under federal law . . . without regard to state law purporting to regulate or otherwise affect their credit activities. . . . . [including] state law purporting to impose requirements regarding . . . [l]oan-related fees, including  . . . late charges . . .," as well as the "processing, origination, servicing, sale or purchase of, or investment or participation in mortgages."  12 C.F.R. § 560.2(a),(b)(5)&(10). 

 

Under its so-called savings clause, HOLA expressly did not preempt state laws, such as contract law, "to the extent that they only incidentally affect the lending operations of Federal savings associations. .  . ."  12 C.F.R. § 560.2(c)(1).  See also 12 C.F.R. § 560.33 (late fee regulation providing in part: "A Federal savings association may not impose a late charge more than one time for late payment of the same installment, and any installment payment made by the borrower shall be applied to the longest outstanding installment due.")

 

Finally, the regulations promulgated under the NBA provided in part:  "Except where made applicable by Federal law, state laws that obstruct, impair or condition a national bank's ability to fully exercise its Federally authorized real estate lending powers do not apply to national banks.  Specifically, a national bank may make real estate loans . . . without regard to state law limitations concerning" such matters as the "[p]rocessing, origination, servicing, sale or purchase of, or investment or participation in, mortgages."  12 C.F.R. § 34.4(a)(10). 

 

Under the NBA's savings clause, state laws that "are not inconsistent with the real estate lending powers of national banks and apply to national banks to the extent that they only incidentally affect the exercise of national banks' real estate lending powers" are not preempted.  12 C.F.R. § 34.4(b)(1).

 

The Appellate Court began its analysis by noting that Servicers were assigned servicing rights to third-party loans originated under state law, including the right to charge late payment fees for Servicers' own benefit, and provided an historical overview of California's requirements regarding late fees.  In so doing, the Appellate Court rejected Servicers' argument that Article 7 was intended to apply to mortgage loan broker transactions involving only those lenders not exempt from Section 10242.5.   Based on its examination of the legislative history of statutes governing mortgage loan brokers, the Appellate Court ultimately ruled that the loans at issue in this case were subject to the late fee limitation of Section 10242.5, reasoning in part that, because the rights and remedies available to mortgage borrowers under Article 7 were not waivable and were established for a public purpose, the limitations on late fees in Section 10242.5 may not be waived by private agreement.  

 

Accordingly, rejecting Servicers' argument that express contract terms may not be varied by operation of law, the Appellate Court went on to conclude that Section 10242.5's payment application requirement was implied by operation of law into the loans, despite terms in the deeds of trust providing that "payments shall be applied to each Periodic Payment in the order in which it became due."  The Court thus concluded that Section 10242.5 applied to the loans regardless of whether the loan originators were exempt entities.

 

Next, addressing whether federal preemption barred Borrowers' breach of contract claims that were premised on the implied incorporation of Section 10242.5 into their home mortgage loans, the Appellate Court determined that the breach of contract claims were preempted under the NBA and HOLA.

 

In so ruling, the Court considered and rejected Borrower's various arguments, including the assertions that:  servicing third-party loans is not "lending"; preemption only applies when a servicer made the loans it services; by choosing to service state-originated loans, Servicers agreed to abide by all the express and implied terms of the loans; and, as assignees, Servicers were liable for state-law violations to the same extent as the original lenders.

 

First, examining state law on an "as applied" basis, the Appellate Court noted that the regulations' savings clauses focused broadly on the effect of state laws on the lending operations of federally regulated financial institutions, rather than narrowly on the extension of credit on a particular loan.  

 

Against this backdrop, the Appellate Court cited among other things increased participation in the secondary mortgage market as a basis for a uniform federal scheme of regulation, noting the increasing number of federal financial institutions servicing loans originated by other lenders.  See In re Ocwen Loan Servicing, LLC Mortg. Serv. Lit., 491 F.3d 638, 642, 645-46 (7th Cir. 2007)(finding a California late fee statute preempted as to a federal servicer); Molosky v. Washington Mutual, Inc., 664 F.3d 10 (6th Cir. 2011)(rejecting argument that preemption does not apply when a federal savings association services a loan it did not originate); Casey v FDIC, 583 F.3d 586, 593-94 (8th Cir 2009). 

