BANKING ALERT: The Texas Supreme Court Issues Opinion That Will Change Texas Home Equity Lending

The Texas Supreme Court Issues Opinion That Will Change Texas Home Equity Lending

July, 2013

Authors:
David M. Clem
Kenneth C. Johnston
Gordon B. Russell

Introduction

On June 21, the Texas Supreme Court issued its long-awaited opinion in The Finance Commission of Texas v. Norwood [1],bringing an end to nine years of litigation over minutiae of Texas home equity lending laws. The opinion is important to the banking industry, and it settles uncertainty regarding three specific provisions of Article XVI, Section 50 of the Texas Constitution ("Section 50").

Here is the bottom line for Texas lenders:

• All fees—including fees paid to the lender—are capped at 3 percent.
• All aspects of the loan closing process must occur at the office of the lender, an attorney, or a title company.
• Lenders are entitled to a "rebuttable presumption" that homeowners received required notices on the third day after mailing.

Section 50 of the Texas Constitution

Section 50, which became effective in 1997, authorized Texas lenders to join the other 49 states in making home equity loans. Most constitutional amendments provide or limit specific powers and authorize the Legislature or the executive branch to delegate rulemaking authority to individual agencies. In this case, however, the Legislature recognized that Texas homesteads are subject to special protections; they did not want to jeopardize those protections by subjecting the home equity lending process to political pressures.

Consequently, Section 50 is far more detailed than ordinary Constitutional amendments. It also provides that the Legislature is not empowered to interpret the section. Acting on an opinion issued by the Attorney General, the Legislature proposed an amendment to Section 50 in 2003. Section 50u allows the Legislature to delegate interpretative authority to specific state agencies—presently identified as the Finance Commission and the Credit Union Commission. Section 50u also provides lenders a "safe harbor": compliance with interpretations issued by the Commissions is compliance with the Constitution itself.

The Commissions quickly proposed interpretations, which became effective in 2004. Three weeks later, six homeowners filed suit against the Commissions, challenging several of the interpretations.

The Supreme Court's Decision on the Merits

After years of briefing and argument, and after opinions from the trial and appellate courts, the Supreme Court determined that the Commissions had incorrectly interpreted two of the three provisions at issue.

Section 50(a)(6)(E): This section imposes a three percent cap on "fees to any person that are necessary to originate, evaluate, maintain, record, insure, or service the extension of credit." The section provides that the capped fees do not include "any interest."

The Commissions argued that "interest" should be defined by reference to Section 301.002(a)(4) of the Texas Finance Code, which includes fees paid to the lender. Under the Commissions' interpretation, then, fees paid to the lender are not subject to the three-percent cap.

The Court disagreed, primarily because such an interpretation would permit the Legislature to define or redefine the term "interest"—which would subject Section 50 to the political influence that its framers had intended to avoid. The Court concluded that the term "interest" as used in Section 50 "means the amount determined by multiplying the loan principal by the interest rate." In other words, all "fees" are now subject to a cap of three percent of the principal.

Section 50(a)(6)(N): This section provides that a home equity loan must be "closed only at the office of the lender, an attorney at law, or a title company." The framers intended for this provision to "prohibit the coercive closing of an equity loan at the home of the owner."

The Commissions argued that homeowners should be permitted to sign certain instruments at their home and mail them to the lender. The Commissions also argued that the actual closing could be attended by an attorney-in-fact for the homeowner.

The Court found that such an interpretation would permit the kind of coercion that the provision was intended to prohibit. Because "closing" is not simply the final action of signing documents, the Court reasoned that the entire "closing process" is subject to the location limitation.

Section 50(g): This section requires that home equity loans may not be closed before the 12th day after the lender provides the required notice to the homeowner. The Commissions issued an interpretation that provided a "rebuttable presumption" that the homeowner had received the notice three days after it was mailed. The Court found that the Commissions' interpretation was consistent with Constitutional requirements.

Jurisdictional Issues

Before reaching the foregoing decisions on the merits, the Court had to determine whether it was empowered to review the Commissions' interpretations at all, given the restriction on judicial interpretation contained in Section 50(u). The Court also had to address the standing of the individual plaintiffs.

With respect to the first point, the Court concluded that a reading of Section 50(u) that would completely bar judicial review of the Commissions' interpretations would both defeat the purpose of Section 50 and would violate separation of powers principles.

As mentioned earlier, the Legislature intended Section 50 to be beyond political influence—thus the provision includes many provisions that would normally be relegated to statutes or regulations. But the Commissions are comprised of just 20 members, all appointed by the Governor. Their interpretive decisions are subject to influence by the executive branch through the appointment process. Their decisions are also subject to influence by the legislative branch through statutes governing the Commissions' functions. If the judiciary were not permitted to review the interpretations of the Commissions, there would be no "check" on the influence of the other branches.

Moreover, such an interpretation would abrogate judicial review in favor of essentially executive review, which would violate the separation of powers doctrine. The Texas Constitution requires exceptions to the separation of powers to be "expressly stated." Because Section 50 does not indicate that it expressly intended to foreclose judicial review, the Court found that it was empowered to review the Commissions' interpretations.

The majority of the Court also found that the plaintiffs had standing to bring their claims. "Standing" requires that plaintiffs have suffered an injury that is "concrete," "particularized," "actual or imminent," and "not hypothetical."

In this case, the issue of standing was not raised until the appellate level. In such circumstances, the plaintiffs' pleadings are construed liberally, and courts are entitled to review the record for evidence that would support jurisdiction. The majority concluded that the homeowners' allegation that the Commissions' interpretations "threaten to interfere with or impair [their] legal right[s]" was sufficient to show an "actual or imminent" injury, at least in the unusual context of Section 50.

In his dissent, Justice Johnson wrote that such allegation is insufficient to confer standing because it implicitly concedes that the homeowners' injury is "only a hypothetical, potential one in the future." Justice Johnson wrote that he would have remanded the case back to the trial court, where the homeowners would have another opportunity to plead their case and establish evidence showing an actual injury. Without such a showing, in Justice Johnson's view, the majority opinion is only "advisory."

Conclusion

The Court's opinion is likely to have a significant impact on home equity lending procedures in Texas. Some charges that lenders treat as "interest" in other contexts will now be treated as "fees" for home equity loans. As a result, lenders may be forced to increase their interest rates to compensate.

The opinion will also impact Texas standing jurisprudence, despite Justice Johnson's well-reasoned dissent. The plaintiffs' bar may see an opening to bring similar lawsuits that challenge rules, opinions, or interpretations of government agencies even where an "actual" injury is difficult to prove. The defense bar, on the other hand, will argue that the standing ruling is limited to the circumstances of Section 50.

This Litigation Alert is a summary of recent developments in the law and is provided for informational purposes only.  It is not intended to constitute legal advice or to create an attorney-client relationship.  Readers should obtain legal advice specific to their situation in connection with topics discussed.

Copyright © 2013 Kane Russell Coleman & Logan PC.  All rights reserved.  Unless otherwise indicated, the authors are not certified by the Texas Board of Legal Specialization.

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