February 28, 2008

Massachusetts Court Enjoins Lender From Foreclosing on “Presumptively Unfair” Mortgage Loans Without Prior Approval

Massachusetts Superior Court Judge Ralph D. Gants issued a preliminary injunction this week prohibiting Fremont Investment & Loan (“Fremont”) from foreclosing on loans the Court deemed to be “presumptively unfair.” After negotiations with Fremont failed, Massachusetts Attorney General Martha Coakley filed suit seeking a preliminary injunction under the Massachusetts Unfair and Deceptive Practices Statute, M.G.L. ch. 93A (“Chapter 93A”), to prevent Fremont from initiating or advancing foreclosure of any loan without the Attorney General’s prior permission. In the alternative, the Attorney General had sought a more limited injunction, requiring approval for loans with a 90% or greater loan-to-value ratio, stated income loans, or loans with prepayment penalties, which the Attorney General deemed “presumptively unfair.”

The Court reviewed the various categories of “presumptively unfair” loans proposed by the Attorney General, and found that although the loans created a higher risk of potential default and foreclosure, Fremont was not at fault for having made such loans. Judge Gants found that Freemont’s origination of the loans, as well as the income verification procedures, were overseen by third parties, and there was no evidence that Fremont was negligent in its supervision or acceptance of those loans. To the extent that misrepresentations of income played any role in the default of certain loans, the Court expressly found that “Fremont was a victim of these misrepresentations and did not encourage or tolerate them,” and that Fremont had not engaged in fraud or misrepresentations to its borrowers. The Court further determined that none of Fremont’s lending practices violated either federal or state law. It did, however, indicate that Fremont had some notice from regulatory agencies expressing concern that such risk-layered loans were not prudent or acceptable.

Despite finding no culpability on Fremont’s part, Judge Gants concluded that injunctive relief was appropriate as to a certain subset of Fremont’s loans that he considered “presumptively unfair.” To define that term, the Court noted that certain terms of some of Fremont’s loans would have been prohibited had the loans qualified as “high-cost loans” under Massachusetts’s Predatory Home Loan Practices Act (“PHLPA”). The Court held that the prohibitions contained in the PHLPA created a “penumbra” which should inform any analysis of whether non-“high cost” loans met the standard for unfairness under Chapter 93A. Specifically, the Court held that a mortgage loan made by Fremont would be treated as “presumptively unfair” if it met all of the following factors:

  1. the loan had an adjustable rate with an introductory period of 3 years or less;
  2. the loan had an introductory rate of more than 3% below the “fully indexed rate;”
  3. the loan had a debt-to-income ratio of more than 50% when calculated using the “fully indexed rate” payments; and
  4. the loan either has a loan-to-value ratio of 100% or has a prepayment penalty that is in effect beyond the introductory rate period or has a prepayment penalty that exceeds 2% of the total prepayment.

The alleged unfairness arose, the Court reasoned, because any loan with all four features is one “that the lender reasonably expects to fall into default” unless it can be refinanced due to home price appreciation after the “teaser” period expires. The Court went on to specifically find that the Attorney General was likely to succeed in proving that a loan with all four features violated Chapter 93A.

For the alleged protection of borrowers with such loans, the Court issued a preliminary injunction requiring Fremont to provide the Attorney General with 45 days notice before beginning any foreclosure of a “presumptively unfair” loan. If the Attorney General does not consent to the foreclosure, Fremont is required to seek Court approval of the foreclosure by demonstrating that the loan is actually fair. In addition, and even more concerning, Fremont must provide 30 days notice to the Attorney General prior to any other foreclosure, to allow the Attorney General to investigate whether the loan is “presumptively unfair.”

The Fremont decision is a troubling step towards judicial intervention, on substantive grounds, in the foreclosure process in what otherwise is a non-judicial foreclosure state. The Court’s unfairness analysis will be potentially difficult to cabin, and is likely to lead to substantial additional litigation. We expect to see other advocates or state actors seek similar relief, against Fremont and others, in the coming weeks or months.

If you have any questions, or need assistance from our Boston-based trial lawyers in the wake of this decision, please call our co-editor, Jim McGarry, at (617) 570-1332.