Com. v. Fremont Investment & Loan

• Citation: 452 Mass. 733,897 N.E.2d 548
• Decision Date: 09 December 2008
• Docket Number: SJC-10258
• Parties: COMMONWEALTH v. FREMONT INVESTMENT & LOAN & another.<SMALL><SUP>1</SUP></SMALL>
• Court: United States State Supreme Judicial Court of Massachusetts

897 N.E.2d 548

452 Mass. 733

COMMONWEALTH v. FREMONT INVESTMENT & LOAN & another.¹

SJC-10258

Supreme Judicial Court of Massachusetts, Suffolk.

Argued October 8, 2008.

Decided December 9, 2008.

James R. Carroll, Boston (Peter Simshauser & Christian R. Jenner with him) for Fremont Investment & Loan.

Christopher K. Barry-Smith, Assistant Attorney General, (John M. Stephan, Assistant Attorney General, & Jean M. Healey, Assistant Attorney General, with him) for the Commonwealth.

The following submitted briefs for amicus curiae:

Richard F. Hans & John P. Doherty, Brockton, for the American Securitization Forum & another.

Jo Ann Shotwell Kaplan, Martin J. Newhouse, Boston, & John Pagliaro, for New England Legal Foundation & another.

Stuart T. Rossman, Boston, Daniel Mosteller, Melissa Briggs, Matthew Brinegar, Jean Constantine-Davis, Washington, DC, Nina F. Simon, Michael R. Schuster, Tara Twomey, & Ira Rheingold for National Consumer Law Center & others.

Paul Collier & Max Weinstein for WilmerHale Legal Services Center of Harvard Law School.

Robert B. Serino, Matthew P. Previn & Kirk D. Jensen, Washington, DC, for American Financial Services Association & others.

Present: MARSHALL, C.J., GREANEY, IRELAND, SPINA, COWIN, CORDY, & BOTSFORD, JJ.²

BOTSFORD, J.

The Commonwealth, acting through the Attorney General, commenced this consumer protection enforcement action against the defendant Fremont Investment & Loan and its parent company, Fremont General Corporation (collectively, Fremont), claiming that Fremont, in originating and servicing certain "subprime"³ mortgage loans between 2004 and 2007 in Massachusetts, acted unfairly and deceptively in violation of G.L. c. 93A, § 2. Fremont appeals from a preliminary injunction granted by a judge in the Superior Court in favor of the Attorney General that restricts, but does not remove, Fremont's ability to foreclose on loans with features that the judge described as "presumptively unfair." All of the loans at issue are secured by mortgages on the borrowers' homes.

Based on the record before him, the judge concluded that the Attorney General had established a likelihood of success on the merits of her claim that in originating home mortgage loans with four characteristics that made it almost certain the borrower would not be able to make the necessary loan payments, leading to default and then foreclosure, Fremont had committed an unfair act or practice within the meaning of G.L. c. 93A, § 2. Fremont filed petitions for interlocutory relief pursuant to G.L. c. 231, § 118, first par., in the Appeals Court from the original preliminary injunction order and a subsequent order entered by the judge that modified the original preliminary injunction. A single justice of the Appeals Court declined to reverse either order, and at the request of Fremont, reported the matter to the Appeals Court. We granted the Commonwealth's application for direct appellate review.⁴ We affirm the motion judge's grant of the preliminary injunction, as modified.

1. Background.⁵ Fremont is an industrial bank chartered by the State of California. Between January, 2004, and March, 2007, Fremont originated 14,578 loans to Massachusetts residents secured by mortgages on owner-occupied homes. Of the loans originated during that time period, roughly 3,000 remain active and roughly 2,500 continue to be owned or serviced by Fremont.⁶ An estimated fifty to sixty per cent of Fremont's loans in Massachusetts were subprime.⁷ Because subprime borrowers present a greater risk to the lender, the interest rate charged for a subprime loan is typically higher than the rate charged for conventional or prime mortgages.⁸ After funding the loan, Fremont generally sold it on the secondary market, which largely insulated Fremont from losses arising from borrower default.⁹ Fremont General Corporation, Annual Report (Form 10-K) 1, 6 (Mar. 6, 2006).

In originating loans, Fremont did not interact directly with the borrowers; rather, mortgage brokers acting as independent contractors would help a borrower select a mortgage product, and communicate with a Fremont account executive to request a selected product and provide the borrower's loan application and credit report. If approved by Fremont's underwriting department, the loan would proceed to closing and the broker would receive a broker's fee.

