Archives for August 2017

Predatory lending is a defense to foreclosure; it is not an affirmative claim that would entitle a borrower to damages from the lender.

Difference between foreclosure defenses and claims for damages

As discussed in my last post, in the Aubut case the Connecticut Appellate Court recognized that predatory lending is a defense to foreclosure. The defense depends on what the lender new or should have known at the time it made the loan. Though predatory lending might give rise to a claim for money damages against the lender that made the loan, the foreclosing plaintiff is rarely that. Most often, because of the prevalence of mortgage securitizations, the foreclosing plaintiff is an assignee of the loan. The question thus becomes whether you can hold a mortgage loan assignee liable for damages for what the original lender knew or should have known. The Aubut court answered “no.” The foreclosing plaintiff in that case was the ultimate assignee of the loan. The court noted that an assignee takes the loan subject to all defenses that might have been asserted against the assignor. But the assignee does not take the loan subject to the assignor’s liabilities unless the assignee expressly assumes those liabilities. Since the plaintiff had not assumed any liabilities, predatory lending could be a defense to foreclosure but not a counterclaim for damages.

Distinction is good for borrowers

This is a significant distinction. If it were a counterclaim instead of a defense, the courts likely would offset the damages the bank would have to pay against the amount the borrower owed on the loan. But that just reduces the debt. Since most large lenders do not pursue the borrowers for deficiencies between the amount owed and the property value in any event, the offset would be a Pyrrhic victory at best for the borrower. What borrowers really want is to save the property. A counterclaim can’t do that; this predatory lending defense can.

The concept of “predatory lending” has been around for some time, not as a foreclosure defense unto itself but as an umbrella term for defenses sounding in things like unconscionability, unclean hands and equitable estoppel. The Connecticut Appellate Court seems to have changed that in its 2016 decision in Bank of America, N.A. v. Aubut. Our courts now recognize predatory lending as a defense that precludes foreclosure if the original lender knew or should have known that the loan was destined to fail.

Courts used to excuse banks for knowingly making bad loans

Before 2007 there was a huge demand for mortgage backed securities. Since mortgages are the primary ingredient of mortgage backed securities, the huge demand for the securities meant a huge demand for mortgages. That, in turn, meant a decline in the quality of the mortgages. In other words, mortgage originators made loans to people who could not afford them. The originators didn’t care whether the borrowers could afford the loans because the originators sold the loans into securitizations, making them somebody else’s problem. See The Big Short.

But the “lender, you should have known better” foreclosure defense never got any traction, mainly because the courts had refused to impose on lenders a duty to make sound lending decisions.

Connecticut Appellate Court changes the philosophy

The Appellate Court in Aubut seems to have changed that philosophy. The borrowers alleged a special, or affirmative, defense that the plaintiff could not foreclose because “the loan which was originated by [the original plaintiff] was unaffordable.” The court considered whether this unaffordability defense – which the borrowers had captioned “predatory lending” – was legally viable. It noted that there is no legal authority that coherently defines a predatory lending defense. The defendants argued that “their predatory lending allegations should be considered within the context of the recognized equitable defenses of fraud, unclean hands, unconscionability, and equitable estoppel.” The court agreed, noting that it did not really matter what the defendants called the defense as long as it provided the plaintiff with sufficient notice of the facts claimed and the issues to be tried. And, the borrowers had alleged a litany of facts, which, if true, supported a claim that the original lender knew or should have known that they could not afford the loan.

The court then set about fashioning a new defense. It noted that since foreclosure is an equitable remedy, a court can withhold it on equitable grounds. The predatory lending defense implicated the recognized equitable defenses of fraud and unconscionability, unclean hands, and equitable estoppel. These principles can be combined to plead a single special defense of predatory lending asserting that because the original lender knew or should have known that the loan was “destined to fail from [its] inception,” the plaintiff should not be permitted to enforce the mortgage.

Though the court did not expressly impose a duty on lenders to determine whether the borrower can afford a prospective loan, it seems to have implied one because the notion that the lender “knew or should have known” suggests foreseeability, which in turn suggests a duty. For example, negligence law imposes a duty to prevent foreseeable harm to others. Foreseeability in the negligence context is determined by whether the actor knew or should have known that the act would cause the harm. In the foreclosure defense context, the harm is a loan that failed.

Now Connecticut has a predatory lending foreclosure defense

In short, under Aubut, a residential mortgage borrower can avoid foreclosure if the loan was predatory when made. A loan is predatory if the originator knew or should have known that it would be just a matter of time before the borrower defaulted. Given this definition of predatory, mortgage originators may well have a duty to make an affordability determination before making a mortgage loan.