HOFSTETTER v. CHASE HOME FINANCE, LLC (N.D.Cal. 10-29-2010)

supposedly "changed the terms" of the mortgages held by Ms. Hofstetter and Mr. Modersbach. Specifically, the proposed complaint alleges (Compl. ¶ 71):

In addition, JPM violated the TILA by, inter alia, (i) adversely changing the terms of Plaintiffs' credit plans after origination without Plaintiffs' consent by requiring and force-placing more insurance than appropriate to protect its interest in the property, see 12 C.F.R. § 226.5b(f)(3); and (ii) failing to provide proper notice, after origination, that JPM was amending the terms of the credit plans as described in the deeds of trust, see 12 C.F.R. § 226.9(c). See 12 C.F.R. §§ 226.18, 226.20.

In their opposition brief, defendants take issue with each of the allegations set forth in this paragraph. First, defendants argue that 12 C.F.R. 226.5b(f)(3) does not apply to federal flood insurance coverage requirements because such requirements are not "terms" under the TILA. Second, defendants contend that 12 C.F.R. 226.5b(f)(3) was not violated because borrowers "agreed" in their deeds of trust and policy documents that they would have to maintain flood insurance as required by JPMorgan Chase Bank. Third, defendants argue that they did provide proper notice under 12 C.F.R. 226.9(c) that they were amending the terms of the credit plans at issue. Fourth, defendants argue that 12 C.F.R. 226.18 and 226.20 — the two regulations cited at the end of the above paragraph — do not even apply to HELOCs. As explained below, all but one of defendants' arguments fail.

Starting with defendants' sole victory, defendants are correct that 12 C.F.R. 226.18 and 226.20 do not apply to open-end lines of credit like HELOCs. See 12 C.F.R. 226.20(a)(20) (defining open-end credit transactions). Rather, these regulations apply to closed-end credit plans. As such, they are inapplicable to the instant dispute, and leave to amend to allege any TILA claims under these regulations is DENIED.

Turning next to the allegations based upon 12 C.F.R. 226.5b(f)(3), this code section — entitled "[r]equirements for home-equity plans" — states in relevant part:

(f) Limitations on home equity plans. No creditor may, by contract or otherwise:

* * *

(3) Change any term, except that a creditor may:

(i) Provide in the initial agreement that it may prohibit additional extensions of credit or reduce the credit limit during any period in which the maximum annual percentage rate is reached. A creditor also may provide in the initial agreement that specified changes will occur if a specified event takes place (for example, that the annual percentage rate will increase a specified amount if the consumer leaves the creditor's employment).

* * *

(iii) Make a specified change if the consumer specifically agrees to it in writing at that time.

(iv) Make a change that will unequivocally benefit the consumer throughout the remainder of the plan.

(v) Make an insignificant change to terms.

According to the proposed complaint, by "requiring and force-placing more insurance than appropriate to protect its interest in the property," JPMorgan Chase Bank adversely changed the terms of the HELOCs in question without the consent of the borrower. Moreover, since these changes were allegedly made after March 2009, they are timely under the TILA's one-year limitations period. For these reasons, plaintiff contends that the proposed complaint states a plausible claim for a violation of 12 C.F.R. 226.5b(f)(3).

This order agrees. The fees and premiums associated with property insurance agreements written in connection with a credit transaction are clearly "terms" of a home-equity plan under the TILA. In fact, the TILA expressly requires lenders to disclose these fees and premiums as part of their initial disclosures to borrowers. See 12 C.F.R. 226.6(a)(1) (requiring lenders to disclose "finance charges" in their initial disclosures); 12 C.F.R. 226.4(b)(8) (listing among examples of finance charges "[p]remiums or other charges for insurance against loss of or damage to property, or against liability arising out of the ownership or use of property, written in connection with a credit transaction"); 12 C.F.R. 226.4(d)(2) (setting forth an exception to the inclusion of property insurance premiums in finance charges). Additionally, the Federal Reserve Board's commentary on what constitutes a "change of terms" to a credit plain is instructive:

In general, a creditor may not change the terms of a plan after it is opened. For example, a creditor may not increase any fee or impose a new fee once the plan has been opened, even if the fee is charged by a third party, such as a credit reporting agency, for a service. The change of terms prohibition applies to all features of a plan, not only those required to be disclosed under this section. For example, this provision applies to charges imposed for late payment, although this fee is not required to be disclosed under § 226.5b(d)(7).

