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6th Cir. Holds Lender Violated TILA’s ‘Ability to Repay’ Income Verification Rule

TILAIn an unpublished opinion, the U.S. Court of Appeals for the Sixth Circuit recently held that a mortgage lender’s reliance upon the borrower’s representations concerning the amount of his future spousal support and rental income without proper verifiable documentation were insufficient to satisfy the “ability to repay” income verification requirements arising under the federal Truth in Lending Act and its implementing regulation (“Regulation Z”).

However, the Sixth Circuit ruled in favor of the lender on the borrower’s negligence, unclean hands, unconscionability, and recoupment claims.

A copy of the opinion in G. Elliott v. First Federal Community Bank is available at:  Link to Opinion.

Prior to the finalization of divorce proceedings between the borrower and his spouse, the borrower applied with the lender for a refinance of his existing mortgage loan in order to remove the spouse as an obligor on the existing loan.  In his loan application, the borrower claimed income from employment, social security, rental proceeds, and spousal support. 

For the spousal support income, the borrower and his spouse made various verbal representations to the lender in which they both promised that a separation agreement for the amounts claimed in the application would be executed by them.  This spousal support constituted a substantial portion of the borrower’s income. 

The lender approved the borrower for the refinance loan based, in part, on the spousal support agreement provided by the borrower.  The agreement was not, in fact, executed by the borrower and his spouse until two months after the loan closed. 

The lender also relied upon the borrower’s tax returns to verify the rental income claimed in the application.  However, the tax returns did not reflect the actual rental income amount claimed in the application and it did not pertain to the same property scheduled in the loan application.  The lender did not review any lease agreements concerning the rental income claimed by the borrower.

After the loan origination, the borrower and his ex-spouse complied with the separation agreement for a few months, but the borrower ultimately broke from the separation agreement.  Instead of complying with the terms of the separation agreement, the borrower petitioned the divorce court for a greater award of spousal support. 

The trial court denied the borrower’s petition, and the final divorce decree awarded the borrower only a fraction of the agreed upon spousal support provided for in the separation agreement.

The borrower fell into arrears on the refinance loan and defaulted some two years after its origination. Following his default, the borrower filed a complaint against the lender alleging that the lender violated the Truth in Lending Act, 15 U.S.C. § 1601, et seq., by extending the loan without a reasonable and good-faith determination that he had a reasonable ability to repay the loan and failing to verify his income.  The borrower also brought a negligence claim against the lender for extending the loan.

After the borrower filed his complaint, the lender initiated a separate proceeding to foreclose on the loan.  That separate proceeding was dismissed, and the lender was provided leave to amend its answer in the present matter to include a counterclaim for foreclosure and breach of contract.

Following the filing of cross motions for summary judgment, the trial court granted judgment in favor of the lender and against the borrower on his claims for violations of TILA and for negligence.  The lower court also granted judgment in favor of the bank on its claims for breach of contract and issued a foreclosure decree.

The borrower appealed.

As to his TILA claims, the borrower argued on appeal that the lender failed to comply with TILA because his spousal support income was not documented or verified as required by TILA and its implementing regulations. 

As you may recall:

  • Section 1639c of TILA provides in relevant part that: “no creditor may make a residential mortgage loan unless the creditor makes a reasonable and good faith determination based on verified and documented information that, at the time the loan is consummated, the consumer has a reasonable ability to repay the loan…”  15 U.S.C. § 1639c(a)(1). 
  • TILA further provides that in making a determination as to the consumer’s ability to repay, the creditor “shall include consideration” of among other things “the consumer’s credit history, current income, expected income the consumer is reasonably assured of receiving…” 15 U.S.C. § 1639c(a)(3). 
  • TILA requires that the creditor verify the income sources through a review of numerous documents including the consumer’s tax returns, payroll receipts, or “other third-party documents that provide reasonably reliable evidence of the consumer’s income or assets”.  15 U.S.C. § 1639c(a)(4).  Regulation Z provides additional clarification on the incomer verification and ability to repay requirements. 
  • TILA and Regulation Z provide for both a conclusive and a rebuttable presumption of the ability to repay for certain “qualified mortgages” under 15 U.S.C. § 1639c(b) and 12 CFR § 1026.43(e).

