I

Vol. 27 No.1 January 2011

LITIGATION RISK FOR THE RESIDENTIAL MORTGAGE INDUSTRY
IN THE WAKE OF THE DODD-FRANK ACT
The act contains significant ability-to-pay and anti-steering provisions, with a safe harbor
for "qualified" mortgages. Borrowers may assert violation of these by
recoupment or setoff, which will at least delay foreclosure proceedings. The act also
restricts federal preemption of state consumer protection laws and protects
whistleblowers who report consumer financial law violations by their employers.
By Eric M. Hurwitz *
To many in the residential mortgage industry, the
forecast calls for more litigation. Courts in recent years
have seen an explosion in the number of lawsuits
brought by borrowers contending that their mortgage
lenders put them into so-called "high-cost, predatory
loans." Lenders, originators, and mortgage brokers, are
increasingly finding themselves defending against the
contention that they improperly pushed borrowers into
high-cost loans they could not afford, for no other reason
than it was profitable. These claims often include
alleged violations of the federal Truth in Lending Act I,
as well as state law claims for fraud and unfair and
deceptive trade practices.
These litigation risks are only likely to increase as a
result of the federal government's ongoing crackdown
on the residential mortgage industry in the wake of the
subprime mortgage crisis. The stated purpose for these
changes is to prevent unfair, abusive, and deceptive
practices by lenders, loan originators, and mortgage
brokers. The end result is likely to be further litigation,
15 U.S.c. 1601 et seq.
* ERIC M HURWITZ is a partner in the litigation department of
the Philadelphia, Pennsylvania lawfirm a/Stradley Ronan
Stevens & Young, LLP, where he a member ofthefirm 's
Mortgage and Lending Litigation Practice Group. His e-mail
address ehurwitz@Stradley.com.
including the potential for more delays in foreclosure
proceedings. In addition, these new laws provide
employees of the lender with protection for blowing the
whistle to regulators on any perceived conduct that runs
afoul of the new federal rules and statutes.
The eye of the proverbial storm, and the centerpiece
of the federal government's crack down on the mortgage
industry, is the behemoth Dodd-Frank Wall Street
Reform and Consumer Protection Act (the "Dodd-Frank
Act,,).2 The Dodd-Frank Act, enacted on July 21, 2010,
was the largest single legislative overhaul of the
financial services industry since the 1930s, and the
mortgage industry was not spared its reach. Title XIV
("Mortgage Reform and Anti-Predatory Lending Act")
of the act takes aim at so-called predatory lending
practices by imposing, among other things, prohibitions
on loan steering, limitations on originator compensation,
and the establishment of minimum standards for
mortgages that require the originator to consider the
2 Dodd-Frank Wall Street Reform and Consumer Protection Act,
Pub. L. No. 111-203, 124 Stat. 1376.
IN THIS ISSUE
LITIGATION RISK FOR THE RESIDENTIAL MORTGAGE
INDUSTRY IN THE WAKE OF THE DODD-FRANK ACT
January 2011 Page 1
I
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borrower's ability to repay the loan. The Dodd-Frank
Act will be implemented through extensive new
regulations from the Federal Reserve Board.
A trip to the recent past provides a good perspective
on how significantly the Dodd-Frank Act promises to
alter the litigation landscape. Until various states and
the federal government intervened, most courts
constlUed the borrower-lender relationship as one
involving two parties operating at arms-length, with each
party seeking to pursue its own economic interest. 3
Attendant to that arms-length relationship, it was
common for courts to reject causes of action alleging
that lenders put residential borrowers in unsuitable loans,
or loans that borrowers could not repay.4 Courts also
resisted efforts to hold banks liable in tort for "loose
internal lending standards or poor business judgments."s
A recent case from the United States District Court
for the District of New Jersey, Jatras v. Bank ofAmerica
Corp.,
6
is representative of this longstanding view of the
creditor-debtor relationship. In Jatras, the borrowers
purchased a home subject to financing from the lender.
The borrowers alleged that the lender offered finance
programs subject to a certain underwriting guideline
designed to qualify each mortgage transaction based
upon criteria that included the borrower's suitability,
market stability, the nature and value of the collateral,
and industry standards. When the borrowers later
defaulted on their loan, they filed suit against a number
of defendants, including the lender, alleging that they
were not qualified for the loan but that the lender
nevertheless forced through the transaction. In
particular, the borrowers claimed that the lender falsified
documents from the transaction, including omitting
information concerning the borrowers' debt-to-income
3 See, e.g., Rangel v. SHI Mortgage Co., No. CV F 09-1035 LJO
GSA, 2009 WL 2190210, at *3 (E.D. Cal. July 21, 2009).
