Over the last few years, a torrent of consumer litigation has washed over mortgage lenders and servicers in the wake of the financial tsunami that wreaked havoc on our economy. In these lawsuits, homeowners have raised the typical claims to stave off a pending foreclosure, including violations of the federal Truth in Lending Act, the Equal Credit Opportunity Act, the Real Estate Settlement Procedures Act, the Fair Credit Reporting Act, and others in our alphabet soup consumer protection world. Now, at least one federal district trial court reached into traditional state-law notions of conscionability and fiduciary duties to find that a mortgage lender violated these concepts when it failed to give its non-English speaking borrowers a translation of the loan documents so that the borrowers could precisely understand the transaction into which they entered. The case raises significant questions regarding how far courts might go to protect underwater homeowners, and how much mortgage creditors should worry.
Sun Joon and Hoi Suk Park refinanced their mortgage in 2006 by obtaining first and second mortgages from M&T Bank Corporation. The Adjustable Rate Rider to the first mortgage provided for an initial fixed interest rate of 6.875% followed by a maximum adjustable interest of 11.875% per year, while the second mortgage called for a yearly interest rate of 11.125%. The Parks received the typical array of forms required at the closing of a mortgage refinance, including the right to cancel under TILA, and signed each document to acknowledge receipt. In 2009, after the first mortgage adjusted and the Parks defaulted, the Parks tried to rescind the transaction based on M&T’s alleged failure to provide proper disclosures. The Parks claimed that they only spoke Korean and that M&T did not give them Korean translations of the documents at closing. The Parks subsequently sued M&T, asserting claims for rescission and damages under TILA, as well as state-law claims for breach of fiduciary duty, breach of the duty of good faith and fair dealing, and unconscionability. M&T moved to dismiss the case on the ground that it owed no special duty to the Parks.
In opposing the state law-law claim for breach of fiduciary duty, M&T argued that the debtor-creditor relationship does not constitute a fiduciary relationship as a matter of law. The Parks disagreed and claimed that the bank owed them a fiduciary duty to disclose all terms of the first mortgage, to diligently review closing documents, and to ensure that the Parks understood the terms of the transaction prior to entering into the contractual relationship. They also claimed M&T violated this duty by placing the Parks in a “no document” verification loan that would saddle the Parks with interest at a rate higher than what they could have qualified for if proper underwriting occurred. In declining to dismiss this claim, the U.S. District Court for the District of New Jersey noted that courts generally have presumed that no fiduciary relations between banks and their customers exists, due, in large part, to the adversarial nature of the debtor-creditor relationship. At the same time, the Restatement of Contracts, which courts apply in New Jersey, will impose such a duty for gross acts of misconduct and deceit, or where special circumstances exist in which the bank knows or has reason to know that borrowers place their trust and confidence in the bank and rely on the bank “to counsel and inform.” Courts have found a fiduciary duty where, for example, the lender encouraged the borrower to “repose special trust or confidence in its advice, thereby inducing the borrower’s reliance.”
The Restatement requires a party to a contract to disclose a fact that such individual knows may justifiably induce another to act, or refrain from acting, in a business transaction only if the individual has some duty to disclose the matter. A party to a contract has a duty to disclose “facts basic to the transaction, if he knows that the other is about to enter into it under a mistake ... and that the other, because of the relationship between them, the customs of the trade or other objective circumstances, would reasonably expect a disclosure of those facts.” Although the Restatement acknowledges the difficulty in determining or identifying the factors that would give rise to an expectation of disclosure, what the Restatement envisions is a situation in which the advantage taken of the other party’s ignorance is “so shocking to the ethical sense of the community, and is so extreme and unfair, as to amount to a form of swindling.”
With this support, the federal trial court found no difficulty in declining to dismiss the claim. Given that the Parks spoke no English and only Korean, plus the fact that M&T only presented documents in English without the aid of an interpreter, the court concluded that the strong implication existed that the Parks “invested trust and confidence” in M&T to consummate the loams. Consequently, the court found that an implied in law fiduciary relationship potentially existed, one sufficient to withstand a motion to dismiss. Similarly, the court found no difficulty in sustaining the Parks’ claim for breach of the duty of good faith and fair dealing. M&T argued that the duty of good faith and fair dealing only arises, among other narrow circumstances, to rectify a party’s unfair exercise of discretion regarding its contract performance. M&T claimed that the Parks suffered from no exercise of discretion, unlawful or otherwise, in the consummation of their loans. The court rejected the argument that only the unfair exercise of discretion gave rise to this duty, finding that an implied covenant of good faith and fair dealing inheres in every contract, and, on a motion to dismiss, the court concluded that it was highly possible that M&T subjected the non-English-speaking Parks – who did not have the aid of an interpreter – to the exercise of unfair discretion.
For mortgage lenders and servicers, the most frightening claim raised by the Parks is unconscionability. For a contract to be conscionable, it must arise from real bargaining between parties who had freedom of choice and understanding and ability to negotiate in a meaningful fashion. In many states, a contract that a court deems unconscionable becomes unenforceable and void – a death penalty sanction that can prevent the lender from any recovery. The court noted that the need for good faith, honesty in fact and observance of fair dealing becomes critically important when the professional seller enters into agreements with those people most subject to exploitation – “the uneducated, the inexperienced and the people of low incomes.” M&T objected that the Parks’ unconscionability claim merely repackaged their time-barred TILA claims. Once again noting the lack of translated documents or an interpreter, the court rejected the bank’s motion to dismiss.
Why does Park represent a shot across the bow for mortgage creditors? The origins of the foreclosure crisis in our country find their root in complex mortgage instruments, including negative amortization and pay-option adjustable rate mortgages, that the people who agreed to obtain these loans rarely understood. As mortgage creditors struggle to modify these loans under both federally available programs and guidelines and proprietary modification programs, cases like Park give borrowers additional leverage, as a consumer who does not obtain a modification could assert, like the Parks, that the deal struck between them and the lender was overwhelmingly complicated, incomprehensible and ultimately unfair. No doubt plaintiffs most like the Parks – non-English speakers – will more be more likely to raise these types of claims. But in the parade of horribles that constitutes creative litigation, where does a court draw the line? No doubt, for example, an elderly widow will make a sympathetic plaintiff. If mortgage creditors have some enhanced duty when dealing with poor people and the “uneducated,” plaintiffs’ attorneys will have guaranteed full employment over the next several years as they find distressed homeowner after distressed homeowner claiming that financial institutions exploited them in their quest for high profits and at the expense of sound underwriting. On a go-forward basis, the Park case also raises concerns that mortgage loan originators should in fact provide translations of documents to borrowers in the language in which they negotiated the transaction. Some states, such as California, already require such translations. Even if other states do not have such a legal requirement, is it only a matter of time before courts read such obligations into their case law? Only time will tell, but the fact remains that a mortgage creditor who fails to consider the need to make your borrower understand the deal they strike does so at their peril.
Park v. M&T Bank Corporation, 2010 U.S. Dist. LEXIS 24905 (D.N.J. March 16, 2010).
Catherine M. Brennan is a partner in the Maryland office of Hudson Cook, LLP. Basis Points readers can reach Cathy at 410-865-5405 or by email at cbrennan@hudco.com.