Supreme Court of Rhode Island Declares Usury Savings Clauses Void

For public policy reasons, the Rhode Island Supreme Court recently held that usury savings clauses are void and unenforceable. In NV One, LLC v. Potomac Home Capital, LLC, borrowers who had defaulted on their note filed a lawsuit against the lender, alleging that the interest rate in a commercial loan agreement violated Rhode Island's usury law. The borrowers sought to void the note and mortgage encumbering the property.

Like many loan agreements, the note contained a usury savings clause that set the "default rate" of interest at the lesser of 24 percent per annum or the maximum rate of interest allowed under applicable law. Because the borrower defaulted on the loan, and the default interest rate exceeded the 21 percent maximum allowable interest rate in Rhode Island, the court considered whether the usury savings clause protected the loan from a violation of the usury law.

The court held that usury savings clauses are unenforceable as a matter of public policy, explaining that allowing lenders to enforce them would "entirely obviate any responsibility on the part of the lender to abide by the usury statute, and would, in essence, swallow the rule." The court observed that allowing these clauses would shift the burden of proving noncompliance to the borrower, even though the lender is in a better position to ensure that its loans comply with the usury laws.

Further, the court said, "[i]f lenders could circumvent the maximum interest rate by including a boilerplate usury savings clause, lenders could charge excessive rates without recourse. This would have the reverse effect of incentivizing lenders to attempt to charge excessive interest rates because, at worst, the lender could invoke the savings clause and the interest rate would simply be reduced to the highest acceptable rate without any penalty to the lender."

Because the usury savings clause was unenforceable, the loan violated the state's usury law. Under Rhode Island law, usurious contracts are void, and the borrower is entitled to recover any amount paid on the loan. Accordingly, the loan and associated mortgage were void, and the lender's liens on the property were removed from the land records.

Violation of usury laws in Rhode Island (and elsewhere) results in severe penalties. Lenders should take note of this recent decision to ensure that their loan documents comply with the usury laws in the states in which they are operating, and to avoid the potentially harsh penalties associated with a usury violation.

- Anthony C. Kaye and Matthew A. Morr


CFPB Settles Self-Reported RESPA Violations

The CFPB announced this week that it has issued a Consent Order under which a Connecticut mortgage lender that self-reported potential RESPA Section 8 violations agreed to pay an $83,000 civil money penalty for such violations. 

According to the CFPB's press release, in addition to reporting its own potential violations, the lender provided information "related to the conduct of other actors" that facilitated other enforcement investigations. The CFPB stated that the lender's self-reporting and cooperation were factored into the settlement, consistent with the CFPB's June 2013 Responsible Business Conduct bulletin. Since the settlement only requires payment of the penalty, it is possible that as a result of its "good behavior," the lender was able to avoid having to make any payments to affected borrowers. 

The lender primarily provides loss-mitigation refinancing to distressed borrowers by offering them new loans with reduced principal amounts. At the closing of such a new loan, the lender would typically receive an origination fee and a loss-mitigation fee from the borrower. In 2010, the lender entered into an arrangement with a hedge fund to finance certain of its loans under which the lender gave the hedge fund a share of its revenues related to the mortgages, including a portion of the origination and loss-mitigation fees. 

In 2011, the lender began using a new warehouse facility rather than the hedge fund to finance its loans. However, the lender continued to share revenues with the hedge fund on 83 loans. After the lender reported to the CFPB that its continued sharing of revenues with the hedge fund may have violated the RESPA Section 8 prohibition against fee splitting, the CFPB's investigation confirmed that RESPA violations had occurred.

The settlement bars the lender from taking a tax deduction or credit for the civil money penalty or from seeking or accepting any reimbursement or indemnification for the penalty, including under any insurance policy. It also orders the lender to refrain from future violations of RESPA or other federal consumer financial laws.

- Richard J. Andreano, Jr.


