Banking & Finance Law Report

Judicial Review of CAMELS Ratings – Banking Organizations Weigh In

Several trade associations for the banking industry have weighed in on a pending potential landmark case in the Northern District of Illinois regarding the possible judicial review of CAMELS (Capital, Asset Quality, Management, Earnings, Liquidity and Sensitivity) ratings of financial institutions. As noted by this blog earlier this year, the United States Court of Appeals for the Seventh Circuit, in Builders Bank v. FDIC, 846 F.3d 272 (7th Cir.2017), vacated a lower court ruling stating that CAMELS ratings by the FDIC were committed to agency discretion and thus beyond judicial review. The case has been remanded to the Northern District of Illinois, where the Clearing House Association, the American Bankers Association, and the Independent Community Bankers of America have filed a brief as amici curiae, in support of neither party but solely to assert that CAMELS ratings are not exempt from judicial review.

In their brief, the amici assert that the availability of judicial review of agency decisions serves important purposes, by “providing assurance that agencies do not exceed the limits of their statutory authority and treat parties fairly, consistently, and rationally,” particularly in the arena of CAMELS ratings, which “are a cornerstone to bank regulation” and have the potential to have “significant impact” on banks’ businesses and activities. Following the introductory section to the U.S. Code’s chapter on judicial review of administrative agency decisions (5 U.S.C. Section 701), the amici state that judicial review ought to be presumptively available absent (1) a statute precluding judicial review, or (2) the FDIC’s action being committed to its discretion by law. The amici note that the Federal Deposit Insurance Act does not preclude judicial review of FDIC examinations. They argue, further, that the Seventh Circuit allows for judicial review of agency decisions where the agency has published factors that guide its decision making process. The amici point to, among other factors, the Uniform Financial Institutions Rating System (“UFIRS”), which the FDIC references in its manual for risk management examiners, as providing such factors undergirding the CAMELS ratings. The amici also claim that commitment of certain CAMELS components to agency discretion (e.g., the Capital component, committed to agency discretion pursuant to 12 U.S.C. Section 3907(a)(2), as noted in this blog’s prior post on this matter) would not foreclose other components from judicial review, as noted by the Seventh Circuit in the case at hand.

Appealability of FDIC decisions continues to be a contentious issue for the banking community. On July 18, 2017, the FDIC adopted revised Guidelines for Appeals of Material Supervisory Determinations (the “Guidelines”), which provided guidelines for certain appeals of agency decisions, including CAMELS ratings, to the FDIC’s own Supervisory Appeals Review Committee (“SARC”). In their Notice of Guidelines, however, the FDIC stated that “because supervisory decisions are entrusted to agency discretion, SARC decisions are not appealable.” The American Bankers Association, in its comment to the prior proposed draft of the Guidelines, had requested that the Guidelines be amended to include an independent appellate review process for agency decisions. The forthcoming ruling in Builders Bank v. FDIC may open the door for them and the banking industry in general to such an independent appellate review.

Potential Changes for HVCRE Loans

In this blog, we have described some of the original concerns with the “high volatility commercial real estate” loan regulation as well as some suggestions for change. These rules apply to certain real estate loans for acquisition, development and construction.

Recently, there have been suggestions that changes are possible regarding “high volatility commercial real estate” loans or “HVCRE” loans.

Here is a quick reminder of the issues. Effective January 1, 2015, all banking organizations were required to allocate significantly more capital when making commercial real estate loans that were considered to be HVCRE. Under these rules, an HVCRE loan had a risk weight for capital purposes 50% greater than the risk weight of a non-HVCRE commercial loan. Questions quickly arose.

An HVCRE loan is a loan that finances the acquisition, development or construction of real property prior to permanent financing. The regulations apply to existing loans as well as new loans.

There are important exceptions to this classification including: loans on one to four residential properties, community development loans, agricultural loans and certain qualifying real estate loans.

For real estate loans to qualify for the exception, the loan to value ratio must be less than or equal to the applicable maximum loan to value ratio (typically 80%), the borrower must have contributed capital in the form of cash or readily marketable assets equal to at least 15% of the project’s value as completed and the borrower’s contribution must be made before the lender advances funds. Furthermore, the capital contributed by borrower must be required to remain in the project throughout the life of the project. The life of the project is defined to end when the loan is converted to permanent financing, the project is sold, or the loan is paid in full.

Once a loan is classified HVCRE it cannot be declassified prior to the end of “life” of the project.

Here are the developments which now suggest changes may be on the horizon.

First, there have been federal legislative proposals about HVCRE. HR2148 has been introduced in the House that would clarify some aspects of the HVCRE definition. The bill would exempt loans made prior to January 1, 2015, from the HVCRE status and would permit a loan to be declassified once a project is completed and cash flow is being generated sufficiently to support interest payments and operating expenses.

Second, as part of its ongoing review of regulatory requirements, the Federal Financial Institution Examination Council reported this year that one of its goals is to clarify each HVCRE treatment for acquisition, development, and construction loans.

When FFIEC reported to Congress that it was considering simplifying community bank capital rules, it listed HVCRE exposure for review. The agencies involved, the Board of Governors, the Office of the Comptroller of Currency, and the Federal Deposit Insurance Corporation, noted that they had received a number of comments from community banks suggesting that the definition of HVCRE classification is not consistent with the safe and sound lending practices that the capital risk weighting requirement is too high, and that the requirement that the 15% borrower equity contribution, whether initially contributed or are internally generated, remain in a project for the life of the loan is not consistent with common business practices.  The prohibition on removing capital has been interpreted in a manner that prevented withdrawal of capital when a construction loan was converting from temporary to permanent financing, for example.