 

The Appellate Court also analyzed the breach of contract claims from a "state-imposed requirement" perspective, noting the difference between state-imposed and voluntarily undertaken obligations.  In rejecting Borrowers' argument that Servicers agreed to abide by all express and implied loan terms simply by assuming the servicing of the loans, the Court also pointed out that the implied incorporation of California's substantive standard on late fees into Servicers' servicing obligations would limit Servicers' ability to service the loans according to their terms, to collect late fees to which they were entitled, and would expose them to liability under a variety of state laws regulating loan-related fees.

 

Thus, the Court reasoned in part that California's requirements regarding the application of late fees to loan payments was a substantive standard implicitly incorporated into each loan agreement by operation of law that impaired the servicers' lending powers, rather than a self-imposed obligation voluntarily undertaken.     

 

Accordingly, the Appellate Court affirmed the judgments dismissing the class action complaints as preempted by the NBA and HOLA.

 

 

 

Ralph T. Wutscher
McGinnis Wutscher Beiramee LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct: (312) 551-9320
Fax: (312) 284-4751
Mobile: (312) 493-0874
Email: RWutscher@mwbllp.com

 

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FYI: Cal App Ct Holds Consumer Arbitration Agreement Enforceable, Finding Only "Minimal Unconscionablity"

Reversing the lower court, the California Court of Appeal, First District, recently ruled that, because an arbitration agreement in a retail installment sales contract was only "minimally unconscionable," it was improper to deny the defendants' petition to compel arbitration.   In so ruling, the Court determined that, in light of the absence of "surprise or other sharp practices" to render the contract procedurally unconscionable, a substantial degree of substantive unconscionablity would be required to defeat enforcement of the arbitration agreement, but was lacking in this case.

 

A copy of the opinion is available at:  http://www.courts.ca.gov/opinions/documents/A134829.PDF.

 

Plaintiff consumer ("Consumer") bought a used car from a car dealer ("Dealer") and signed a retail installment sales agreement.  A few days after the sale, Dealer allegedly contacted Consumer, asking Consumer to execute a second retail installment sales contract (the "RIC"), because Dealer had supposedly been unable to procure financing for the sales transaction.  The RIC was on a two-page pre-printed form identical to the first agreement, but contained slightly different terms.  Dealer later sold and assigned the RIC to defendant financing company ("Company").  

 

On the second page of the RIC was an arbitration clause with provisions governing requests for "appeals" of arbitration decisions and advancing certain arbitration costs.  The arbitration clause also contained a class-action waiver and exempted  from arbitration small claims disputes and the statutorily-governed remedy of repossession.  Immediately above the arbitration clause was the heading in all capital letters and bold type, stating "ARBITRATION CLAUSE . . . PLEASE REVIEW – IMPORTANT – AFFECTS YOUR LEGAL RIGHTS."  Immediately below were three numbered provisions all in capital letters informing the buyer that either party may request arbitration, that the clause would prevent a court proceeding or class-action, and might limit discovery.  The actual terms of the clause followed in smaller type. 

 

Seeking damages and injunctive and other relief, Consumer filed a lawsuit against Dealer and Company, alleging that the RIC violated California's consumer protection laws, including the Rees-Levering Automobile Sales Finance Act, Cal. Civ. Code § 2981 et seq. and the Consumers Legal Remedies Act, Cal. Civ. Code § 1750 et seq.   Also among the allegations was the assertion  that Dealer had backdated the RIC causing the financing terms to be inaccurate and the disclosed annual percentage rate to vary by more than what is permitted under the federal Truth in Lending Act's Regulation Z, 12 C.F.R. § 226.1, et seq. 

 

Dealer and Company filed a petition to compel arbitration pursuant to the RIC's arbitration clause.  Consumer opposed the petition on various grounds, including that the arbitration clause was unconscionable, asserting that at the closing of the purchase transaction, he had been presented with a large stack of pre-printed form documents and was not given the opportunity to read any of the documents or to negotiate any of the terms.

 

Agreeing with Consumer that the arbitration clause was unconscionable because of "adhesion, oppression, and surprise," the lower court denied the petition to compel.   Dealer and Company appealed.

