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Vol. 27 No.1 January 2011

LITIGATION RISK FOR THE RESIDENTIAL MORTGAGE INDUSTRYIN THE WAKE OF THE DODD-FRANK ACT

The act contains significant ability-to-pay and anti-steering provisions, with a safe harborfor "qualified" mortgages. Borrowers may assert violation of these r e q u i r ~ m e n t s byrecoupment or setoff, which will at least delay foreclosure proceedings. The act alsorestricts federal preemption of state consumer protection laws and protectswhistleblowers who report consumer financial law violations by their employers.

By Eric M. Hurwitz *To many in the residential mortgage industry, theforecast calls for more litigation. Courts in recent yearshave seen an explosion in the number of lawsuitsbrought by borrowers contending that their mortgagelenders put them into so-called "high-cost, predatoryloans." Lenders, originators, and mortgage brokers, areincreasingly finding themselves defending against thecontention that they improperly pushed borrowers intohigh-cost loans they could not afford, for no other reasonthan it was profitable. These claims often includealleged violations of the federal Truth in Lending Act I ,as well as state law claims for fraud and unfair anddeceptive trade practices.

These litigation risks are only likely to increase as aresult of the federal government's ongoing crackdownon the residential mortgage industry in the wake of thesubprime mortgage crisis. The stated purpose for thesechanges is to prevent unfair, abusive, and deceptivepractices by lenders, loan originators, and mortgagebrokers. The end result is likely to be further litigation,

15 U.S.c. 1601 et seq.

* ERIC M HURWITZ is a partner in the litigation department ofthe Philadelphia, Pennsylvania law firm a/Stradley RonanStevens & Young, LLP, where he a memberofthe firm 'sMortgage and Lending Litigation Practice Group. His e-mailaddress [email protected].

including the potential for more delays in foreclosureproceedings. In addition, these new laws provideemployees of the lender with protection for blowing thewhistle to regulators on any perceived conduct that runsafoul of the new federal rules and statutes.

The eye of the proverbial storm, and the centerpieceof the federal government's crack down on the mortgageindustry, is the behemoth Dodd-Frank Wall StreetReform and Consumer Protection Act (the "Dodd-FrankAct,,) .2 The Dodd-Frank Act, enacted on July 21, 2010,was the largest single legislative overhaul of thefinancial services industry since the 1930s, and themortgage industry was not spared its reach. Title XIV("Mortgage Reform and Anti-Predatory Lending Act")of the act takes aim at so-called predatory lendingpractices by imposing, among other things, prohibitionson loan steering, limitations on originator compensation,and the establishment of minimum standards formortgages that require the originator to consider the

2 Dodd-Frank Wall Street Reform and Consumer Protection Ac t,Pub. L. No. 111-203 , 124 Stat. 1376.

IN THIS ISSUE LITIGATION RISK FOR THE RESIDENTIAL MORTGAGE INDUSTRY IN THE WAKE OF THE DODD-FRANK ACT

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RSCR Publications LLC Published 12 times a year by RSCR Publications LLC. Executive and Editorial Offices, 2628 Broadway, Suite 29A,New York, NY 10025-5055. Subscription rates: $650 per year in U.S., Canada, and Mexico; $695 elsewhere (air mail delivered). A 15% discount isavailable for qualified academic libraries and full-time teachers. For subscription infonnatio n and customer service call(866) 425-1171 or visit our Website at www.rscrpubs.eom. General Editor: Michael O. Finkelstein; tel. 212-876-1715; e-mail [email protected]. Associate Editor: Sarah StraussHimmclfarb; tel. 301-294-6233; e-mail [email protected]. To submit a manuscript for publication contact Ms. Himmelfarb. Copyright 2011 byRSCR Publications LLC. ISSN: 1051-1741. Reproduction in whole or in part prohibited except by pennission. All rights reserved. Infonnation has beenobtained by The Review ofBanking & Financial Services from sources believed to be reliable. However, because orthe possibility of human or mechanicalerror by our sources, The Review o/Banking & Financial Services does not guarantee the accuracy, adequacy, or completeness of any information and is notresponsible for any errors or omissions, or for the results obtained from the use of such infonnation.

borrower's ability to repay the loan. The Dodd-FrankAct will be implemented through extensive newregulations from the Federal Reserve Board.