CFPB Sends Warning to Mortgage Servicers

Describing his message as a "tough one," CFPB Deputy Director Steven Antonakes recently told attendees at the Mortgage Bankers Association's National Mortgage Servicing Conference that "continued sloppiness" by servicers "is difficult to comprehend and not acceptable." Mr. Antonakes acknowledged the CFPB's past statements that it would not immediately expect perfect compliance with the new mortgage servicing rules and instead would be looking at whether companies were making a good faith effort to comply, but his remarks indicate that the CFPB will be taking a very narrow view of what constitutes a "good faith effort."

Telling mortgage servicers that a "good faith effort does not mean servicers have the freedom to harm consumers," Mr. Antonakes stated that he wanted to "very clearly lay out [the CFPB's] expectations." He indicated that "in these very early days, technical issues should simply be identified and corrected" and that the CFPB expects servicers to "conduct outreach to ensure that all customers in default know their options" and "assess loss mitigation applications with care." He stated that the CFPB will be paying "exceptionally close attention" to servicing transfers, looking to see if all information and documents are transferred as required. He further stated that failures to honor existing permanent or trial modifications "will not be tolerated" and that force-placed insurance should only be used as "a last resort" and not "as a profit center."  

As we continue to work with clients on implementing the new mortgage servicing rules and conducting assessments/gap analyses of their compliance management systems, we are navigating the issues Mr. Antonakes highlighted. His remarks indicate that any delay by servicers in fully complying with the new mortgage servicing rules will carry significant risks. Now that the CFPB has delivered its warning, our industry friends should consider making full compliance an immediate priority.


Karen Morgan Heading to Consumer Financial Protection Bureau

Please join us in offering well wishes to Karen Morgan, a Mortgage Banking Group associate in the Washington, D.C., office who is leaving Ballard Spahr for a new opportunity at the Consumer Financial Protection Bureau. Karen will be Attorney-Advisor in the CFPB’s Office of Supervision Policy under its Division of Supervision, Enforcement, and Fair Lending.

Karen has been a highly valued member of the Group. She counsels national mortgage servicers and financial institutions on compliance issues and legal risks under state and federal financial services laws and regulations. In this regard, she has a very keen understanding of how the CFPB’s regulatory and enforcement actions affect the mortgage banking industry.

Karen has been a wonderful part of the team, and we will miss her considerable legal talents. But we know that those same talents will make her a tremendous asset to the CFPB.

Richard J. Andreano, Jr. and John D. Socknat

DID YOU KNOW?

Arkansas Amends Rules Regarding Fair Mortgage Lending Act

The Arkansas Securities Department (Department) recently amended provisions to the Rules of the Fair Mortgage Lending Act (Rules) that became effective on February 9, 2014. The new Rules concern the licensing of loan officers and mortgage brokers, servicing disclosure requirements, and record-keeping requirements, among other things. The changes the amendments made to the Rules are as follows:

• A person may be considered to be a loan officer or mortgage broker and be required to obtain licensing if he or she refers a consumer to a loan officer or mortgage broker and the person receives compensation from a mortgage broker or mortgage banker.

• Servicing disclosures for new and transferred loans are required to include any notice required under federal law or regulation, as well as a notice in the form and content acceptable to the Department that the mortgage servicer is licensed in Arkansas and that complaints about the mortgage servicer may be submitted to the Department.

• Licensees regulated by the Rules must maintain their records in a format compatible with electronic examination software and in a form acceptable to the Commissioner. In addition, the list of all mortgage loan applications or executed fee agreements maintained by licensed mortgage brokers and mortgage bankers must include the NMLS number of the entity that funded the loan and a record of all monies received from a borrower for fees to be paid to third parties for services related to the loan. A mortgage broker must also maintain any document on which it relied in underwriting the loan.

• Advertising that indicates the consumer's ability or likelihood to obtain any mortgage credit product or term, or obtain a refinancing or modification of any mortgage credit product or term, is prohibited. This includes advertising that contains misrepresentations of whether the consumer has been preapproved or guaranteed for any such refinancing or modification.

- Marc D. Patterson 

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This alert is a periodic publication of Ballard Spahr LLP and is intended to notify recipients of new developments in the law. It should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own attorney concerning your situation and specific legal questions you have.

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