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Home Improvement Loan Fraud: Caveat Emptor

The Set-Up

Following a knock on the door, residential Homeowner answers to find General Contractor offering to secure Homeowner a $15,000.00 loan to make long-time needed home improvements, which would increase the value of the property as well as the aesthetics, and to retain and oversee Sub-Contractors making those repairs. With loan application in hand, Homeowner signs, is given a cash signing reward, and shortly thereafter is directed to General Contractor's recommended Mortgage Broker who coordinates the "cash-out refinancing" of Homeowner through Lender via closing with Broker's suggested Title Agency.

The Closing

At the in-home closing, Homeowner signs a new first mortgage paying off the original purchase money mortgage while increasing the loan amount (and thus, monthly payments). The settlement sheet indicates the: (1) Broker receiving both its fee (up front flat fee charged to Homeowner) and Yield Spread Premium (difference between lower Lender offered mortgage rate and higher rate which Broker "locked-in" for Homeowner); (2) Title Company receiving its premium (approximately less then 1% of the amount of the loan) plus other "necessary" charges (notary fees, overnight and wire costs, etc.); and (3)

Homeowner receiving the remaining "cash-out" portion, which is really disbursed to General Contractor "outside of closing". Homeowner has many questions, but the only party in attendance at the closing is the Notary who advises Homeowner that he/she cannot answer any questions as Notary is an unaffiliated independent contractor retained by Broker solely to provide notary services. Homeowner signs the loan documents regardless, noting the monthly mortgage payments are only slightly increased from the prior loan and the closing costs worth it to make the promised home improvements.

The Scam

Immediately after closing, General Contractor shows up with Sub-Contractors to start the month-long improvements. After introducing Sub-Contractors, General Contractor exits.

One (1) week later, Sub-Contractors disappear and General Contractor cannot be found. Broker sends his regrets and advises that he/she also cannot locate the General Contractor. Homeowner contacts Attorney who declines representation as against the General and Sub-Contractors due to their likely uninsured and insolvent nature plus low value of the case.

The Aftermath

Living in a partially demolished home, with remaining savings Homeowner pays a neighborhood handyman to restore the home to its former condition. Now, with a higher monthly mortgage payment but no increase in equity, Homeowner seeks to refinance yet again hoping to extend the life of the loan with a view to lowering the monthly payment to once affordable terms. However, Homeowner is for the first time verbally advised that the loan contains a three (3) year prohibitive pre-payment penalty and the current rate will begin to vary (rise) after two (2) years.

Attorney again declines representation as against the Broker and Lender believing Broker an independent contractor shielding unassuming Lender from liability and after advising Homeowner of her own contributory negligence in failing to read the loan packet's pre-payment penalty and variable rate clear disclaimers.

Two (2) years later, Homeowner is in foreclosure.

Currently pending before the Commonwealth's Attorney General and being civilly prosecuted (including by this Author) in the Philadelphia County Court of Common Pleas, are approximately 65 of these cases: all involving the same lender, title agency, general contractor, and mortgage broker.

The Law

The Pennsylvania Home Improvement Finance Act ("HIFA"), 73 P.S. §500-101, governs a home improvement installment sales contract concerning a residential home's non-freestanding (i.e., refrigerators, microwaves, etc. are excluded from the Act) structures in excess of $300 where the buyer does not obtain the loan directly from the lender.

HIFA requires notice to the buyer of buyer's right of rescission-one (1) business day subsequent to date of execution given in writing at contractor's place of business (thereafter, buyer can rescind offering traditional contract defenses). HIFA also prohibits pre-payment penalties, mandates the contract identify the contractor and its address as well as the services specifically to be provided, preempts any waivers of liability, and limits not only the interest rate to be charged but also the collection costs and fees that can be assessed (brokerage fees, appraisal charges, and credit inquiry cost "pass-throughs" are prohibited).

No monetary rewards may be offered to the buyer for executing the contract, buyer may not receive cash of any kind from the loan, and buyer is entitled to receive a precise accounting upon request.

Most importantly, violations by the contractor or mortgage brokerage, by express HIFA's express language, are imputed to the lender.

In severely limiting the fees that can be charged, HIFA, in conjunction with application of the Pennsylvania Usury Statute, 41 P.S. §501, et seq. (limiting excessive interest and providing penalties and remedies for same), requires buyer's payment of otherwise prohibited fees to be allocated to the next due installment or reimbursed to the buyer if the loan is paid off. A foreclosing lender subject to HIFA may find its foreclosure premature given the amount of the prohibited fees paid by the buyer at the time of closing required to be allocated to the alleged delinquency.

Violations include criminal (misdemeanor) and civil ($1,000 per violation) penalties. An action must be brought within four (4) years.

A traditional defense to a HIFA claim is that the documentation indicates the buyer having contracted directly with the lender (an absolute defense under the Act). However, buyer can overcome that defense per the "dragging the body" doctrine: where the buyer does not take independent steps to contact the lender and the contractor dominates and arranges (i.e., "ubiquitous presence") for the financing, that conduct makes the contractor the de facto intermediary.

Also known as the Commonwealth's "UDAP" (Unfair and Deceptive Acts and Practices) Statute, the Pennsylvania Unfair Trade Practices and Consumer Protection Law ("UTPCPL"), 73 P.S. 201-1, et seq., prohibits fraudulent or deceptive conduct as it relates to the sale of consumer goods or services.