A trip to the recent past provides a good perspectiveon how significantly the Dodd-Frank Act promises toalter the litigation landscape. Until various states andthe federal government intervened, most courtsconstlUed the borrower-lender relationship as oneinvolving two parties operating at arms-length, with eachparty seeking to pursue its own economic interest. 3Attendant to that arms-length relationship, it wascommon for courts to reject causes of action allegingthat lenders put residential borrowers in unsuitable loans,or loans that borrowers could not repay.4 Courts alsoresisted efforts to hold banks liable in tort for "looseinternal lending standards or poor business judgments."s

A recent case from the United States District Courtfor the District of New Jersey, Jatras v. Bank ofAmericaCorp., 6 is representative of this longstanding view of thecreditor-debtor relationship. In Jatras, the borrowerspurchased a home subject to financing from the lender.The borrowers alleged that the lender offered financeprograms subject to a certain underwriting guidelinedesigned to qualify each mortgage transaction basedupon criteria that included the borrower's suitability,market stability, the nature and value of the collateral,and industry standards. When the borrowers laterdefaulted on their loan, they filed suit against a numberof defendants, including the lender, alleging that theywere not qualified for the loan but that the lendernevertheless forced through the transaction. Inparticular, the borrowers claimed that the lender falsifieddocuments from the transaction, including omittinginformation concerning the borrowers' debt-to-income

3 See, e.g., Rangel v. SHI Mortgage Co., No. CV F 09-1035 LJOGSA, 2009 WL 2190210, at *3 (E.D. Cal. July 21, 2009).

4 See, e.g., Whitley v. Taylor Bean & Whitaker Mortgage, 607 F.Supp.2d 885, 902 (N.D. Ill. 2009).

5 See, e.g., Fedders N. Am., Inc. v. Goldman Sachs CreditPartners LP, 405 B.R. 527,551 (8ankr. D. Del. 2009).

6 No. 09-3107, 2010 WL 1644407 (D. N.J. April 22, 2010).

ratio and "manipulatin,f the home appraisal to arrive at apredetermined value."The district court in Jatras granted the defendants'motion to dismiss the borrowers' complaint. The court

rejected the borrowers' fraud-based claims as pleaded,finding that the lender did not owe the borrowers anyduty to advise them if the loan they sought was againsttheir economic interest:

Reduced to its simplest form, Plaintiffs'claim is this: We found a house, whichwe wanted to buy. We signed a contractto purchase the house contingent onfinancing. We went to Defendants to getthat financing. They gave us exactly whatwe wanted. They should not have doneso. . .. In effect, Plaintiffs ask the Courtto save them from themselves. They askthe Court to impose a duty on banks to actnot as self-interested, adversarial businesspartners, but to act as paternalistic friends,who will tell borrowers when they riskperi l. This is not the state of the law inNew Jersey. 8

This foundational premise - that the lender does notowe any duty to ensure that the borrower can repay aloan - started to form cracks following the enactment ofvarious state laws seeking to regulate so-called "highcost, predatory loans." For example, in 1999, NorthCarolina enacted a statute prohibiting a lender frommaking a "rate spread home loan" - a loan where theAPR exceeds certain thresholds defined by the statute based upon the value of a borrower's collateral without"due regard to the borrower's repayment ability as ofconsummation.,,9 As the notion of the borrower's abilityto repay the loan began to take hold, it found its way intoother states' lending laws, often without regard forwhether the loan was "high cost" or otherwise. Forexample, a New Mexico statute states that "[n]o creditorshall make a home loan without documenting and

7 Id. at *l .8 Id. at *4.9 N.C. Gen. Stat. 24.1.1E (1999, as amended).
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considering the borrower's reasonable ability to repaythat loan pursuant to its terms ." I 0 This concept wouldultimately become a key component of the Dodd-FrankAct.

