Insights

The Consumer Financial Protection Bureau (CFPB) issued a short (2-1/2 page) bulletin in April 2012, stating its position that entities under CFPB supervision must “oversee their business relationships with service providers in a manner that ensures compliance with Federal consumer financial law.”[1] This bulletin constitutes CFPB “guidance” and states the CFPB’s “expectations” of entities under its supervision.[2] Regardless of the ultimate resolution of questions concerning Director Cordray’s recess appointment and the impact of that appointment on the CFPB’s activities, the bulletin is worth reading.

The CFPB has indicated that a supervised entity should monitor its service providers to ensure ongoing compliance with applicable consumer protection requirements, and take “prompt action to address fully any problems identified through the monitoring process, including terminating the relationship where appropriate.” This is consistent with general legal principles that make a business responsible for the authorized acts of its agents. However, a supervised entity will not always be held responsible for its service provider’s errors and omissions – such liability will “depend[] on the circumstances,” according to the CFPB. This is again consistent with general legal principles that may excuse a business from responsibility for unlawful and unauthorized acts of agents that clearly fall outside the scope of the agents’ actual and apparent authority.

The CFPB’s guidance about service providers does not contain surprising or new information, but is a useful reminder about the importance of carefully selecting and monitoring service providers. The need to conduct due diligence before selecting service providers (including settlement agents), and to continually monitor service providers’ activities, has been previously communicated by various bank regulatory agencies to their regulated banks. For example, the Office of the Comptroller of the Currency (OCC) advised national banks in 2001 about certain compliance and other risks that could arise from national banks’ business relationships with third party service providers.[3] Mortgage lenders are also well-aware of the inherent risks associated with settlement agent error or misconduct, and have long-standing reasons to monitor their settlement agents’ conduct, to avoid becoming innocent victims. For example, if a settlement agent fails to use refinancing loan proceeds to pay off senior mortgages, the borrower and the new refinancing lender likely will be innocent victims (the refinancing loan proceeds would not have been put to their intended use and the mortgage securing the refinancing will not have the lien priority the lender had required and anticipated), and full restitution may be difficult to obtain from such a settlement agent if the defalcation is not promptly discovered.

Recent events have driven home the fact that lenders are generally held responsible for post-closing loan servicer errors (including errors committed by outside foreclosure counsel). But what about settlement agent errors that occur before, at or immediately after closing?

Contracts between mortgage lenders and settlement agents may describe the extent to which the agents will be liable to the lenders for the agents’ errors and omissions. Some court cases indicate that a settlement agent also may be liable to an assignee of a mortgage loan for the agent’s closing-related negligence, if the agent knew that the loan would be assigned post-closing (even if the identity of the assignee was not known to the settlement agent).[4]

In some cases, the clear wording of a statute may dictate that the settlement agent is responsible for damages caused by the settlement agent’s failure to comply with that statute. For example, in Chase Manhattan Mortgage Co. v. Lane, 2010 U.S. Dist. LEXIS 82501 (W.D. N.D. 2010) a settlement agent was liable for damages arising from the settlement agent’s violation of North Carolina’s Good Funds Settlement Act (N.C. Gen. Stat. Section 45A-1 et seq.), based on the express provisions of that Act. Similarly, in Bonanno v. Security Atlantic Mortgage Co., 2010 U.S. Dist. LEXIS 51593 (E.D.N.Y. 2010) the court held that, based on the wording of RESPA and Regulation X, only the settlement agent (not the mortgage lender) is responsible for allowing the borrower to inspect the HUD-1 or HUD-1A (completed only to the extent of information known to the settlement agent at that time) during the business day immediately before closing.

