Monday, December 15, 2008

Massachusetts Appellate Court Affirms Preliminary Injunction against Foreclosure of Subprime Mortgages

In a landmark decision, the Supreme Judicial Court of Massachusetts issued it opinion on December 9, 2008 unanimously upholding the lower court's order in the case of Commonwealth v. Fremont Investment & Loan & another, 452 Mass. 733 (2008)(Botsford, J.) preliminarily enjoining subprime mortgage lender Fremont Investment & Loan from foreclosing on any "structurally unfair" loan without further prior court approval and a final hearing on the merits. The lower court's ruling of February 25, 2008 was reportedly the first of its kind in the nation that restricts a subprime lender's ability to foreclose based on unfair or deceptive loan origination misconduct.

The trial court issued the preliminary injunction upon a finding of a likelihood of success on the merits that Fremont's loans were "unfair" based on four characteristics of the loans. Massachuetts General Laws c. 93A, section 2 (a) makes unlawful any "unfair or deceptive acts or practices in the conduct of any trade or commerce." It is noted that in a similar manner, Florida's Deceptive and Unfair Trade Practice Action provides in section 501.204(1), Florida Statutes (2008) that (1) Unfair methods of competition, unconscionable acts or practices, and unfair or deceptive acts or practices in the conduct of any trade or commerce are hereby declared unlawful. The four characteristics found by the court as establishing unfairness were
  • 1. the loans were ARM loans with an introductory rate period of three years or less
  • 2. they feature an introductory rate for the initial period that was at least three per cent below the fully indexed rate
  • 3. they were made to borrowers for whom the debt-to-income ratio would have exceeded fifty percent measured on the fully indexed rate, and
  • 4. the loan-to-value ratios was 100% or the loan featured a substantial prepayment penalty.
The court reasoned that "Fremont as a lender should have recognized that loans with the first three characteristics ...were 'doomed to foreclosure' unless the borrower could refinance the loan at or near the end of the introductory rate period, and obtain in the process a new and lower introductory rate." The court also found that the fourth characteristic, the prepayment penalty, "would make it essentially impossible for subprime borrowers to refinance unless housing prices increased..." The court's preliminary injunction required Fremont to work with the Attorney General to "resolve" their differences regarding foreclosure, presumably through a loan workout.
Most of the involved Fremont loans, which were procured through independent mortgage brokers who received a commissions, were subsequently sold to the secondary market with Fremont acting as servicer for the purchaser. The majority of Fremont's subprime loan products were adjustable rate mortgages with fixed interest for the first two or three years which then adjusted every six months to a higher variable rate. The court found that Fremont determined loan qualification based on a debt-to-income ratio of fifty per cent or less based on the payment at the introductory rate not the payment that would ultimately be required after the introductory period. Furthermore, Fremont offered loans with no down payment by providing a first mortgage at eighty percent financing with an additional "piggy-back loan" providing twenty percent.

The court's order does not bar foreclosure nor relieve borrowers of their obligations to repay their loans, but it requires Fremont to "explore alternatives to foreclosure" and then seek approval of the court to foreclose which may not be granted, leaving the preliminary injunction in place until the Attorney General has the opportunity to have a final hearing on the issue of unfairness.