4 See, e.g., Whitley v. Taylor Bean & Whitaker Mortgage, 607 F.
Supp.2d 885, 902 (N.D. Ill. 2009).
5 See, e.g., Fedders N. Am., Inc. v. Goldman Sachs Credit
Partners LP, 405 B.R. 527,551 (8ankr. D. Del. 2009).
6 No. 09-3107, 2010 WL 1644407 (D. N.J. April 22, 2010).
ratio and "manipulatin,f the home appraisal to arrive at a
predetermined value."
The district court in Jatras granted the defendants'
motion to dismiss the borrowers' complaint. The court
rejected the borrowers' fraud-based claims as pleaded,
finding that the lender did not owe the borrowers any
duty to advise them if the loan they sought was against
their economic interest:
Reduced to its simplest form, Plaintiffs'
claim is this: We found a house, which
we wanted to buy. We signed a contract
to purchase the house contingent on
financing. We went to Defendants to get
that financing. They gave us exactly what
we wanted. They should not have done
so. . .. In effect, Plaintiffs ask the Court
to save them from themselves. They ask
the Court to impose a duty on banks to act
not as self-interested, adversarial business
partners, but to act as paternalistic friends,
who will tell borrowers when they risk
peri l. This is not the state of the law in
New Jersey.
8
This foundational premise - that the lender does not
owe any duty to ensure that the borrower can repay a
loan - started to form cracks following the enactment of
various state laws seeking to regulate so-called "high
cost, predatory loans." For example, in 1999, North
Carolina enacted a statute prohibiting a lender from
making a "rate spread home loan" - a loan where the
APR exceeds certain thresholds defined by the statute
based upon the value of a borrower's collateral without
"due regard to the borrower's repayment ability as of
consummation.,,9 As the notion of the borrower's ability
to repay the loan began to take hold, it found its way into
other states' lending laws, often without regard for
whether the loan was "high cost" or otherwise. For
example, a New Mexico statute states that "[n]o creditor
shall make a home loan without documenting and
7 Id. at *l.
8 Id. at *4.
9 N.C. Gen. Stat. 24.1.1E (1999, as amended).
January 2011 Page 2
considering the borrower's reasonable ability to repay
that loan pursuant to its terms." I 0 This concept would
ultimately become a key component of the Dodd-Frank
Act.
Reasonable Ability to Repay the Loan and Anti
Steering
The Dodd-Frank Act codifies the concept of the
borrower's reasonable ability to repay a home loan as a
key factor in loan origination. Section 1403 of Title
XIV ("Prohibition on Steering Incentives") mandates
that the Federal Reserve Board prescribe regulations "to
prohibit a mortgage originator from steering any
consumer to a residential mortgage that (i) the consumer
lacks a reasonable ability to repay...." I I
This reference to the borrower's "reasonable ability to
repay" a loan is a significant litigation pitfall in the
Dodd-Frank Act. It provides no uniform standard,
which is troubling because what may be reasonable for
one borrower may be unreasonable for another
Moreover, as litigation attorneys well know,
"reasonableness" is a concept that is inherently fact
dependent, and is typically a question for resolution by
the fact-finder. In a trial setting, that ordinarily means
the jury. It may well fall to civil juries to help define
what "reasonableness" means in this context, which may
come as little comfort to lenders.
Subtitle B of Title XIV ("Minimum Standards for
Mortgages") further embraces the concept of a
"reasonable ability to repay the loan." Section 1411
("Ability to Repay") states:
[N]o creditor may make a residential
mortgage loan unless the creditor makes a
reasonable and good faith determination
based on verified and documented
information that, at the time the loan is
consummated, the consumer has a
reasonable ability to repay the loan,
according to its terms, and all applicable
taxes, insurance (including mortgage
. ) d 12
guarantee msurance ,an assessments.
Thus, under section 1411, a creditor must not only act
reasonably in deciding whether to extend the loan, but
must act in "good faith" by reviewing "verified and
documented information" to show that the borrower has
10 N.M.S.A. 58-21A-4 (2009).
I I Dodd-Frank Act, Title XIV, 1403.