 

The Appellate Court reversed, ruling that the arbitration clause was only "minimally procedurally unconscionable" and lacked significant substantive unconscionablity to render it unenforceable.

 

Analyzing the arbitration clause in terms of both procedural and substantive unconscionablity, the Appellate Court observed that each of these elements is examined on a sliding-scale basis according to which the more substantively oppressive the clause, the less evidence of procedural unconscionablity is required to conclude that the arbitration clause is unenforceable.   See Armendariz v. Foundation Health Psychcare Services, Inc., 24 Cal.4th 83, 114 (2000).  The Court further noted that procedural unconscionablity focuses on oppression and surprise, whereas substantive unconscionablity focuses on fairness of the terms of the agreement and on whether they are overly harsh or one-sided.

 

Thus, looking first at the procedural aspects of the purchase transaction in this case, the Appellate Court initially concluded that the RIC was procedurally unconscionable under California law in light of the "take-it-or-leave-it" basis in which it was presented to Consumer.  See Gentry v. Superior Court, 42 Cal.4th 443, 469 (2007)("Ordinary contracts of adhesion . . . contain a degree of procedural unconscionablity even without notable surprises).  Nevertheless, despite the inequality of bargaining power between the parties in the transaction, the Appellate Court ultimately determined that Dealer's conduct did not demonstrate a high degree of procedural unconscionablity that warranted non-enforcement of the arbitration clause.  In so doing, the Court considered:  (1) the common, industry-wide use of preprinted nonnegotiable  form contracts; (2) the high number of state and federal regulatory requirements associated with consumer transactions as to both substance and form of disclosures; and (3) merchants' use of preprinted contracts to ensure compliance with those requirements.  

 

Further, with regard to Consumer's argument that he was not given the opportunity to read the documents, the Appellate Court noted that Consumer never contended that Dealer actively interfered with his ability to review the RIC or that Dealer made any affirmative misrepresentations about its terms.   Comparing the consumer transaction at issue here with the situation in which an employer seeks to impose an arbitration agreement on an employee, the Court noted that, unlike the employment context where the burdens of disclosure and informed consent fall on the employer, "conduct found objectionable in the employment context does not carry the same stigma in an ordinary consumer transaction." 

 

Among other things, the Appellate Court also found lacking the element of surprise, given that the arbitration clause was obvious and prominent, even if it was located on the reverse side of a two-page contract, and that Consumer had in his possession an identical preprinted contract for several days before being presented with the RIC at issue here.

 

Turning to substantive unconscionablity, the Appellate Court applied the standard set forth in a California Supreme Court opinion that in order to render a contract term unenforceable, it must "'be so one-sided" as to "shock the conscience."   See Pinnacle Museum Tower Assn. v. Pinnacle Market Development (US), LLC, 55 Cal.4th 223, 246 (2012).   Thus, reviewing the arbitration clause according to that standard and further noting that the minimal amount of procedural unconscionablity present in this case required a substantial degree of substantive unconscionablity to declare the arbitration clause unenforceable, the Court concluded that there was no such basis here for declining to enforce the arbitration agreement. 

 

In so ruling, the Appellate Court looked at such factors as:  Consumer's failure to present evidence as to his financial resources, anticipated cost of arbitration, and potential award to show how the requirement that Consumer advance certain costs was unconscionable;  the balancing of interests incorporated in the arbitration clause's "appeal" provision as well as in the exemption for repossession and small claims disputes.   See Green Tree Financial Corp.-Ala. V. Randolph, 531 U.S. 79, 91092 (2000)(declining to invalidate arbitration on grounds of expense, noting party resisting arbitration bears burden of proving that claims at issue are unsuitable for arbitration).  See also Cal. Code of Civ. Pro. § 1284.3, subdiv. (a)(proscribing arbitration clauses requiring the non-prevailing consumer party to pay costs of prevailing opposing party).  Moreover, in examining the respective interests of Consumer and Dealer incorporated into the arbitration clause, the court took into account the practical application of various potential remedies available to each party, such as the effect of injunctive or monetary relief, as well as certain procedural requirements such as the different thresholds each party must meet in order to qualify for a second arbitration.