Reasonable Ability to Repay the Loan and Anti SteeringThe Dodd-Frank Act codifies the concept of theborrower's reasonable ability to repay a home loan as akey factor in loan origination. Section 1403 of Title

XIV ("Prohibition on Steering Incentives") mandatesthat the Federal Reserve Board prescribe regulations "toprohibit a mortgage originator from steering anyconsumer to a residential mortgage that (i) the consumerlacks a reasonable ability to repay. . . ." I I

This reference to the borrower's "reasonable ability torepay" a loan is a significant litigation pitfall in theDodd-Frank Act. It provides no uniform standard,which is troubling because what may be reasonable forone borrower may be unreasonable for anotherMoreover, as litigation attorneys well know,"reasonableness" is a concept that is inherently factdependent, and is typically a question for resolution bythe fact-finder. In a trial setting, that ordinarily meansthe jury. It may well fall to civil juries to help definewhat "reasonableness" means in this context, which maycome as little comfort to lenders.

Subtitle B of Title XIV ("Minimum Standards forMortgages") further embraces the concept of a"reasonable ability to repay the loan." Section 1411("Ability to Repay") states:[N]o creditor may make a residentialmortgage loan unless the creditor makes areasonable and goodfaith determinationbased on verified and documentedinformation that, at the time the loan isconsummated, the consumer has areasonable ability to repay the loan,according to its terms, and all applicabletaxes, insurance (including mortgage. ) d 12guarantee msurance ,a n assessments.

Thus, under section 1411, a creditor must not only actreasonably in deciding whether to extend the loan, butmust act in "good faith" by reviewing "verified anddocumented information" to show that the borrower has10 N.M.S.A. 58-21A-4 (2009).I I Dodd-Frank Act, Title XIV, 1403.121d. 1411 (emphasis added).

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a reasonable ability repay the loan. In addition toamorphous references to "reasonableness," the phrase"good faith" is also a potential litigation trap. "Goodfa ith" is not defined in the Dodd-Frank Act itself. Byway of analogy, however, Article 2 of the UniformCommercial Code, applicable to the sale of goods,defines "good faith" as "honesty in fact and theobservance of reasonable commercial standards of fairdealing in the trade." 13 Good faith implies honesty andthe observance of reasonable standards of conduct.These are by nature vague terms ripe for disagreementbetween borrowers and lenders - and disagreementcorrelates with litigation.

Congress was more charitable in actually defining thetypes of documents and information a lender mustexamine in deciding whether the borrower has an abilityto repay a residential mortgage loan. Section 1411 ofthe Dodd-Frank Act identifies the following types ofconsumer information that the lender must consider: credit history; current income; expected income the consumer is reasonably assured

of receiving; current obligations; debt to income ratio, or the residual income theconsumer will have after paying non-mortgage debtand mortgage-related obligations; employment status; and other financial resources other than the consumer'sequity in the dwelling or real property that securesrepayment of the loan.The act also requires the creditor to verify theborrower's income or assets - and hence the borrower'sability to repay the loan - by reviewing "the consumer'sInternal Revenue Service Form W-2, tax returns, payrollreceipts, financial institution records, or other third-partydocuments that provide reasonably reliable evidence ofthe consumer's income or assets.,,14

In light of the Dodd-Frank Act's inclusion of certainsources of information that the creditor must revi ew inmaking a loan suitability determination, lenders and13 See, e.g., N.J. Stat. 12A:2-103(1)(b).14 Dodd-Frank Act, Title XIV, 1411.

