by Sheri Qualters
November 5, 2007

A wave of state laws and regulations aimed at curbing unsuitable mortgage loans is opening the door to more litigation by allowing borrowers to file lawsuits instead of complaining to regulatory agencies.

The laws are also creating compliance work for lawyers assisting national lenders navigating a thicket of new state requirements.

Colorado, Maine, Minnesota, North Carolina and Ohio have all recently passed laws to address consumers' ability to repay and the "reckless underwriting of unsuitable, if not outright dangerous," mortgage products, said Uriah King, policy associate at the Durham, N.C.-based Center for Responsible Lending.

Massachusetts Attorney General Martha Coakley issued regulations in October under the state's consumer protection law, which allows for triple damages and attorney fees. And similar Illinois legislation currently awaits the governor's signature to become law.

The laws, which kick in between January 2007 and early 2008, authorize private lawsuits, frequently under state consumer protection or unfair or deceptive acts or practices laws.

Legislative hearings have been held in Michigan and Oregon, and California and Connecticut are also likely to address the issue in their upcoming legislative sessions, said King.

Greenberg Traurig's co-managing shareholder, Bob Sherman, a Boston lawyer who is also in the firm's subprime and mortgage markets group, said there's the potential for litigation similar to lawsuits against securities brokers.

"Anticipated claims would not be unlike the securities industry where brokers are accused of putting customers into investments that didn't meet reasonable investment objectives," Sherman said.

Recent rate increases on subprime and prime adjustable-rate mortgages have driven defaults and foreclosures to more than 1 million as of June 2007, a 50% spike since June 2005, according to a U.S. Government Accountability Office report last month.

Although some lawyers contend that the shrinking subprime mortgage market means fewer questionable loans that borrowers can attack through lawsuits, others say national mortgage companies are likely to trip on the plethora of state laws and offer products with legal pitfalls.

North Carolina's Rate Spread Home Loan Law, which addresses underwriting guidelines and takes effect in January 2008, supplements a 1999 law that also allowed for a private right of action, said Don Lampe a lawyer in Womble Carlyle Sandridge & Rice's Charlotte, N.C., office who helps lender groups with legislative activity in various states.

It was difficult to bring class actions under the 1999 law, but many individual cases were filed, said Lampe, who also defends banks and mortgage lenders in mortgage cases. The new North Carolina law allows consumers to go to court in more circumstances, said Lampe. "Anytime anyone goes into foreclosure, [there will be an] incentive to go to court," Lampe said.

Ohio's sweeping Consumer Sales Practices Act overhauled laws regulating consumer real estate lending in the state as of January.

Arthur Rotatori, a Cleveland lawyer at New Orleans-based McGlinchey Stafford who specializes in creating multistate lending programs for consumers, expects borrowers facing collection actions for loans made this year and in the future to file counterclaims based on companies' alleged compliance errors.

"I imagine you'll start to see claims of people not given the right product and procedures not followed," Rotatori said. "[The collection] would have to come to a head. It takes a while for them to work their way through."

When Maine's Act to Protect Maine Homeowners from Predatory Lending goes on the books in January 2008, it "absolutely" increases the possibility of lawsuits, said Richard Hackett, a partner at Portland, Maine's Pierce Atwood who specializes in advising banks and mortgage companies about regulatory issues. The law amends Maine's Truth-in-Lending Act, part of Maine's Consumer Credit Code, by creating the possibility of up to $5,000 in statutory damages and attorney fees for all home loan violations.

Running afoul of rules that apply to high-cost loans, which have points and fees totaling more than 5% of the loan or an interest rate more than 8% above the U.S. Treasury Bill rate, can generate remedies of twice the finance charge and forfeiture of interest on the loan, he said. That compares with previous maximum liability of $2,000 for violating any truth-in-lending provisions relating to home mortgage lending, he said.

"Twice the finance charge is a huge number," Hackett said. "That's what I call the nuclear remedy."

Consumers also have five years to bring lawsuits against a loan holder or assignee and 10 years to raise it as a defense in the case of a foreclosure proceeding, Hackett said.

Residential-mortgage originators will have to meet new standards of conduct under Minnesota's new law, which took effect in August. Defense attorney Eldon Spencer Jr. of Leonard, O'Brien, Spencer, Gale & Sayre in Minneapolis expects consumers to avail themselves of the new remedies.

"This is the first time people have been able to have a private right of action [for this in Minnesota]," Spencer said. "That clearly leads to the potential of more litigation."

Colorado also passed a spate of laws this past summer, including a mortgage fraud prevention act outlining additional consumer protections in residential-mortgage loan transactions, which took effect in June. The new law requires a reasonable net benefit to borrowers and subjects violations to the Colorado Consumer Protection Act.

But plaintiffs' lawyer John Head of Denver's Head and Associates said he's not sure if there will be more litigation because mortgage brokers are making fewer unsavory loans.

He said it's also difficult to sue them because they tend to have few assets.