121d. 1411 (emphasis added).
January 2011
a reasonable ability repay the loan. In addition to
amorphous references to "reasonableness," the phrase
"good faith" is also a potential litigation trap. "Good
faith" is not defined in the Dodd-Frank Act itself. By
way of analogy, however, Article 2 of the Uniform
Commercial Code, applicable to the sale of goods,
defines "good faith" as "honesty in fact and the
observance of reasonable commercial standards of fair
dealing in the trade." 13 Good faith implies honesty and
the observance of reasonable standards of conduct.
These are by nature vague terms ripe for disagreement
between borrowers and lenders - and disagreement
correlates with litigation.
Congress was more charitable in actually defining the
types of documents and information a lender must
examine in deciding whether the borrower has an ability
to repay a residential mortgage loan. Section 1411 of
the Dodd-Frank Act identifies the following types of
consumer information that the lender must consider:
credit history;
current income;
expected income the consumer is reasonably assured
of receiving;
current obligations;
debt to income ratio, or the residual income the
consumer will have after paying non-mortgage debt
and mortgage-related obligations;
employment status; and
other financial resources other than the consumer's
equity in the dwelling or real property that secures
repayment of the loan.
The act also requires the creditor to verify the
borrower's income or assets - and hence the borrower's
ability to repay the loan - by reviewing "the consumer's
Internal Revenue Service Form W-2, tax returns, payroll
receipts, financial institution records, or other third-party
documents that provide reasonably reliable evidence of
the consumer's income or assets.,,14
In light of the Dodd-Frank Act's inclusion of certain
sources of information that the creditor must revi ew in
making a loan suitability determination, lenders and
13 See, e.g., N.J. Stat. 12A:2-103(1)(b).
14 Dodd-Frank Act, Title XIV, 1411.
Page 3
originators should prepare for claims by borrowers
predicated upon the failure to review some of this
information. Loan origination files will likely come
under significant scrutiny once the act goes into effect.
Lenders and originators can prepare to defend against
such claims by maintaining well-documented loan
origination files.
The Dodd-Frank Act also incorporates a number of
anti-steering rules by, among other things, establishing
new standards aimed at preventing origination
compensation abuses. The act prohibits a mortgage
originator from receiving, directly or indirectly,
compensation that varies based on the terms of the loan.
It also expressly prohibits "any yield spread premium or
other similar compensation that would, for any mortgage
loan, permit the total amount of direct and indirect
compensation from all sources permitted to a mortgage
originator to vary based on the terms of the loan (other
than the amount of the principal)." 15 Section 1403
requires the Federal Reserve Board to prescribe
regulations prohibiting a mortgage originator from
steering any consumer into a residential mortgage that
"the consumer lacks a reasonable ability to repay" or
that has "predatory effects (such as equity stripping,
excessive fees, or abusive terms)."
As a result of these anti-steering provisions,
borrowers are likely to pay special attention to the
compensation paid to their mortgage originators and
brokers for potential violations of the Dodd-Frank Act.
In addition, the act's conclusory prohibition on steering
borrowers to loans with "predatory effects" raises the
prospects of legal challenges, including as to whether
fees were excessive or abusive. The required regulations
from the Federal Reserve Board may add some much
needed clarity to these provisions.
Safe Harbor for Qualified Mortgages
Because what constitutes a "reasonable ability to
repay" a residential mortgage loan is less than clear
under the Dodd-Frank Act, Congress attempted to
provide some protection for lenders and originators by
introducing the concept of a "qualified mortgage."
Pursuant to section 1412 of the Dodd-Frank Act, "[a]ny
creditor with respect to any residential mortgage loan,
and any assignee or such loan subject to liability under
this title, may presume that the loan has met the
requirements ... if the loan is a qualified mortgage." 16
In other words, if the lender can show that the loan was a
15 1d. 1403.
16 fd. 1412.
January 2011
qualified mortgage, then there is a presumption that the
borrower has the ability to repay the loan.
The definition of a qualified mortgage under the
Dodd-Frank Act is lengthy, consisting of nine subparts.
Of these, the more significant characteristics of a
"qualified mortgage" are that "the income and financial
resources relied upon to qualify the obligors on the loan
are verified and documented," "the total points and fees.