The Court found that 12 C.F.R. § 1026.43 and Appendix Q to Regulation Z were particularly relevant to the claims.

The Sixth Circuit noted that a determination that a loan is a “qualified mortgage” under Regulation Z can result in either a conclusive or rebuttable presumption that the lender complied with the reasonable-ability-to-repay requirement.  See 12 C.F.R. § 1026.43(e)(1).  However, the lender did not claim that the loan was a “qualified mortgage” or that it was otherwise entitled to the presumption.

Appendix Q generally requires that a creditor verify that spousal-support payments have “been received during the last 12 months” to include those in a consumer’s income calculation.  But, Appendix Q allows for a creditor to rely upon “evidence that spousal support payments have been received” for “[p]eriods less than 12 months …, provided the creditor can adequately document the payer’s ability and willingness to make timely payment.”  App. Q § II(A)(3).  Appendix Q further requires that for spousal support income to be effective, the consumer must provide required documentation which may include a final divorce decree, legal separation agreement, court order or voluntary payment agreement.  Id.

Notwithstanding the issues as to whether or not Appendix Q even applied in this instance, which the Sixth Circuit did not resolve, the Court determined the lender failed to comply with Appendix Q because at the time of origination for the refinance loan, the borrower had not received any spousal support payments. 

The Sixth Circuit also found that the borrower’s ex-spouse’s verbal promises to enter into the separation agreement clearly did not meet the required document criteria. 

Similar to Appendix Q, section 1026.43(c) of Regulation Z requires the creditor to use “third-party records that provide reasonably reliable evidence of the consumer’s income or assets.”  12 C.F.R. § 1026.43(c)(2)(i). A “third-party record” under Regulation Z is limited to: (i) “a document or other record prepared or reviewed by an appropriate person other than the consumer, the creditor, or the mortgage broker … or an agent of the creditor or mortgage broker;” (ii) a copy of the consumer’s state or federal tax returns; (iii) business records from the creditor for the consumer’s account; (iv) if the consumer is an employee of the creditor or mortgage broker, then the consumer’s employment records are allowed.  12 C.F.R. § 1026.43(b)(13).

The Sixth Circuit soundly rejected the lender’s argument that it complied with the requirements of Section 1026.43 by reliance upon the representations of the borrower and his ex-spouse.  The verbal promises did not meet the definition of required documentation under Appendix Q or a “third-party record” because as the Court noted, it was not any agreement or document at all, and the lender did not present any argument to explain how it believed that these representations met this criteria. 

Accordingly, the Court found that the lender violated TILA and Regulation Z in its handling of the spousal income.

The Sixth Circuit was not persuaded by the lender’s argument that its reliance upon these representations was justified because it was in fact executed and the borrower and his ex-spouse did perform under that agreement.  As noted by the Court, “[a]lthough the [lender’s] arguments are sympathetic, they do not change the fact that technical violations of TILA generally result in liability.”  Putle v. Eldridge Auto Sales, Inc., 91 F.3d 797, 801-02 (6th Cir. 1996). Thus, the Court determined that the lender’s good faith efforts and the borrower’s actions in reneging on the separation agreement did not provide a defense or justification for the lender’s violation of TILA. 

The Court also determined that the lender violated the income verification requirements pertaining to the borrower’s rental income.  Specifically, the lender failed to obtain copies of the lease agreement to verify that his claimed rental income was accurate, and as the Court noted, the amount of the borrower’s actual rental income at the time of the origination was less than what he claimed on his application.  Instead, the lender merely relied upon tax returns which showed a different amount of rental income and for different properties. 

The Sixth Circuit found that this was a violation of the lender’s requirement to verify the sources of the claimed rental income as provided for in Section 1024.36(c)(3) and (4) of Regulation Z.