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originators should prepare for claims by borrowerspredicated upon the failure to review some of thisinformation. Loan origination files will likely comeunder significant scrutiny once the act goes into effect.Lenders and originators can prepare to defend againstsuch claims by maintaining well-documented loanorigination files.The Dodd-Frank Act also incorporates a number ofanti-steering rules by, among other things, establishingnew standards aimed at preventing originationcompensation abuses. The act prohibits a mortgageoriginator from receiving, directly or indirectly,compensation that varies based on the terms of the loan.

It also expressly prohibits "any yield spread premium orother similar compensation that would, for any mortgageloan, permit the total amount of direct and indirectcompensation from all sources permitted to a mortgageoriginator to vary based on the terms of the loan (otherthan the amount of the principal)." 15 Section 1403requires the Federal Reserve Board to prescriberegulations prohibiting a mortgage originator fromsteering any consumer into a residential mortgage that"the consumer lacks a reasonable ability to repay" orthat has "predatory effects (such as equity stripping,excessive fees, or abusive terms)."

As a result of these anti-steering provisions,borrowers are likely to pay special attention to thecompensation paid to their mortgage originators andbrokers for potential violations of the Dodd-Frank Act.In addition, the act' s conclusory prohibition on steeringborrowers to loans with "predatory effects" raises theprospects of legal challenges, including as to whetherfees were excessive or abusive. The required regulationsfrom the Federal Reserve Board may add some muchneeded clarity to these provisions.

Safe Harbor for Qualified MortgagesBecause what constitutes a "reasonable ability torepay" a residential mortgage loan is less than clearunder the Dodd-Frank Act, Congress attempted toprovide some protection for lenders and originators by

introducing the concept of a "qualified mortgage."Pursuant to section 1412 of the Dodd-Frank Act, "[a]nycreditor with respect to any residential mortgage loan,and any assignee or such loan subject to liability underthis title, may presume that the loan has met therequirements . . . if the loan is a qualified mortgage." 16In other words, if the lender can show that the loan was a15 1d. 1403.16 fd. 1412.

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qualified mortgage, then there is a presumption that theborrower has the ability to repay the loan.The definition of a qualified mortgage under theDodd-Frank Act is lengthy, consisting of nine subparts.

Of these, the more significant characteristics of a"qualified mortgage" are that "the income and financialresources relied upon to qualify the obligors on the loanare verified and documented," "the total points and fees... do not exceed three percent of the total loan amount,"and that the loan "complies with any guidelines orregulations established by the [Federal Reserve Board]relating to ratios of total monthly debt to monthlyincome or alternative measures of ability to pay regularexpenses after payment of total monthly debt, taking intoaccount the income levels of the borrower and suchother factors as the Board may determine relevant." 17

A substantial source of litigation is prone to arise overwhether a mortgage was qualifying under the act. Toattack a mortgage as non-qualifying, borrowers will beable to challenge, among other things, thedocumentation relied upon by the lender and the actualpoints and fees associated with the loan. Borrowers alsocould potentially take advantage of whatever additionalregulations the Federal Reserve Board adopts to enforceand implement the act. Ultimately, it will fall to thecourt system to impose some clarity to the definition of a"qualified mortgage."

But even if the lender can show that a loan is a"qualified mortgage," the presumption that the borrowerhas the ability to repay the loan is only rebuttable. Thismeans that the borrower can still present additionalevidence to overcome the presumption. Viewed thisway, the concept of a "qualified mortgage" is by nomeans a complete defense to an attack from a borrowerclaiming that the lender did not consider the borrower'sreasonable ability to repay the loan. From a litigationperspective, the so-called "safe harbor" may proveillusory.

Defenses to Foreclosure and Limitations PeriodsCongress gave the ability-to-repay and anti-steeringprovisions of the Dodd-Frank Act teeth by incorporatingthem into the defenses to foreclosure available under theact. Section 1413 gives borrowers the right to defendagainst a judicial or non-judicial foreclosure, or anyother action to collect the debt, by asserting that thecreditor violated the anti-steering and the ability-torepay provisions of the Dodd-Frank ACt. 18 The

17 1d.