2 C.F.R. Pt. 226, Supp. I, § 5b(f)(3), cmt. 1 (emphasis added). Since the "change of terms" prohibition encompasses more than just those terms that are required to be disclosed under the TILA, it is safe to say that the imposition and modification of mandatory flood insurance coverage (and the fees and premiums associated with such coverage) are clearly encompassed by this regulation.

Given this backdrop, a lender's imposition of mandatory flood insurance coverage in connection with a HELOC, where no such insurance was required at the loan's consummation and insufficient initial disclosures were made to the borrower that such insurance would have to be purchased in the future, must be deemed a "change of terms" under 12 C.F.R. 226.5b(f)(3). In the instant case, it is undisputed that the purchase of flood insurance coverage was not required as a condition for either Ms. Hofstetter or Mr. Modersbach to obtain their HELOCs from JPMorgan Chase Bank. Additionally, as well be discussed shortly, the terms of their loans at consummation did not reserve the right for JPMorgan Chase Bank to impose mandatory flood insurance coverage requirements at a later date and at its sole discretion.

An important point, however, must be emphasized regarding the interplay between the disclosure requirements of the TILA and the mandatory flood insurance requirements of the NFIA. As discussed in detail in the August 2010 order, the NFIA has specific notice provisions that require federally regulated lenders (and their affiliated servicers) to notify borrowers in writing that they must purchase flood insurance within a specified period of time if they lack the minimum insurance coverage required under the Act. See 42 U.S.C. 4012a(e)(1). The Act further authorizes these lenders to force-purchase a sufficient amount of flood insurance coverage to achieve compliance with the NFIA if a borrower fails to purchase adequate insurance. See 42 U.S.C. 4012a(e)(2). Critically, these requirements of the NFIA make no reference to the terms set forth in loan agreements between lenders and borrowers. Stated differently, even if the borrower was not required to maintain flood insurance when the loan was consummated, the NFIA would nevertheless require the lender to impose such a requirement and require a certain amount of

flood insurance coverage to be placed on the property that secures the loan if the property was later found to be located in a "special flood hazard area."

In light of this discussion, if JPMorgan Chase Bank properly complied with the requirements of the NFIA and acted pursuant to its notice and "force-purchase" provisions, it cannot be held liable under the TILA for "changing the terms" of the HELOCs at issue in this dispute. See Watt v. Alaska, 451 U.S. 259, 267 (1981) (holding that courts should read federal statutes "to give effect to each . . . while preserving their sense and purpose"). To hold that a lender's compliance with the provisions of the NFIA would render it liable for "changing terms" under the TILA (under the circumstances presented herein) would frustrate the intent and effect of these congressional acts.

Of course, a different analysis might apply if the NFIA's requirement of flood insurance coverage existed at the time the loan was consummated. This order takes no position on this issue.

As explained in the August 2010 order, however, JPMorgan Chase Bank was not required under the NFIA to purchase flood insurance coverage for the property securing Ms. Hofstetter's HELOC. For this reason, the NFIA does not shield the bank from liability under the TILA for changing the terms of her HELOC after origination. As to her situation, the proposed complaint states a plausible claim under 12 C.F.R. 226.5b(f)(3). With respect to the proposed second named plaintiff, Mr. Modersbach, his situation is somewhat different. Since he indisputably carried a positive principal loan balance and a $100,000 open line of credit at the time the property securing his HELOC was deemed by FEMA to be located within a "special flood hazard area," the initial set of flood insurance "form letters" sent to him by defendants (requiring him to obtain at least $100,000 in flood insurance coverage) were arguably authorized and required under the NFIA. Plaintiff's counsel conceded as much at the hearing on this motion, acknowledging that if defendants had only required Mr. Modersbach's to maintain $100,000 in flood insurance coverage, he would likely have no claims against defendants.

