A recent New Jersey appeals court decision could spark a series of lawsuits against lenders and extend liability for predatory practices all the way up the mortgage food chain.
The Appellate Division of New Jersey Superior Court ruled in Associates Home Equity Services Inc. v. Troup that borrowers can sue lenders for "reverse redlining," the practice of using race, income, and other demographic information to target high-cost loans to certain neighborhoods. It also said lenders buying loans in the secondary market could be held responsible for the actions of the loan's originator.
Some legal experts say the July 25 decision could result in a spate of class actions involving home improvement loans.
Laurence Platt, a partner with Kirkpatrick & Lockhart LLP in Washington, said in an e-mail, "The court seemed determined to find a way to hold a purchaser of a closed, independently funded loan liable for the acts of the originator, and this is a troubling development."
Court documents say Beatrice Troup, 74, of Newark, who is black, and her son, Curtis, hired a local contractor to complete exterior repairs on their home in the fall of 1995.
The contractor, Gary Wishnia of General Builders Supply Inc. and Property Redevelopment Center Inc., now in West Orange, N.J., introduced the Troups to East Coast Mortgage Corp. of Clark, N.J., which in April 1996 originated a $46,500, 15-year loan at an annual interest rate of 11.65%, adjustable after six months. The family was charged four points - or 4% of the loan amount - in fees. Within days East Coast Mortgage sold the loan to Associates Home Equity, which had preapproved it. (Associates was acquired by Citigroup Inc. in November 2000.)
Associates foreclosed on the Troups in May 1998 after they defaulted on the loan. The Troups countersued Associates, Mr. Wishnia, and East Coast Mortgage, alleging violations New Jersey's Consumer Fraud Act and Law Against Discrimination as well as federal fair-housing, civil rights, and truth-in-lending laws.
The Troups, accusing Mr. Wishnia and East Coast Mortgage of racial discrimination, said the lender failed to provide a "clear and conspicuous notice" of the expiration date of their right to rescind the loan, failed to make proper disclosures, and understated the finance charge. They charged that Associates, in preapproving the loan, knew the terms and conditions and thus engaged in predatory lending.
A lending expert who testified on behalf of the Troups said their credit history should have qualified them for a much lower interest rate.
The Troups lost in trial court because the statute of limitations under the state and federal laws they cited had expired. But the appeals court reversed that decision, and citing evidence of unfair lending, ruled that the Troups should be allowed to initiate discovery under the principle of "equitable recoupment" to reduce the amount of money Associates could recover as part of the foreclosure. Further, the appeals court said East Coast Mortgage could be held liable for Mr. Wishnia's actions, and that Associates in turn could be liable for what East Coast did.
Leonard Bernstein, a partner with Reed Smith LLP in Princeton, N.J., which represented Associates, said his client should not be held accountable for the loan originator's actions. "This investor never laid eyes on the plaintiff, didn't know the plaintiff's race, never talked with the plaintiff," he said.
That the court let the case be brought despite the statute-of-limitations expiration is a bigger concern, Mr. Bernstein said. A source who requested anonymity said that the decision may spur borrowers subject to foreclosure "to bring civil rights or discrimination claims even though the limitations period has long since passed."
Michael Nolan, a lawyer with Pitney Hardin Kipp & Szuch LLP of Morristown, N.J., had a similar assessment.
"The danger is that plaintiffs' counsel will be able to take this, build upon it, and it will become the knee-jerk defense to any kind of foreclosure action on a property owned by a member of a minority group in an urban area," he said.
Because the court's decision was based on federal law, Mr. Nolan said, it provides a "road map" for lawyers to attack mortgage companies. The decision could have a chilling effect on lending in urban areas, he said, and may make it harder for lenders to extend credit by buying loans from originators.
"You have to take a close look at your business practices as to handling your due diligence, and look carefully at the background of loans before you take them on: you wouldn't want to pay a premium on this kind of loan," Mr. Nolan said.
However, Risa Kaufman, a lawyer with Gibbons, Del Deo, Dolan, Griffinger & Vecchione of Newark, who defended the Troups pro bono, countered that the decision "provided a tool for people to prevent foreclosure on their home when they have been victims of unfair practices."
Mr. Bernstein said Associates may ask the full appeals court to reconsider the case. Kathleen Cavanaugh, a lawyer with Greiner, Gallagher & Cavanaugh in Parsippany, N.J., who argued the case on behalf of East Coast Mortgage, said that the lender could appeal the ruling to the state supreme court.