FYI: 2nd Cir Holds False Claims Act Applies to Loans Made By the FRBs

The U.S. Court of Appeals for the Second Circuit recently held that the federal False Claims Act ("FCA") applies to persons who present false or fraudulent loan applications to Federal Reserve Banks because the latter are "agents of the United States" within the meaning of the FCA and the loan money is provided by the United States to advance a Government program or interest within the meaning of the FCA.

 

A copy of the opinion is available at:  Link to Opinion

 

Two individuals (the "relators") who were former employees of a federally-chartered bank and a savings and loan association that were acquired in October 2006 by another federally-chartered bank, filed an action under the FCA in November 2011 alleging that the acquiring holding company and its federally-chartered bank presented fraudulent applications for emergency loans to several Federal Reserve Banks ("FRBs") that misrepresented their financial condition. The relators alleged they were terminated in 2006 because they questioned the allegedly illegal business practices of their employers.

 

In October of 2008, the acquired bank "requested billions of dollars in loans from two of the emergency lending facilities operated by the Fed: the Discount Window and the Term Auction Facility ('TAF')." Despite this, the bank could not "survive as a standalone entity," and it merged into the acquiring bank in December of 2008. The acquiring bank then borrowed "$15 billion in January 2009 and $30 billion in February 2009. … at an interest rate of 0.25%."

 

"The Discount Window is a standing facility through which the Fed makes short-term loans to depository institutions. … The terms of these loans depend on a borrower's financial condition[.]"

 

"The TAF was a temporary facility created by the Board on December 12, 2007, to increase liquidity in financial markets at the outset of the financial crisis. The program's goal was to address the reluctance of financial institutions to borrower from the Discount Window at that time. … Only firms in a generally sound condition are eligible to participate."

 

The defendants moved to dismiss and the trial court granted the motion, "holding that relators' complaint failed to allege false claims under the FCA." The relators appealed and the Second Circuit affirmed. The relators then "petitioned for certiorari and, the Supreme Court vacated [the Second Circuit's] decision … and remanded the case for further consideration …."

 

On remand, the Second Circuit "vacated the trial court's judgment and remanded the case 'for the trial court to determine, in the first instance, whether the relators have adequately alleged the materiality of the defendants' alleged misrepresentations.'"

 

On remand to the trial court, the relators amended their complaint and defendants again moved to dismiss. In May 2018, "the trial court granted the motion, holding that loan requests made to FRBs are not 'claims' within the meaning of the FCA because (1) FRBs are neither part of the government, nor agents of the government, and (2) the United States does not 'provide … the money … requested or demanded' by banks that borrow from the Fed's emergency lending facilities." The relators appealed again.

 

In the second appeal, the Second Circuit reviewed "the trial court's grant of defendants' Rule 12(b)(6) motion to dismiss de novo, 'accepting all factual claims in the complaint as true and drawing all reasonable inferences in the plaintiff's favor.'"

 

The Court explained that "the Fed is comprised of twelve FRBs, which are separately incorporated banks dispersed geographically throughout the country, and a Board, which is based in Washington, D.C. and is an independent agency within the executive branch."

 

Under the Federal Reserve Act ("FRA") and "regulations promulgated by the Board[,]" FRBs can extend credit at a preferred "'primary credit rate' as a backup source of funding to a depository institution … that is in generally sound financial condition,' … and at a higher, 'secondary credit rate' … to a depository institution that is not eligible for primary credit …."

 

"But the FRBs are not permitted to extend credit through the Discount Window to those institutions that are insolvent or to those that are borrowing for the purpose of lending to a person who is insolvent."

 

First, the Second Circuit discussed the FCA's background and statutory framework, explaining that the FCA was adopted as the result of congressional investigations into the sale of worthless or over-priced goods to the War Department during the Civil War. "The Act was passed in sum and substance 'to stop this plundering of the public treasury."