 

Notably, the Appellate Court also pointed out that, like arbitration, repossession and other self-help remedies operate outside judicial proceedings and, further, that exempting repossession from arbitration preserves the efficiency of the remedy, which, in the Court's view, would be frustrated if a car seller had to arbitrate its right to repossess.  See Cal. Bus. & Prof. Code § 7500 et seq.; Cal. Civ. Code § 2983.2 (provisions governing repossession).    Additionally, according to the Appellate Court, considerations of efficiency similarly supported the exclusion of small claims from arbitration.

 

Finally, with regard to the waiver of class-action rights and the requirement to arbitrate so-called "public" state-law consumer protection claims, the Appellate Court, citing a decision by the U.S. Supreme Court, ruled that claims, such as those based on California's statutory ban on class-action waivers, would be preempted by federal law.  See AT&T Mobility, LLC v. Concepcion, 131 S. Ct. 1740 (2011)(Federal Arbitration Act preempted state-law claims). 

 

Accordingly, finding "minimal unconscionablity," the Appellate Court reversed the lower court's denial of the petition to compel arbitration, and remanded.

 

 

 

Ralph T. Wutscher
McGinnis Wutscher Beiramee LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct: (312) 551-9320
Fax: (312) 284-4751
Mobile: (312) 493-0874
Email: RWutscher@mwbllp.com

 

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FYI: Cal App Ct Holds FHLB's State-Law Action on Purchase of RMBS Barred by Prior Dismissal of Similar Federal Claim

The California Court of Appeal, First District, recently ruled that res judicata barred a Federal Home Loan Bank's ("FHLB") state law claim against a securities dealer for control-person liability associated with misrepresentations allegedly made by a subsidiary in connection with the sale of residential mortgage-backed securities. 

 

In so ruling, the Court determined in part that, under the so-called "primary rights" theory, the FHLB's state law claim was the same "cause of action" as its federal claim against the securities dealer that it dismissed with prejudice in prior litigation.  The Court reasoned that, because the FHLB sought compensation for the same harm in both proceedings and could have pursued its state law claim against the securities dealer in the prior litigation, the FHLB's voluntary dismissal with prejudice of that claim against the securities dealer was a final judgment on the merits, thereby precluding the state law claim against the securities dealer in the subsequent proceeding. 

 

A copy of the opinion is available at:  http://www.courts.ca.gov/opinions/documents/A135898.PDF.

 

Plaintiff FHLB purchased mortgage-backed securities from various securities dealers, and later sued a number of those securities dealers as well as other entities, alleging that the defendants made untrue or misleading statements in the documents they used to sell the securities, in violation of both federal and California securities laws.   Among the defendants in that action (the "Prior Action") was the same defendant securities dealer ("Dealer") named in this case.

 

Among other things, FHLB alleged in the Prior Action that Dealer violated Section 15 of the federal Securities Act of 1933 (the "1933 Act") based on Dealer's alleged control of a subsidiary and which, according to FHLB, Dealer used for the sole purpose of receiving and depositing mortgage loans into the trusts holding the mortgage-backed assets.   Thus, under a "control-person" liability theory, FHLB asserted that Dealer was liable to it to the same extent as the securities dealer that Dealer allegedly controlled.

 

About six months later, FHLB filed the complaint in this case (the "Declaratory Relief Action"), seeking a declaration that a bank holding company that had purchased the assets of Dealer and its affiliates was liable for any damages Dealer was required to pay in the Prior Action.  

 

When FHLB obtained an adverse ruling on a demurrer in the Prior Action, it voluntarily dismissed with prejudice a number of its 1933 Act claims against certain defendants in the Prior Action, including the Section 15 claim against Dealer.   

 

Shortly thereafter, FHLB amended its complaint to add Dealer as a defendant in the Declaratory Relief Action, alleging that Dealer was liable as a "control person" under Section 25504 of the California Corporations Code.  Specifically, FHLB alleged that Dealer was jointly and severally liable along with its subsidiary for the alleged misrepresentations in the sale to FHLB of the securities at issue in the Prior Action.    FHLB attached to its complaint a copy of the complaint filed in the Prior Action alleging that the "control person liability claims asserted against [Dealer] arise out of  the same facts alleged in [the Prior Action], and [the FHLB] seeks the same remedy that it sought in the [Prior Action], that is, rescission and recovery of the consideration paid for [the] certificates."