JPMorgan Chase Bank, however, decided to increase Mr. Modersbach's minimum flood insurance requirements for his HELOC to $250,000 in coverage. This move was arguably not authorized by the NFIA or any of its implementing regulations. Since Mr. Modersbach's credit limit at the time the bank imposed the $250,000 minimum-coverage requirement was only $100,000, and because his principal loan balance was far below that amount, the NFIA only required flood insurance coverage in the amount of $100,000 ( see Dkt. No. 51 at 13). See 42 U.S.C. 4012a(b)(1). Given this conclusion, any decision by JPMorgan Chase Bank to increase Mr. Modersbach's minimum required flood insurance coverage above $100,000 — even if based upon the "best practices" set forth by FEMA or some other agency — forms a plausible basis for "change of terms" liability under 12 C.F.R. 226.5b(f)(3). In other words, Mr. Modersbach can state a plausible claim that JPMorgan Chase Bank violated this regulation.

Adhering to flood insurance "best practices" set forth by a regulatory agency does not absolve lenders from complying with the requirements of the TILA or applicable state laws. Simply because an agency recommends that lenders maintain a certain amount of flood insurance coverage does not mean that lenders have carte blanche to do so without regard to the terms of their loan agreements with borrowers.

None of defendants' arguments to the contrary is persuasive. First, this order wholly rejects defendants' contention that property insurance requirements are not "terms" under the TILA and 12 C.F.R. 226.5b(f)(3). As stated, both the regulations and Federal Reserve Board commentary on this issue confirm that fees and premiums associated with property insurance written in connection with a loan are terms under the TILA. Second, this order rejects defendants' argument that the borrowers "agreed in their respective Deeds of Trust that they would be required to maintain flood insurance if their respective properties fell within a flood zone" and that defendants' actions in imposing and increasing flood insurance requirements were authorized under 12 C.F.R. 226.5b(f)(3)(i) (Opp. 14). The proposed complaint plausibly alleges that no such "agreement" existed. The deeds of trust for both Ms. Hofstetter and Mr. Modersbach merely stated (Dkt. Nos. 39-1, 92):

You shall keep the Property insured against loss by fire, hazards included within the term "extended coverage" and any other hazards, including floods or flooding, for which we require insurance. This insurance shall be maintained in the amounts and for the periods that we require. You may choose any insurer reasonably acceptable to us. . . . If you fail to maintain coverage as required in this section, you authorize us to obtain such coverage as we in our sole discretion determine appropriate to protect our interest in the Property in accordance with the provisions in Section 6.

If defendants intended for this language in its initial disclosures to reserve their right to impose a requirement of flood insurance at a later date pursuant to 12 C.F.R. 226.5b(f)(3)(i), they should have disclosed — as the regulation requires — "that specified changes will occur if a specified event takes place." As explained in the Federal Reserve Board's commentary on this rule, "[b]oth the triggering event and the resulting modification must be stated with specificity." 12 C.F.R. Pt. 226, Supp. I, § 5b(f)(3), cmt. 1 (emphasis added). In the excerpt from the deeds of trust shown above, no "triggering event" was disclosed for the imposition or increase of flood insurance coverage by the lender. Similarly, no specificity was provided as to how much flood insurance coverage would be required. In sum, JPMorgan Chase Bank cannot rely on this so-called "agreement" to justify the "change of terms" alleged herein.

Third, this order rejects defendants' argument that because their flood insurance notices were sent from Chase Home Finance (the servicer of the HELOCs in question), JPMorgan Chase Bank (the owner of the loans) cannot be held liable under the TILA. While it is true that only "creditors" ( i.e., the owners of a loan) can be held liable for the alleged TILA violations, the mere fact that the notices were mailed by the servicer of the loan says nothing conclusive about whether JPMorgan Chase Bank was responsible for changing the terms of the loan. Discovery will color in these details. As pleaded, the proposed complaint sufficiently alleges that JPMorgan Chase Bank "changed the terms" at issue.