.. do not exceed three percent of the total loan amount,"
and that the loan "complies with any guidelines or
regulations established by the [Federal Reserve Board]
relating to ratios of total monthly debt to monthly
income or alternative measures of ability to pay regular
expenses after payment of total monthly debt, taking into
account the income levels of the borrower and such
other factors as the Board may determine relevant." 17
A substantial source of litigation is prone to arise over
whether a mortgage was qualifying under the act. To
attack a mortgage as non-qualifying, borrowers will be
able to challenge, among other things, the
documentation relied upon by the lender and the actual
points and fees associated with the loan. Borrowers also
could potentially take advantage of whatever additional
regulations the Federal Reserve Board adopts to enforce
and implement the act. Ultimately, it will fall to the
court system to impose some clarity to the definition of a
"qualified mortgage."
But even if the lender can show that a loan is a
"qualified mortgage," the presumption that the borrower
has the ability to repay the loan is only rebuttable. This
means that the borrower can still present additional
evidence to overcome the presumption. Viewed this
way, the concept of a "qualified mortgage" is by no
means a complete defense to an attack from a borrower
claiming that the lender did not consider the borrower's
reasonable ability to repay the loan. From a litigation
perspective, the so-called "safe harbor" may prove
illusory.
Defenses to Foreclosure and Limitations Periods
Congress gave the ability-to-repay and anti-steering
provisions of the Dodd-Frank Act teeth by incorporating
them into the defenses to foreclosure available under the
act. Section 1413 gives borrowers the right to defend
against a judicial or non-judicial foreclosure, or any
other action to collect the debt, by asserting that the
creditor violated the anti-steering and the ability-to
repay provisions of the Dodd-Frank ACt.
18
The
17
1
d.
18 Dodd-Frank Act, Title XIV, 1413.
..
Page 4
borrower can assert the purported violation by way of a
recoupment claim or as a setoff to the total amount
claimed to be owed under the mortgage note. This right
of offset and recoupment arms borrowers with new tools
to defend, or at a minimum to delay, foreclosure
proceedings.
One of the more extraordinary aspects of these
defenses to foreclosure is that the borrower can assert
them "without regard for the time limit on a private
action for damages." 19 In other words, if the borrower
obtains a 30-year mortgage, and in year 25 the home
goes into foreclosure, the borrower can still defend
against the foreclosure by asserting that the loan violated
the anti-steering and ability-to-repay provisions of the
Dodd-Frank Act. Given how frequently mortgage loans
are bought and sold, it could prove difficult for the then
existing note holder to track down relevant witnesses
and loan origination records as time goes by and
memories fade.
This defense to foreclosure may have a significant
impact on the foreclosure process by creating another
hurdle and time delay for the lender. In judicial
foreclosure states - those states in which the lender must
file a foreclosure lawsuit against the borrower - the
borrower's defense of offset and recoupment will not
prevent foreclosure entirely. Rather, the defense
amounts to a potential reduction of the lender's
foreclosure claim predicated upon an underlying Dodd
Frank Act violation. This claim by the borrower would
need to be litigated along with any other issues relevant
to the foreclosure. It thus has the effect of delaying the
foreclosure while the offset and recoupment defense is
litigated. Further, depending on the damages at issue, it
could stop the foreclosure if the recoupment claim
exceeds the then-existing balance of the mortgage. It
exerts pressure on the lender because it is not subject to
a statute of limitations, and the amount of recoupment
includes the right to recover attorneys' fees.
In non-judicial foreclosure states, the lender need not
file a lawsuit to begin foreclosure proceedings. Instead,
r
the lender typically sends the borrower a notice of intent
to foreclose to begin the process. If the borrower then
feels there is some defense presented by the Dodd Frank
Act, the borrower would have to initiate a lawsuit as the
plaintiff to assert a claim that in effect amounts to the
defense of offset and recoupment to the foreclosure
itself, seeking to limit the foreclosure claim. The
borrower's offset and recoupment claim should halt the
foreclosure until such time as the court adjudicates the
merits of the claim; borrower's counsel also can be
19 Jd.
January 2011
expected to request a judicial stay of the foreclosure
pending the litigation of the right to offset and
recoupment. Even though this would be an affirmative
claim by the borrower, it would not be subject to a
statute of limitations under the Dodd-Frank Act if
brought as a defense to the foreclosure. Section 1413 of
the act specifically mentions both judicial and non
j udicial foreclosures, and states that in either case the
borrower can seek a recoupment claim "without r e ~ a r d
for the time limit on a private action for damages." 0
Practically speaking, the only avenue for pursuing such a
defense in a non-judicial foreclosure state is to file an
affirmative claim with the court.