 

Dealer demurred in the Declaratory Relief Action, arguing in part that res judicata barred the FHLB's Section 25504 claim, because the Section 25504 claim was the same cause of action as its Section 15 claim under the 1933 Act in the Prior Action, and that FHLB claimed a violation of the same primary right, namely, the right to offering documents free of material misrepresentations.

 

In response, asserting that there had been no final judgment on the merits in the Prior Action because certain claims as to its "entire cause of action" still remained pending, FHLB argued that the Section 25504 claim in the Declaratory Relief Action was different than the Section 15 claim it voluntarily dismissed earlier and that res judicata thus did not bar it from asserting claims under a different statute. 

 

The lower court sustained Dealer's demurrer without leave to amend, reasoning that the same primary right was at issue and that the core issue in both proceedings was control-person liability.  FHLB appealed.  The Appellate Court affirmed.

 

As you may recall, the California Corporations Code prohibits sales of securities "by means of any written or oral communication which includes an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements made . . .  not misleading" and establishes liability for violations of this provision. See Cal. Corp. Code §§ 25401; 25501.    In addition, Section 25504 "imposes joint and several liability for securities law violations on "[e]very person who directly or indirectly controls a person under Section 25501."  Cal. Corp. Code § 25504.

 

Moreover, Section 15 of the 1933 Act ("Section 15") provides that "[e]very person who . . . controls any person liable" under Sections 11 or 12 is jointly and severally liable "with and to the same extent as such controlled person."  15 U.S.C. § 77o.  Sections 11 and 12 of the 1933 Act in turn prohibit untrue or misleading statements of material fact in registration statements or prospectuses with respect to the sale of securities.  15 U.S.C. § 77k; 77l(2).

 

Finally, res judicata bars a cause of action that was or could have been litigated in a prior proceeding if:  (1) the present action is on the same cause of action as the prior proceeding; (2) the prior proceeding resulted in a final judgment on the merits; and (3) the parties in the present action or parties in privity with them were parties to the prior proceeding." 

 

In disagreeing with FHLB that its voluntary dismissal with prejudice of the Section 15 claim against Dealer in the Prior Action was not a final judgment on the merits because certain claims regarding primary liability of other defendants remained pending, the Appellate Court emphasized that dismissal with prejudice is indeed a final judgment on the merits.  See, e.g., Torrey Pines Bank v. Superior Court, 216 Cal. App. 3d 813, 820 (1989)("Dismissal with prejudice is determinative of the issues in the action and precludes the dismissing party from litigating those issues again.").  

 

The Court stressed that central to the issue of res judicata is whether FHLB could have raised a claim against Dealer in the Prior Action based on Dealer's control of its subsidiary, not whether it actually did.  Citing precedent, the Court stated "[t]he law is settled that a 'prior judgment on the merits not only settles issues that were not actually litigated but also every issue that might have been raised and litigated in the first action."  Mattson v. City of Costa Mesa, 106 Cal.App.3d 441, 446 (1980); Villacres v. ABM Industries, Inc., 189 Cal. App.4th 562, 576 (2010)(if a matter is within the "scope of the [prior] action, related to the subject matter and relevant to the issues, so that it could have been raised, the judgment is conclusive on it . . . .").

 

The Court also concluded that FHLB's Section 25504 claim was the same cause of action as the Section 15 claim it dismissed with prejudice in the Prior Action.  In so ruling, the Court applied the "primary rights" theory, thus focusing on the harm suffered in determining the "cause of action" for res judicata purposes rather than on any particular legal theory.  Accordingly, the Court looked at the various claims asserted in the Prior Action against the defendants, and, pointing out that FHLB also sought to hold Dealer liable as a control person under Section 15 in the Prior Act, determined that FHLB's attempt to hold Dealer similarly liable under Section 25504 in the Declaratory Relief Action was substantially the same as its Section 15 claim against Dealer. 

