Ninth Circuit Applies Limited Exception to Supreme Court’s Holding in Italian Colors to Affirm Denial of a Motion to Compel Arbitration

By Christopher Reese

The Ninth Circuit recently affirmed the denial of a motion to compel arbitration based on a limited exception to the United States Supreme Court’s holding in American Express v. Italian Colors Restaurant.  The Ninth Circuit determined that California’s rules for deciding whether a contract is unconscionable were not preempted by the Federal Arbitration Act in the case before it, because provisions contained in the arbitration agreement “effectively foreclose[d] pursuit of the claim.”

The plaintiff in Chavarria v. Ralphs Grocery Company filled out an employment application while seeking employment with defendant Ralphs.  Chavarria obtained employment, and worked as a deli clerk for Ralphs for approximately six months.  After her employment ended, she filed an action on behalf of herself and all similarly situated employees of Ralphs, alleging that Ralphs violated several provisions of the California Labor Code and the California Business and Professions Code by failing to pay employees for rest and meal breaks.

Ralphs’ employment application contained a clause pursuant to which the prospective employees acknowledged receipt of a mandatory arbitration policy.  The arbitration policy contained a procedure for selecting an arbitrator that ensured that the selected arbitrator would be nominated by the party that did not bring the claim.  The arbitration policy also required the parties to split evenly the arbitrator’s fees between them at the outset of the arbitration, without any consideration for the merits of the claim.  The district court held that the arbitration policy was unconscionable under California law and therefore denied Ralphs’ motion to compel arbitration based on the arbitration policy.

The Ninth Circuit began its analysis by setting forth California’s rules for determining whether a contract is unconscionable.  Under California law, the party challenging the enforceability of the contract must demonstrate both procedural unconscionability, which concerns the manner in which the contract was negotiated and the circumstances of the parties, and substantive unconscionability, which concerns whether the contract is so unjustifiably one-sided that it “shocks the conscience.”  The Ninth Circuit determined that Ralphs’ arbitration policy was procedurally unconscionable because: (1) a prospective employee had to agree to it as a condition of applying for employment with Ralphs; (2) the arbitration policy was presented on a “take it or leave it” basis, without any opportunity for negotiation; and (3) Ralphs did not provide Chavarria with the terms of the policy until three weeks after she agreed to be bound by it.

The Ninth Circuit also determined that Ralphs’ arbitration policy was substantively unconscionable for two reasons.  First, the arbitrator selection process would not result in a truly neutral arbitrator because Ralphs’ chosen arbitrator always would be selected in claims brought by an employee against Ralphs.  Second, the policy imposed great up-front costs on the employee – which could run as high as $3,500 to $7,000 per day of arbitration – thus preventing many employees from bringing claims against Ralphs.  Therefore, the Ninth Circuit affirmed the district court’s holding that Ralphs’ arbitration policy was unconscionable and unenforceable.

The Ninth Circuit went on to hold that California’s unconscionability rules are not preempted by the Federal Arbitration Act because they do not disproportionately affect arbitration agreements.  The Ninth Circuit determined that the Supreme Court’s decision in Italian Colors (which we previously analyzed here) did not prevent it from examining the up-front cost that Ralphs’ arbitration policy imposed on employees seeking to bring claims against Ralphs, because Italian Colors only prohibited consideration of the costs needed to prove a claim, not costs imposed simply to “get in the door.”  The provision in Ralphs’ arbitration policy requiring employee-claimants to pay up-front half of the arbitrator’s potentially substantial fees without any consideration of the merits of the claims, the Ninth Circuit held, was just such a “get in the door” fee.  The Ninth Circuit concluded by stating its view that state law unconscionability rules still have a role to play in ensuring that arbitration agreements contain some level of fairness, even after the Supreme Court’s recent decisions in this area.

Creditors can be found liable for violating the FDCPA when they use third party debt collectors that do not make bona fide attempts to collect debts

By Stephen J. Shapiro

Last week the Second Circuit held that: (1) a creditor can face liability under the Fair Debt Collection Practices Act (FDCPA) when a third party it hires to contact debtors does not make bona fide attempts to collect the debt but rather acts as a mere conduit between the creditor and debtor; and (2) the assignee of a debt is not a “creditor” for purposes of the Truth in Lending Act (TILA).

The plaintiffs in Vincent v. The Money Store were several homeowners who took out mortgage loans, each from a different lender. Each mortgage was assigned to The Money Store, and each plaintiff thereafter defaulted on his or her mortgage.