 

"[T]he FCA imposes liability on any person who either 'knowingly presents … a false or fraudulent claim for payment or approval,' … or 'knowingly makes … a false record or statement material to a false or fraudulent claim[.] … The term 'claim' means any request or demand, whether under a contract or otherwise, for money or property and whether or not the United States has title to the money or property, that— (i) is presented to an officer, employee, or agent of the United States; or (ii) is made to a contractor, grantee, or other recipient, if the money or property is to be spent or used on the Government's behalf or to advance a Government program or interest …."

 

The Court then concluded that "[r]equests made to FRBs for loans from the Fed's emergency lending facilities are 'claim[s]' within the meaning of the False Claims Act[,]" reasoning that the statute's language "reflects a broad legislative purpose that is most faithfully effectuated by recognizing that the FCA applies, in some cases, to functional instrumentalities of the government and to agents pursuing its ends."

 

However, because the FCA "does not reach frauds directed at private entities that only incidentally lead to payments with money provided by the government[,]" the Court reasoned that "[t]he overarching question in this case, therefore, is whether a fraudulent loan request made to one of the FRBs is an effort to defraud a private entity or an effort to defraud the United States. … The specific questions are whether (1) FRB personnel are 'officer[s]' or 'employee[s]' … of the United States … ; (2) the FRBs, in operating the Fed's emergency lending facilities, are 'agent[s] of the United States' …; or (3) fraudulent loan requests knowingly presented to one or more of the FRBs are 'claim[s]' under the FCA because the 'money … requested' is 'provided' by the United States …."

 

Addressing each question in turn, the Second Circuit first concluded that "FRB personnel are not 'officer[s]' or 'employee[s] … of the United States' within the meaning of § 3729(b)(2)(A)(i)" because "[t]he FRBs are not part of any executive department or agency … [n]or do they have the authority to promulgate regulations with the force and effect of law. Instead, they are corporations … that operate 'under the supervision and control of a board of directors,' which 'shall perform the duties usually appertaining to the office of directors of banking associations.'" The Court thus "agree[d] with defendants that fraudulent loan requests made to the FRBs do not qualify as claims under the first clause of § 3729(b)(2)(A)(i)."

 

Turning to the second question, the Court concluded that "the alleged fraudulent loan applications [were] nonetheless 'claims' under the FCA [because] the FRBs act as 'agents of the United States' under § 3729(b)(2)(A)(i) when operating the Fed's emergency lending facilities." The Court cautioned, however that it did so "on a narrow reading where we confine ourselves to only to the circumstances at hand, which require use to determine the meaning of the FCA in the context of extending emergency credit."

 

In light of the purpose of the FCA, the Second Circuit saw "no reason to depart from the plain meaning of the phrase 'agent of the United States' [because] … [f]raud during a national emergency against entities established by the government to address that emergency by lending and spending billions of dollars is precisely the sort of fraud that Congress meant to deter when it enacted the FCA."

 

Turning to the third question, the Court also concluded that "the alleged fraudulent loan applications are 'claims' under the FCA because the United States 'provides' the money 'requested' by borrowers from the Fed's emergency lending facilities within the meaning of § 3729(b)(2)(A)(ii) and the money requested is to be spent to advance a Government program or interest."

 

The Second Circuit rejected the argument of amici and defendants that "the Fed's emergency lending facilities do not qualify as money requested or demanded by the U.S. because the FRBs are not funded by the United States Treasury[,]" reasoning that "the FCA nowhere limits liability to requests involving 'Treasury Funds.' … The text of the FCA is deliberately broad, including 'any request or demand … for money or property … whether or not the United States has title to the money or property,' as long as 'the United States Government … provides or has provided any portion of the money or property requested or demanded.'"

