Today's Trends in Credit Regulation

A Complicated Compromise: The Supreme Court Rules on Disparate Impact
By L. Jean Noonan

The Supreme Court handed down its much-anticipated decision on the disparate-impact theory on June 25. In Texas Department of Housing and Community Affairs v. The Inclusive Communities Project (Inclusive Communities), a closely divided court held that the Fair Housing Act recognizes a disparate-impact theory. The issue in Inclusive Communities was whether a lawsuit can be brought under the Fair Housing Act, which prohibits housing discrimination "because of" race, by claiming that a law or policy has a "disparate impact" - that is, it has a discriminatory effect, even if it wasn't motivated by an intent to discriminate.

Consumer advocates and government lawyers danced in the street following the ruling. The decision was a bit of a surprise, because many thought the court would strike down the disparate-impact theory under the FHA. But the 5-4 decision upholding the lower court does not tell the whole story. A thorough reading of the Supreme Court's opinion in Inclusive Communities reveals some good news for mortgage creditors.

A possible clue as to how the Court liberals picked up the critical fifth vote is found in Justice Kennedy's language in the opinion limiting the scope of the disparate-impact theory, clarifying the burdens on plaintiffs pursuing a disparate-impact claim, and giving creditors wide latitude to defend their challenged policies. First, let's look at the Court's basis for finding that the FHA recognizes disparate-impact liability.

Supreme Court Relies on "Results-Oriented" Language

The Court first looked for, and found, what it called "results-oriented" language in the FHA. Section 804(a) of the act declares it unlawful:

To refuse to sell or rent after the making of a bona fide offer, or to refuse to negotiate for the sale or rental of, or otherwise make unavailable or deny, a dwelling to any person because of race, color, religion, sex, familial status, or national origin.

42 U. S. C. Ā§ 3604(a). (emphasis added). The Court characterized the emphasized phrase as "results-oriented language" that "refers to the consequences of an action rather than to the actor's intent." It emphasized that "the phrase 'otherwise makes unavailable' is of central importance" to its analysis, stating that "[t]his results-oriented language counsels in favor of recognizing disparate-impact liability."

The Supreme Court has previously held that both Title VII of the Civil Rights Act of 1964 and the Age Discrimination in Employment Act of 1967 incorporate disparate-impact liability. The Court's conclusion that the FHA also recognizes disparate-impact claims was supported by the fact that the FHA, like Title VII and the ADEA, uses "operative text that looks to results." Although the phrase used in the FHA is not identical to the disparate-impact wording in Title VII and the ADEA, the Court said both phrases, introduced with the word "otherwise," signal "a shift in emphasis from the actor's intent to the consequences of his actions."

Another basis for the Court's ruling was grounded in Congress' amendments to the FHA in 1988 against the unanimous view of nine Courts of Appeals. When Congress amended the FHA in 1988, nine of the twelve federal Courts of Appeals had considered whether the FHA recognized the disparate-impact theory, and all nine of them found that to be the case. In Inclusive Communities, the Supreme Court found it to be of "crucial importance" that Congress knew of this unanimous precedent and made "a considered judgment to retain the relevant statutory text." In other words, Congress knew that the courts recognized the disparate-impact theory under the FHA and, if Congress had not intended that interpretation, it would have made that clear when it made the 1988 amendments.

In addition, the Court found "[f]urther and convincing confirmation of Congress' understanding that disparate-impact liability exists under the FHA" in "the substance of the 1988 amendments." Specifically, the Court stated that the amendments included three "exemptions" from liability that would not "make sense if the FHA encompassed only disparate-treatment claims."

Many of my lawyer friends - and the four justices who dissented from the majority decision in Inclusive Communities - take issue with the contention that not changing the law necessarily meant that Congress agreed with it. In 1988, there was far less certainty that the FHA included disparate impact than the majority opinion suggests. As the dissent written by Justice Alito notes, shortly before Congress adopted the 1988 amendments, the Solicitor General "formally argued in this Court that the FHA prohibits only intentional discrimination. . . . It is implausible that the 1988 Congress was aware of certain lower court decisions but oblivious to the United States' considered and public view that these decisions were wrong."

Inclusive Communities Limits Disparate-Impact Claims

The Supreme Court's clarification of the burdens of bringing a disparate impact case is good news for creditors. The Court spent much of its analysis on the "important and appropriate means of ensuring that disparate-impact liability is properly limited." The Court warned that insufficiently limited disparate-impact claims could "undermine . . . the free-market system." The Court described the safeguards necessary "to protect potential defendants against abusive disparate-impact claims." The first step of a disparate-impact claim requires the person bringing the suit to establish a prima facie case by identifying a facially neutral factor that causes a racial disparity. The Court held that a "racial imbalance does not, without more, establish a prima facie case of disparate impact" and that a plaintiff can no longer maintain a disparate-impact claim by pleading a mere "statistical disparity."

