THE “MORTGAGE CRISIS”:
HOW CURRENT CREDIT WOES AFFECT YOU
AND YOUR CLIENTS
Litigation and Dispute
Resolution:
New Cases, New Causes
Jim D. Cooley
Meredith J. McKee
Womble Carlyle Sandridge & Rice, PLLC
Charlotte, NC
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The Current Litigation Environment
 New legislation
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Federal and state
 Increased enforcement activity
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Federal and state
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Civil and criminal penalties
 Increased litigation
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By states’ Attorneys General and regulators
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By local governments
•
By private plaintiffs
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New Legislation
 Federal
• Housing and Economic Recovery Act of 2008
(signed 7/30/08)
 Allows FHA to guarantee new loans for subprime
borrowers if lenders reduce balance to 90% of home value
 Increases conforming loan limits in high-cost areas
 First-time buyer tax credit
 Provided basis for oversight and now takeover of
Government Sponsored Enterprises (Fannie Mae, Freddie
Mac)
• HOEPA Amendments (generally effective 10/1/09)
 Prohibits “unfair, abusive or deceptive” lending practices
 New “higher-priced mortgage loan” regulations, including
consideration of “ability to pay”
 Restrictions on advertising
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New Legislation (cont.)
 State
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Mortgage Debt Collection and Servicing Act (eff. 4/1/08)
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Amendments to N.C. Mortgage Lending Act (H.B. 2463) (eff. 1/1/09)
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First time that mortgage servicing subject to NC regulations
Unique language requires NC-specific procedures
New pitfalls, short fuses and potential for liability
Amended again in the short session of 2008 (H.B. 2188) (eff. 10/1/08) to ban yield
spread premiums (YSP) on all “rate spread home loan” transactions – N.C. first state
to do so.
Comprehensive regulation of “mortgage servicers” (defined to include “receiving any
scheduled periodic payments from a borrower,” including escrow amounts)
Servicers required to: (i) be licensed; (ii) act with “skill, care and diligence”; and (iii) file
fee schedules with Commissioner of Banks
Expands list of “prohibited activities”
Requires 45-day pre-foreclosure notice to borrowers and gives Office of
Commissioner of Banks (“OCOB”) additional powers to suspend foreclosure for 60
days
Foreclosure moratoria enacted in North Carolina and New York, and being
considered in many other states
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The new North Carolina servicing law imposes delays and additional procedures (e.g.,
in addition to the 45-day pre-foreclosure notice and OCOB’s authority to suspend
foreclosure proceedings at any point in the process by 60 days, (noted above), the
Emergency Program to Reduce Home Foreclosures Act (H.B. 2623) (eff. 11/1/08 to
10/31/10) gives OCOB authority to extend the foreclosure filing date up to 30 days
beyond the date established in the pre-foreclosure notice).
Compare mandatory foreclosure mediation by judicial rule (Philadelphia Court of
Common Pleas; effective April 2008)
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Increased Enforcement Activity
 Federal – civil
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SEC – investigations into publicly-traded companies (e.g., 9/3/08 civil
complaint against two Credit Suisse brokers – see below)
OTS – AIG Bank, F.S.B.
FDIC – e.g., investigations of Fremont and Countrywide have been
announced
FTC – preparing settlements with loan servicers
 Federal – criminal
•
Federal-state task forces formed in several cities (New York,
Philadelphia, Atlanta, Dallas, Los Angeles)
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First indictments (securities fraud, wire fraud, conspiracy) unsealed in
E.D.N.Y. on 9/3/08 against two former Credit Suisse brokers for
allegedly deceiving customers in the sale of over $1 billion in auctionrate securities by representing that the collateral of the loans was
federally guaranteed student loans when they were actually backed, in
part, by subprime mortgages and CDOs.
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Increased Enforcement Activity (cont.)
 State
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Office of Commissioner of Banks
 Conducts routine examination of mortgage lenders. N.C.G.S. Section 53243.12(i)
 Brings disciplinary proceedings under the Administrative Procedure Act.
N.C.G.S. Section 53-243.12 (with Attorney General’s office)
 May require restitution to borrowers for violations of Chapter 24.