 

Thus, concluding that the Section 15 and Section 25504 claims constituted identical causes of action, the Court ruled that the Section 25504 claim in this case was barred under res judicata.  Accordingly, the Appellate Court affirmed the lower court's ruling sustaining Dealer's demurrer.

 

 

 

 

Ralph T. Wutscher
McGinnis Wutscher Beiramee LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct: (312) 551-9320
Fax: (312) 284-4751
Mobile: (312) 493-0874
Email: RWutscher@mwbllp.com

 

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FYI: US Sup Ct Reverses Class Certification for Failure to Meet "Predominance" Element

The U.S. Supreme Court recently ruled that class certification was improper in an antitrust action where the model used to measure alleged classwide damages did not show that any harm was the certain result of the one theory of anticompetitive conduct the lower court relied on to certify the class.

 

A copy of the opinion is available at:  http://www.supremecourt.gov/opinions/12pdf/11-864_k537.pdf

 

The named plaintiffs ("Plaintiffs") filed a putative class-action lawsuit, alleging that a cable-television provider ("Cable Provider") improperly concentrated operations within the Philadelphia "Designated Market Area" ("DMA") consisting of 16 counties located in Pennsylvania, Delaware, and New Jersey.  Specifically, Plaintiffs alleged that Cable Provider unlawfully acquired competitors within the DMA, thereby allegedly engaging in monopolizing behavior in supposed violation of federal antitrust law.  Cable Provider's alleged "clustering scheme" supposedly harmed cable customers in the DMA by allegedly eliminating competition and holding prices for cable services above levels they would otherwise be in a more competitive environment.

 

Plaintiffs sought class certification under Federal Rule of Civil Procedure 23, proposing four theories of harm, each of which supposedly increased cable subscription rates throughout the DMA.  One such theory related to the allegedly anticompetitive effects of Cable Provider's activities on "overbuilders," companies that build competing networks in areas in which other cable companies already operate. 

 

Rejecting the three other theories of antitrust impact, the District Court accepted only the so-called "overbuilder theory" of antitrust impact as capable of class-wide proof, thus limiting proof of antitrust harm to showing that Cable Provider's anticompetitive clustering conduct deterred the entry of overbuilders into the DMA.  The trial court also concluded that the damages resulting from this particular alleged anticompetitive conduct could be calculated on a classwide basis, despite critical expert testimony that evidence comparing actual cable prices with hypothetical prices failed to isolate damages resulting from any one theory of anticompetitive impact.  Nevertheless, the district court certified the class based on the overbuilder theory of antitrust harm.

Cable Provider appealed, arguing that the damages methodology the district court relied on failed to attribute damages stemming specifically from the overbuilder theory to all subscribers within the DMA.  The Court of Appeals affirmed, reasoning in part that at the class certification stage, it was not necessary to "tie each theory of antitrust impact to an exact calculation of damages" and that "an attack on the merits of the methodology" used to determine damages was premature. 

 

The Supreme Court reversed, ruling that class certification was improper based on the theory of damages the lower courts used, as that model failed to show that damages could be measured on a class-wide basis to satisfy the predominance requirement of Rule 23(b)(3).

 

As you may recall, class certification requires numerosity of parties, common questions of law or fact, typicality of claims or defenses, and adequacy of representation.  Fed. R. Civ. Proc. 23(a).  In addition, Rule 23(b)(3) requires in pertinent part that questions of law or fact common to class members predominate over any questions affecting only individual members."  Fed. R. Civ. Proc. 23(b)(3).

 

With regard to Rule 23(a), the Court emphasized that it may be necessary to take up issues related to the merits of the plaintiffs' underlying claim in order to conduct the "rigorous analysis" required to rule on the certification question, and pointed out that the same principles govern Rule 23(b)(3)'s predominance element.  In so doing, the Court noted certain procedural safeguards, such as the opt-out provision, and stressed that Rule 23(b)(3), designed for situations in which class-action treatment may not be so clear-cut, is even more exacting than Rule 23(a).  

 

Thus, taking the Court of Appeals to task for failing to consider arguments against Plaintiffs' damages model merely because doing so required an examination of the merits, the Court, while noting the duty imposed by Rule 23(b)(3) to take a "close look" at whether common questions predominate over individual ones, concluded that class certification in this case was improper, because Plaintiffs' model failed to establish that damages were actually capable of measurement on a classwide basis. 