Prior to 1996, the UTPCPL only prohibited fraudulent conduct (fraud discussed below). However, by adding the word "deceptive", courts have uniformly (although not yet binding precedentially) held that the UTPCPL also prohibits conduct likely to cause confusion (the legislature is presumed to avoid redundancy and every word of a statute is likewise configured to give it effect). Courts have also held a violation of certain like consumer protection statutes as per se UTPCPL violations.

The UTPCPL entitles plaintiff to be awarded causally related actual damages arising from the fraud or deceptive conduct as well as attorney's fees, costs, and treble damages. To date, there is no strict guidance as to when these exemplary damages are to be awarded.

Interpreting the potential for treble damages to be a substitute for punitive damages available in fraud claims, courts have held the compensatory award may be trebled only when outrageous, shocking, wanton, or reckless conduct is proven. In contrast, proving a violation of the UTPCPL being easier then proving fraud (for the reasons aforesaid surrounding the addition of "deceptive"), other courts have contradictorily held that trebling is available merely for proving a violation. Whichever view is taken, it is clear trebling is discretionary with the court (not the jury) and is likely to be awarded in the more egregious circumstances.

As for attorneys' fees, they are traditionally awarded using the "lodestar" method, which multiplies the proven reasonable hours billed by a reasonable hourly rate. Reasonable is determined primarily by: (1) time, labor, skill, novelty, and difficulty involved; (2) customary (within the bar) charge for like services; (3) amount in controversy and benefit to the client; and (4) certainty of recovery, especially when contrasted with necessary costs advanced. In analyzing an attorney's submitted request for fees, courts often inadvertently invoke the necessity for what becomes a second trial as to that request. While the strictness of trial proofs are often substituted by an allowable global review, contemporaneous billing records and the ability to substantiate are required.

While the traditional percentage contingent fee stands in contrast to the lodestar approach, same, recently, has also been awarded and is becoming more accepted.

Actions under the UTPCPL must be brought within six (6) years. However, in arguing per se violations premised on violations of other like consumer protection statutes, one must be prepared to defend against motions in limine seeking to preclude not only that underlying violation but also the conduct giving rise as being time barred.

Fraud must be proven through clear and convincing evidence of an intentional material misrepresentation with knowledge of its falsity or reckless disregard for its truth that is justifiably relied upon and proximately results in the claimed damages. Material has been defined as effecting the buyer's decision to enter into the transaction.

A common law claim for fraud must be brought within two (2) years and enables traditional tort remedies, plus a jury's award of punitive damages.

The Credit Services Act ("CSA"), 73 P.S. §2190, et seq., applies to a person who represents that he/she can obtain an extension of credit from another. The CSA primarily regulates mortgage brokers (whom otherwise have no licensing requirements).

Notably, the CSA allows for a five (5) day right of rescission, prohibits untrue or misleading representations, and a violation thereof is a per se violation of the UTPCPL.

While an action in fraud enables a jury to assess punitive damages and a violation of the UTPCPL enables the court to assess treble damages, the CSA combines both concepts and allows the court to assess punitive damages for its violation cumulative with any other successful cause(s) of action.

Under the Real Estate Settlement Procedures Act ("RESPA"), 12 U.S.C.A. §2605, et seq., no person shall give or receive anything of value ("kickback" or "unearned fee") incident to a residential real estate settlement service (closing). Additionally, all charges must be conspicuously and clearly itemized and provided to the buyer at closing on the uniform settlement sheet (HUD-1).

Damages include can include those similar to violations of the UTPCPL.

The Lawsuit

In applying the law as discussed to our facts, we see that Attorney declined what could otherwise have been successful representation. Not seeing the forest for the trees, Attorney should not have worried about the deep pockets of General or Sub-Contractors knowing that the conduct of General Contractor could be imputed to Lender under HIFA by General Contractor's dragging the body of the Homeowner and its HIFA violations including a pre-payment penalty, a cash inducement, Homeowner's cash-out, and General Contractor's effectively prohibiting rescission by beginning immediately after closing.

The Mortgage Broker's intentional omission of material loan terms (variable rate and pre-payment penalty) or brokering a HIFA prohibited or otherwise deceptive contract (variable rate commencing prior to expiration of the pre-payment penalty) certainly gives Attorney grounds under both F.R.C.P. 11 and Pa.R.C.P. 1023.1 to join Mortgage Broker for violations of the CSA. After a basic corporation's bureau internet search, Attorney can then find that Mortgage Broker and Title Agency share the same officers and address, and after conducting a Department of Banking inquiry can determine that Title Agency has had numerous similar complaints giving rise to a reasonable belief that RESPA violations may be lurking.

After suing Lender, Mortgage Broker, Title Agency, and General Contractor, Attorney could then, through discovery, find that a pattern and practice existed to enable a claim for conspiracy to commit fraud or, at the very least, joint and several violations of the UTPCPL.

Conclusion

Only by knowledge of the intricacies and inter-relationships of the law surrounding home improvement contracts coupled with conspiracy theory-esque curiosity can counsel uncover the fraud hidden below what on the surface appears to be nothing more then a non-viable contractor negligent repair claim.

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