In an effort to aid borrowers in the current housing crisis, the Home Affordable Modification Program (HAMP) was implemented by the secretary of the U.S. Department of the Treasury (Treasury) in 2009 to assist borrowers by allowing loan modifications if certain conditions were met. HAMP, in essence, provided mortgage companies with an alternative to foreclosing troubled mortgage loans and was largely a voluntary program. After HAMP was implemented, a slew of individual and class action lawsuits were filed by borrower plaintiffs when their mortgage loan was not permanently modified under HAMP. Although many of the initial suits were dismissed because HAMP did not provide a private right of action, some borrowers have now modified their claims to assert a second generation of HAMP lawsuits by alleging only state law causes of action which are largely based on contract principles.
The Fifth Circuit's recent decision in Pennington v. HSBC Bank, 2012 WL 4513333 (5th Cir. Oct. 3, 2012) perhaps signals what will become the dominant trend in this next generation of cases alleging mortgage servicers failed to provide loan modifications under the HAMP's Trial Period Plans (TPP).
In Pennington, the Fifth Circuit joins the Eleventh Circuit (and arguably the Seventh Circuit) in rejecting the argument, which is often advanced by borrowers' counsel, that TPPs promise a permanent modification regardless of eligibility for HAMP. The first federal circuit-level HAMP decision, Wigod v. Wells Fargo, 673 F.3d 547 (7th Cir. 2012), arguably opened the door to HAMP TPP claims, but left unanswered what the TPP actually promises. The Fifth Circuit's decision in Pennington now appears to answer those questions.
The Typical HAMP TPP Case
The HAMP TPP case has become, like the TCPA (Telephone Consumer Protection Act) or FACTA (Fair and Accurate Credit Transactions Act) cases, something of its own genre of lawsuit. Prior to June 2010, when the HAMP program guidelines changed, the typical case involved a borrower in default (or very close to it) on his mortgage loan who then applied for a modification from his mortgage servicer. The mortgage servicer would then initially evaluate the borrower for qualification under the federal HAMP program and, if the borrower met some threshold requirements, the servicer would issue a TPP to the borrower. Borrowers would be able to meet the threshold criteria by providing stated, unverified income information. Although a TPP would be issued at this threshold stage, not all of the HAMP requirements were evaluated before issuing a TPP. The purpose of the TPP was not only to ensure the borrower could make the modified payments for a temporary period of time before receiving a permanent modification, but the guidelines also called for the borrowers' eligibility to be evaluated and verified during this time of the TPP. Predictably, many borrowers provided stated income that could not be verified, either due to borrower falsification, borrower mistake, and or sometimes just due to income that is ultimately unverifiable under the standards set by the HAMP program. While income differing from stated amounts or an inability to provide documentation to substantiate income were the dominant reasons why income could not be verified, there are certainly many other reasons, for example, the borrower's income actually changed during the trial period (such as when he lost a job or found a new one). Regardless of the reason, however, many borrowers entered into TPPs, but were ultimately eligible and did not receive permanent modification offers from their servicer. Borrowers then filed suit against their mortgage servicers alleging they made the monthly payments required by the TPP, and as to the additional eligibility requirements, borrowers argued either that the TPP did not clearly spell them out or that the servicer erroneously applied them.
Because of perceived borrower confusion with the two-step verification process, and many borrowers receiving TPPs but not qualifying for a permanent modification, Treasury changed the HAMP guidelines effective June 2010. For applications after that date, servicers were required to fully verify a borrower's eligibility before offering a TPP. Borrowers could still fail to receive a permanent modification, but only if the borrower's circumstances materially changed, for example, their income was reduced during the TPP or they stopped occupying the property. Most HAMP TPP cases therefore arose from the pre-June 2010 period and from cases involving initial eligibility determinations based on stated, unverified income. On this point, the facts in Wigod are notable. Although Wigod involved facts prior to June 2010, some servicers were already fully verifying income prior to it being required, and the Wigod plaintiff alleged that is how the servicer in her case was operating at the time of her application.
The Law on HAMP TPP Cases Prior to Pennington
Initially, most courts dismissed lawsuits following the general fact pattern above because HAMP plainly stated that it did not allow borrowers to sue for a private right of action. Eventually, however, while many courts outside of the Seventh Circuit continue to dismiss such suits on that basis, a minority of courts began to recognize exceptions to this doctrine where the borrower could otherwise state the elements for a state law cause of action (such as breach of contract, promissory estoppel, or fraud) and without relying on an alleged violation of HAMP itself (i.e., just on the TPP alone without reference to the HAMP guidelines). See Wigod, 673 F.3d at 559 n.4 (summarizing the state of the law in federal district courts as of March 2011).