 

The Court found that the government provided the money because "the FRBs are the issuers of base money. They do not lend out preexisting funds; they create 'funds' in the most elemental sense. They perform this function on behalf of the United States, as federal instrumentalities. When banks request loans from the FRBs, the FRBs extend those loans by increasing these reserves. …These new reserves are created ex nihilo, at a keystroke. They are promises by the FRBs to pay Federal Reserve notes (dollar bills) to the banks on demand. … The FRBs' promises to pay notes serve as money or legal tender because they must be accepted by the Treasury and by other banks as payment. … Had Congress not delegated this power to the Fed, the FRBs would be unable to extend the loans at issue in this case. And we see no reason why Congress's decision to separate the FRBs from the Board and the Board from the Treasury Department should alter our conclusion that the United States is the source of the purchasing power conferred on the banks when they borrow from the Fed's emergency lending facilities."

 

The Second Circuit reasoned that "[t]he loans in this case are also money provided by the United States in a further sense. The Board puts Federal reserve notes into circulation by supplying them to the FRBs, which are the actual direct issuers. … Thus, when banks like [the defendant and the bank it acquired by merger] withdraw the proceeds of loans requested from (and extended by) the FRBs, the banks quite literally receive money 'provided' by the Board, i.e., money made available and/or supplied by the United States."

 

Accordingly, the Court "disagree[d] with the trial court that fraudulent loan requests made to the FRBs do not qualify as claims under § 3729(b)(2)(A)(ii)(I)" of the FCA, vacated the lower court judgment, and remanded the case for further proceedings.

 

 

 

Ralph T. Wutscher
Maurice Wutscher 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@MauriceWutscher.com

 

Admitted to practice law in Illinois

 

 

 

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FYI: 7th Cir Reduces Punitive Damage Award Against Mortgage Servicer by Over 80%

The U.S. Court of Appeals for the Seventh Circuit recently reversed as excessive a jury's award of $3,000,0000 in punitive damages against a mortgage servicer for inadequate recordkeeping, misapplication of payments, and poor customer service.

 

However, the Court affirmed the jury's award of $582,000 in compensatory damages and remanded the case to the trial court with instructions to reduce the punitive damages award to $582,000, a 1:1 ratio of compensatory to punitive damages.

 

A copy of the opinion is available at:  Link to Opinion

 

A borrower filed a Chapter 13 bankruptcy case and complied with the reorganization plan by curing her mortgage default and making 42 monthly payments. The loan servicer provided her with statements showing she was not only current, but had actually paid more than what was required. Accordingly, the bankruptcy court granted her a discharge.

 

Unfortunately, despite this, the servicer tried to collect money that was not actually owed after the bankruptcy discharge.

 

One problem was that an employee mistakenly treated the discharge as a dismissal of the bankruptcy case, which meant that the bankruptcy stay had been lifted and no obstacle remained to collecting the borrower's allegedly delinquent amount owed.

 

Another problem was that the servicer "manually set the due date for [debtor's] plan payments to September 2013. … That manual setting took place in a bankruptcy module that overrode and hid [the servicer's] active foreclosure module, which instead reflected that [the debtor] had not made a single valid payment in 2013, as each check was being placed into a suspense account and not being applied to the loan." By incorrectly treating the bankruptcy discharge as a dismissal, the foreclosure module was re-activated. If this had not occurred, "then someone in [the servicer's] bankruptcy department would have reconciled the plan payments with the suspense accounts before closing both modules."

 

The borrower repeatedly provided paperwork showing she was current and requested an explanation. The servicer maintained its position and refused to provide an explanation.

 

The servicer began rejecting the borrower's payments in September of 2013 "because each payment was not enough to cure her supposed default." It also filed a foreclosure action in state court.

 

The borrower filed suit in federal court, seeking "damages under four legal theories: breach of contract, for the refused payments; the Fair Debt Collection Practices Act (FDCPA), 15 U.S.C. § 1692, for the false collection letters; the Real Estate Settlement Procedures Act (RESPA), 12 U.S.C. § 2601, for the inadequate responses to [debtor's] inquires; and the [Illinois Consumer Fraud and Deceptive Business Practices Act (ICFA)]."

