Predatory Lending Defense

The concept of “predatory lending” has been around for some time, not as a foreclosure defense unto itself but as an umbrella term for defenses sounding in things like unconscionability, unclean hands and equitable estoppel. The Connecticut Appellate Court seems to have changed that in its 2016 decision in Bank of America, N.A. v. Aubut. Our courts now recognize predatory lending as a defense that precludes foreclosure if the original lender knew or should have known that the loan was destined to fail.

Courts used to excuse banks for knowingly making bad loans

Before 2007 there was a huge demand for mortgage backed securities. Since mortgages are the primary ingredient of mortgage backed securities, the huge demand for the securities meant a huge demand for mortgages. That, in turn, meant a decline in the quality of the mortgages. In other words, mortgage originators made loans to people who could not afford them. The originators didn’t care whether the borrowers could afford the loans because the originators sold the loans into securitizations, making them somebody else’s problem. See The Big Short.

But the “lender, you should have known better” foreclosure defense never got any traction, mainly because the courts had refused to impose on lenders a duty to make sound lending decisions.

Connecticut Appellate Court changes the philosophy

The Appellate Court in Aubut seems to have changed that philosophy. The borrowers alleged a special, or affirmative, defense that the plaintiff could not foreclose because “the loan which was originated by [the original plaintiff] was unaffordable.” The court considered whether this unaffordability defense – which the borrowers had captioned “predatory lending” – was legally viable. It noted that there is no legal authority that coherently defines a predatory lending defense. The defendants argued that “their predatory lending allegations should be considered within the context of the recognized equitable defenses of fraud, unclean hands, unconscionability, and equitable estoppel.” The court agreed, noting that it did not really matter what the defendants called the defense as long as it provided the plaintiff with sufficient notice of the facts claimed and the issues to be tried. And, the borrowers had alleged a litany of facts, which, if true, supported a claim that the original lender knew or should have known that they could not afford the loan.

The court then set about fashioning a new defense. It noted that since foreclosure is an equitable remedy, a court can withhold it on equitable grounds. The predatory lending defense implicated the recognized equitable defenses of fraud and unconscionability, unclean hands, and equitable estoppel. These principles can be combined to plead a single special defense of predatory lending asserting that because the original lender knew or should have known that the loan was “destined to fail from [its] inception,” the plaintiff should not be permitted to enforce the mortgage.

Though the court did not expressly impose a duty on lenders to determine whether the borrower can afford a prospective loan, it seems to have implied one because the notion that the lender “knew or should have known” suggests foreseeability, which in turn suggests a duty. For example, negligence law imposes a duty to prevent foreseeable harm to others. Foreseeability in the negligence context is determined by whether the actor knew or should have known that the act would cause the harm. In the foreclosure defense context, the harm is a loan that failed.

Now Connecticut has a predatory lending foreclosure defense

In short, under Aubut, a residential mortgage borrower can avoid foreclosure if the loan was predatory when made. A loan is predatory if the originator knew or should have known that it would be just a matter of time before the borrower defaulted. Given this definition of predatory, mortgage originators may well have a duty to make an affordability determination before making a mortgage loan.