Commonwealth v. Fremont Investment & Loan
23 Mass. L. Rptr. 567 (2008)
Rule of Law:
A lending practice is unfair under G.L.c. 93A, §2, even without deception or fraud, if it is immoral, unethical, oppressive, or unscrupulous, or causes substantial injury to consumers. Loans secured by a borrower’s principal dwelling are presumptively unfair if they combine an adjustable rate, a low introductory rate significantly below the fully indexed rate, a debt-to-income ratio exceeding 50% when calculated at the fully indexed rate, and either a 100% loan-to-value ratio or a substantial prepayment penalty.
Facts:
- Between January 2004 and March 2007, Fremont Investment & Loan originated 14,578 sub-prime mortgage loans to Massachusetts residents, secured by owner-occupied homes.
- Many of these loans were adjustable-rate mortgages (ARMs) with a low introductory 'teaser' rate for two or three years, designed for borrowers who would not qualify for traditional mortgages.
- Fremont's underwriting department generally qualified borrowers for these ARMs by calculating their debt-to-income ratio based on the low introductory rate, not the higher 'fully indexed rate' that would apply after the initial period.
- A significant portion (38.4%) of Fremont’s originated loans were 'stated-income' loans, where borrowers declared income without requiring standard verification like tax returns or pay stubs.
- Fremont frequently offered mortgage loans with little or no down payment, resulting in loan-to-value ratios approaching or exceeding 100%.
- Mortgage brokers, acting as independent contractors, facilitated these loans, and in some instances, inflated borrower income on loan applications without Fremont's direct knowledge or encouragement.
- In March 2007, Fremont entered a Stipulation and Consent to an Order to Cease and Desist with the Federal Deposit Insurance Corporation (FDIC) due to charges of unsound banking practices, including operating with inadequate underwriting criteria and extending ARMs in an unsafe manner.
- In July 2007, Fremont and the Massachusetts Attorney General entered into a Term Sheet agreement establishing a 90-day review procedure for proposed foreclosures, but Fremont terminated this agreement in December 2007 after the Attorney General objected to most of its foreclosure referrals.
Procedural Posture:
- On October 4, 2007, the Commonwealth of Massachusetts, acting through the Massachusetts Attorney General, filed a complaint against Fremont Investment & Loan in Superior Court, alleging unfair and deceptive acts or practices in violation of G.L.c. 93A, §2.
- The Attorney General subsequently moved for a preliminary injunction to bar Fremont from initiating or advancing foreclosures on residential mortgage loans in Massachusetts without the Attorney General’s written consent during the pendency of the action.
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Issue:
Does a lender engage in unfair or deceptive acts or practices in violation of G.L.c. 93A, §2, by issuing home mortgage loans to borrowers secured by their principal dwelling that are "presumptively unfair" because they combine certain characteristics indicating the lender reasonably expects the loan to fail unless property values increase?
Opinions:
Majority - Gants, Ralph D., J.
Yes, a lender engages in unfair or deceptive acts or practices under G.L.c. 93A, §2, by issuing home mortgage loans secured by a borrower's principal dwelling that are 'presumptively unfair' due to a combination of characteristics indicating the lender reasonably expects the loan to fail without market appreciation. The court found that many of Fremont's sub-prime mortgage loans were 'structurally unfair' and likely violated G.L.c. 93A, §2, which broadly prohibits 'unfair or deceptive acts or practices.' While no specific statute or regulation directly prohibited Fremont's individual lending practices at the time, the court emphasized that Chapter 93A's concept of unfairness is broad and evolving, extending beyond common law or statutory violations. Citing the PMP Assocs., Inc. test, the court considered whether the practice was within the penumbra of established concepts of unfairness, immoral/unethical/oppressive/unscrupulous, and caused substantial injury. The court drew upon the 'spirit' of the Predatory Home Loan Practices Act (G.L.c. 183C, §2 et seq.), which deems it unfair to make 'high-cost mortgage loans' when the lender reasonably believes the borrower cannot make scheduled payments. The court extended this principle to any home mortgage loan, reasoning that such loans are 'presumed to be structurally unfair' if they combine four specific characteristics: 1) an Adjustable Rate Mortgage (ARM) with an introductory period of three years or less; 2) an introductory 'teaser' rate at least 3% lower than the fully indexed rate; 3) a debt-to-income ratio exceeding 50% when measured at the fully indexed rate (not the teaser rate); and 4) a 100% loan-to-value ratio OR a substantial prepayment penalty extending beyond the introductory period. The court explained that loans with these four characteristics are 'doomed to foreclosure' unless the borrower is able to refinance, which is unlikely if housing prices decline for loans with high LTV or prepayment penalties. This makes such loans unfair because their success relies on unpredictable market appreciation or income increases. The court justified this evolving definition of unfairness by pointing to the 'irrational exuberance' in the mortgage market, the rise of mortgage-backed securities, and recent guidance from federal agencies warning of the risks of such lending. The court clarified that 'stated income' loans alone are not presumptively unfair if the income stated is accurate. The court granted a preliminary injunction requiring Fremont to follow a multi-step process before foreclosing on any loan, involving written notice to the Attorney General and, for presumptively unfair loans on owner-occupied dwellings, potential court approval after attempting loan workouts.
Analysis:
This case significantly broadened the scope of 'unfair and deceptive acts or practices' under G.L.c. 93A, §2, by establishing that certain lending practices, even without explicit deception or fraud, can be inherently unfair if they create an unreasonable expectation of borrower default. It introduces the concept of 'structurally unfair' loans, shifting the burden of production to lenders to demonstrate fairness once the four criteria are met. This ruling provides a powerful tool for consumer protection against predatory lending practices and emphasizes that commercial morality, as interpreted by courts, can evolve with changing market conditions and societal understanding of economic harm, especially in critical sectors like housing. It highlights a proactive role for the Attorney General in regulating financial markets and protecting vulnerable borrowers.
