Daily Development for Monday, April 1, 2002

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

MORTGAGES; PREDATORY LENDING; FALSIFIED APPLICATIONS: Lenders, escrow agents and other "involved professionals" have responsibility to identify mortgage broker-induced fraud in mortgage loan applications, and are liable to borrower in tort if, as a consequence of such fraud, borrower incurs loans beyond borrower's means.

Nocorpus v. Albatross Federal S&L Assoc., 432 SE. 2d 999 (Ga. App. 2002)

Borrower applied for a mortgage loan to refinance a variety of personal debts. Borrower's home had gone up in value, and was worth over $300,000, with an equity of about $200,000. But borrower had lost her job and was working through a temp agency. Borrower's income was under $2000 per month, and she had car payments of $400 per month, and numerous other debts. Borrower went to see a mortgage broker who told borrower that she could finance her house and car and other debts, and make payments of $1722 per month on a loan of $200,000. Borrower agreed to do this.

At the time of the initial interview, mortgage broker made all required disclosures, including a disclosure that the borrower would charge a loan fee of 4 points along with various miscellaneous handling fees. The written disclosure indicated that refinancing would pay some, but not all debts, that the interest rate would adjust annually, and that the first adjustment, even if just to current market, would increase the rate by 1.5%.

Borrower initialled all the disclosures provided to her, but later claimed that she was very emotional, completely trusting of the mortgage broker, and read nothing that she signed. She claimed that the mortgage broker led her to believe that she was getting a fixed rate loan and that all her debts would be paid from the proceeds. She never did the math to determine that this was impossible. She also claimed that she thought that the payments would be $1410 per month (the difference between $1400 per month and the $1722 figure represented tax and insurance escrows.)

Also at the original interview, mortgage broker filled out a loan application based upon verbal responses to questions from borrower, and gave her the application to sign. Again, borrower did not read the application. In fact, the application showed as current income borrower's previous salary at the job she had lost, misrepresented her assets by more than double, including counting her 401K account both as a bank account and as a pension asset, and failed to disclose personal debts to borrower's parents, represented by formal debt instruments, that borrower claimed to have disclosed to the mortgage broker (and that borrower claimed she expected to be paid from the refinancing).

At the loan closing, borrower asked the escrow officer if certain debts, including those to her parents, were being paid from loan proceeds. The officer had no instructions to pay such debts, and had no surplus from the loan proceeds after paying other debts in the escrow instructions, but the officer simply indicated that Borrower should check this out with the mortgage broker. In addition, the agent, as instructed by the mortgage broker, asked Borrower was to execute an "amended and updated" loan application, which was even more distorted than the one she had originally signed. She commented to the escrow agent that this didn't look like her asset and income statement, and asked if she should mark it up to reflect lower income and assets. The agent replied that if she changed the documents, the agent would not be able to close that day, and that the borrower might not get the loan at all. Borrower, assuming that the agent had filled out the application properly, and that she simply didn't understand what all the terms meant, signed everything.

Borrower subsequently discovered that approximately $400 per month in obligations had not been refinanced, including the debt to her parents. She nevertheless struggled forward for a while, making the mortgage loan payments for about six months before she finally defaulted.

Ultimately, the lender foreclosed on the home. Borrower alleged that the lender bid in the $235,000 outstanding indebtedness and acquired the home for $70,000 less than the fair market value. Borrower further alleged that the mortgage broker had fraudulently induced borrower to take out a loan which she had no hope of paying, and that it had done so with the complicity of both the escrow agent and the funding lender, because both of the latter parties knew or should have known the true status of borrower's finances and that she was not in a position to make the payments to which she had committed.

The trial court granted summary judgment to both the escrow agent and the funding lender, and ordered a trial on the fraud counts against the mortgage broker.

On appeal: Held: Reversed as to the summary judgments.

With respect to the lender, the court noted that the lender had engaged in a regular course of dealing with the mortgage broker, dictated the mortgage forms that the broker should use (the standard FNMA/FHLMC instruments) and the other underwriting forms, and consequently was "closely connected" to the mortgage broker. Although the court acknowledged that such a relationship in the past might not have resulted in vicarious liability for fraud on the part of the mortgage broker, the court concluded that a broader liability was called for in modern consumer finance. Lender have a duty of care to consumer borrowers to evaluate loan applications to verify that they are accurate and fully support the requested credit.

Characterizing home borrowers as "lambs delivered for slaughter," the court noted that the phenomenon of borrowers overcommitting to debts due to mortgage broker inducement was a widespread and serious problem of "predatory lending," citing various magazine and newspaper articles supporting this claim, and that parties in the mortgage lending business had a responsibility to protect the public from overzealous agents. It noted that the default rate on loans initiated by this broker had been almost double the lender's overall average during the preceding three years. It commented: "Whether lenders admit it or not, consumer borrowers expect lenders to be experts on the issue of whether borrowers can afford a loan. They rely on lenders to ask the right questions and to develop an accurate assessment of borrower's financial picture. . . if lender's inspection of this file did not disclose to the lender the fact that the borrower was not currently employed by [the indicated employer at the indicated salary] and that borrower's assets were woefully short of the indicated total, then that investigation was prima facie negligent and fell far short of lender's duty to borrower to evaluate her credit potential."

The court was even more pointed about the behavior of the escrow agent. Aside from the allegedly fraudulent mortgage broker, the court noted, the escrow agent was the only professional party with whom the borrower had any contact. "Escrow agents know that consumers view them as professionals familiar with the mysteries of the lending process and capable of identifying defects in the process. Borrowers are entitled to expect that escrow agents will responsibly advice them when uncertainties exist, and warn them about dangers that are reasonably evident to a seasoned professional."

Here, the court indicated that the borrower had made a more than adequate case that the escrow agent had received "signals" that something was amiss in the loan application and that borrower was a victim of predatory lending.

Because of breach of these professional duties, the court concluded borrower had made out a claim of tortious negligence against the escrow agent. In dicta, the court noted that other "involved professionals," with whom the borrower might interract, such as real estate brokers and attornies, might also have similar duties of care.

As to the lender, the court further held that the court could conclude that the lender's failure to exercise "supervision and oversight" over the mortgage broker made the broker the "alter ego" of the lender, and consequently the lender would be liable vicariously for the lender's fraud, including borrower's emotional distress and punitive damages.

Remanded for a jury trial.

Comment 1: Whew!! The editor's been warning and warning about the dangers of overreaction to the concerns about predatory lending, and here, unhappily, is the forecast case. There is nothing in this case that goes too far afield from existing theory in other consumer and tort contexts, and bringing the pieces all together to focus on lending professionals perhaps was just a matter of time. Although this is just an April Fool's joke, we have here a situation that could be coming to a court near you. And there is every reason to believe that lawyers engaged in closings and title analysis are likely to be tarred with the same broad brush.

Comment 2: The editor is hearing on a regular basis from sophisticated friends that fully disclose their finances to mortgage brokers only to have the formal loan application come back to them far rosier than that disclosed. Some of editor's friends have insisted on revision of the documents. Others undoubtedly decided "they must know what they're doing," and, unwilling to suffer further delays in closing, signed what was put in front of them. Others, undoubtedly, sign without reading at all, trusting that the documents reflect what the verbal exchanges disclosed. Don't we all, to one degree or another, dumbly trust "the system" as modern consumers? Should the "system" then be liable when one of us is crushed under its wheels?

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

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