N.C.G.S. Section 53-243.12(j)
•
Jurisdiction of OCOB limited by Federal preemption to state-chartered
institutions
 See this year’s U.S. Supreme Court decision in Watters v. Wachovia
 Look for battles over state power to regulate mortgage subsidiaries of
national banks
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Increased Litigation:
The “Radiating Ripples of ‘Sub-Prime’ Litigation”

Claims against mortgage originators by or on behalf of borrowers [“Bottom
Up”]
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Claims arising from the securitization process by investors, by and against
trusts/underwriters and against originators, including insurers, as to which
group should bear the ultimate risk of defaults [“Top Down”]

Claims involving collateral debt obligations (CDOs) against placement
agents, portfolio managers, financial advisors, officers and directors of
CDOs, rating agencies, insurers, accountants and perhaps lawyers
[“Buyers Burnt”]

Shareholder and derivative claims on behalf of classes of shareholders of
investment banks, mortgage companies, homebuilders, etc. [More “Buyers
Burnt”]
See Jayant W. Tambe, “The Radiating Ripples of ‘Sub-Prime’ Litigation” in Those Lowdown
Subprime and Credit Crunch Blues and What Every Business Litigator Needs to Know About Them
(ABA, Section of Business Law, Aug. 9, 2008).
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The Variety of “Bottom Up” Claims
 Actions by states against originators on behalf of borrowers (parens
patriae) alleging:
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Deceptive advertising
That the fundamental business model of some originators promotes unfair and
deceptive practices
 Actions by local governments against:
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A single lender for reverse redlining – City of Baltimore
“Wall Street” for creating a public nuisance – City of Cleveland
Lenders which have already foreclosed, seeking demolition costs for
abandoned homes – City of Buffalo
Lenders who are trying to foreclose, seeking injunctions to halt the process –
City of San Diego
 Actions by private plaintiffs:
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To halt foreclosure process
For breach of “fiduciary” duty
For discriminatory practices
To enforce “suitability” standards contained in new HOEPA rule and North
Carolina law
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Bottom-Up Claims by States
 Actions by State Attorneys General against the largest
(formerly) independent mortgage originator, Countrywide
Home Loans and subsidiaries
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California, Illinois, Florida, Connecticut, West Virginia, Indiana
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National Association of Attorneys General and its Standing Committee
on Consumer Protection provide forum for discussion and coordination
•
Look for greater coordination among state bank/mortgage company
regulators, especially as part of parallel proceedings involving the
Attorneys General
 Claims by State Attorneys General framed primarily
around “Little FTC”/unfair and deceptive trade practice
statutes
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The California Approach: Attacking the
Business Model
 Claims focus on the fundamental structure of the subprime,
securitization business model as promoting unfair and deceptive
trade practices (UDTP).
 Use of conspiracy claims joined with UDTP claims.
 Key Allegations:
• Easing of underwriting standards and increasing use of “exceptions” to
underwriting.
• Use of low- or no-documentation loans.
• Encouraging “risk-layering” by financing up to 100% of home value
through use of “piggybacks.”
• Using piggybacks without attention to the total monthly payment and
underwriting on basis of “interest-only” payments.
• Other allegations relate to deceptive advertising and the creation of a
“high pressure” sales environment.
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Relief Requested
 Civil Penalties ($2,500 - $10,000 per violation)
 Preliminary and permanent injunctions against continuation of the
practices (but cf. more specific foreclosure injunctions under the
Massachusetts approach)
 Restitution to borrowers
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“any money or property, real or personal, which may have been acquired by
means of unfair competition” -- California Amended Complaint
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“. . . whose homes were lost due to foreclosure. . . .” -- Illinois Complaint
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“notify every consumer . . . of the availability of restitution -- Connecticut
Complaint
 Reformation or recession
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“. . . rescinding, reforming or modifying all mortgage loans . . . affected by the
use of the . . . unlawful acts and practices” -- Illinois Complaint
-- Connecticut Complaint
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The Massachusetts Approach: Halting (or
Slowing Down) Foreclosures
 On May 2, 2008, the Massachusetts Court of Appeals upheld a
preliminary injunction against California-based Fremont Investment
& Loan and its parent which:
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Restricts foreclosure against owner-occupied properties where the
mortgage loan is “presumptively unfair” under the state’s Predatory
Home Loan Practices Act.
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Provides advance notice to the Attorney General before it forecloses
on any Massachusetts loan originated and serviced by Fremont.
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Extends to any subsequent assignee of any Fremont residential
mortgage loan.
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On appeal to MA Supreme Court.
 On June 3, 2008, the Massachusetts Attorney General obtained
similar injunction against H&R Block, Option One Mortgage and
American Home Mortgage. The complaint adds claims of race
discrimination under the Fair Housing Act.
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Massachusetts v. Fremont Investment & Loan
Injunction Decision Matrix for Foreclosure
(Courtesy of Greenberg Traurig,
“Subprime & Mortgage Markets Alert,”
May, 2008)
Is the mortgage loan owner occupied?