18 Dodd-Frank Act, Title XIV, 1413.

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borrower can assert the purported violation by way of arecoupment claim or as a setoff to the total amountclaimed to be owed under the mortgage note. This rightof offset and recoupment arms borrowers with new toolsto defend, or at a minimum to delay, foreclosureproceedings.

One of the more extraordinary aspects of thesedefenses to foreclosure is that the borrower can assertthem "without regard for the time limit on a privateaction for damages." 19 In other words, if the borrowerobtains a 30-year mortgage, and in year 25 the homegoes into foreclosure, the borrower can still defendagainst the foreclosure by asserting that the loan violatedthe anti-steering and ability-to-repay provisions of theDodd-Frank Act. Given how frequently mortgage loansare bought and sold, it could prove difficult for the thenexisting note holder to track down relevant witnessesand loan origination records as time goes by andmemories fade.

This defense to foreclosure may have a signi ficantimpact on the foreclosure process by creating anotherhurdle and time delay for the lender. In judicialforeclosure states - those states in which the lender mustfile a foreclosure lawsuit against the borrower - theborrower's defense of offset and recoupment will notprevent foreclosure entirely. Rather, the defenseamounts to a potential reduction of the lender'sforeclosure claim predicated upon an underlying DoddFrank Act violation. This claim by the borrower wouldneed to be litigated along with any other issues relevantto the foreclosure. It thus has the effect of delaying theforeclosure while the offset and recoupment defense islitigated. Further, depending on the damages at issue, itcould stop the foreclosure if the recoupment claimexceeds the then-existing balance of the mortgage. Itexerts pressure on the lender because it is not subject toa statute of limitations, and the amount of recoupmentincludes the right to recover attorneys' fees.

In non-judicial foreclosure states, the lender need notfile a lawsuit to begin foreclosure proceedings. Instead,the lender typically sends the borrower a notice of intentto foreclose to begin the process. If the borrower thenfeels there is some defense presented by the Dodd FrankAct, the borrower would have to initiate a lawsuit as theplaintiff to assert a claim that in effect amounts to thedefense of offset and recoupment to the foreclosureitself, seeking to limit the foreclosure claim. Theborrower 's offset and recoupment claim should halt theforeclosure until such time as the court adjudicates themerits of the claim; borrower's counsel also can be19 Jd.

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expected to request a judicial stay of the foreclosurepending the litigation of the right to offset andrecoupment. Even though this would be an affirmativeclaim by the borrower, it would not be subject to astatute of limitations under the Dodd-Frank Act ifbrought as a defense to the foreclosure. Section 1413 ofthe act specifically mentions both judicial and nonj udicial foreclosures, and states that in either case theborrower can seek a recoupment claim "without r e ~ a r d for the time limit on a private action for damages." 0Practically speaking, the only avenue for pursuing such adefense in a non-judicial foreclosure state is to file anaffirmative claim with the court.

Aside from asserting violations of the Dodd-FrankAct as defense to foreclosure, borrowers can also assertsuch claims as the plaintiff in an affirmative privatecourt action seeking damages. In the event the borrowerchooses to proceed with an affirmative private courtaction, the act does include a statute of limitations. Aborrower may bring any anti-steering or ability-to-repayclaims "before the end of the three-year periodbeginning on the date of the occurrence of theviolation. ,,21

The Erosion of National Bank Act PreemptionOne of the more significant aspects of the Dodd

Frank Act is its weakening of the federal preemptiondefense for national banks and their operatingsubsidiaries and affiliates. By way of background,Congress enacted the National Bank Act ("NBA") in1864, and in l a r ~ e measure the banking system it createdis still in place. 2 The NBA grants federally charterednational banks several enumerated powers, and "all suchincidental powers as shall be necessary to carry on thebusiness ofbanking.,,23 Among those powers, the NBAspecifically authorizes national banks to engage in realestate lending.24 National banks are subject to thestatutory requirements of the NBA itself, as well as theregulatory oversight of the Office of the Comptroller ofthe Currency ("OCC"). The OCC is charged with the