To date, there have only been three cases decided at the federal circuit level on these issues. The first was the Seventh Circuit's decision in Wigod, which held borrowers may sue under state law theories regardless of whether their claims relate to HAMP. The Wigod court also rejected most of the arguments that servicers typically made in HAMP TPP cases such as to argue the TPP was invalid or unenforceable (as it was merely a preliminary agreement or it lacked consideration or lacked the final loan modification terms, etc.). Even though it allowed certain claims, the Seventh Circuit also appeared to hold that the borrower must still qualify for HAMP in order to be entitled to a permanent loan modification, but the unusual facts in the Wigod case make it difficult to determine the court's precise holding (the borrower alleged the servicer already had her financial documentation and had fully evaluated her eligibility prior to issuing the TPP).
Pennington Supports Dismissal on Three New Grounds
The most recent federal circuit decision, Pennington v. HSBC Bank, 2012 WL 4513333 (5th Cir. Oct. 3, 2012), lends circuit-level support for three important propositions that should lead to dismissal of most HAMP TPP claims.
Borrowers Who Would Have Been Current But-For Servicer Malfeasance
First, Pennington held borrowers who were current when they applied for HAMP and alleged they would not have defaulted but for a botched TPP process are not entitled to any relief because the TPP presupposes either actual or imminent default on the loan. This is an important development because, for the most part, courts appeared to have been more sympathetic to borrowers who were current with their loan before they attempted to modify their loan through HAMP as opposed to borrowers already in default who, for whatever reason, the program failed to help.
In the relatively small number of HAMP TPP cases that survived dismissal at the federal district court level, many featured an allegation that the borrower was current and defrauded into defaulting by the servicer's promise of a modification, or that the servicer's representation that the borrower would not qualify for any relief until he or she first defaulted. In those cases, the federal district courts reasoned the servicers' alleged encouragement to apply for a HAMP modification and initial qualification - which were all things required by the HAMP guidelines - potentially misled the borrower into believing there was hope when, in fact, based on the borrower's financial information, there was no possibility of him or her ultimately qualifying for a HAMP modification. As a practical matter, servicers do not, and cannot, perform a full qualification review until the end of the process, but borrowers have had at least some success surviving motions to dismiss at the pleadings stage by alleging the financial information had been provided before a TPP was offered.
Pennington persuasively reverses that trend. As the Fifth Circuit correctly noted, borrowers are only eligible for HAMP if they are actually in default, or their default is imminent. Therefore, if the borrower's allegation is that he would not have defaulted but for his or her reliance on the alleged promises in the TPP, then the borrower never could have been eligible for HAMP in any event. Therefore, no matter what conduct the servicer engaged in, if the allegation is that the borrower would have stayed current on the mortgage but for the servicer's alleged acts or omissions, there can be no claim under HAMP nor under state law theories based on a failure to receive a HAMP modification.
Borrowers Who Did Not Receive Signed Modification Agreements
Second, the Pennington court refused to enforce the TPP against the servicer where there is no evidence the servicer had ever signed the TPP. Borrowers have sometimes been able to circumvent statute of frauds defenses by alleging they made the TPP payments and thus partially performed. Depending on state law, partial performance can replace the signature requirement for purposes of the statute of frauds. However, the Fifth Circuit has now rejected that reasoning because borrowers "already owed regular payments. Although the fact that they paid under the TPP indicates that they hoped to be bound, the question is whether the bank expressed a similar intent despite the fact that conditions in the TPP remained unfulfilled. The bank deposited the payments, but the [borrowers] owed more than that. Even if the bank intended to refuse to accept the TPP, it would still take the money in partial satisfaction of the amount owed while interest accrued." Under this reasoning, borrowers must therefore need to have received a signed TPP from their servicer in order to advance any potential claims.