Yes
No
Is the mortgage loan “presumptively unfair”?
Is the mortgage loan “presumptively unfair”?
Fremont provides AG 30
days written notice
(1) ARM teaser period of 3 years or less;
(1) ARM teaser period of 3 years or less;
(2) “Teaser” rate 3% or more below fully
No
indexed rate;
(2) “Teaser” rate 3% or more below fully
indexed rate;
(4) LTV is 100%, or prepayment penalty is
(3) Borrower DTI ratio exceeds 50% if
measured at fully indexed rate; and
substantial or extends beyond teaser period.
(3) Borrower DTI ratio exceeds 50% if
Yes
measured at fully
indexed rate; and
AG does not object
within 30 days
AG objects within
30 days
Fremont provides AG with 45 days written notice
before foreclosure, identifying why foreclosure is
reasonable
(4) LTV is 100%, or prepayment penalty is
substantial or extends beyond teaser period
AG does not
object within 45
AG objects within
45 days
Fremont and AG have 15 days to resolve
differences
Not resolved
Resolved
Fremont must obtain court order
Court considers whether (i) loan is actually
“unfair” (i) reasonable steps have been taken to
“work out” and avoid foreclosure and (iii) any
fair or reasonable alternative to foreclosure
exists
Not Granted
Granted
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Fremont prohibited from pursuing loan
foreclosure
Fremont may proceed with loan foreclosure
The Massachusetts Approach (cont.)
 The City Attorney of San Diego has recently taken the
Massachusetts approach, seeking to enjoin foreclosure
actions (presumably limited to San Diego County) in
People of the State of California v. Countrywide
Financial Corporation; Bank of America, et al. (July 23,
2008).
 Cf. Massachusetts v. Doherty:
State sued would-be “flipper” who defaulted on multiple
loans allegedly obtained by submitting false information,
thereby damaging nearby property owners.
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Actions by State Attorneys General
and/or Regulators: What’s Next?
 Similar actions against other lenders and by other Attorneys
General using California or Massachusetts model, or both
 Emergence of aiding and abetting theories in order to try to draw in
affiliated parties up the chain
 Stepped-up enforcement against originators and servicers by state
regulators
 Perhaps a coordinated effort at a global settlement between
Attorneys General and what is left of subprime industry (shades of
settlement with tobacco industry)
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Bottom-Up Claims: Actions by Local Governments
 Subprime mortgages as a public nuisance: City of Cleveland v.
Deutsche Bank Trust Company, et al.
City claims that Wall Street securitizers are primarily responsible for
a cycle of loans to unqualified buyers, which led to defaults, which
led to foreclosures, which led to abandoned homes, depletion of tax
base, and increased fire and police protection, thereby creating a
public nuisance.
 Failure to upkeep: City of Buffalo v. ABN AMRO Mortgage Group,
Inc.
City claims that mortgage holders who foreclosed and then walked
away from 57 foreclosed properties should be required to reimburse
it for demolition costs ranging from $16,000 to $40,000 each.
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Bottom-Up Claims: Actions by Local Governments (cont.)
 Reverse redlining: Baltimore v. Wells Fargo Bank
City claims that Wells Fargo, the largest mortgage lender in the
City, violated Fair Housing Act by targeting African-American
communities for sub-prime and other predatory lending products.
The “disparate impact” of these practices are allegedly manifested
by much higher foreclosure rates in the African-American
neighborhoods than in white neighborhoods.
See Gotlieb and McGuinness, “When Bad Things Happen to Good Cities Are Lenders to
Blame?” Business Law Today (July/August 2008) 13-17.
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Bottom-Up Claims: Private Plaintiffs
 Traditional disclosure-type claims (individual and class actions),
which attack the originator’s documentation of the loan, abound.
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TILA, HOEPA, RESPA, FACTA, ECOA
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Some accompanied by state-law add-ons, such as:
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Usury
Misrepresentation/fraud
Breach of the duty of good faith/fair dealing
UDTP
 New theories (or new variations on old theories) include:
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“Who holds the note?” foreclosure defense/offense
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“Special relationship” claims
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Disparate impact on minority applicants through HMDA data
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“Suitability” standard for high-cost loans (new
HOEPA regs.)
North Carolina law,
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Bottom-Up Claims: “Who Holds the Note?”
 In re Foreclosure Cases, Civil Action No. 07-CV-2282 (N.D. Ohio):
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Federal judge dismissed foreclosures in scathing opinion after
Deutsche Bank was unable to prove it held the notes at the time
foreclosures were filed.