In Sears Mortgage Corp. v. Rose, 134 N.J. 326 (N.J. 1993), the buyer of a condominium unit retained a closing lawyer to represent the buyer’s interests and to provide the buyer with an owner’s title insurance policy. The facts of this case were a little unusual, in that the buyer was paying cash and was not relying on mortgage loan proceeds to purchase the condominium unit. Consequently, the closing lawyer selected by the buyer was not also representing a purchase-money mortgage lender at the closing. The closing lawyer misappropriated cash proceeds from the buyer’s contemporaneous sale of other real property, and failed to forward those proceeds to pay off a pre-existing purchase-money first mortgage loan on the condominium being purchased. The result of this misappropriation of funds was that the buyer did not acquire title to the condominium free and clear of liens, and the seller of the condominium did not have the seller’s pre-existing purchase-money first mortgage loan paid off from the cash sale proceeds paid to the buyer at the contemporaneous sale of the buyer’s other real property. These facts came to light after the purchase-money first mortgage lender notified the seller of the condominium unit that the loan had not been paid off, the loan was now in default, and the lender intended to commence foreclosure proceedings. The New Jersey Supreme Court held that, because the closing lawyer was an authorized agent of the title insurance company that issued the owner’s title commitment to the buyer, the title insurance company was liable for its agent’s failure to pay off the first mortgage on the property purchased by the buyer, and ordered the title insurance company to pay off the first mortgage. (If no title insurance commitment had been requested or issued, the buyer’s recourse for the lawyer’s misappropriation of funds would have been against the New Jersey Lawyers’ Fund for Client Protection.) Similar reasoning could give a mortgage lender recourse against a title insurance company for the wrongdoing of a settlement agent acting as the title company’s agent when issuing a mortgage title insurance policy, if the agent fails to pay off an existing mortgage loan on the mortgaged property with the mortgage lender’s proceeds (and many mortgage lenders require title companies to provide specific written assurance that the companies will make the lenders whole if their title insurance agents mis-apply mortgage loan proceeds and fail to pay off pre-existing mortgages or other liens).

As another example of a situation where settlement agent misconduct was not considered to be the responsibility of the innocent (and victimized) mortgage lender, the OCC entered into a Stipulation and Consent Order with Chicago Title Insurance Company (CTIC) in 2005, in CTIC’s capacity as the mortgage loan settlement agent (and thus as a service provider) for three national banks.[5] The OCC alleged that CTIC provided inaccurate HUD-1 settlement statements that “failed to accurately reflect all the actual charges and adjustments in connection with settlement of federally related mortgage transactions.” Without admitting or denying any of these allegations, CTIC agreed to a $5 million civil money penalty and to take certain corrective actions.[6] This OCC settlement pertained to alleged residential and commercial mortgage loan fraud in the Houston, Texas area and also resulted in civil money penalties and other enforcement action against two former national bank officers. Press reports indicate that the alleged fraud may have included disguised payments to bank officers (disguised through the use of incorrect third party payee names and/or inflated disbursement amounts on HUD-1 settlement statements). The OCC treated the national bank lenders affected by these enforcement actions as unwitting victims, not wrongdoers, and the two former national bank officers allegedly involved in the fraud entered into restitution agreements with their former employers.

For less egregious settlement agent errors, such as good faith arithmetic or transcription mistakes on HUD-1 settlement statements, RESPA regulations (12 CFR Section 1024.7(i)) allow the “loan originator” (including the mortgage lender and/or broker) to cure certain good faith estimate tolerance violations by mailing the appropriate reimbursement amount to the borrower within 30 days after settlement. Inadvertent and technical errors in completing a HUD-1 settlement statement that do not implicate closing cost tolerances may be cured by sending the borrower a corrected HUD-1 settlement statement within 30 days after settlement. (See 12 CFR Section 1024.8(c).) If an appropriate and timely post-closing cure occurs, regulators may have less incentive to take additional action against the lender for a settlement agent’s HUD-1 related errors.

If a lender terminates its business relationship with a settlement agent immediately after uncovering suspected settlement agent error or misconduct, that might also help reduce regulators’ attempts to hold the lender responsible for that error or misconduct. This raises the question of how a lender should inform a settlement agent that its business relationship is being terminated. A lender may discuss with its settlement agent the specific underlying facts, transactions and documents (such as HUD-1 settlement statements and records of how and when loan proceeds were disbursed, mortgages and releases were recorded, etc.) that form the basis for the lender’s decision to terminate the lender’s business relationship with the settlement agent. However, the lender should not disclose to the settlement agent (or anyone else involved with the suspected settlement agent error or misconduct– subject to narrow exceptions for disclosure to government officials who have a “need to know” in order to carry out their official duties) any information that would reveal whether a Suspicious Activity Report (SAR) is being (or has been) filed by the lender. The lender should neither confirm nor deny the existence or non-existence of a SAR.[7]