The Fifth Circuit applied the same reasoning to the lack of a signed permanent modification agreement. The TPP forms clearly provide that no modification will result until the servicer sends a servicer-signed permanent modification agreement to the borrower. There had been a split of authority on this issue, with many courts, like the Fifth Circuit, giving effect to the TPP's language in that regard. Other courts, like the Seventh Circuit in Wigod, reasoned that giving effect to that language nullified any promise character of the TPP because it left the decision for whether to grant a permanent modification entirely in the servicer's discretion. Viewed that way, it was then argued the TPP would be illusory. As that is precisely what servicers tended to argue, the Fifth Circuit's view of the issue is persuasive given that the TPP plainly states that any modification is contingent upon the servicer signing a permanent modification agreement.
Fees and Charges in the Normal Course Are Not Damages
Third, the Pennington court questioned what damages the borrower could potentially prove even if he had a legal right to relief. In other HAMP TPP cases, borrowers typically alleged they suffered accrued interest, late penalties, negative credit reporting, and other default-associated fees during and/or after the TPP. That these claims ever survived dismissal should have raised eyebrows since all of these things happen to borrowers who receive a TPP and are immediately approved for a permanent HAMP modification, i.e., the HAMP guidelines quite clearly specify that interest will continue to accrue, and negative credit reports will be given, even if a previously current borrower qualifies for a permanent HAMP modification. If a permanent modification does result, the charges get capitalized into the modified loan balance, and the borrower has to repay them. These fees and charges would therefore not be "damages" - the HAMP program was deliberately designed in this way by the Treasury. Stated differently, all of these "damages" occur even when everything about HAMP proceeds correctly (except late fees, which are typically waived once the permanent modification is entered into).
Even though the Fifth Circuit focused less on the design of HAMP, it reached the same result by looking to the natural consequences of defaulting on a mortgage loan, regardless of whether it was in or out of HAMP: "[I]nterest and fees that accrued while the plaintiffs were following the TPP did not arise because of the TPP. As a prerequisite of entering the TPP, plaintiffs certified that they were unable to continue making their monthly payments. If they truly were unable to make the payments, they still would have fallen behind, accrued interest, suffered late charges, and owed addition payments on that interest. If the plaintiffs were able to make all their payments as they came due, they would have been ineligible for the HAMP program for lacking the requisite hardship and would have been rejected from Step Two landing them in the same predicament they face now. Accrual of unpaid interest was a foregone conclusion, not a result of negligent misrepresentation."
In its reasoning, the Fifth Circuit has recognized the two important characteristics of HAMP, which are that borrowers have a choice in whether to pursue the program and that even successfully receiving a permanent HAMP modification is not an absolute benefit to the borrower. Borrowers need not participate in the HAMP program, but they may choose to do so to reduce the amount of their monthly payments temporarily. Yet, by doing so, certain consequences result, including accrued interest, negative credit reporting, etc., even if everything goes right. In the HAMP TPP cases that survived motions for dismissal, courts often referred to these factors as damages that supposedly resulted from the lack of a permanent modification, but that reasoning is not consistent with the design of HAMP itself nor as the Fifth Circuit recognized in Pennington.
Pennington provides support for attorneys representing mortgage servicers such that they can successfully argue for dismissal of HAMP TPP claims with federal circuit level authority even if the court recognizes a private right of action through state law. Simply arguing that HAMP "lacks a private right of action" initially was a fast and simple way to dismissal, and still may be viable in most courts. But even if a court agrees with Wigod that plaintiffs can use state law claims to plead around the private right of action bar and even if a borrower brings suit under HAMP and if the TPP is found to be a fully enforceable contract, servicers can still successfully argue the TPP's terms do not provide what the borrowers argue it promises. That was largely the result of the only other federal circuit level HAMP decision, Miller v. Chase Home Finance, 677 F.3d 1113, 1117 (11th Cir. 2012) (TPP promised "only that it would temporarily modify the terms of his loan," not that any permanent modification would result).
Pennington and Miller, coupled with the unusual "verified-first" facts in Wigod, should lead to most HAMP TPP cases still being dismissed at the early stages of litigation. In the future, you might expect that borrowers' counsel in this area will then move toward more non-contract causes of action such as state law fraud or breach of a duty of care in handling the modification process. But those theories have problems for borrowers' counsel as well. Not only should non-contract causes of action also be defensible based on current case law, but they pose further problems for borrowers' counsel because they are more fact-intensive as to the relationship between the borrower and the mortgage company and thereby far less amenable to class treatment than the contract cases (though one might query whether a HAMP TPP class action could ever be certified in the first place, even under a straight contract theory).