 

The state UDAP claim "related to [the servicer's] false oral and written statements regarding [debtor's] default and its unfair practices in violation of consent decrees that [the servicer] previously had entered with various regulatory bodies. These decrees addressed, among other things, its inadequate recordkeeping, misapplication of payments, and poor customer service. Among the steps [the servicer] had consented to take was to track Chapter 13 plan payments accurately and to reconcile its accounts on discharge or dismissal."

 

The case went to trial and the jury awarded the debtor "substantial damages for the pain, frustration, and emotional torment [the servicer] put her through." Specifically, the jury awarded "$500,000 in compensatory damages based on three causes of action that could not support punitive damages" and $3,000,000 in punitive damages plus an additional $82,000 in compensatory damages under the ICFA.

 

The servicer filed three post-trial motions. "The first, a motion for new trial, objected to the admission of the consent decrees. The second, a request for judgment as a matter of law, challenged the sufficiency of the evidence on every count other than the FDCPA claim[, arguing that] that the award of punitive damages was not supported by sufficient evidence. The third motion, to amend the judgment, argued that the punitive damage amount was excessive, in violation of the Due Process Clause."

 

The trial court denied all three motions.

 

On appeal to the Seventh Circuit, the servicer challenged only the punitive damages award, which it argued was "so large that it deprives the company of property without due process of law."

 

The Appellate Court first addressed the servicer's "argument that there was insufficient evidence for the jury to award punitive damages at all[,]" explaining that "[u]nder Illinois law, punitive damages may be awarded only if 'the defendant's tortious conduct evinces a high degree of moral culpability, that is, when the tort is 'committed with fraud, actual malice, deliberate violence or oppression, or when the defendant acts willfully, or with such gross negligence as to indicate a wanton disregard of the rights of others.' … When the defendant is a corporation, … the plaintiff must demonstrate also that the corporation itself was complicit in its employees' tortious acts."

 

The Seventh Circuit rejected the servicer's argument, finding that "[w]e are not sure how many  human errors a company like [the servicer] gets before a jury can reasonably infer a conscious disregard of a person's rights, but we are certain [the servicer] passed it."

 

This is because the servicer "still has offered no real explanation for any of the errors its employees made, and never acted to correct its mistakes. This 'unwilling[ness] to take steps to determine what occurred' warranted punitive damages under the ICFA. The utter lack of explanation also supports a finding of corporate complicity" because it amounted to the company's ratification of its employees' errors and refusal to correct them. "The jury was not required to accept [the servicer's] bare assertion that this was a unique case — especially considering the consent decrees implying it was not — and could have inferred that this is just how [the servicer] does business. For that Illinois law permits punitive damages."

 

Turning to the servicer's argument that the punitive damages award was unconstitutionally excessive, the Seventh Circuit reasoned that while the federal constitution was the outer limit on a state court's award of punitive damages, "[a] federal court, however, can (and should) reduce a punitive damages award sometime before it reaches the outermost limits of due process."

 

The Court then embarked upon an "[e]xacting de novo review of the jury's award, in which [it] consider[ed] three guideposts: the degree of reprehensibility, the disparity between the harm suffered and the damages awarded, and the difference between the award and comparable civil penalties."

 

After reviewing each guidepost, the Seventh Circuit concluded that "the $3,000,000 awarded here exceeds constitutional limits and must be reduced to $582,000." "The number of opportunities [the servicer] had to fix its mistakes is the core fact that justifies punishment in this case." In addition, the Court found that the servicer's actions were more than negligent, they amounted to "reckless indifference" to the borrower's rights, "including those rights that originated from her bankruptcy."

 

However, $3,000,000 was too much because although the servicer's "conduct was reprehensible, [it was] not to an extreme degree. It caused no physical injuries and did not reflect an indifference to [the debtor's] health or safety." Also, the Court found that there was no evidence that that servicer "was acting maliciously, though the number of squandered chances it had to correct its mistakes comes close. These factors then point toward a substantial punitive damages award, but not one even approaching the $3,000,000 awarded here."