20 Jd. 1413. 21 Jd. 1416. 2212 U.S.C. 1 et seq. 23 Jd. 24 Seventh. 24 Jd . 371.

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task of overseeing the operations of national banks andtheir interactions with customers. 2S

The acc has enacted a preemption regulationproviding that "state laws that obstruct, impair, orcondition a national bank's ability to fully exercise itsFederally authorized real estate lending powers do notapply to national banks.,,26 Pursuant to accregulations, "a national bank may make real estate loansunder 12 U.S.C. 371 and 34.3, without regard to statelaw limitations" concerning a number of enumeratedsubject matters, including licensing and registration bycreditors, loan-to-value ratios, terms of credit (includingschedule for repayment of principal and interest,amortization of loans, balance, payments due, minimumpayments, or term to maturity of the loan), and rates ofinterest. 27

The United States Supreme Court has held thatnational banks are shielded by federal law with regard tothe powers provided to them by the NBA and accregulations, and they are not subject to undulyburdensome and duplicative state regulation, visitation,and control. For example, in one of the seminal cases onNBA preemption, Barnett Bank ofMarion County, N. A.v. Nelson, Florida Insurance Commissioner,28 theSupreme Court determined that state law that "preventsor significantly interferes" with a national bank'sexercise of its powers is preempted. Part of that federalshield is the protection of a national bank's real estatelending powers from state interference. As the SupremeCourt recently stated in Watters v. Wachovia Bank, N.A.,"state law may not significantly burden a national bank'sown exercise of its real estate lending power.,,29

National banks have been able to rely upon thisfederal shield as the basis for claiming preemption ofstate laws, including state consumer protection laws, thatseek to impose requirements different from orinconsistent with the NBA and applicable accregulations. Indeed, the Supreme Court even extendedthe scope of federal preemption to the operatingsubsidiaries of a national bank in Watters. Relying inpart upon acc regulations that allow national banks to25 See Watters v. Wachovia Bank, NA., 550 U.S. 1, 6 (2007);

NationsBank ofNC., NA. v. Variable Annuity Life Ins. Co.,513 U.S. 251, 256 (1995).

26 12 C.F.R. 34.4(a) ("Applicability of state law").27 Id.28 Barnett Bank ofMarion County, N A. v. Nelson, Florida

Insurance Commissioner, et al., 517 U.S. 25 (1996).29 Watters, supra note 25 at 13.

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do business through operating subsidiaries, the Court inWatters held that a national bank's mortgage business,"whether conducted by the bank itself or through thebank's operating subsidiary, is subject to acc ' ssuperintendence, and not to the licensing, reporting, andvisitorial regimes of the several States in which thesubsidiary operates.,,30 Watters had the effect ofexpanding the scope ofNBA preemption, therebyproviding even greater protection to national banks andtheir subsidiaries and affiliates from state regulation,visitation, and consumer protection laws.

The Dodd-Frank Act rolls back much of the scope ofnational bank preemption for consumer loans thatexisted following Watters. Section 1044 ("State LawPreemption Standards For National Banks AndSubsidiaries Clarified") directly addresses when "stateconsumer finance laws" are preempted under the act.Section lO44 defines "state consumer finance laws" asstate laws that do not "directly or indirectly discriminateagainst national banks and that directly and specificallyregulate the manner, content, or terms and conditions ofany financ ial transaction (as may be authorized fornational banks to engage in) , or any account relatedthereto, with respect to a consumer.,,31 This definitionof "state consumer finance laws" is expansive, andwould include any number of state anti-predatorylending laws, origination compensation rules, unfair anddeceptive trade practices acts, and a host of other issuespertaining to mortgage loan origination and servicing, tothe extent such laws pertain to a national bank'srelationship with a consumer.