The Money Store had an arrangement with a law firm, Moss Codilis, pursuant to which the firm would mail breach notices to borrowers who had defaulted. The Money Store provided Moss Codilis with spreadsheets containing contact information for the borrowers in default, and Moss Codilis would send each borrower a virtually identical letter stating that The Money Store had retained Moss Codilis to collect a debt. However, after sending the letters, Moss Codilis rarely played any further role in collecting the debts, and if The Money Store brought collection actions against the borrowers, other firms would handle those actions. The Money Store initially paid Moss Codilis $50 for each letter, but later reduced the payment to $35 per letter. During a five-year period, Moss Codilis sent almost 89,000 of these letters. Testimony suggested that the The Money Store used Moss Codilis to send default letters on the theory that a letter on law firm letterhead was more likely to catch the attention of the defaulted borrowers.

After receiving letters from Moss Codilis, plaintiffs brought a putative class action against The Money Store, arguing that, by having Moss Codilis send the letters, The Money Store violated the FDCPA. Plaintiffs also argued that The Money Store violated TILA by charging them unauthorized fees, which created credit balances on their accounts, and then refusing to refund those credit balances. The district court granted summary judgment to The Money Store on both claims.

On appeal, the Second Circuit first addressed the FDCPA claim. The Court noted that the FDCPA applies only to “debt collectors,” and that creditors such as The Money Store, as a general rule, do not qualify as debt collectors. However, the FDCPA includes within its definition of debt collector “any creditor who, in the process of collecting his own debts, uses any name other than his own which would indicate that a third person is collecting or attempting to collect such debts.” The Court held that:

[W]hen determining whether a representation to a debtor indicates that a third party is collecting or attempting to collect a creditor’s debts, the appropriate inquiry is whether the third party is making bona fide attempts to collect the debts of the creditor or whether it is merely operating as a “conduit” for a collection process that the creditor controls.

Because the record contained evidence from which a jury could find that Moss Codilis made no attempts to collect the debts and was merely acting as a “conduit” for The Money Store, the Court reversed the district court’s grant of summary judgment in favor of The Money Store on the FDCPA count, and remanded that claim for further proceedings.

On the TILA claim, the Court acknowledged that TILA requires “creditors” to refund credit balances on their borrowers’ accounts, but pointed out that an entity only qualifies as a “creditor” for purposes of TILA if the debt at issue was “initially payable” to that entity. The Money Store was not such an entity. Rather, other lenders originated the loans to the plaintiffs and The Money Store only later acquired the loans. Therefore, the Court held, The Money Store was not a “creditor” as that term is defined in TILA, and, as such, TILA did not require it to refund credit balances. In so ruling, the Court rejected the plaintiffs’ argument that the entity that receives the first payment on a loan is a “creditor” for purposes of TILA, regardless of whether that entity originated the loan.

Although it affirmed the dismissal of plaintiffs’ TILA claim, the Court questioned whether Congress intended the result that the statutory language mandated. The Court pointed out that TILA requires loan originators to refund credit balances on borrowers’ accounts, but exempts any entity other than the originating lender from that requirement. In light of the fact that many originators assign their mortgage loans to others, the narrow definition of “creditor” exempts a significant number of loans from the protections afforded by TILA. The Court surmised that this result may have been the unintended consequence of amendments Congress made to TILA, and “note[d] th[e] discrepancy . . . for the benefit of Congress and the Federal Reserve.”

Joining a Growing Trend, California District Court Refuses To Follow Glaski

By Stephen J. Shapiro

In Glaski v. Bank of America, a California Court of Appeal held that a borrower has standing to challenge the validity of an assignment of his mortgage to an MBS trust if he alleges that the assignment violated the terms of the instrument creating the trust. A recent decision joins a growing body of case law suggesting that the district courts in California will not follow Glaski.

In Glaski, the plaintiff homeowner, Thomas Glaski, obtained a mortgage loan from Washington Mutual Bank (WaMu), and WaMu assigned the mortgage to an MBS trust. When Glaski defaulted on his mortgage, Bank of America, the successor trustee of the MBS trust, initiated a nonjudicial foreclosure. Glaski sued Bank of America and others defendants for, among other claims, wrongful foreclosure. Glaski alleged that WaMu transferred his loan into the MBS trust after the last date on which the pooling and servicing agreement (PSA), the document that created and governed the trust, permitted the trust to accept new mortgages. As a result, Glaski argued, the assignment to the trust was void, the trust did not hold his mortgage, and Bank of America, as trustee, had no right to foreclose on it. The trial court dismissed Glaski’s claims, holding that Glaski had no basis to challenge the trustee’s authority to foreclose under California precedent.