For all these reasons, and since all factors under FRCP 15(a) weigh in favor of allowing this amendment, leave to amend the complaint to add a TILA claim against JPMorgan Chase Bank based upon a "change of terms" under 12 C.F.R. 226.5b(f)(3) is GRANTED.

Finally, this order also finds that a plausible claim under 12 C.F.R. 226.9(c) has been stated. This particular claim is premised on the allegation that JPMorgan Chase Bank "fail[ed] to provide proper notice, after origination, that [it] was amending the terms of the credit plans as described in the deeds of trust" (Compl. ¶ 71). This regulation states in relevant part:

For home-equity plans subject to the requirements of § 226.5b, whenever any term required to be disclosed under § 226.6(a) is changed or the required minimum periodic payment is increased, the creditor shall mail or deliver written notice of the change to each consumer who may be affected. The notice shall be mailed or delivered at least 15 days prior to the effective date of the change. The 15-day timing requirement does not apply if the change has been agreed to by the consumer; the notice shall be given, however, before the effective date of the change.

12 C.F.R. 226.9(c)(1)(i).

This order has already concluded that property insurance coverage written in connection with a loan triggers mandatory "finance charge" disclosures under 226.6(a). It has also been determined that the loan agreements in question did not authorize defendants to unilaterally impose or increase mandatory flood insurance requirements to whatever amounts they deemed proper. Accordingly, unless the notices sent to borrowers were required under the NFIA and its implementing regulations, the requirements of 12 C.F.R. 226.9(c)(1)(i) apply to the various flood insurance "form letters" sent to Ms. Hofstetter and Mr. Modersbach by defendants. Given that Ms. Hofstetter was not required to purchase any flood insurance coverage under the NFIA, the notices mailed to her were clearly subject to the requirements of 12 C.F.R. 226.9(c)(1)(i). Similarly, the letters mailed to Mr. Modersbach informing him that he was required to purchase $250,000 in flood insurance coverage (above and beyond the minimum coverage amount required under the NFIA) similarly fell within the reach of 12 C.F.R. 226.9(c)(1)(i).

For these reasons, and since all factors under FRCP 15(a) weigh in favor of allowing this amendment, leave to amend the complaint to add a TILA claim against JPMorgan Chase Bank under 12 C.F.R. 226.9(c)(1)(i) is also GRANTED. ii. Violations Based Upon Initial Loan Disclosures

At the hearing on the instant motion, plaintiff's counsel made clear that the flood insurance "form letters" sent by defendants to Ms. Hofstetter and Mr. Modersbach in 2009 and 2010 formed the backbone of their proposed amended TILA claim. In other words, the initial loan disclosures made by JPMorgan Chase Bank years earlier are not being challenged as "inadequate" under the TILA. Given this clarification, it is unnecessary to address whether equitable tolling applies to plaintiff's revised TILA claim. So long as plaintiff's TILA challenge is limited to the bank's supplemental disclosures — e.g., the flood insurance "form letters" — mailed to Ms. Hofstetter and Mr. Modersbach, there is no need to "toll" the TILA claim herein. In sum, there is no TILA claim targeting the bank's initial disclosures.

B. Section 17200 Claims

Turning next to plaintiff's state claims, the proposed complaint seeks to add two additional claims against JPMorgan Chase Bank and Chase Home Finance: (1) a claim of "unlawful" business practices under Section 17200 of the California Business and Professions Code, and (2) a claim of "unfair" business practices pertaining to the factual allegations tied to Mr. Modersbach.

i. "Unlawful" Business Practices

Since this order has already found that a plausible claim for a violation of the TILA has been stated, it follows that a claim of "unlawful" business practices under Section 17200 of the California Business and Professions Code has also been stated. See Cel-Tech Commc'ns, Inc. v. Los Angeles Cellular Tel. Co., 20 Cal. 4th 163, 180 (1999). Since all factors under FRCP 15(a) weigh in favor of allowing this amendment, leave to amend the complaint to allege a claim of "unlawful" business practices under Section 17200 is GRANTED.

