Recent decisions from the state’s Supreme Judicial Court have reaffirmed that deep-pocketed investors half a world away may still be called upon to face the music in Massachusetts courts when it comes to claims of predatory lending and violations of consumer protection statutes. 

“What this says is, depending on the facts in the case, you might absolutely be liable, even though you didn’t originate the loan,” said Michael MacClary, a partner at Boston’s Burns and Levinson LLP and 2013 president of the Massachusetts Real Estate Bar Association. 

The two cases handed down by the SJC last week, Drakopoulos v. U.S. Bank National Assoc. and Deutsche Bank National Assoc. v. First American Title Insurance Co., both involve “stated income” loans originated during the boom. The loan products – often derisively nicknamed “no-doc” or “liar’s loans” did not require borrowers to provide proof of income in order to obtain a loan. In both cases, borrowers alleged that unscrupulous brokers misled them about the nature of the products, and that the loans violated Massachusetts statutes governing predatory lending. (In the Drakopoulos case, the monthly mortgage payment for the loan that was issued was $600 more than the borrower’s entire monthly income.) 

By the time the borrowers defaulted and foreclosure proceedings began, the brokers who originated the loans had long since sold them on to be securitized and sold on to investors, with big banks like Deutsche and U.S. Bank selected as trustees to oversee the disbursement of funds. But despite the fact that big national banks acting as trustees did not themselves originate the loan, they could still be on the hook for the fraudulent practices of the originator, the SJC ruled in the Drakopoulos case. And claims that the lender violated predatory lending and consumer protection laws aren’t covered by title insurance, the court said in the Deutsche Bank case. 

When it comes to the state’s anti-predatory lending statute, the question is simply, “whether the lender should have recognized at the outset that the plaintiffs were unlikely to be able to repay the loan,” the court wrote, not whether all the individual loan terms matched up with statutory definitions of a “high-cost loan,” the judges wrote.  

AG ‘Pleased’ With Decision

That ruling was hailed by Attorney General Martha Coakley’s office, which had filed an amicus brief in the Drakopoulos case. “We are pleased with the court’s decision that supports Massachusetts law protecting homeowners from unfair predatory loans, and makes it clear that the loan providers and their assignees are responsible for the harm they cause,” said Coakley spokeswoman Jillian Fennimore. “Consumers deserve strong legal protections from predatory lenders, and this decision reaffirms a broad range of consumer rights.”

Local real estate attorneys also described the decisions as sound. “I’m not surprised by the outcome in either one of them,” said Ed Bloom, a partner in the real estate department of Boston-based Sherin and Lodgen LLC. “Anytime someone takes the assignment of a loan, they take it subject to all the original defenses the borrower may have had against the original lender.” 

But while the issues in the case may not be unique, the rulings could still be important given the typical practices in the securitization industry of the mid-2000s, said Tamar Frankel, a professor at Boston University’s School of Law and internationally recognized expert on trust law and securitization. “A trustee, when he purchases [an asset] for the trust, has a higher obligation,” to perform sufficient due diligence to verify that the investment is sound, said Frankel. Frankel said the question courts will now have to decide is: “Could the bank, under reasonable conditions, verify that this [loan] was really a forged document?” If they could, they may be liable.   

Back in the mid-2000s, many big banks certainly weren’t trying very hard. Thousands of “stated-income” loans like Drakopoulos’ were issued during the housing boom. It’s unclear how many may still be sitting in mortgage-backed securities, presenting a potential liability risk to the big banks commissioned to oversee them. With the court also making clear that title insurance won’t cover such claims, trustee banks (and the investors in the securities) may now be facing much higher legal costs than they bargained for. 

Down the road, that could put a damper on lending in Massachusetts, mortgage industry experts say. Federal regulators are still putting the finishing touches on their own predatory lending rules, particularly the CFPB’s highly anticipated ruling on the definition of a “qualified mortgage,” which could pre-empt state laws. But if the CFPB chooses to defer to the states on consumer protection laws, that could make big banks skittish about buying up Massachusetts loans, mortgage industry experts said, and potentially raise loan costs for Bay State borrowers.

Email: csullivan@thewarrengroup.com