Financial Services Law
On March 27, 2020 the President signed into law the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). The statute is the largest economic stimulus in the nation’s history—totaling more than $2 trillion—and was designed to provide significant financial and regulatory relief in response to the ongoing COVID-19 health crisis.
Like many of the other sweeping laws Congress enacted to contain previous economic disasters, the CARES Act will be fertile ground for litigation. A month has now passed since the CARES Act was passed—enough time for financial institutions to survey the post-CARES litigation landscape and to take stock of the various risks that lie ahead. This article examines the main components of the CARES Act affecting financial institutions, and identifies specific areas in which disputes have already arisen or will likely arise in the future: (1) the Paycheck Protection Program (“PPP”); (2) Economic Impact Payments; and (3) the Mortgage Forbearance Program.
I.The Paycheck Protection Program
The PPP is implemented by the Small Business Administration with support from the Department of the Treasury. The program enables lenders to provide small businesses with loans to pay up to eight weeks of payroll costs including benefits. Funds can also be used to pay interest on mortgages, rent, and utilities. PPP loans will be forgiven if a business restores its full-time employment and salary levels by June 30, 2020. The program was initially funded with $350 billion, but funds were exhausted just two weeks after the program’s inception. On April 24, 2020, however, Congress infused the PPP with an additional $310 million in funding.
Of all the components of the CARES Act, the PPP has drawn the most criticism from the public and would-be borrowers. On the evening of April 2, 2020, just hours before the PPP application window was to open, the SBA issued its interim final rule implementing the PPP— leaving banks virtually no time to digest the rule. Many applicants had difficulty obtaining loans because of confusion surrounding the PPP rules, bank eligibility restrictions, or because the program funds were exhausted just two weeks after the program was unveiled.
For many of the reasons described above, it is no surprise that the PPP has been the target of most CARES Act-related litigation thus far. A putative class action was filed in the Maryland District Court on April 3, 2020—the very same day the program went live—in which the plaintiffs alleged that their bank wrongly restricted eligibility to clients with a pre-existing business lending and business deposit relationship with the bank. Another putative class action in Maryland alleges that the PPP unfairly discriminates against minority- and women- owned businesses. A series of putative class-action complaints were also filed in the U.S. District Court for the Central District of California alleging that various banks engaged in unfair and fraudulent business practices by prioritizing high-value loans over low-value loans in order to maximize the banks’ processing fees. A nearly identical class-action lawsuit was filed in the Northern District of California as well. A series of putative class-action complaints were also filed in the U.S. District Courts for the Central District of California and the District of Colorado alleging that various banks engaged in unfair and fraudulent business practices by prioritizing high-value loans over low-value loans in order to maximize the banks’ processing fees.
But PPP-related litigation will surely not be limited to allegations that banks wrongly narrowed eligibility to pre-existing business clients, prioritized some applications over others, or wrongly withheld agent fees. We expect applicants and borrowers to also litigate the following issues as well:
Whether an applicant is eligible for a loan under the PPP. The interim final rule expressly addresses which applicants are eligible under the PPP, and which applicants are ineligible. Expect litigation addressing the banks’ interpretation of those sections, including but not limited to what it means to have 500 or fewer employees, and what documentation is sufficient to prove eligibility. Whether the lender has properly calculated the maximum amount than an applicant may borrow. The maximum amount an applicant may borrow under the PPP is determined by a formula that contains five calculation steps involving payroll, compensation amounts, averages, and any Economic Injury Disaster Loan the applicant received. That five-step process contains plenty of opportunities for both disagreement and ambiguity.
Whether the lender has properly calculated the amount of the loan that may be forgiven.
The time it takes the lender to making a lending decision.
The sufficiency of a lender’s communication with the applicant about the application status.
The causes of action that plaintiffs will use to target financial institutions for perceived violations of the CARES Act is less certain. The CARES Act contains no express private right of action, and at least one Court has held that Congress did not intend to impliedly create such a cause of action. That order is not final because the plaintiffs in that case appealed to the Fourth Circuit, but we think the probability of the Fourth Circuit finding a private right of action in the CARES Act is low. Assuming no private right of action exists, plaintiffs will resort to other common law and statutory claims to fill the void. We believe the most likely candidates are claims for unlawful, unfair, or fraudulent business practices under California Business and Professions Code section 17200, promissory estoppel, negligence, and breach of contract.
To mitigate risk, financial institutions should closely monitor PPP-related guidance provided by the SBA and the Department of the Treasury. They should also carefully track
litigation that has been filed thus far to ensure they stay aware of the specific issues prone to disputes, and follow how the courts are responding to requests for preliminary injunctive relief and motions to dismiss.
II.Economic Impact Payments
The CARES Act entitles certain taxpayers to economic impact payments. Taxpayers with adjusted gross income up to $75,000 for individuals and up to $150,000 for married couples filing joint returns will receive payments of $1,200 and $2,400, respectively, plus $500 for each child. For filers with income above those amounts, the payment amount is reduced by $5 for each $100 above the $75,000/$150,000 thresholds.
The IRS has already issued millions of paper checks to taxpayers across the nation in accordance with the CARES Act, and it will continue to do so over the coming months. Financial institutions should expect at least two distinct types of disputes to arise as a result of these economic impact payments.