Fremont's subprime loan products offered a number of different features to cater to borrowers with low income. A large majority of Fremont's subprime loans were adjustable rate mortgage (ARM) loans, which bore a fixed interest rate for the first two or three years, and then adjusted every six months to a considerably higher variable rate for the remaining period of what was generally a thirty year loan.¹⁰ Thus, borrowers' monthly mortgage payments would start out lower and then increase substantially after the introductory two-year or three-year period. To determine loan qualification, Fremont generally required that borrowers have a debt-to-income ratio of less than or equal to fifty per cent—that is, that the borrowers' monthly debt obligations, including the applied-for mortgage, not exceed one-half their income. However, in calculating the debt-to-income ratio, Fremont considered only the monthly payment required for the introductory rate period of the mortgage loan, not the payment that would ultimately be required at the substantially higher "fully indexed" interest rate.¹¹ As an additional feature to attract subprime borrowers, who typically had little or no savings, Fremont offered loans with no down payment. Instead of a down payment, Fremont would finance the full value of the property, resulting in a "loan-to-value ratio" approaching one hundred per cent. Most such financing was accomplished through the provision of a first mortgage providing eighty per cent financing and an additional "piggy-back loan" providing twenty per cent.¹²

As of the time the Attorney General initiated this case in 2007, a significant number of Fremont's loans were in default.¹³ An analysis by the Attorney General of ninety-eight of those loans indicated that all were ARM loans with a substantial increase in payments required after the first two (or in a few cases, three) years, and that ninety per cent of the ninety-eight had a one hundred per cent loan-to-value ratio.

On March 7, 2007, Fremont executed a "stipulation and consent to the issuance of an order to cease and desist" (consent agreement) with the Federal Deposit Insurance Corporation (FDIC), settling charges of unsound banking practices brought by that agency. The consent agreement ordered Fremont, inter alia, to cease and desist from originating ARM products to subprime borrowers in ways described as unsafe and unsound, including making loans with low introductory rates without considering borrowers' ability to pay the debt at the fully indexed rate, and with loan-to-value ratios approaching one hundred per cent. In entering into the consent agreement, Fremont did not admit to any wrongdoing.

On or about July 10, 2007, Fremont entered into a term sheet letter agreement (term sheet agreement) with the Massachusetts Attorney General, agreeing to give the Attorney General ninety days' notice before foreclosing on any Massachusetts residential mortgage loan. If the Attorney General objected, Fremont agreed to negotiate in good faith to resolve the objection, possibly by modifying the loan agreement. If no resolution could be reached the Attorney General was granted an additional fifteen days in which to determine whether to seek an injunction.

As it turned out, the Attorney General objected to every proposed foreclosure that Fremont identified except those where the home was not owner-occupied and Fremont had been unable to contact the borrower. On October 4, 2007, the Attorney General filed this action. On December 10, 2007, Fremont exercised its right to terminate the term sheet agreement, on the grounds that the Attorney General had "no intention of engaging in a meaningful review process on a borrower-by-borrower basis." However, in the same letter Fremont stated that it would continue to seek to avoid foreclosure and to provide the Attorney General with loan files prior to foreclosure. The Attorney General then filed the motion for preliminary injunctive relief.

The judge granted a preliminary injunction in a memorandum of decision dated February 25, 2008. In his decision, the judge found no evidence in the preliminary injunction record that Fremont encouraged or condoned misrepresentation of borrowers' incomes on stated income loans, or that Fremont deceived borrowers by concealing or misrepresenting the terms of its loans. However, the judge determined that the Attorney General was likely to prevail on the claim that Fremont's loans featuring a combination of the following four characteristics qualified as "unfair" under G.L. c. 93A, § 2:(1) the loans were ARM loans with an introductory rate period of three years or less; (2) they featured 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 per cent had Fremont measured the borrower's debt by the monthly payments that would be due at the fully indexed rate rather than under the introductory rate; and (4) the loan-to-value ratio was one hundred per cent, or the loan featured a substantial prepayment penalty (defined by the judge as greater than the "conventional prepayment penalty" defined in G.L. c. 183C, § 2) or a prepayment penalty that extended beyond the introductory rate period.

The judge reasoned that Fremont as a lender should have recognized that loans with the first three characteristics just described 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...