At the state level, Connecticut recently amended its licensed mortgage lender and mortgage broker statutes as of October 1, 2012, to allow the Banking Commissioner to suspend, revoke or refuse to renew a mortgage lender license, and/or impose other administrative sanctions and penalties on a licensed mortgage lender, if any settlement agent selected by the licensee to close a loan on the licensee’s behalf (as identified on the HUD-1 settlement statement for a mortgage loan) fails to perform “any agreement” with a borrower, or violates “any law or regulation applicable to the conduct of its business.”[8] The statute is worded broadly, and could potentially be interpreted as covering virtually any breach by a settlement agent selected by the licensed mortgage lender of any agreement between that settlement agent or the mortgage lender and a consumer borrower, including a failure to disburse funds when and as promised. The statute could also apply to settlement agent errors in completing a HUD-1 settlement statement (since RESPA is a “law or regulation applicable to the conduct” of a licensed lender’s business). The statute also specifies that “[a]ny settlement agent whose name appears on the licensee’s list of approved settlement agents shall be deemed selected by the licensee even if the settlement agent is selected from such list by the borrower.” Consequently, a Connecticut licensed mortgage lender could risk administrative sanctions (potentially including loss of its license) if (for example) a settlement agent approved by the lender commits fraud and fails to use the lender’s refinancing mortgage loan proceeds to pay off a borrower’s pre-existing loan, or charges a borrower more than the agreed-upon fee for closing-related services. The statute effectively requires Connecticut-licensed mortgage lenders to carefully monitor the conduct of their Connecticut mortgage loan settlement agents (including closing lawyers), to reduce risk of administrative sanctions.

One of the primary reasons a state imposes license, surety bond, continuing education, and similar requirements on nonbank mortgage lenders is to protect the state’s consumers (borrowers and mortgagors). Similarly, the CFPB’s (and other regulators’) focus is on preventing and mitigating harm to consumers. Under circumstances where a settlement agent’s error or misconduct results in harm to the borrower, mortgagor, and also the lender, a state or federal regulator therefore might be primarily interested in knowing whether the harm to the borrower and mortgagor has been appropriately addressed. If a settlement agent acting on behalf of a mortgage lender is unable or unwilling to promptly resolve the harm it might have caused to a borrower or mortgagor, the regulator might turn to the lender for appropriate consumer redress.

Elizabeth C. Yen is a partner in the Connecticut office of Hudson Cook, LLP. Elizabeth can be reached at 203-776-1911 or by email at eyen@hudco.com.

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[1] See CFPB Bulletin 2012-03 (April 13, 2012), copy available at http://files.consumerfinance.gov/f/201204_cfpb_bulletin_service-providers.pdf.

[2] Notably, 12 USC Section 5516(e) gives the CFPB authority to supervise and examine service providers that work for “a substantial number” of insured banks and credit unions with total assets of $10 billion or less. This is separate from CFPB’s statutory authority (under 12 USC Section 5515(d)) to supervise and examine the service providers of any insured bank or credit union with total assets greater than $10 billion (and the service providers of any affiliates of such a bank or credit union).

[3] See OCC Bulletin 2001-47, copy available at http://www.occ.gov/news-issuances/bulletins/2001/bulletin-2001-47.html.

[4] See, e.g., First Financial Savings & Loan Association v. Title Insurance Company of Minnesota, 557 F. Supp. 654 (N.D. Ga. 1982).

[5] See OCC Enforcement Action 2005-12, copy available at http://www.occ.gov/static/enforcement-actions/ea2005-12.pdf.

[6] CTIC settled related administrative enforcement actions with the Department of Housing and Urban Development (HUD), Office of Thrift Supervision, and the Texas Department of Insurance. See, e.g., HUD News Release 05-021 (February 28, 2005), copy available at http://archives.hud.gov/news/2005/pr05-021.cfm and OCC News Release 2005-21 (February 28, 2005), copy available at http://www.occ.gov/news-issuances/news-releases/2005/nr-occ-2005-21.html.

[7] FinCEN has stated that the prohibition against directly or indirectly disclosing whether a SAR has been filed does not extend to disclosure of “the underlying facts, transactions, and documents upon which a SAR is based…” See FinCEN SAR Guidance (FinCEN-2010-G006) issued November 23, 2010, copy available at http://www.fincen.gov/statutes_regs/guidance/pdf/fin-2010-g006.pdf.

[8] See Section 14 of Connecticut Public Act 12-96, amending Conn. Gen. Stat. Section 36a-494 effective October 1, 2012.