Antitrust Law Daily Wrap Up, RICO—6thCir: False Appraisal May Have Proximately Caused Mortgage Borrower’s RICO Injuries, (Apr 24, 2013)

By Tobias J. Gillett, J.D., LL.M.

A borrower asserting RICO claims against a mortgage broker, a mortgage lender, an appraiser, and related individuals sufficiently alleged that they proximately caused his injuries by arranging for a false appraisal of his home that grossly overstated its value, inducing him to enter into a mortgage that became unaffordable, the U.S. Court of Appeals in Cincinnati has ruled (Wallace v. Midwest Financial & Mortgage Services, Inc., April 23, 2013, Cole, R.).

The court of appeals reversed the district court’s grant of summary judgment to the defendants on the RICO claims. However, it affirmed summary judgment in favor of the defending lender on a conspiracy claim under Kentucky law because the borrower failed to show that the broker and the lender had entered into an agreement to commit an unlawful act.

According to the complaint, in June 2006, Harold Wallace met with a loan officer at the mortgage broker Midwest Financial & Mortgage Services, Inc. to discuss obtaining a refinance loan on his home to build out his basement. According to Wallace, the meeting led him to believe he would receive a new fully amortizing mortgage with equal monthly payments.

As part of the loan process, Midwest needed an appraisal of Wallace’s property, which it obtained from Accupraise, Inc. Accupraise had a practice of tailoring appraisals to the appraisal value requested by the broker, frequently without even visiting the property. Accupraise returned an appraisal of Wallace’s home at nearly twice the value he paid for it only two years before, more than enough to cover the refinance loan. Wallace and Midwest agreed on the terms of the loan, and Midwest submitted his application to mortgage lender MortgageIT for approval.

Despite the apparent steep appreciation in the value of Wallace’s property, MortgageIT approved the application. Wallace then executed several loan documents, allegedly unaware that they were consistent with an option adjustable-rate mortgage (ARM). An option ARM permits a borrower to avoid paying the principal payment and some of the interest payment for an introductory period, which allows for negative amortization. Here, Wallace’s payments became unaffordable, causing him to incur fees, interest costs, and other expenses. The actual value of his home turned out to be only three-quarters of the appraised value, not enough to permit him to sell it to repay the loans. Ultimately, Wallace declared bankruptcy and surrendered his home.

In May 2007, Wallace filed suit against Midwest, MortgageIT, Accupraise, and related individuals, alleging that Midwest collaborated with Accupraise to generate misleading appraisals that induced borrowers to enter into loans, causing Midwest to receive larger premiums from MortgageIT, which in turn bundled the loans with others as mortgage-backed securities it sold to investors, thus avoiding much of the risk of default. He claimed that Midwest and Accupraise committed fraud by producing a false appraisal that gave him the illusion of equity and induced him to enter his loan, eventually resulting in his injuries. He asserted claims under the RICO Act and Kentucky conspiracy law, among other claims.

The defendants moved to dismiss. The district court granted the motion with respect to the RICO claims and Kentucky conspiracy claim, concluding that Wallace failed to establish proximate cause because his injuries were "unrelated to the inflated appraisal" that constituted the predicate act of mail or wire fraud, but were instead a result of "the high interest rate and unfavorable terms of his adjustable rate mortgage." Wallace appealed.

RICO claims. The court explained that RICO incorporates common law proximate cause considerations, including whether there is "some direct relation between the injury asserted and the injurious conduct alleged," whether the injury was "a foreseeable consequence of the conduct alleged," and "whether the causal connection between the injury and the conduct is logical and not speculative." The court noted that "the appropriate inquiry in this case is not whether Wallace actually relied on the allegedly inflated appraisal, but whether the fraudulent scheme furthered by that appraisal proximately caused his financial injuries."

The court initially concluded that Wallace’s causation theory was sufficiently direct. The false appraisal could well have given him unwarranted confidence in his ability to afford the mortgage, and coupled with his confusion regarding its terms could have "led directly to his decision to enter into the option ARM," in the court’s view. Nothing suggested that Wallace would have pursued the loan at all costs, and the court was "able to trace a straight line between the alleged fraud and the asserted injury."