 

As the Court explained, in this case "[q]uestions of individual damage calculations will inevitably overwhelm questions common to the class[,]" given that: (1) the damages methodology used by the lower court would mean that any damages Plaintiffs could expect would be limited to damages specifically resulting from reduced overbuilder competition; and, moreover, (2) in purporting to serve as evidence of all damages in this case, the damages model must measure only those damages attributable to the overbuilder theory, regardless of whether Plaintiffs in fact suffered damages attributable to some other theory of Cable Provider's anticompetitive conduct.   Accordingly, the Court ruled that the lower court erred in reasoning that, because Plaintiffs had provided a method to measure and quantify class-wide damages, it was unnecessary to inquire as to whether that methodology was "a just and reasonable inference or speculative." 

 

The Court further observed that the model of damages that the lower court relied on for certification failed to measure damages allegedly stemming specifically from conduct with respect to overbuilders, because that model assumed the validity of all four theories of anticompetitive harm as a whole, and did not attribute damages specifically to any one particular theory of anticompetitive impact.  The Court also offered that the model may have been sound had all four of the theories of antitrust injury remained in the case, but that without all four in the case, it was impossible to identify how any anticompetitive harm was the "certain result" of the overbuilder theory of anticompetitive conduct.

 

Thus, the Court stressed that at the class-certification stage, any model supporting "a plaintiff's damages case must be consistent with its liability case, particularly with respect to the alleged anticompetitive effect of the violation[,]" thereby reiterating the need to consider the merits of a claim in assessing compliance with Rule 23.  See ABA Section of Antitrust Law, Proving Antitrust Damages; Legal and Economic Issues 57, 62 (2d ed. 2010); Wal-Mart Stores, Inc. v. Dukes, 564 U.S. ___, ___ n.6  (2011)(slip op. at 10-11,  and n.6).   See also Federal Judicial Center, Reference Manual on Scientific Evidence 432 (3d ed. 2011)("The first step in a damages study is the translation of the legal theory of the harmful event into an analysis of the economic impact of that event.").  In the Court's view, following the lower court's reasoning would reduce Rule 23(b)(3)'s predominance requirement to a "nullity." 

  

Accordingly, the Court reversed the judgment of the Appellate Court and trial court, ruling that Rule 23(b)(3) did not authorize treating cable subscribers in the Philadelphia DMA as members of a single class.

 

 

 

Ralph T. Wutscher
McGinnis Wutscher Beiramee LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct: (312) 551-9320
Fax: (312) 284-4751
Mobile: (312) 493-0874
Email: RWutscher@mwbllp.com

 

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Our updates are available on the internet, in searchable format, at:
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FYI: Cal App Ct Upholds Dismissal of All Claims Except Wrongful Foreclosure for Alleged Violation of § 2923.5

The California Court of Appeal, First District, recently ruled that a borrower stated a cause of action for wrongful foreclosure based on a mortgage servicer's alleged noncompliance with California's requirement to exercise due diligence in contacting a borrower prior to initiating foreclosure proceedings under Cal. Civ. Code § 2923.5.  

 

In so ruling, the Appellate Court noted the impropriety of the lower court's taking judicial notice of the facts in a mortgage servicer's declaration asserting that the servicer had complied with the due diligence requirement, where the very facts asserted in the declaration were in dispute.  However, the Appellate Court agreed with the lower court's ruling that the borrower failed to state claims for fraud, intentional misrepresentation, breach of contract, breach of the implied covenant of good faith and fair dealing, slander of title, quiet title, and unfair competition, among others.

 

A copy of the opinion is available at:  http://www.courts.ca.gov/opinions/documents/A135782.PDF.