The Dodd-Frank Act provides three bases underwhich federal law may preempt a "state consumerfinance law": (1) the state law discriminates againstnational banks, in comparison with the effect of the statelaw on a bank chartered by that state; (2) the state law"prevents or significantly interferes with the exercise bythe national bank of its powers"; or (3) the state law ispreempted by some other federallaw. 32 Because statelaws typical do not discriminate against national banks,the second and third standards will likely be the mostoften litigated. Taking them in reverse order, the thirdbasis for preemption will apply when some law otherthan the Dodd-Frank act provides for preemption of statelaw. An example would be the preemption provisions ofthe Fair Credit Reporting Act. 33

30 Id. at 6.31 Dodd-Frank Act, Title X, 1044.32 Id.33 15 U.S.c. 1681 h(e) and 168lt(b)(I)(F).

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The second preemption standard will allow nationalbanks to continue making preemption argumentspredicated upon state law intrusions of powers grantedby the NBA and acc regulations. The act specifies thatthe standard established by the Supreme Court in BarnettBank will control such determinations. Thus, nationalbanks will be able to continue to rely upon Barnett Bankand its progeny to support arguments for the preemptionof state laws that prevent or significantly interfere withtheir exercise of their NBA power to make real estateloans.

However, the ability to rely upon Barnett Bank willno longer extend to the operating subsidiaries andaffiliates of a national bank. Under section 1044 of theDodd-Frank Act, "a State consumer financial law shallapply to a subsidiary or affiliate of a national bank (otherthan a subsidiary or affiliate that is chartered as anational bank) to the same extent that the State consumerfinancial law applies to any person, corporation, or otherentity subject to such State law.,,34 In other words,operating subsidiaries and affiliates of national bankswill be unable to avail themselves of the shield offederalpreemption unless they are themselves national banks.This is a substantial retreat from the doctrine of federalpreemption as previously recognized by the SupremeCourt in Watters. Given that many national banks haveestablished subsidiaries and affiliates to handle their realestate lending operations, the effect of the Dodd-FrankAct is to expose such entities to a host of various statelaw-based, predatory lending and unfair and deceptivetrade practices claims. It remains to be seen whethernational banks might find it advantageous to roll-up suchsubsidiaries into the parent bank to continue to receivethe benefit ofNBA preemption.

Under the Dodd-Frank Act, both courts and the acchave the power to determine whether preemption appliesto any particular state law on a case-by-case basis (inconsultation with the newly created Bureau of ConsumerFinancial Protection).35 Notably, courts will not bestrictly bound by any preemption determination made bythe acc. Section 1044 instructs a court reviewing anacc preemption determination to "assess the validity ofsuch determinations, depending upon the thoroughnessevident in the consideration of the agency, the validity ofthe reasoning of the agency, the consistency with othervalid determinations made by the agency, and otherfactors which the court finds persuasive and relevant toits decision.,,36 National bank lenders will need to be34 Dodd-Frank Act, Title X, 1044.35 Id.36 Id.

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prepared to investigate the basis of any acc preemptiondetermination that might be applicable in a given casefor arguments to support federal preemption. Lenderswill not simply be permitted to defer to thedetermination of the acc.

Lastly, the Dodd-Frank Act does not purport toestablish a uniform set of national mortgage guidelines,nor does it by its terms displace all state predatorylending statutes. Rather, the act provides a minimumfloor for the protection of consumers. The Dodd-FrankAct states that it does not preempt any state law claims,exceft where such state laws are inconsistent with theact. 3 Any state law that affords consumers moreprotection than the Dodd-Frank Act is not inconsistentwith the act, and thus is not preempted by the act. 38

Can You Hear the Whistle Blowing?The Dodd-Frank Act also could lead to an increase inlabor litigation due to its protection for whistleblowers.

