Court Holds That a Mortgage Broker and Lender Can Be Held Liable for Predatory Lending Practices Based on Alleged Misrepresentation to First Time Home Buyers

In Fuller v. First Franklin Financial Corporation, a California court of appeal reversed judgments of dismissal in favor of a lender and mortgage broker and directed the trial court to overrule the demurrers. 

In 2006, plaintiffs, first-time home buyers, engaged SFM to act as their mortgage broker in their purchase of a new home.  SFM worked with First Franklin in a scheme that resulted in plaintiffs obtaining two unfavorable purchase loans.  Among other things, the alleged scheme involved a fraudulent appraisal.  SFM hired an appraiser who chose properties that were not comparable to the property plaintiffs intended to purchase, which resulted in an inflated appraisal, and ultimately, higher loan amounts.  SFM knew the appraisal was inflated.  In addition, although plaintiffs wanted a thirty-year fixed loan, the broker offered them two loans, one that was limited to interest-only payments for the first three years and a second mortgage with a 9.5 percent interest rate and a balloon payment.  Although plaintiffs had credit scores that qualified them for better loan terms, the broker told them they did not qualify for any other loans and failed to explain the consequences of the loan terms, including the potential for negative amortization.  The broker also told them they would be able to refinance if they had trouble making payments in the future.  In addition, no party disclosed to plaintiffs that the closing costs included an illegal kickback from First Franklin to SFM. 

In 2009, plaintiffs’ earnings decreased and they contacted First Franklin to discuss a loan modification.  Plaintiffs claim that this is when they first learned the true nature of the loan terms.  They also obtained a new appraisal and learned that they had no equity in their home, which precluded any possibility of a refinance.  First Franklin was generally unwilling to work with plaintiffs, though it eventually agreed to a forbearance agreement that allowed plaintiffs to make reduced payments for six (6) months.  In 2010, plaintiffs ceased making their mortgage payments. 

After further investigating, plaintiffs learned that First Franklin extended many subprime loans and that it ignored standard underwriting protocols in connection with many of the loans it extended at the time plaintiffs obtained their loans. 

In November 2010, plaintiffs filed suit against their loan broker (Sacramento First Mortgage, “SFM”), their original lender (First Franklin Financial Corporation), and Bank of America (the successor in interest on their loan).  Plaintiffs alleged that First Franklin and SFM engaged in a predatory lending scheme, made material misrepresentations and fraudulently induced them to obtain unfavorable loans.  Among other causes of action, plaintiffs alleged fraud, breach of fiduciary duty, unfair business practices and negligence.  Because the alleged misrepresentations and wrongdoing occurred before the June 2006 purchase, the limitations periods for plaintiffs’ causes of action had expired.  After several rounds of pleadings, the court sustained the defendants’ demurrers on the ground that plaintiffs’ claims were barred by the statute of limitations. 

Plaintiffs appealed.  On appeal, the court found that there was nothing in the loan process that made plaintiffs’ “unawareness of the true circumstances unreasonable.”  The court also noted that there were no “red flags” between June 2006 and late 2009 (when plaintiffs claim they first learned the true loan terms), that would have put plaintiffs on notice that their home was overvalued, that they could have originally qualified for more favorable loan terms, that their broker had received an illegal kickback, or that they could not refinance.  The court noted that the allegations sufficiently alleged delayed discovery and that the defendants, therefore, had not established the expiration of the limitations period on the face of the pleadings. 

The lender alternatively argued that as the lender, it had no fiduciary obligations or other duties to plaintiffs and that the demurrer should be sustained on this basis as well.  The appellate court disagreed, explaining that plaintiffs alleged that First Franklin conspired with SFM.  In such circumstances, First Franklin could be liable for SFM’s negligence, misrepresentations, and nondisclosures. 

The court reversed the judgments of dismissal and directed the trial court to enter orders overruling the demurrers.

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