ii. "Unfair" Business Practices

With respect to the proposed complaint's claim of "unfair" business practices, the August 2010 order already found that a plausible claim for relief had been stated against defendants by the original named plaintiff, Ms. Hofstetter (Dkt. No. 51 at 20). As explained in that order, conduct is "unfair" if it is "tethered" to some legislatively declared policy or proof of some actual or threatened impact on competition. Id. at 186-87. In this connection, the prior complaint cited to two legislatively declared policies pertaining to flood insurance coverage to satisfy the "tethering" requirement under Cel-Tech. These policies state (Compl. ¶ 58):

These business practices are contrary to the principle that (i) "lenders should avoid creating situations where a building is overinsured", 74 Fed. Reg. 35,914, 35,918 (July 21, 2009) [and] (ii) consumers should receive "meaningful disclosure of credit terms", 15 U.S.C. § 1601(a).

Both of these policies — one of which is found within the language of the TILA itself — support plaintiff's theory that defendants' conduct in sending allegedly misleading flood insurance "form letters" to borrowers regarding federal flood insurance requirements, and force-purchasing flood insurance coverage in excess of the minimum amount required under the NFIA were "unfair" under Section 17200. Accordingly, the August 2010 order concluded that a claim of "unfair" business practices had been plausibly stated.

The only issue that needs to be addressed herein is whether Mr. Modersbach — the proposed second named plaintiff — has also stated a plausible claim for "unfair" business practices under Section 17200. The answer is yes. At the time his property was determined to be located in a "special flood hazard area," Mr. Modersbach had a $100,000 line of credit with JPMorgan Chase Bank and a principal loan balance of around $37,000. When defendants initially informed Mr. Modersbach that he was required to purchase flood insurance coverage under the NFIP, he was instructed to purchase insurance coverage in an amount that was the "lesser" of (Compl. ¶ 29):

• The maximum amount of insurance coverage available through the National Flood Insurance Program (NFIP), which is currently $250,000; or

• 100% of the full replacement cost of the dwelling and insurable improvements; or

• The principal balance of the loan or credit line amount for lines of credit.

This language reasonably tracks the minimum flood insurance requirements set forth in the NFIA and its implementing regulations ( see Dkt. No. 51 at 13). In response, Mr. Modersbach purchased flood insurance coverage in the amount of $100,000 — the amount of his credit line at the time. The proposed complaint does not challenge this conduct by defendants.

The complaint, however, does challenge the notice that was mailed to Mr. Modersbach six months later, wherein he was informed that he was now required to purchase flood insurance coverage in an amount equal to the "lesser" of (Compl. ¶ 38):

• The maximum amount of insurance coverage available through the National Flood Insurance Program (NFIP), which is currently $250,000; or

• 100% of the full replacement cost of the dwelling and insurable improvements.

Unlike the prior notice which included language that tracked the minimum requirements of the NFIA, the criteria set forth in the "new" notice made no reference to either the principal balance of the loan or the credit line amount for lines of credit. The effect of this change for was that Mr. Modersbach was now required to purchase $250,000 in flood insurance coverage — over $150,000 more than his credit limit and over $100,000 more than his principal loan balance.

By making this move, defendants exposed themselves to both the requirements of the TILA and applicable state laws. Indeed, the regulating agencies of the NFIA commented directly upon the risks of requiring flood insurance coverage in excess of the Act's minimum required coverage, stating that while "[l]enders are permitted to require more flood insurance coverage than required by" the NFIA, "lenders should avoid creating situations where a building is `over-insured.'" 74 Fed. Reg. 35914, 35936 (July 21, 2009). The agencies further explained that while "there are no penalties for over insurance under the Act and Regulation[s] . . . there may be penalties for over-insurance under applicable State law." Id. at 35918 (emphasis added). In other words, the regulating agencies expressly contemplated the applicability of state law to situations where a lender exceeds the minimum flood insurance coverage requirements under the NFIA. This is exactly what has been plausibly alleged with respect to Mr. Modersbach.