Aside from asserting violations of the Dodd-Frank
Act as defense to foreclosure, borrowers can also assert
such claims as the plaintiff in an affirmative private
court action seeking damages. In the event the borrower
chooses to proceed with an affirmative private court
action, the act does include a statute of limitations. A
borrower may bring any anti-steering or ability-to-repay
claims "before the end of the three-year period
beginning on the date of the occurrence of the
violation. ,,21
The Erosion of National Bank Act Preemption
One of the more significant aspects of the Dodd
Frank Act is its weakening of the federal preemption
defense for national banks and their operating
subsidiaries and affiliates. By way of background,
Congress enacted the National Bank Act ("NBA") in
1864, and in l a r ~ e measure the banking system it created
is still in place.
2
The NBA grants federally chartered
national banks several enumerated powers, and "all such
incidental powers as shall be necessary to carry on the
business ofbanking.,,23 Among those powers, the NBA
specifically authorizes national banks to engage in real
estate lending.
24
National banks are subject to the
statutory requirements of the NBA itself, as well as the
regulatory oversight of the Office of the Comptroller of
the Currency ("OCC"). The OCC is charged with the
20 Jd. 1413.
21 Jd. 1416.
2212 U.S.C. 1 et seq.
23 Jd. 24 Seventh.
24 Jd. 371.
Page 5
task of overseeing the operations of national banks and
their interactions with customers.
2S
The acc has enacted a preemption regulation
providing that "state laws that obstruct, impair, or
condition a national bank's ability to fully exercise its
Federally authorized real estate lending powers do not
apply to national banks.,,26 Pursuant to acc
regulations, "a national bank may make real estate loans
under 12 U.S.C. 371 and 34.3, without regard to state
law limitations" concerning a number of enumerated
subject matters, including licensing and registration by
creditors, loan-to-value ratios, terms of credit (including
schedule for repayment of principal and interest,
amortization of loans, balance, payments due, minimum
payments, or term to maturity of the loan), and rates of
interest. 27
The United States Supreme Court has held that
national banks are shielded by federal law with regard to
the powers provided to them by the NBA and acc
regulations, and they are not subject to unduly
burdensome and duplicative state regulation, visitation,
and control. For example, in one of the seminal cases on
NBA preemption, Barnett Bank ofMarion County, N. A.
v. Nelson, Florida Insurance Commissioner,28 the
Supreme Court determined that state law that "prevents
or significantly interferes" with a national bank's
exercise of its powers is preempted. Part of that federal
shield is the protection of a national bank's real estate
lending powers from state interference. As the Supreme
Court recently stated in Watters v. Wachovia Bank, N.A.,
"state law may not significantly burden a national bank's
own exercise of its real estate lending power.,,29
National banks have been able to rely upon this
federal shield as the basis for claiming preemption of
state laws, including state consumer protection laws, that
seek to impose requirements different from or
inconsistent with the NBA and applicable acc
regulations. Indeed, the Supreme Court even extended
the scope of federal preemption to the operating
subsidiaries of a national bank in Watters. Relying in
part upon acc regulations that allow national banks to
25 See Watters v. Wachovia Bank, NA., 550 U.S. 1,6 (2007);
NationsBank ofNC., NA. v. Variable Annuity Life Ins. Co.,
513 U.S. 251 , 256 (1995).
26 12 C.F.R. 34.4(a) ("Applicability of state law").
27 Id.
28 Barnett Bank ofMarion County, N A. v. Nelson, Florida
Insurance Commissioner, et al., 517 U.S. 25 (1996).
29 Watters, supra note 25 at 13.
January 2011
do business through operating subsidiaries, the Court in
Watters held that a national bank's mortgage business,
"whether conducted by the bank itself or through the
bank's operating subsidiary, is subject to acc's
superintendence, and not to the licensing, reporting, and
visitorial regimes of the several States in which the
subsidiary operates.,,30 Watters had the effect of
expanding the scope ofNBA preemption, thereby
providing even greater protection to national banks and
their subsidiaries and affiliates from state regulation,
visitation, and consumer protection laws.