First, financial institutions doing business in California are prohibited from garnishing any economic impact payments, with limited exceptions for child support, spousal support, or family support, and criminal restitution. Depository institutions should immediately implement appropriate procedures to ensure that funds from federal economic impact payments are not subject to garnishment or any other legal process unrelated to child/spousal support or criminal restitution. However, because the CARES Act did not identify economic impact payments as exempt, payments deposited directly do not have a standard ACH entry code associated with other government benefits. So, it will likely be difficult to identify exempt funds. For that reason, financial institutions should be prepared to encounter claims of wrongful garnishment, unfair, business practices, or unfair debt collection practices.
Second, instances of check fraud and identity theft are certain to ensue as a result of the economic impact payments. Indeed, there are already reports of callers and emailers masquerading as federal employees who request private information from taxpayers as a “precondition” to obtaining stimulus payments or other federal relief. Many customers will no doubt fall prey to these scams. When the ruse is discovered and the money long gone, many consumers will assign blame to their financial institutions for not preventing the harm from being incurred.
Based on the fraud and identity theft litigation our firm has encountered during earlier economic declines, financial institutions should expect an increase in their customers falling victim to scams such as:
Phishing emails/texts/calls seeking to verify account information to facilitate payment of the funds;
Receiving a fake check accompanied by a request to provide personal account information as part of a “verification” process;
Receiving a fake check followed by a subsequent call about an “overpayment” and request that the surplus be returned (often through an electronic transfer or a gift card).
Forward-thinking financial institutions should also ensure they are educating their customers about the risk of fraud and things their customers can do to minimize the risk of fraud. This may include delineating the ways in which the financial institution and the government will never communicate with the customer. The IRS, for example, will never call, text, or e-mail taxpayers to prompt them for more information as a prerequisite to getting an Economic Impact Payment. Financial institutions may also wish to advise customers that if they receive a check, there is nothing special or extraordinary they need to do to deposit it— such as supplying a social security number, credit card number, or any other sensitive information.
Those customers who are victimized by such scams and who attempt to hold their bank responsible may assert claims for breach of contract, negligence, conversion, fraud, and unjust enrichment.
Under the CARES Act, all borrowers with federally backed mortgages may obtain forbearances by submitting a request to their loan servicer and affirming that they are experiencing a financial hardship during the COVID-19 emergency. There are no other qualifications, and no documentation is required. Servicers’ obligations under this statute are also relatively clear. They must forbear from enforcement activities, including foreclosure, and their obligations with respect to credit reporting and the assessment of interest, fees and penalties are spelled out in the CARES Act.
Despite the relative clarity about when a servicer may issue a CARES Act forbearance, the program is likely to create litigation in the coming months for at least four reasons.
First, there will be confusion and complaints from borrowers regarding the different types of relief available for GSE and non-GSE loans. Borrowers whose loan servicers offer forbearances that contain balloon payments due at the end of the forbearance—rather than at the end of the loan term—will of course be far more likely to default, and therefore, result in litigation. Recent guidance from Fannie Mae and Freddie Mac confirming that borrowers need not repay their missed payments at once following the expiration of their forbearances agreements will surely help avoid many disputes, but others will remain. The forbearance agreements that were negotiated over the past month in the wake of the COVID-19 epidemic will likely lead to a second loss mitigation review when those forbearance agreements expire. Borrowers who are unable to negotiate some kind of permanent solution will likely assert arguments that mirror what the industry witnessed in the aftermath of the Great Recession: such forbearance agreements are unconscionable, predatory, unaffordable, or an example of unfair business practices, and the borrowers were only duped into the forbearance by a promise that some permanent relief would be offered at its conclusion. Of course, any comments that were made by the servicer’s employees to the borrower while processing or negotiating the forbearance can serve as the basis for misrepresentation, negligence, and promissory estoppel lawsuits as well.
Second, servicers have reported significant increases in both the average call wait times and the rate of abandonment of loss mitigation requests—two statistics that could be related.  So, there could be large numbers of borrowers whose loans will end up in default but will insist that they tried to obtain a CARES Act forbearance but gave up because they were unable to reach anybody at their loan servicing company.
Third, the CARES Act forbearance program will likely cause confusion about its interplay with various state law foreclosure prevention statutes such as California’s Homeowner Bill of Rights, which imposes various restrictions on the foreclosure and loss mitigation review process—such appointing a single point of contact, prohibiting dual-tracking, and affording the borrower with the right to an appeal if his or her request for a foreclosure prevention alternative is denied.
Fourth, the sheer number of forbearance requests that borrowers submitted will significantly increase the probability of forbearance-related litigation arising in the future. The Mortgage Bankers Association estimates that forbearance requests grew by 1,270% between the week of March 2 and the week of March 16, and another 1,896% between the week of March 16 and the week of March 30.  To mitigate the risks identified above, banks and servicers should adhere to many of the best practices developed in the wake of litigation following the Great Recession: clearly communicating to borrowers that forbearances are temporary in nature, warning that any payments held in abeyance are not forgiven, and ensuring that employees on the front lines
receiving borrower calls have clear instructions about what types of statements are inappropriate. In addition, banks and financial institutions need to communicate promptly and clearly with other industry players in addition to borrowers, including but not limited to foreclosure trustees, REO agents, credit reporting agencies, and outside counsel. Finally, servicers should ensure their teams are sufficiently staffed to ensure they can responsibly manage this sudden influx of calls and letters.
The size and scope of the CARES Act is unprecedented. And the CARES Act was designed to mitigate the impact of an economic downturn of equally historic proportions. But neither of those forces—new sweeping legislation or an economic recession—are strangers to those who work in the financial services industry. Banks and loan servicers should prepare themselves for working in this new chapter by anticipating significant and varied litigation in the months and years ahead.
Should you have any questions or seek additional information, please contact Kerry W. Franichat firstname.lastname@example.org.