This does not mean, however, that liability for "unfair" business practices would be a foregone conclusion any time a lender requires flood insurance coverage in excess of minimum NFIA requirements. In fact, the regulating agencies have also expressly stated that while "[t]he Regulation requires a minimum amount of flood insurance . . ., lenders may require more coverage, if appropriate." Ibid. On this point, the agencies further explained that "[e]ach lender has the responsibility to tailor its own flood insurance policies and procedures to suit its business needs and protect its ongoing interest in the collateral." Id. at 35936. In this connection, defense counsel correctly noted at the hearing that FEMA's own guidelines encourage lenders to consider other factors, such as the replacement cost value of the property securing the loan, when determining an "appropriate" amount of flood insurance coverage to impose on borrowers. Defendants also reasonably argued that the presence of a senior lien might be an appropriate consideration for deviating upwards from the NFIA's minimum requirements. Any one of these considerations could potentially be a strong defense against a claim of "unfair" business practices.

That said, the sole question presented in the instant motion is whether a plausible claim of "unfair" business practices has been stated, not whether defendants' had plausible justifications for their actions. Whether defendants' actions were consistent with FEMA's "best practices" and other agency materials is irrelevant to whether plaintiff's claim can proceed. For these reasons, and since all factors under FRCP 15(a) weigh in favor of allowing this amendment, leave to amend the complaint to state a claim of "unfair" business practices under Section 17200 based upon the factual allegations of Mr. Modersbach is GRANTED.

3. PROPOSED PLAINTIFF ROGER MODERSBACH

Given that the claims brought by Mr. Modersbach against defendants overlap on many levels with those asserted by Ms. Hofstetter, plaintiff's motion for leave to add Mr. Modersbach as a second named plaintiff is GRANTED. As stated, his addition to this action is not being sought in bad faith, will not unduly prejudice defendants, and is not the product of undue delay or repeated failures by plaintiff. Moreover, his addition will neither "greatly alter[] the nature of the litigation" nor "require[] defendants to . . . undertake[], at a late hour, an entirely new course of defense." See Morongo Band of Mission Indians v. Rose, 893 F.2d 1074, 1079 (9th Cir. 1990).

This order will, however, comment briefly upon potential hurdles on the horizon with respect to Rule 23 and Mr. Modersbach's claim. While defendants' alleged adherence to FEMA "best practices" and other agency guidelines in its flood insurance practices cannot bar plaintiff's "unfair" business practices claim, it appears highly relevant to whether the flood insurance coverage they required for Mr. Modersbach's HELOC and property was "appropriate" and not "unfair." In this connection, the specific circumstances surrounding Mr. Modersbach's HELOC — such as whether he had a first mortgage — may significantly impact whether his claims are "typical" of other borrowers. This order should not be interpreted as taking a position on any Rule 23 issues at this time. That said, counsel should be mindful of these considerations as class certification approaches.

4. PUTATIVE CLASS AND DAMAGES ALLEGATIONS

Finally, defendants' criticisms targeting the scope of the putative class allegations and the appropriateness of various "remedies" set forth in the proposed complaint are premature and will not be addressed at this time. The propriety of plaintiff's proposed class definitions will be addressed during the class certification process, when full attention can be given to the issue. Similarly, the appropriateness of the various remedies sought in the complaint need not be addressed until, if ever, the proceedings reach a point where liability is established and relief ordered. For these reasons, defendants' requests to strike these portions of the proposed complaint is DENIED. This denial is without prejudice to defendants re-raising these objections and arguments when the issues become ripe for adjudication.

CONCLUSION

For the foregoing reasons, plaintiff's motion for leave to file a second amended complaint and add a second named plaintiff is GRANTED IN PART and DENIED IN PART. Plaintiff shall file the amended complaint within FIVE CALENDAR DAYS of this order and an answer must be filed within TWENTY CALENDAR DAYS thereafter. No further dismissal motions will be allowed.

IT IS SO ORDERED.