The outcome of a recent mortgage case from the Fourth Circuit offers potentially exciting news to financial institutions engaged in the business of buying loans. Although the case received little to no coverage in mainstream news, it creates an ongoing split with the Ninth Circuit and has the potential to drastically change restitution calculations following mortgage fraud.
The facts of the Fourth Circuit case United States v. Ritchie are fairly simple. Timothy Richie wanted to buy some land to develop for future profit. ((United States v. Ritchie, 858 F.3d 201, 206 (4th Cir. 2017).)) He both fraudulently filled out a form and faked partial payment during the closing, enabling him to get a loan for $2,445,102. ((Id.)) Two years later when he defaulted on that loan, the outstanding balance was $2,491,444.83. ((Id.)) The property he had bought was seized and sold at auction for $1,106,000. ((Id.)) That leaves a remainder of $1,385,444.83 unpaid.
It may not seem surprising that the Fourth Circuit ordered him to pay restitution in the amount of $1,385,444.83 considering that was his outstanding balance, and therefore the overall loss caused by his fraud. ((Id. at 214.)) Yet, there is one wrinkle in the facts that causes a divergence of the decision from the precedent of other circuits: another company had acquired Mr. Richie’s debt before he defaulted. ((Id.))
There is a flourishing secondary market for buying and selling loans. ((Emily Starbuck Crone, Why Banks Sell Loans They Make, NerdWallet (Mar. 3, 2015), https://www.nerdwallet.com/blog/mortgages/banks-sell-loans/.)) Usually, banks sell loans to free up capital so they can lend to more borrowers. ((Id.)) The loan itself, including the interest rate and all other terms, remains the same. ((Id.)) If a bank were to acquire Mr. Richie’s loan at a 50% discount, then the losses to that bank would be close to zero. After all, they would have acquired the loan for a little over $1 million and they would have sold his land for close to that amount. Similarly, it would stand to reason that the original owner of the loan would have no claim to damages as they willingly sold the loan for a negotiated amount that they likely assumed to be a reasonable price (both eliminating their claim to the loan and to any argument based on unfair payment).
As the Ninth Court notes, this means that “[d]ifferent formulas apply to determine a victim’s actual losses on loans, depending on whether the victim is a loan originator or a loan purchaser.” ((United States v. Luis, 765 F.3d 1061, 1067 (9th Cir. 2014).)) If the loan is still owned by the originator, then the calculation starts with the amount of the unpaid principle of the loan. ((Id.)) If a loan purchaser is seeking restitution, then the calculation starts with the amount paid for the loan or the loan’s value when it was acquired. ((Id.)) Paying the loan acquirer the full amount of the loan would create a windfall to that entity.
The main disagreement between the Fourth and Ninth Circuit centers on how to classify the entity controlling the loan. In Ritchie, Bank of America bought the entire originator of the loan, Countrywide Bank. ((United States v. Ritchie, 858 F.3d 201, 212 (4th Cir. 2017).)) The Fourth Circuit decided that despite acquiring the loan, Bank of America “stands in the shoes of that now-defunct financial institution” and should be treated as a loan originator entitled to the full remainder of the outstanding balance. ((Id.)) This saves the court from the nigh-impossible endeavor of calculating what a single, and overall fairly insignificant, loan was worth in a deal to buy an entire financial institution. ((See id. at 225.))
In Luis, the Ninth Circuit ruled that the acquiring entity is considered a loan acquirer under almost identical facts. ((Luis, 765 F.3d at 1064-65.)) This disagreement over classification really boils down to which entity should “bear the consequences of the originating bank being acquired.” ((Jennifer L. Achilles et al., Fourth Circuit Splits with Ninth Circuit Regarding Restitution to Financial Institutions Following Mortgage Fraud, Reed Smith (Sept. 27, 2017), https://www.reedsmith.com/en/perspectives/2017/09/fourth-circuit-splits-with-ninth-circuit-regarding-restitution.)) In the Fourth Circuit, the acquiring entity gets a windfall, as it gets the full outstanding balance despite almost certainly acquiring the loan at a discount, while in the Ninth Circuit the windfall goes to the criminal defendant by lowering the restitution below what he owed. ((Id.))
Ultimately, it is unclear what the practical effects of the different points of view will be. Mr. Richie and Mr. Luis may be judgment proof. After all, it takes a specific type of convicted criminal defendant, such as one with insurance coverage or wealth, to be able to pay the difference in restitution pricing. Still, banks and other financial institutions should obviously consider this split when filing claims, or calculating losses. That way, they might be able to increase their odds at a favorable ruling.