The Dodd-Frank Act rolls back much of the scope of
national bank preemption for consumer loans that
existed following Watters. Section 1044 ("State Law
Preemption Standards For National Banks And
Subsidiaries Clarified") directly addresses when "state
consumer finance laws" are preempted under the act.
Section lO44 defines "state consumer finance laws" as
state laws that do not "directly or indirectly discriminate
against national banks and that directly and specifically
regulate the manner, content, or terms and conditions of
any financial transaction (as may be authorized for
national banks to engage in), or any account related
thereto, with respect to a consumer.,,31 This definition
of "state consumer finance laws" is expansive, and
would include any number of state anti-predatory
lending laws, origination compensation rules, unfair and
deceptive trade practices acts, and a host of other issues
pertaining to mortgage loan origination and servicing, to
the extent such laws pertain to a national bank's
relationship with a consumer.
The Dodd-Frank Act provides three bases under
which federal law may preempt a "state consumer
finance law": (1) the state law discriminates against
national banks, in comparison with the effect of the state
law on a bank chartered by that state; (2) the state law
"prevents or significantly interferes with the exercise by
the national bank of its powers"; or (3) the state law is
preempted by some other federallaw.
32
Because state
laws typical do not discriminate against national banks,
the second and third standards will likely be the most
often litigated. Taking them in reverse order, the third
basis for preemption will apply when some law other
than the Dodd-Frank act provides for preemption of state
law. An example would be the preemption provisions of
the Fair Credit Reporting Act. 33
30 Id. at 6.
31 Dodd-Frank Act, Title X, 1044.
32 Id.
33 15 U.S.c. 1681 h(e) and 168lt(b)(I)(F).
Page 6
The second preemption standard will allow national
banks to continue making preemption arguments
predicated upon state law intrusions of powers granted
by the NBA and acc regulations. The act specifies that
the standard established by the Supreme Court in Barnett
Bank will control such determinations. Thus, national
banks will be able to continue to rely upon Barnett Bank
and its progeny to support arguments for the preemption
of state laws that prevent or significantly interfere with
their exercise of their NBA power to make real estate
loans.
However, the ability to rely upon Barnett Bank will
no longer extend to the operating subsidiaries and
affiliates of a national bank. Under section 1044 of the
Dodd-Frank Act, "a State consumer financial law shall
apply to a subsidiary or affiliate of a national bank (other
than a subsidiary or affiliate that is chartered as a
national bank) to the same extent that the State consumer
financial law applies to any person, corporation, or other
entity subject to such State law.,,34 In other words,
operating subsidiaries and affiliates of national banks
will be unable to avail themselves of the shield offederal
preemption unless they are themselves national banks.
This is a substantial retreat from the doctrine of federal
preemption as previously recognized by the Supreme
Court in Watters. Given that many national banks have
established subsidiaries and affiliates to handle their real
estate lending operations, the effect of the Dodd-Frank
Act is to expose such entities to a host of various state
law-based, predatory lending and unfair and deceptive
trade practices claims. It remains to be seen whether
national banks might find it advantageous to roll-up such
subsidiaries into the parent bank to continue to receive
the benefit ofNBA preemption.
Under the Dodd-Frank Act, both courts and the acc
have the power to determine whether preemption applies
to any particular state law on a case-by-case basis (in
consultation with the newly created Bureau of Consumer
Financial Protection).35 Notably, courts will not be
strictly bound by any preemption determination made by
the acc. Section 1044 instructs a court reviewing an
acc preemption determination to "assess the validity of
such determinations, depending upon the thoroughness
evident in the consideration of the agency, the validity of
the reasoning of the agency, the consistency with other
valid determinations made by the agency, and other
factors which the court finds persuasive and relevant to
its decision.,,36 National bank lenders will need to be
34 Dodd-Frank Act, Title X, 1044.
35 Id.
36
I
d.
January 2011
prepared to investigate the basis of any acc preemption
determination that might be applicable in a given case
for arguments to support federal preemption. Lenders
will not simply be permitted to defer to the
determination of the acc.
Lastly, the Dodd-Frank Act does not purport to
establish a uniform set of national mortgage guidelines,
nor does it by its terms displace all state predatory
lending statutes. Rather, the act provides a minimum
floor for the protection of consumers. The Dodd-Frank
Act states that it does not preempt any state law claims,
exceft where such state laws are inconsistent with the
act. 3 Any state law that affords consumers more
protection than the Dodd-Frank Act is not inconsistent
with the act, and thus is not preempted by the act. 38
Can You Hear the Whistle Blowing?