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Case reveals difficulties of presenting MERS (Mortgage Electronic
Registration System) and the technology of the “modern” mortgage
market to a court.
 Whittiker v. Deutsche Bank National Trust Company, (N.D. Ohio,
filed February 7, 2008): Follow-on class action against Deutsche
Bank for FDCPA violations and RICO violations arising out of In re
Foreclosure Cases. Action seeks appointment of a receiver for
foreclosed properties.
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Bottom-Up Claims: Special Relationship Claims

Tomlin v. Dylan Mortgage Inc., 2000 NC Business Court 9: Judge Tennille declined to dismiss breach of fiduciary
duty claim against broker, where broker had entered into exclusive 3 month brokerage agreements with each
borrower.
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Rose v. SLM Financial Corp., Civil Action No. 3:05-CV-445 (W.D.N.C.): UDTP, breach of contract and breach of
good faith and fair dealing claims against broker
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Plaintiff attempts to broaden Tomlin to create a fiduciary duty arising from a non-exclusive broker
agreement.
Smith v. GMAC Mortgage Corp., Civil Action No. 5:06-CV-125 (W.D.N.C.): UDTP, breach of fiduciary duty,
breach of contract and negligence claims.
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Cf. Hinton v. West (N.C. Supreme Court 1935): Mortgagor and mortgagee as a “relation of confidence.”
U.S. District Court Judge Vorhees denied defendant’s Rule 12(b)(6) motion, finding that plaintiff
had sufficiently pled a claim for breach of a fiduciary duty “surrounding the mortgagor-mortgagee
relationship” which may give rise to an extra-contractual duty to make timely payments from
escrow to plaintiff’s homeowner’s insurance carrier.
Fiduciary duty by conduct? Iannuzzi v. Washington Mutual (E.D.N.Y. August 21, 2008), as reported on Law.com
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Despite NY authority that the mortgage broker generally does not owe a fiduciary duty to a
customer, the U.S. District Court denied defendant’s motion to dismiss, finding that “a broker may
take on a fiduciary duty by performing tasks and obligations beyond that of an independent broker
or traditional middleman,” and that plaintiff had alleged sufficient facts based on a “close
relationship” between defendant broker and the plaintiff’s financial advisor.
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Bottom-Up Claims:
Disparate Impact on Minority Borrowers
 Miller v. Countrywide Bank, et al. (D.Mass.):
Putative
class action alleging:
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Pricing policy contains discretionary component to credit-based pricing
policy which allows increase in financing charges and interest mark-ups.
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While race-neutral on its face, pricing policy resulted in discriminatory impact
on African-American applicants, based on data compiled pursuant to the
Home Mortgage Disclosure Act (“HMDA”).
(Motion to Dismiss denied 7/30/08)
 Lewis v. Alpha Mortgage and American Home Mortgage
Servicing, Inc. (Baytown, Texas):
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Reverse redlining claims by African-American homeowner brought
under HOEPA and the Texas Constitution, as reported at Law.com
on 9/5/08.
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Bottom-Up Claims:
The Emerging “Suitability” Standard
 Articulated in recent state and federal laws as “ability to repay”
 North Carolina usury law, Chapter 24, now regulates higher cost
home loans, defined as “rate spread home loans,” at N.C.G.S.
§ 24-1.1F (eff. 1/1/08)
•
Lender may not make a “rate spread home loan” unless it “reasonably
and in good faith believes . . . [borrower] . . . has the ability to repay
the loan . . . . N.C.G.S. § 24-1.1F(c)
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Detailed analysis of ability to repay required
Limited right by lender to “cure” and to assert bona fide error defense
Remedies:
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Forfeiture of interest in connection with the loan
An affirmative recovery of twice the amount of interest already paid
Similar laws are in effect in New York, Maine and Maryland
 The new Home Ownership and Equity Protection Act (“HOEPA”)
Rules at 12 C.F.R. § 226.135 (eff. 10/1/09) contains a suitability
standard similar to North Carolina.
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Some (Obvious) Defensive Strategies
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Which forum?
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Other parties and claims:
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Cross-claims – assignee liability
Counterclaims – borrower misrepresentations and false financial statements
Borrower misconduct defenses
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Removal under CAFA
Preemption
Compelling Arbitration
Unclean hands
Fraud
Illegality
Class action defenses
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Subprime loan transactions are complex with many players – unfocused,
“shot-gun” attacks by plaintiff destroy predominance or create such a morass
of subclasses that the action becomes unmanageable
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Borrower misconduct may result in predominance of questions affecting
individual class members over questions of law or fact common to the class
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