Daily Development for Friday, January 7, 1999

By: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
randolphp@umkc.edu

LENDER LIABILITY; DECEPTIVE TRADE PRACTICES: Purchasers of unfinished home may recover statutory damages from a mortgagee's "unconscionable" violations under the Texas Deceptive Trade Practices Act (DTPA) as mortgagee provided "services" to purchasers in funding the construction and purchase of a home sufficient to grant consumer recovery under the act.

Norwest Mortgage, Inc. v. Salinas, 999 S.W.2d 846 (Tex. Ct. App. 1999).

Here, the mortgagee had paid out the mortgage funds to an insolvent builder who failed to complete construction of the home, had failed to obtain appropriate lien waivers, and had hired (without the home buyers' approval) a second contractor who also quit work on the home, leaving the home buyers with full mortgage payments on a home that was half finished and burdened by multiple mechanics' liens, for which they had to take out a second mortgage loan and hire a third contractor to complete. The home buyers finally moved into the home when it was still in an incomplete condition, after making mortgage payments for a full year.

Norwest apparently had made an advance agreement with the first builder to fund construction loans for its customers. The builder advertised Norwest's participation in its literature, and in fact introduced the plaintiffs to Norwest. Builder, Norwest and plaintiffs joined together in a single closing initiating the loan and the construction project. For a fee of $300, Norwest agreed to supervise loan disbursements. Its own policies required that there be lien waivers for work done to date prior to every disbursement. The court found that Norwest's failure to require such waivers and otherwise to supervise the behavior of both the first and second builder (which Norwest selected without specific approval of plaintiff) constituted a substantial cause of the plaintiff's damages here.

Out of these facts the court fashioned substantial relief under the DTPA: $660,000.00 in damages granted in a case where the home buyers' purchase price was $124,000.00 plus the cost of the home's lot. The damages included recovery for mental anguish. Forty percent of the total damages were awarded as attorney's fees.

The court found that the home buyers were "consumers" with standing under the Act, even though by definition party who simply borrows money is not a "consumer." The court concluded that Norwest failed to properly supervise disbursements and to abide by its mandatory policy of obtaining lien waivers prior to disbursement. These were "services" they acquired from Norwest in connection with the loan agreement, and the agreement to purchase these services made them "consumers."

The court concluded that Norwest was "inextricably intertwined" in the overall consumer transaction because the extension of credit formed the means of making the sale or purchase from the buyer's perspective." Thus the lender was liable under Texas consumer law for the misbehavior of the builder.

Further, the court held that the mortgagee was liable for "unconscionable behavior" (as defined in the DTPA) of its own in financing a home that (because of the problems with the contractor) had a value "grossly disparate" with the amount of the home buyer's mortgage loan. The DTPA defines as an "unconscionable practice" a transaction in which there is a "gross disparity" between the consideration paid and the value received. The court concluded that the plaintiffs had paid $300 for loan supervision and had been required to pay over $52,000 to remedy the problems caused by faulty performance of this supervision.

Comment 1: This case undoubtedly comes as a big "shocker" to Norwest, which likely had viewed itself as in the lending business, and not subject to Texas' tough consumer laws. But it appears to be a case where the marketing department got out in front of the legal department. Had Norwest been aware of the dangers here, it might have been more circumspect in selecting the builders with whom it would be dealing in this construction finance program. Anyone familiar with the DPTA would have told them that once your toe is caught in the net, you're going to be involved with a dangerous lawsuit before one of those notorious Texas juries.

Comment 2: The discussion of Norwest's liability for negligent supervision of loan disbursements is interesting for several reasons. First, the cases around the country are legion that find no liability for a lender to a borrower when the lender does not observe its own lending guidelines in supervising loan disbursements. The usual conclusion is that the lender's guidelines are for its own protection and that the borrower has not right to rely on those guidelines being followed. There are some notable exceptions to this line of reasoning, however, and lenders are well advised to include language in their loan agreements making clear that the lender's disbursement policies are for its own protection and that borrowers have no right to rely upon them.

In this case, however, Norwest went the other way and actually collected (if the court's record is reliable) a fee specifically chargeable for loan disbursement supervision. Once again, a good legal department should have warned against this. (It's unlikely that the question was addressed to experienced counsel). Experienced real estate lawyers know that in a busy construction season many corners get cut by loan disbursers in order to keep projects going. Red tape and orderly construction scheduling don't always make a good match. Therefore, when things go wrong, it will always be possible to find that the lender did not punctiliously enforce every loan requirement. In fact, if it had, it is likely that things would have gone wrong much sooner!

Consequently, a $300 fee to perform a function that likely will not be performed precisely in supervising behavior of home builders (who themselves hardly perform with the precision of the Texas Aggies Marching Band) is a ticket to the courthouse, and unlikely to show up as a "profit item."

The bottom line: don't charge fees to consumers for services that you have no hope of performing precisely in an area that commonly results in consumer dissatisfaction and damages claims.

Comment 3: The court's analysis of the "unconscionable behavior" finding is another interesting aspect of this case. The court appears to be comparing the damages suffered to the amount of the fee. The real comparison ought to be the services performed as compared to the amount of the fee. If, for instance, Norwest could show that it provided extensive services, but that in the end someone messed up and damages resulted, it might be liable for negligence, but not for unconscionable behavior. It did provide services in proportion to the fee. By leaping over the "value of services" computation and going straight to the "damages resulting" computation, the court again widens the net of the DPTA. By this standard, any consumer services negligently performed, resulting in substantial damages, constitute "unconscionable behavior" and trigger the horrific provisions of the Act attorneys' fees, punitive damages, etc. The editor is hard pressed to speak for Texas lawmakers, but this is probably not what they had in mind.

Readers are urged to respond, comment, and argue with the daily development or the editor's comments about it.

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