Wallace’s injuries were also foreseeable, according to the court. The defendants’ alleged scheme "created more than a bare possibility that Wallace would enter into a large loan," and was in fact calculated to achieve that result. Wallace’s injuries were therefore "hardly unforeseeable or uncertain consequences."

Wallace’s theory was also "neither illogical nor speculative," in the court’s view. The theory was not "contingent on intervening causes." The court observed that Wallace and Midwest did not engage in protracted negotiations after Midwest gave Wallace news of the appraisal, and only two days passed between Midwest providing that news and the parties reaching an oral agreement. The connection between the alleged scheme and Wallace’s decision to obtain the loan was "strong enough to raise a genuine issue of material fact regarding causation."

The court disagreed with the district court’s conclusions that the appraisal only "influenced the size of Wallace’s loan," and that "the high interest rate and unfavorable terms" of the loan were the true sources of his injuries. The appeals court considered the interest rate and unfavorable terms to be "more properly viewed as components of the alleged injuries rather than the proximate cause" of them. Moreover, the appraisal was more significant to a borrower’s decision to obtain a loan than the district court considered it to be.

The district court also erred in stating that "a falsely inflated appraisal harms only the lender" because the lender would be left "with an asset that is worth less than the amount loaned to the borrower" if the borrower defaulted, according to the appeals court. A borrower would have "much to lose" from taking out a loan the borrower could not pay back. Here, Wallace was unable to make payments large enough to avoid negative amortization on his larger loan, eventually resulting in bankruptcy. Moreover, the lender’s ability to quickly securitize and sell the mortgages minimized the risk of default to the lender. Therefore, the appeals court reversed the district court’s decision on the federal RICO claims, and remanded them to the district court for consideration of the other elements of the claims.

Kentucky conspiracy claim. However, the appeals court affirmed the district court’s grant of summary judgment as to Wallace’s Kentucky conspiracy claims. The court explained that under that law a plaintiff must show "an unlawful/corrupt combination or agreement between the alleged conspirators to do by some concerted action an unlawful act," and that the act caused the plaintiff’s injuries. The court observed that Wallace’s conspiracy claim consisted of two subparts, one involving an alleged agreement between Midwest, Accupraise, and related individuals to manufacture false appraisals, and the other involving an alleged agreement between Midwest, MortgageIT, and related individuals to provide "unlawful kickbacks."

With respect to the first subpart, the appeals court observed that the district court had relied on its conclusion that Wallace could not show the appraisal caused his injuries in determining that his claim failed. Since the appeals court had found that he "raised a sufficient question of fact as to causation," the appeals court left to the district court the determination whether he "raised a sufficient question of fact as to the remaining elements of his claim."

However, with respect to the second part, the appeals court agreed with the district court that Wallace had not presented evidence that Midwest and MortgageIT had "entered into an agreement to commit an unlawful act." "Yield spread premiums" of the kind employed by Midwest and MortgageIT were "not illegal per se under federal law," and nothing indicated that MortgageIT had provided an illegal premium in the present case. Moreover, no evidence demonstrated that MortgageIT and Midwest had a relationship "outside of the application process and payment of such premiums—certainly nothing on the order of an illicit agreement." Therefore, the appeals court affirmed the district court’s grant of summary judgment as to Wallace’s Kentucky conspiracy claim.

The case is No. 12-5208.

Attorneys: William H. Blessing for Harold C. Wallace. Michael T. Sutton (Sutton Rankin) for Midwest Financial & Mortgage Services, Inc. Matthew W. Breetz (Stites & Harbison) for MortgageIT, Inc.

Companies: Midwest Financial & Mortgage Services, Inc.; MortgageIT, Inc.; First Financial Home Lending, Inc.; Accupraise, Inc.

Cases: RICO KentuckyNews MichiganNews OhioNews TennesseeNews