On appeal, the Court of Appeal first noted that, because Glaski alleged that the MBS trust was formed under New York law, New York law governed. Next, the court looked to the New York Estates, Powers & Trusts Law (EPTL), which provides that any action taken by a trustee in contravention of the instrument that created the trust is void. The court then concluded that, because the MBS trust “was created by the pooling and servicing agreement and that agreement establishes a closing date after which the trust may no longer accept loans, [the EPTL] provides a legal basis for concluding that the trustee’s attempt to accept a loan after the closing date would be void as an act in contravention of the trust document.” Therefore, the Court of Appeal held that Glaski had stated a viable claim for wrongful foreclosure.

In the few months since the Court of Appeal issued the Glaski decision, California’s district courts have shown that they are disinclined to adopt the Glaski court’s rationale. Last week, in Dahnken v. Wells Fargo, the United States District Court for the Northern District of California refused to follow the lead of the California Court of Appeal. Rather, citing to several pre-Glaski cases, the Dahnken court chose to adopt what it described as the “majority position” that “‘plaintiffs lack standing to challenge noncompliance with a PSA in securitization unless they are parties to the PSA or third party beneficiaries of the PSA.’”

Dahnken joined a growing line of California federal trial courts that have rejected the Glaski court’s analysis. For instance, the United States District Court for the Southern District of California expressly refused to follow Glaski in Diunugala v. JP Morgan Chase. There, after stating that it found “the reasoning in the [pre-Glaski] case law to be more persuasive than that in Glaski,” the court held that the plaintiff borrower lacked standing to challenge the defendants’ compliance with the terms of a PSA.

Likewise, after noting that “no courts have yet followed Glaski and Glaski is in a clear minority on the issue,” the United States District Court for the Eastern District of California in Newman v. Bank of New York Mellon decided that “[u]ntil either the California Supreme Court, the Ninth Circuit, or other appellate courts follow Glaski, this Court will continue to follow the majority rule.”  See also Subramani v. Wells Fargo (declining to follow Glaski in favor of the majority rule). In short, Glaski is meeting resistance in California’s federal trial courts.

UPDATE:  On February 26, 2014, the California Supreme Court denied a request to depublish Glaski. 

Seventh Circuit affirms dismissal of state law claims challenging lender-placed insurance procedures on the basis that they contain alleged “kickbacks”

By Christopher Reese

On November 4, 2013, the Seventh Circuit affirmed the dismissal of a putative class action claiming that a lender and insurance company violated several state laws by allegedly paying and accepting “kickbacks” in connection with the purchase of lender-placed insurance. In so doing, the Seventh Circuit declined to analyze, as the district court had, whether plaintiff’s claims were preempted by federal law or barred by the filed-rate doctrine, and instead concluded that plaintiff’s allegations simply did not state viable causes of action under any of the state law claims she pled.

The plaintiff in Cohen v. American Security Insurance Company took out a mortgage loan from a lender that later merged into Wachovia Mortgage to purchase a townhouse. The loan agreement required plaintiff to maintain acceptable property insurance on the home and authorized plaintiff’s lender to purchase insurance on the property if plaintiff failed to do so. At closing, plaintiff signed an additional notice that also set forth plaintiff’s obligation to purchase property insurance and her lender’s right to purchase such insurance if plaintiff did not.

Plaintiff initially purchased property insurance but allowed her policy to lapse. Wachovia notified plaintiff that if she did not obtain insurance, it would do so and charge her for it. Plaintiff never obtained the required insurance, and, therefore, Wachovia purchased from American Security Insurance Company (ASI) a hazard insurance policy, backdated to the date on which plaintiff’s insurance policy lapsed, to cover plaintiff’s townhouse. Wachovia notified plaintiff of the cost of this insurance and indicated that such replacement insurance could be cancelled at any time if plaintiff provided proof that she had obtained the required insurance.

Plaintiff then filed a putative class action, alleging that the conduct of defendants was deceptive because defendants did not disclose that Wachovia was receiving what plaintiff described as “kickbacks” from ASI. The alleged “kickbacks” were commissions ASI paid to an insurance agent affiliate of Wachovia. Plaintiff set forth claims under the Illinois Consumer Fraud and Deceptive Business Practices Act, and claims for breach of contract, fraud, conversion, and unjust enrichment. The district court dismissed all of the claims against Wachovia, holding that they were preempted by federal law, and dismissed most of the claims against ASI as barred by the filed-rate doctrine.

