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   ARTICLE   |   From Scotsman Guide Residential Edition   |   July 2009

Fighting Back on the Buyback

Scrutinizing underwriting practices can offer a defense in cases that target brokers

Mortgage brokers frequently find themselves in litigious tugs of war, with lenders demanding loan repurchases on one side and borrowers claiming ignorance of their agreements on the other. Thoroughly investigating lenders' underwriting guidelines and practices can help settle, or even obtain dismissal, of such disputes. Implementing a step-by-step process for responding to and fighting lenders' buyback demands can keep brokers from absorbing punishment they may not necessarily deserve.

Lender-initiated lawsuits often begin with the demand that brokers repurchase defaulted loans or pay damages. One-sided broker agreements frequently support such demands. In some cases, lenders seek strict liability for borrower misstatements or omissions. But brokers shouldn't always be held strictly liable, particularly because many of these cases involve questionable underwriting.

As lenders continue to respond to increasing default and foreclosure rates by attempting to cash in buyback and damage provisions contained in broker agreements, brokers must be prepared. By knowing which steps to take and understanding good underwriting from bad, brokers can position themselves to fight legal demands that might otherwise jeopardize their careers. Brokers who prepare to defend themselves not only increase their chances of winning in court, but they also increase their chances of keeping calm when and if the threat of legal demands becomes reality.

Respond to initial demands

Buyback demands, if unanswered or inadequately answered, will likely lead to litigation. There are a few ways brokers can respond to initial buyback demands, which almost always come in the form of a letter from the lender or the lender's attorney.

Brokers who don't have the resources to hire an attorney should address such demands directly with the lender. If brokers can substantiate their inability to pay, some lenders will drop the demand. For lenders, it makes little sense to waste resources on litigation with no potential for future recovery.

In cases where a broker has some resources, initial contact can pave the way for settlement at a substantially reduced amount. In cases where brokers have greater resources, it is best to have an attorney deal with lender demands.

Moreover, in situations where many lenders are demanding buybacks -- or where one lender is demanding buybacks for several loans -- retaining an experienced attorney is critical because patterns of defaulted loans could lead to criminal investigations.

Look into lender complacency

State and federal authorities have shifted their attention and resources toward examining the causes of the current economic crisis. Among the various types of mortgage and other fraud allegedly perpetrated by financial-industry professionals is an emphasis on lender complacency. In fact, some have suggested that lenders should be liable under theories of criminal negligence for their failure to investigate borrowers  adequately before making subprime (aka, nonprime) mortgage loans.

Stated-income loans, for example, didn't require borrowers to provide proof of income. Accepting these loans contributed in part to increased foreclosure rates, which in turn led to significant financial losses for lenders and investors.

It's becoming apparent that even in cases where borrowers provided documentation, some lenders may have cut corners with respect to underwriting -- even though borrowers were charged fees for underwriting services. These shortcomings range from a failure on the lenders' part to follow their own underwriting procedures to a failure to perform any underwriting at all.

Where demands for buybacks and damages relate to subprime mortgages, brokers should focus on lenders' own practices as a means of bolstering legal defenses and counterclaims.

Investigate underwriting practices

Even when dealing with the most one-sided broker agreements, it can be argued that proper underwriting was an express and implied duty imposed on lenders. The following are examples of provisions in broker agreements that attempt to shift all of the risk onto brokers' shoulders:

  • Broker-warranty provisions, whereby a broker represents that none of the statements or information contained in a loan-application package will contain untrue statements or omissions of material fact, regardless of whether the broker knew or had reason to suspect these misstatements or omissions
  • Provisions that acknowledge the lender will provide underwriting services but that state that the broker is not entitled to rely on these services in any way
  • Separately signed policies, guidelines or procedures, such as zero-fraud-tolerance policies, which define loan fraud as, among other things, submitting inaccurate information on a loan application without regard to a broker's knowledge of such falsity

Moreover, many broker agreements expressly provide that mortgage companies and sometimes their principals are liable for all actions of agents, employees and even independent contractors. For larger companies that cannot oversee every loan originator on a day-to-day basis -- or that have little contact with their independent contractors -- these provisions can result in unexpected liability. These agreements, however, are not impenetrable.

The first step in defending buyback lawsuits is to identify whether a lender's underwriting procedures were adequate, both in general and with respect to the loans at issue.

Discovery requests can help

Discovery aimed at uncovering faulty underwriting practices should target lenders' policies, procedures, training materials and employee handbooks during relevant time periods, as well as any changes that have occured since originating the loans at issue. Discovery also should seek to identify the individuals who worked on the loans as well as evidence concerning underwriting performed on those specific loans.

After a complaint and summons are served, defendants can begin the discovery process -- which can be particularly useful when initial settlement discussions lead nowhere. Defendants always should consult local rules regarding the types of discovery allowed, however, as well as any limits on the number of requests. In addition to helping attorneys formulate legal theories and defenses, early discovery often will force the other side to decide how much a particular case is worth.

In many cases, thorough discovery requests will deter lenders from taking aggressive settlement positions. Some lenders, for example, face financial and organizational uncertainty and will have difficulty getting the information and witnesses requested. In other cases, buyback claims are assigned to collection agencies, which have an even harder time gathering such evidence. This often is because lenders that assign such cases likely will be reluctant to expend significant resources responding to discovery.

Even lenders that are financially sound and can litigate their own claims may find this type of investigation into underwriting practices a strong deterrent to pursuing litigation. If the underwriting procedures at issue were clearly inadequate or even nonexistent, evidence of this not only will weaken cases against brokers but also could gain the attention of class-action attorneys or state and federal regulators.

•  •  •

While investigating underwriting practices may not compel settlement in all cases, inadequate underwriting can play a prevalent role in subprime-mortgage-based litigation. In the context of broker-buyback cases, it also can be instrumental in resolving litigation in a timely and cost-effective manner.


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