The Court makes two important points about the prima facie case:

  • The plaintiff must identify a creditor's policy that causes the disparity. In the auto pricing and the mortgage yield-spread cases, the Consumer Financial Protection Bureau and Department of Justice claimed that the policy is "discretion." Is pricing discretion really a policy? In another Supreme Court decision interpreting Title VII, the Court held that Wal-Mart's practice of allowing managers discretion in setting salaries was not a policy, but rather the absence of a policy. I couldn't have said it better myself!
  • A causal relationship must exist between the challenged policy and the disparity. Justice Kennedy wrote: "A robust causality requirement ensures that '[r]acial imbalance . . . does not, without more, establish a prima facie case of disparate impact' and thus protects defendĀ­ants from being held liable for racial disparities they did not create." These are comforting words to creditors, especially creditors that buy loans for which another company has set the price and thus did not create any disparities the CFPB or the DOJ may have found.

Let's look some more at this "robust causality" standard. In the auto finance cases, the CFPB and DOJ have expressed reluctance to allow a creditor to use any controls in its pricing regressions. The agencies usually look at raw disparities in rate spreads to minority and non-minority groups. What if a creditor could show that other factors, such as credit score, loan-to-value ratio, contract term, or new/used explained the disparity? Such evidence would tend to undercut any agency claim that discretion "caused" a difference in rate spread on a prohibited basis.

The causality requirement will make it more difficult for a plaintiff to make out a prima facie case, and the Court's majority is perfectly fine with that. The Court sets the bar high at the pleading stage because "prompt resolution of these cases is important." The Court notes that one-time decisions, like the Texas Department of Housing's decision in Inclusive Communities, "may not be a policy at all." The Court also observed that the more factors that go into the decision or policy, the more difficult it may be to establish causation.

Once a plaintiff establishes a prima facie case in disparate-impact litigation, the burden shifts to the creditor. Sometimes this is called the business necessity defense. But exactly how necessary the policy must be has been a point of debate. The standard set in Inclusive Communities is one that many creditors will easily meet.

A creditor can maintain the challenged policy if "it is necessary to achieve a valid interest." The interest need not be an indispensible one, or even an important one. The creditor's goal must be valid, and the policy must significantly advance it. Under this standard, the creditor's goal need not be limited to credit risk factors. It can include profit considerations and meeting competition. In language all creditors will appreciate, the Court cautioned that "[e]ntrepreneurs must be given latitude to consider market forces."

In words that should comfort beleaguered creditors who struggle with mitigating disparate-impact risk, the Court said: "The limitations on disparate-impact liability discussed here are also necessary to protect potential defendants against abusive disparate-impact claims." So what does Inclusive Communities mean for creditors worried about the CFPB's and DOJ's aggressive use of disparate impact?

  • Although the outcome in the case may have been disappointing, the discussion of the plaintiff's tough burden of proof and the creditor's wide latitude in defending its challenged policy should bring more fairness for creditors defending these claims.
  • This decision does not address whether disparate-impact claims can be brought under the Equal Credit Opportunity Act. Many of the factors the majority relied on in support of disparate-impact liability under the FHA don't apply to the ECOA. So do we think disparate-impact claims can be brought under the ECOA? I'm reminded of the answer on my Magic 8 Ball: Reply hazy, try again.
  • Don't expect the CFPB and DOJ to back off on the use of disparate impact under the ECOA. Instead, we can expect them to declare victory and double down on their enforcement zeal. This is ironic, because leading up to this decision, they declared the Inclusive Communities opinion would be irrelevant to ECOA cases because that case involved the FHA, not the ECOA. Will they continue to say this decision is irrelevant? Call me a cynic, but I'm guessing not.

If I'm right, that leaves the industry in a bind. Creditors defending ECOA cases brought on disparate-impact theories are likely to fare better in court than in settlements with the agencies. And the CFPB and DOJ know this. But as long as the agencies can bully creditors into settlements on their terms, they will. The cost of fighting the government can be high, and I have yet to meet a bank or other client who is eager to challenge its regulator.

At some point, the consumer credit industry will declare "enough" and fight back. Until then, it is likely to be business as usual with the CFPB and DOJ. Inclusive Communities was not a defeat for creditors. It might just be a challenge. But from where I sit, the Supreme Court has armed creditors with ammunition to fight the agencies' overly aggressive use of the disparate-impact theory. Will the industry benefit from rising to such a challenge? In the words of my Magic 8 Ball: Signs point to yes.

L. Jean Noonan is the managing partner of Hudson Cook's Washington, DC office. Jean can be reached at 202-327-9700 or by email at

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