Client Alert

Important Appellate Decision Affecting Residential Lending Practices


Since 1994, more than fifty putative nationwide class actions have been filed against financial institutions challenging the widespread practice of paying yield spread premiums and related forms of compensation to mortgage brokers in wholesale loan transactions. Typically, the complaints allege that the payment of yield spread premiums violates Section 8 of the Real Estate Settlement Practices Act of 1974 ("RESPA"). In 1997, Morrison & Foerster LLP was retained by the Mortgage Bankers Association of America to act as nationwide coordinating counsel with respect to the defense of class action complaints against MBA member companies. During 1997, district courts resolved eight different class certification motions in Section 8 cases, and in each instance, denied class certification. Summary judgment was entered for financial institution defendants in three different cases in the same year.

On Friday, January 9, 1998, the Eleventh Circuit Court of Appeals issued its decision in Culpepper v. Inland Mortgage Corporation 1998 U.S. App. LEXIS 274, reversing a district court decision in which summary judgment had been granted in favor of the lender defendant. This is the first appellate decision arising from the yield spread premium class actions. This memorandum is to advise you of the Culpepper decision and to provide background thereon.

The Business Practice of Paying Yield Spread Premiums

Many wholesale mortgage lenders observe a practice, common in the industry, of offering yield spread premiums to brokers in connection with specific loan programs. Such lenders typically publish rate sheets which show for a given loan product combinations of points and interest rates which the lender deems to be equivalent under the lender's pricing model. Greatly simplified, a rate sheet might show three basic pricing options: 7.25% if the borrower pays the lender one point; 7.5% if no points are paid by either the borrower or the lender; and 7.75% if the lender pays one point to the borrower's mortgage broker. The second pricing option is commonly referred to as "par." The point paid to the broker in the third pricing option is an illustration of a yield spread premium.

Plaintiffs' Allegations

Plaintiffs' allege that the payment of yield spread premiums violates Section 8 of RESPA. That statute prohibits both unearned fee splits and the payment of referral fees. However, Section 8 expressly exempts payments for goods actually furnished or services actually performed from this prohibition. Plaintiffs typically allege that the yield spread premium is a payment made to induce the mortgage broker to refer a loan with an "above par" interest rate to the lender. Lenders have defended the payment of yield spread premiums by arguing variously that the payment is made for services rendered by the broker to the borrower and the lender, or that the payment is made for a good, e.g., the servicing rights, loan pipeline value and other valuable assets created by the broker and ultimately assigned to the lender in the transaction.

The Decision

On Friday, January 9, 1998, the Eleventh Circuit issued its decision in Culpepper v. Inland Mortgage Corporation 1998 U.S. App. LEXIS 274. The circuit court reversed the district court's summary judgment in favor of Inland Mortgage Corporation. The court reasoned that the yield spread premium paid by Inland to the mortgage broker could not have been for a "good" because "in a table-funded transaction," such as the one at issue in that case, "the lender, not the broker, owns the loan from the outset."

While the district court had not addressed the alternative analysis that the yield spread premium was a payment for "services," the issue was raised on appeal. The appellate court concluded that the yield spread premium was not, on the facts presented in the Culpeppers' case, payment for "services" either. The court noted that there was "no evidence" to suggest that the origination fee paid by the borrowers to the mortgage broker was not intended to compensate the mortgage broker fully for the services rendered to the borrowers. (This statement, as well as other factual statements in the opinion, appear to be contradicted by the record.) The court also noted that when Inland responded to an interrogatory regarding the purpose of the yield spread premium payment, Inland did not refer to services to the borrower. In the context of this "services" discussion, the court did comment in footnote 5 that "[m]ortgage transactions are structured in a variety of ways, and the holding here is highly dependent upon the facts of this financial transaction." In somewhat more categorical terms, the court stated that the yield spread premium could not have been payment for services the broker performed for the lender.

The appellate court concluded that the "market value" test described in the regulations and relied upon by the district court was inapplicable, since the payment made by Inland was for neither a "good" nor a "service."

The district court had dismissed the class allegations in the complaint after granting summary judgment for Inland. With the reversal of summary judgment, the appellate court directed the district court to consider plaintiffs' class certification motion on the merits.

What's Next?

In the next three weeks, Inland has the option of seeking reconsideration by the same panel of judges, or a rehearing by all the judges of the Eleventh Circuit. Although such steps could produce important clarifications to the decision, historically appellate courts have been reluctant to revisit anew or substantially modify prior decisions. It is also technically possible for Inland to seek review before the United States Supreme Court, but the chances that the Supreme Court would accept the case for review are relatively small.

Under the decision as it stands, the case returns to the district court for consideration of class certification. We anticipate that the court will allow a period of discovery on class certification to proceed before requiring the parties to brief the issue. Accordingly, a class certification decision from the district court would not be expected for several months.

Industry Impact

Although the pace at which plaintiffs' counsel had been filing new Section 8 cases had slowed dramatically over the last several months, we expect the Culpepper decision to provoke a new round of class action cases. We also expect that the impact of Culpepper on the central question of class certification will be addressed immediately by parties in the several pending cases where class certification has been briefed but not yet decided by the court.

For a copy of the Culpeppper decision, information about prophylactics against such litigation, and any questions you might have, please feel free to contact us at one of the offices below:

Washington, D.C
Rick Fischer: (202) 887-1566
Martha Ellett: (202) 887-1559

Los Angeles
Joe Gabai: (213) 892-5284
Maren Nelson: (213) 892-5358

New York
Jack Auspitz: (212) 468-8046
Mark Ladner: (212) 468-8035

San Francisco
Jim McCabe: (415) 268-7011
Michael Agoglia: (415) 268-6057

Steve Kaufmann: (303) 592-2236



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