On appeal, the Seventh Circuit questioned the district court’s reliance on the filed-rate doctrine because the Illinois Department of Insurance, unlike its counterparts in most other states, does not have the authority to approve or disapprove property insurance rates. Ultimately, however, the Court did not rely on the filed-rate doctrine or the law of preemption to affirm the dismissal of plaintiff’s claims. Instead, the Court held that plaintiff failed to set forth any viable claims for relief.

The Seventh Circuit held that plaintiff could not set forth a plausible claim under the Illinois Consumer Fraud Act because Wachovia gave plaintiff consistent, clear warnings regarding her obligation to purchase insurance and Wachovia’s right to purchase it for her if she failed to do so. The Court held that there was nothing wrongful or coercive about holding plaintiff to her contractual obligations, especially when plaintiff always had the right to avoid the higher cost of lender-placed insurance by purchasing her own insurance.

With respect to plaintiff’s allegations that the commission paid by ASI to an affiliate of Wachovia constituted a kickback, the Seventh Circuit first noted that the defining characteristic of a kickback is divided loyalties. The Court then rejected plaintiff’s contention that the commission was a kickback because Wachovia never acted on behalf of plaintiff and made clear all along that, in purchasing hazard insurance to cover the property collateralizing its mortgage loan, the bank only was acting to protect its own interests.

The Seventh Circuit also held that plaintiff could not set forth a plausible claim for breach of contract because nothing in the contract between plaintiff and Wachovia prohibited Wachovia and its insurance agency affiliate from receiving a fee or commission when lender-placed insurance became necessary or prohibited Wachovia from backdating the lender-placed insurance to the date the borrower’s policy lapsed. In addition, plaintiff could not set forth a plausible claim for fraud because Wachovia had no duty to disclose the commissions. Finally, the Seventh Circuit held that plaintiff could not set forth plausible claims for conversion or unjust enrichment under Illinois law.

Consumer Financial Protection Bureau Puts Creditors on Notice of Rulemaking Under the Fair Debt Collection Practices Act

By Edward J. Sholinsky

Last week, the Consumer Financial Protection Bureau issued a news release and Advance Notice of Proposed Rulemaking that signals the Bureau’s intention to broadly exercise its claimed power under the Fair Debt Collection Practices Act to regulate creditors and debt collectors.  Most notably, the Bureau is claiming the power to regulate creditors.  Although creditors generally are exempted from liability under the Act, the 113-page Notice touches on nearly every aspect of debt collection under the Act, seeking comments on a wide variety of topics from traditional written notices to how contemporary communication technology – like social media, text messaging, and cell phones – affect debt collection practices.

Even while acknowledging that Congress specifically excluded creditors from the Act’s reach, the Bureau stated that it “believes it is important to examine whether rules covering the conduct of creditors . . . are warranted,” citing the Dodd-Frank Act as its authority for doing so.  The Bureau’s potential reach here is staggering and could impact creditors, like retailers, medical providers, and small business, which would not likely have considered themselves subject to the Bureau’s jurisdiction or the Act itself. The Bureau signaled earlier this fall that it wished to expand its reach when it claimed supervisory authority over any furnisher of information to credit agencies under the Fair Credit Reporting Act.  We discussed that bulletin in an earlier blog post.  This Notice seems to be the next step in the Bureau’s broad claim to jurisdiction over consumer creditors.

While far ranging, the Notice focuses specific attention on the adequacy of information that creditors provide to collectors and buyers of debts, and how creditors transmit that information.  The questions posed by the Bureau suggest that it is contemplating rules governing how creditors provide information to debt collectors and buyers when assigning or selling a debt and the oversight creditors have over the collection of the sold or assigned debt.  Additionally, the Bureau dedicated a section of the Notice to technology that both creditors and debt collectors and buyers can use to share information, and privacy concerns relating to that technology.

This Notice is the second signal since September that the Bureau is looking to expand its purview in the area of debt collection to creditors, who generally are considered to be outside of the reach of federal debt collection laws.

Webinar: Effective Loan Documentation for Lenders: How to Deter and Prevent Litigation through Proven Loan Documentation Safeguards

Schnader attorneys Melissa S. Blanton, vice chair of the firm’s Corporate and Finance Practice Group, and Stephen J. Shapiro, co-chair of the firm’s Financial Services Litigation Practice Group, will be presenting a financial services webinar on November 19 at Noon EST titled “Effective Loan Documentation for Lenders: How to Deter and Prevent Litigation through Proven Loan Documentation Safeguards.”