The Dodd-Frank Act also could lead to an increase in
labor litigation due to its protection for whistleblowers.
Section 1057 ("Employee Protection") prohibits anyone
who offers or provides a "consumer financial product or
service" from terminating or discriminating against any
employee who provides information concerning the
alleged violation of any consumer financial law subject
to the jurisdiction of the Bureau of Consumer Financial
Protection.
39
Section 1002 ("Definitions") in tum
defines the phrase "consumer financial product or
service," and it is broad. It applies to employers in a
wide range of industries, including mortgage lending,
credit cards, loan servicing, lease brokering, certain real
estate settlement services, deposit-taking and other
consumer banking, financial advising, and credit
reporting.
4o
Based upon this definition, mortgage
lenders and servicers fall squarely within the reach of the
employee protections of section 1057 of the act.
Notably, section 1057 does not apply to alleged
violations of any state-law-based consumer financial
protection laws. Rather, it prohibits the termination or
discrimination of employees who provide information
concerning the alleged violation of only "federal
consumer financial laws," because only such federal
37 Dodd-Frank Act, Title X, 1041.
38 Jd. ("a statute, regulation, order, or interpretation in effect in
any State is not inconsistent with the provisions of this title if
the protection that such statute, regulation, order, or
interpretation affords to consumers is greater than the
protection provided under this title").
39 Dodd-Frank Act, Title X, 1057.
40 Dodd-Frank Act, Title X, 1002.
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laws fall within the jurisdiction of the Bureau of
Consumer Financial Protection.
41
Section 1057 also
protects employees who testify against their employers
in such matters, or who file or institute any proceedings
under any federal consumer financial law. It even
protects employees who object to, or refuse to
participate in "any activity, policy, practice, or assigned
task that the employee ... reasonably believed to be in
violation of any law, rnle, order, standard, or prohibition,
subject to the jurisdiction of, or enforceable by, the
Bureau.,,42
Any employee who believes that he or she was
discharged or otherwise discriminated against in
violation of the Dodd-Frank Act can file a complaint
with the Secretary of Labor. After the alleged violator
files a response, the Labor Department is empowered to
initiate an investigation and reach a preliminary written
determination, subject to any request for a formal
hearing following the written determination. If the
employee prevails, he or she is entitled to be reinstated
with the employer at his or her former position, in
addition to recovering compensatory damages, including
back pay. In the event the SecretarY' of Labor does not
issue a final order within 210 days after the date of filing
of a complaint, or within 90 days after the date of receipt
of a written determination, the employee can bring an
action in federal court against the employer.
These whistleblower protections essentially amount to
new labor laws to which mortgage lenders and
originators must comply. The only protection for the
lender is that, under the act, the employee may be
41 Supra note 38. The definition of a "federal consumer financial
law" in the act is limited to those federal consumer Jaws for
which authorities are transferred to the jurisdiction of the
Bureau. Dodd-Frank Act, Title X, 1002.
42 Dodd-Frank Act, Title X, 1057.
January 2011
required to pay the employer a fee not exceeding $1,000
if the employer's claim is found to be frivolous or in bad
faith.43 Unfortunately, the lender's attorneys' fees could
far exceed that amount. Perhaps more importantly, if the
employee's claim has merit, it could well lead to an
additional governmental investigation of the allegedly
improper consumer finance activity. That, in tum, could
lead to administrative, or worse, criminal proceedings
against the company.
Bracing for the Storm
Most of the provisions of the Dodd-Frank Act will go
into effect based upon the date that the current
regulatory powers transfer to the newly created Bureau
of Consumer Financial Protection. The Secretary of the
Treasury has set the so-called "transfer date" as July 21,
2011. With regard to Title XIV, governing Mortgage
Reform and Predatory Lending, implementing
regulations must be prescribed in final form no later than
18 months of the transfer date (January 21, 2013), and
must take effect no later than 12 months after that
(January 21, 2014). These are outside dates, however,
and the actual effective dates may well happen sooner.
The good news is that there is a significant period of
time for lenders and originators to prepare for the
dramatic changes to the industry coming in the wake of
the Dodd-Frank Act. Lenders will need to develop new
business models, train employees, and make systemic
changes to implement the new rules. Given the
numerous pitfalls in the Dodd-Frank Act, litigation risk
management should be added to that list.
43 Jd.
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