Section 1057 ("Employee Protection") prohibits anyonewho offers or provides a "consumer financial product orservice" from terminating or discriminating against anyemployee who provides information concerning thealleged violation of any consumer financial law subjectto the jurisdiction of the Bureau ofConsumer FinancialProtection.39 Section 1002 ("Definitions") in tumdefines the phrase "consumer financial product orservice," and it is broad. It applies to employers in awide range of industries, including mortgage lending,credit cards, loan servicing, lease brokering, certain realestate settlement services, deposit-taking and otherconsumer banking, financial advising, and creditreporting.4o Based upon this definition, mortgagelenders and servicers fall squarely within the reach of theemployee protections of section 1057 of the act.

Notably, section 1057 does not apply to allegedviolations of any state-law-based consumer financialprotection laws. Rather, it prohibits the termination ordiscrimination of employees who provide informationconcerning the alleged violation of only "federalconsumer financial laws," because only such federal

37 Dodd-Frank Act, Title X, 1041.38 Jd. ("a statute, regulation, order, or interpretation in effect in

any State is not inconsistent with the provisions of this title ifthe protection that such statute, regulation, order, orinterpretation affords to consumers is greater than theprotection provided under this title").

39 Dodd-Frank Act, Title X, 1057.40 Dodd-Frank Act, Title X, 1002.

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laws fall within the jurisdiction of the Bureau ofConsumer Financial Protection. 41 Section 1057 alsoprotects employees who testify against their employersin such matters, or who file or institute any proceedingsunder any federal consumer financial law. It evenprotects employees who object to, or refuse toparticipate in "any activity, policy, practice, or assignedtask that the employee . . . reasonably believed to be inviolation of any law, rnle, order, standard, or prohibition,subject to the jurisdiction of, or enforceable by, theBureau.,,42

Any employee who believes that he or she wasdischarged or otherwise discriminated against inviolation of the Dodd-Frank Act can file a complaintwith the Secretary of Labor. After the alleged violatorfiles a response, the Labor Department is empowered toinitiate an investigation and reach a preliminary writtendetermination, subject to any request for a formalhearing following the written determination. If theemployee prevails, he or she is entitled to be reinstatedwith the employer at his or her former position, inaddition to recovering compensatory damages, includingback pay. In the event the SecretarY'of Labor does notissue a final order within 210 days after the date of filingof a complaint, or within 90 days after the date of receiptof a written determination, the employee can bring anaction in federal court against the employer.

These whistleblower protections essentially amount tonew labor laws to which mortgage lenders andoriginators must comply. The only protection for thelender is that, under the act, the employee may be

41 Supra note 38. The definition of a "federal consumer financiallaw" in the act is limited to those federal consumer Jaws forwhich authorities are transferred to the jurisdiction of theBureau. Dodd-Frank Act, Title X, 1002.

42 Dodd-Frank Act, Title X, 1057.

required to pay the employer a fee not exceeding $1,000if the employer's claim is found to be frivolous or in badfaith.43 Unfortunately, the lender's attorneys' fees couldfar exceed that amount. Perhaps more importantly, if theemployee's claim has merit, it could well lead to anadditional governmental investigation of the allegedlyimproper consumer finance activity. That, in tum, couldlead to administrative, or worse, criminal proceedingsagainst the company.

Bracing for the StormMost of the provisions of the Dodd-Frank Act will gointo effect based upon the date that the currentregulatory powers transfer to the newly created Bureau

of Consumer Financial Protection. The Secretary of theTreasury has set the so-called "transfer date" as July 21,2011. With regard to Title XIV, governing MortgageReform and Predatory Lending, implementingregulations must be prescribed in final form no later than18 months of the transfer date (January 21, 2013), andmust take effect no later than 12 months after that(January 21, 2014). These are outside dates, however,and the actual effective dates may well happen sooner.

The good news is that there is a significant period oftime for lenders and originators to prepare for thedramatic changes to the industry coming in the wake ofthe Dodd-Frank Act. Lenders will need to develop newbusiness models, train employees, and make systemicchanges to implement the new rules. Given thenumerous pitfalls in the Dodd-Frank Act, litigation riskmanagement should be added to that list.

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dodd frank act hurwitz authored 1 2011

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