Accordingly, the Court reversed the trial court’s summary judgment orders on the borrower’s TILA claim and remanded the matter for further proceedings.

As to the borrower’s negligence claim, the Sixth Circuit agreed with the trial court that the borrower failed to establish that the lender owed him any duty.  As stated by the Court, “Ohio law provides that lenders owe no duty to prospective borrowers during negotiations about terms and conditions of a loan.”  Blon v. Bank One, 519 N.E.2d 363, 368 (Ohio 1998); Shaner v. United States, 976 F.2d 990, 993 (6th Cir. 1992). 

The Court rejected the borrower’s argument that TILA provided a duty on which it could premise his negligence claim, determining that it could not find any Ohio case which supported his argument and that “when given a choice between an interpretation of [state] law which reasonably restricts liability and one which greatly expands liability, we should choose the narrower and more reasonable path.”  Combs v. Int’l Ins. Co., 354 F.3d 568, 577 (6th Cir. 2004). 

Accordingly, the Sixth Circuit affirmed the lower court’s entry of summary judgment in favor of the lender on the negligence count.

The borrower further argued on appeal that the trial court’s judgment in favor of the lender on its foreclosure claim was in error because he had valid defenses to foreclosure in the form of unclean hands, unconscionability, and recoupment or setoff. 

The Sixth Circuit found that the evidence in the record did not rise to the level of unclean hands which under Ohio law required a showing that the lender’s conduct was reprehensible.  Basil v. Vincello, 553 N.E.2d 602, 607 (Ohio 1990).  As noted by the Court, although the lender failed to verify his income as required by TILA, the borrower himself signed the application confirming that the income was accurate, and the lender gathered and reviewed many standard loan-file documents including tax returns and bank statements. 

Similarly, the Court found that the evidence did not support a claim for unconscionability.  The borrower argued the lender engaged in prohibited “mortgage flipping” which is an unconscionable act under Ohio law.  See Ohio Rev. Code Ann. § 1345.031(B)(12).

The Sixth Circuit was not persuaded by the borrower’s argument, however, as the terms of the refinance loan were not demonstratively worse than the prior loan.  As noted by the Court, although the interest rate was slightly higher on the refinance loan, it resulted in a lower monthly payment for the borrower.  The Court also found persuasive the fact that the refinance was extended based upon representations from the borrower and his ex-spouse that it was required to facilitate their separation agreement, not as a plot by the lender to saddle the borrower with debt and to strip the equity from the property. 

The Court also found that the borrower’s claim for recoupment was without merit.  As noted by the Court, under TILA, recoupment or setoff is “a matter of defense” to foreclosure, and recovery is limited to the “amount to which the consumer would be entitled under [§ 1640(a)] for damages for a valid claim brought in an original action against the creditor.”  15 U.S.C. § 1640(k)(1) & (2).  Because the borrower brought his own original claim against the lender for a violation of TILA, he cannot also assert recoupment as defense as this would result in an award of double damages. 

However, the Sixth Circuit found that the damages that he is awarded for a violation of TILA under Section 1640(a) can be applied as a set-off against the amount due in the foreclosure. 

Accordingly, the Sixth Circuit did not reverse the trial court’s judgment as to foreclosure or breach of contract in favor of the lender, but it remanded these claims to be considered for a determination of damages under the borrower’s TILA claim and for further proceeding consistent with its opinion. 

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Cole Braun is based in Maurice Wutscher's Chicago office, where he practices in the firm's Commercial Litigation, Consumer Litigation, and Insurance Recovery and Advisory groups. He has significant litigation experience in a number of state and federal jurisdictions in a variety of different types of litigation. Cole graduated magna cum laude from Florida State University College of Law, and earned the distinction to be elected to the Order of the Coif. He was awarded his Bachelor of the Arts degree from the University of Tennessee. For more information, see https://mauricewutscher.com/attorneys/coleman-braun/

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