 

The Seventh Circuit then turned to address the "disparity between the harm to the plaintiff and the punitive damages awarded. … This guidepost is often represented as a ratio between the compensatory and punitive damages awards."

 

Although the Supreme Court of the United States has not provided strict rules clarifying how to calculate this ratio, it has provided general guidelines, including that "few awards exceeding a single-digit ratio 'to a significant degree' will satisfy due process. … Second, the ratio is flexible. Higher ratios may be appropriate when there are only small damages, and conversely, '[w]hen compensatory damages are substantial, then a lesser ratio, perhaps only equal to compensatory damages, can reach the outermost limit.' … Third, the ratio should not be confined to actual harm, but also can consider potential harm."

 

Applying these factors, reasoned that "$582,000 is a considerable compensatory award for the indifferent, not malicious, mistreatment of a single $135,000 mortgage. Moreover, nearly all this award reflects emotional distress damages that 'already contain [a] punitive element.' … A ratio relative to this denominator, then, should not exceed 1:1."

 

Analyzing the final "guidepost," "the disparity between the award and 'civil penalties authorized or imposed in comparable cases[,]'" the Court agreed with the servicer that the "$50,000 monetary penalty authorized by the ICFA" could not support a punitive damages award of $3,000,000 because the servicer's "actions are not so reprehensible that they might justify an award equal to the maximum penalty for  60 intentional violations. Notably, we see no evidence that [the servicer's] action in this case were either intentional or fraudulent, only indifferent. This aspect of the guidepost thus points to a lower award."

 

Finally, the Seventh Circuit agreed the trial court correctly considered the possibility that the servicer could lose its license to service mortgages under the Illinois Residential Mortgage License Act (RMLA). First, it reasoned that "the ICFA too, allows, the attorney general to seek 'revocation, forfeiture or suspension of any licenses … of any person to do business,' … and though that may give way here to the more specific provisions of the RMLA, that law allows revocation of licenses for violation of 'any … law, rule or regulation of [Illinois] or the United States,' … presumably including the ICFA as well as RESPA."

 

Second, the Court reasoned that while Illinois is not likely to take away [the servicer's] business license for deceptively saying one customer owes a few thousand dollars on a $135,000 mortgage, no matter how unjustified the error[,] … like a criminal penalty, this weapon in Illinois's arsenal has 'bearing on the seriousness with which a State views the wrongful action.' … This seriousness would be exaggerated by comparing the award here with the loss of [the servicer's] license but would be unduly minimized by limiting an award to only the $50,000 civil penalty."

 

The Court concluded that after "[c]onsidering all the factors together, we are convinced that the maximum permissible punitive damages award is $582,000. An award of this size punishes [the servicer's] atrocious recordkeeping and service of [borrower's] loan without equating its indifference to intentional malice. It reflects a 1:1 ratio relative to the large total compensatory award and a roughly 7:1 ratio relative to the $82,000 awarded on the ICFA claim alone, both of which are consistent with the Supreme Court's guidance in [State Farm Mut. Auto Ins. Co. v.] Campbell. It is equivalent to the maximum punishment for less than 12, not 60, intentional violations of the ICFA, though it is also a miniscule amount compared to the value of [servicer's] business license."

 

On the final issue presented, "whether the Seventh Amendment mandates an offer of a new trial after determining the constitutional limit on the punitive damages award[,]" the Court "agree[d] with every circuit to address this question that the constitutional limit of a punitive damage award is a question of law not within the province of the jury, and thus a court is empowered to decide the maximum permissible amount without offering a new trial."

 

The Seventh Circuit accordingly remanded the case to the trial court "to amend its judgment and reduce the punitive damages award to $582,000."

 

 

 

 

Ralph T. Wutscher
Maurice Wutscher 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@MauriceWutscher.com

 

Admitted to practice law in Illinois

 

 

 

Alabama   |   California   |   Florida   |   Georgia  |   Illinois   |   Massachusetts   |   New Jersey   |   New York   |   Ohio   |   Pennsylvania   |   Texas   |   Washington, DC

 

 

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