 

Plaintiff borrower ("Borrower") obtained a home mortgage loan from a bank that was secured by a deed of trust on Borrower's property.  The deed of trust named Mortgage Electronic Registration Systems, Inc. ("MERS") as the beneficiary.  Borrower eventually defaulted on her home loan, and MERS assigned its beneficial interest in the deed of trust to the trustee of a pool of securitized mortgage loans ("Loan Owner").  Around the same time, the trustee under the deed of trust ("Trustee") recorded a notice of Borrower's default.    Recorded along with the notice of default was a sworn declaration ("Declaration") by an employee of the loan servicer stating that the loan servicer "tried with due diligence to contact the borrower in accordance with California Civil Code Section 2923.5."  

 

Trustee subsequently recorded a Notice of Trustee's Sale, scheduling the foreclosure sale to take place a few weeks later.  Just one day before the scheduled foreclosure sale, Borrower filed a lawsuit against the loan servicer and Trustee (collectively, "Defendants"), seeking declaratory and injunctive relief and asserting various causes of action, including claims for wrongful foreclosure, fraud, intentional misrepresentation, breach of contract, breach of the implied covenant of good faith and fair dealing, slander of title, quiet title, and violation of California's Unfair Competition Law.   

 

Defendants filed a demurrer, supported by a request for judicial notice of the deed of trust, the notice of default, MERS's assignment of the trust deed, and the notice of the trustee's sale.  In opposition, Borrower argued in part that the demurrer misstated facts and should accordingly be stricken or denied.   The lower court granted the request for judicial notice, and sustained the demurrer and dismissed the complaint without leave to amend.   Borrower appealed.

 

The appellate court reversed only as to the wrongful foreclosure cause of action, based solely on allegations that Defendants failed to comply with California's due diligence requirement, but affirmed in all other respects.

 

As you may recall, California law precludes a trustee under a deed of trust from recording a notice of default until 30 days after the loan servicer has made initial contact with the borrower to assess the borrower's financial situation and explore options for avoiding foreclosure, or has satisfied the due diligence requirements of the statute.  Cal. Civ. Code § 2923.5 subd.(a)(1).   Due diligence, in turn, requires sending a letter by first-class mail, making three attempts to contact the borrower by telephone, and sending a certified letter if no response is received within two weeks of the telephone attempts.  Cal. Civ. Code S 2923.5 subd. (e).

 

In focusing primarily on Borrower's wrongful foreclosure cause of action, the Appellate Court noted among other things that:  (1) as to this cause of action, Borrower was not required to tender the amount owed on her loan, as she was seeking to enjoin an upcoming foreclosure sale on grounds that a condition precedent had not been met;  (2) a lender has no general duty to offer a borrower a loan modification; and  (3) it was proper to take judicial notice only of the existence of the Declaration, but not of the facts of compliance asserted therein, where those facts were in dispute.  

 

Of the various wrongful foreclosure theories Borrower asserted, including several permutations on lack of standing, the Appellate Court determined that Borrower's allegation that Defendants failed to comply with Section 2923.5 was sufficient to state a cause of action for wrongful foreclosure.    Specifically, the Appellate Court noted that Borrower's complaint expressly alleged that Defendants did not comply with the contact and due diligence requirements of Section 2923.5, that the facts asserted in the Declaration were in dispute, and that the Declaration provided no information as to when, how or by whom the elements of due diligence were satisfied, or how the declarant knew if they had been. 

 

Thus, pointing out that a demurrer is not the appropriate procedure for ventilating facts in dispute, the Appellate Court concluded that Borrower stated a cause of action for wrongful foreclosure solely based on the loan servicer's purported noncompliance with Section 2923.5 before recording the notice of default.

 

As to Borrower's other causes of action, the Appellate Court ruled that the lower court properly sustained the demurrer for reasons of lack of particularity, failure to state a claim, no duty to Borrower to offer a loan modification, Borrower's failure to satisfy the terms of the deed of trust, and the like.

 

Accordingly, the Appellate Court ruled that the lower court erred only to the extent that it sustained the demurrer as to the Section 2923.5 allegation. 

 

 

 

Ralph T. Wutscher
McGinnis Wutscher Beiramee LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
Direct: (312) 551-9320
Fax: (312) 284-4751
Mobile: (312) 493-0874
Email: RWutscher@mwbllp.com

 

NOTICE: We do not send unsolicited emails. If you received this email in error, or if you wish to be removed from our update distribution list, please simply reply to this email and state your intention. Thank you.

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