The webinar derives from a recent decision by the United States Court of Appeals for the Third Circuit, which suggested steps that lenders who accept the assets of a borrower’s wholly-owned subsidiary as collateral should consider taking to reduce the likelihood of litigation in the event the lender must pursue the collateral. In Wachovia Bank National Association v. WL Homes LLC (In re: WL Homes), borrower WL Homes pledged the bank account of JLH, its wholly-owned subsidiary, to Wachovia as collateral on a loan. When WL Homes later filed a bankruptcy petition, Wachovia brought an action in the bankruptcy court for a declaration that its security interest in JLH’s bank account was enforceable. The bankruptcy court ruled in Wachovia’s favor because it concluded that JLH had consented to WL Homes’ pledge of its bank account, and both the district court and the Court of Appeals affirmed that holding.

This engaging webcast will highlight documentation strategies that lenders should consider to potentially dissuade opponents from litigating the enforceability of security interests and others aspects of loan agreements.

Fourth Circuit holds that lenders can require borrowers to waive ECOA claims in connection with loan work-outs

By Stephen J. Shapiro

The Equal Credit Opportunity Act (ECOA) prohibits lenders, with certain exceptions, from requiring a borrower’s spouse to sign a loan.  In a recent decision, the Fourth Circuit held that, although a lender cannot require a borrower’s spouse to waive claims under ECOA as a precondition to extending credit, once the borrower defaults, a lender can demand that the borrower’s spouse agree to waive claims under ECOA as part of a negotiated restructuring of the loan.

In Ballard v. Bank of America, N.A., the plaintiff’s husband applied to Bank of America for a $4 million loan for use in operating his business.  Bank of America agreed to the loan on the condition that plaintiff sign the loan agreement as a guarantor, which she did.  When the company defaulted on the loan, Bank of America agreed to restructure it.  In connection with the restructuring, the bank required plaintiff to sign the restructured loan agreement as a guarantor.  The restructuring agreement, unlike the original loan agreement, also contained a clause pursuant to which plaintiff waived any and all claims she had against the bank.

After the company defaulted on the restructured loan and the bank placed a lien on property that collateralized the loan, plaintiff sued the bank, alleging that it violated ECOA by requiring her to guaranty her husband’s loan.  The district court dismissed plaintiff’s complaint, holding that it failed to state a claim, and that, in any event, plaintiff had waived any claims against the bank.

On appeal, the Fourth Circuit concluded that plaintiff had pled a viable claim under ECOA.  The Court first discussed the three circumstances in which a lender may require a borrower’s spouse to sign a loan agreement under ECOA: where (1) the borrower does not independently qualify for the loan; (2) the borrower’s spouse owns or co-owns the entity that will benefit from the loan; and (3) the borrower’s spouse co-owns property pledged as collateral for the loan.

The Court held that the first two exceptions to ECOA did not apply because plaintiff alleged that the bank did not evaluate whether her husband independently qualified for the loan and that she was not an owner of the company that benefitted from the loan – allegations that the Court was required to accept as true on a motion to dismiss.  The Court also held that the third exception did not apply.  Although plaintiff co-owned property that she and her husband pledged as collateral, that fact did not entitle the bank, as it did here, to require plaintiff to guaranty the entire loan.  Rather, ECOA’s “co-owned collateral” exception only entitled the bank to require plaintiff to sign documents that would have enabled it to obtain a lien over the pledged property.

After noting that “Bank of America well may have violated ECOA by requiring [plaintiff] to sign as an unlimited guarantor without first determining that her husband was not creditworthy,” the Fourth Circuit nevertheless affirmed the dismissal of plaintiff’s complaint because, it concluded, plaintiff had waived her right to bring any claims against the bank when she signing the agreement that restructured the defaulted loan.  The waiver clause might not have been enforceable, the Court suggested, had it appeared in the original loan agreement because requiring a borrower’s spouse “to waive her ECOA rights as a precondition for obtaining a loan” arguably would violate public policy by undermining the very purpose of the ECOA.  However, the Court reasoned that “[a]n ECOA waiver obtained in exchange for a loan restructuring differs significantly from one required as a precondition for a loan” because a waiver in a loan restructuring agreement “merely affords both parties a negotiated benefit: a means of escaping default for the borrower, and protections against future claims for the lender.”

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