7th Circuit Overrules FDCPA Bona Fide Mistake Case

In a divided en banc decision, the U.S. Circuit Court of Appeals for the Seventh Circuit has reversed (by vote of 7 to 4) a 2016 decision that a law firm when acting as a debt collector was shielded from liability under the Fair Debt Collection Practices Act when it relied on precedent that was subsequently overruled.  The prior decision was described in this blog here.

The issue is the extent of the bona fide error defense that is provided by the Fair Debt Collection Practices Act for debt collectors who make a mistake despite having procedures in place to avoid such mistakes. A 2010 U.S. Supreme Court decision holds that the defense does not protect mistakes of law.

A prior three-judge panel of the Seventh Circuit had concluded that relying on a controlling appellate court decision was not a mistake of law and that the law firm had made no legal error even though the decision was later overruled.

The new decision however concluded that the law firm had violated the statute since the firm made a mistake in interpreting applicable law. And since the error was a mistake in interpreting law, the bona fide error defense had no application under the controlling U.S. Supreme Court precedent even though the law firm had relied on a prior controlling Seventh Circuit decision which was overruled after the law firm relied on it.

The majority wrote that the U.S. Supreme Court did not intend that the bona fide defense would “protect some mistakes in the law…but not others.” It noted that there is “no workable line between protected and unprotected mistakes of law.”  Judicial opinions are usually retroactive in nature, the majority noted, and the appellate court had explicitly held in the recent decision in which it overruled its prior holding, that the new decision would have retroactive effect.  At footnote 2 in the new decision, the majority also noted that no other district court decision addressing the issue had not given retroactive effect to appellate court’s recent decision.  It said its current decision was necessary, among other things, to “maintain the uniformity of circuit law.”

The three judges who originally reviewed the case were among the four dissenters from the new opinion. The dissenters said they could not agree with a rule of law that “punished debt collectors for doing exactly what the controlling law explicitly authorizes them to do at the time they do it.” Ronald Oliva v. Blat, Hasenmiller, Leibsker & Moore LLC (7th Cir., No. 15-2516, July 24, 2017).  The dissent argued that the majority misunderstand the extent of the 2010 U.S. Supreme Court decision which dealt with the application of a non-controlling judicial interpretation.  In contrast, in the current matter, the law firm complied with controlling judicial precedent, the dissent argued.

Ohio Amends the Good Funds Law Effective on September 29, 2017

The Good Funds Law went into effect on April 6, 2017 amending Section 1349.21 of the Ohio Revised Code to require stricter controls for all residential real estate transactions involving the sale, purchase, or refinance of such real estate. The law was passed as an attempt to combat and thwart fraudulent activities associated with the closings of such residential real estate transactions.  While the Good Funds Law only applies to residential real estate, some title companies have elected to also apply the law to commercial real estate transactions.  The law applies to buyers, sellers, and lenders.

The basic purpose of the law is to eliminate the use of checks and instead to require, with limited exceptions, the transfer of funds to purchase the property at closing to the title company by electronic transfer. While the law initially required that any funds for more than $1,000.00 be electronically wired to the title company prior to the closing, the Ohio legislature has increased this amount to be effective on September 29, 2017 from $1,000.00 to $10,000.00.  Cash, personal checks, certified checks, official checks, or money orders are still acceptable for expenses up to $1,000.00 or $10,000.00 (after September 29, 2017).  This threshold cannot be circumvented by issuing multiple checks or utilizing a multitude of different forms of payment.  Additionally, while the Ohio legislature has elected to increase this threshold amount, some title companies, as the risk bearers of any such fraudulent checks, may establish a policy to accept these alternative forms of payment in an amount less than this statutory threshold.

For buyers, the Good Funds Law means that they can no longer bring a certified check for the purchase price (unless the dollar amount is less than the threshold above). Further, a lender must electronically wire the funds to the title company in sufficient time for the deposit to show up in the title company’s bank account prior to the scheduled closing.  For sellers, if they need the funds from the first closing to immediately attend a second closing to purchase another property, they may need to delay the second closing until the funds from the first closing have been wired and received by the next title company in sufficient time for the second closing.  Thus, going forward, the electronic transfer of funds to purchase property in Ohio will be a mandatory process for buyers, sellers, lenders, and title companies.

New CFPB Rule Limiting Arbitration Clauses Faces Possible Congressional Veto

The enforceability of arbitration clauses in financial contracts took a hit from the Consumer Financial Protection Bureau (the “CFPB”) this week, but threatened congressional action may undo the effects of the CFPB’s newest regulation before it takes effect.

The CFPB Rule

 On Monday, July 10, the CFPB issued its final rule limiting pre-dispute arbitration agreements in certain financial contracts, in an effort to strengthen financial consumers’ access to class actions. The rule, codified at 12 CFR part 1040, imposes several requirements on providers of certain financial services, including extensions of consumer credit, participating in credit decisions, and referring applicants for consumer credit to creditors:

(1) The provider is prevented from relying on pre-dispute arbitration agreements with respect to class actions until the presiding court in the dispute has ruled that the case may not proceed as a class action;

(2) The provider must include language in its pre-dispute arbitration agreement preserving the consumer’s rights to a class action and notifying the consumer of the same; and Continue Reading


Bankers will be interested in a recent appellate court order in a bank regulatory case. Their lawyers will be astonished by it because the ruling lights a flicker of hope in an area where there has been none for many years:  the judicial review of CAMELS ratings.

The ruling came early in a litigation seeking to contest the imposition of a CAMELS rating of 4. A CAMELS rating is a summary rating regulators use to quantify the condition of banks at a given point in time.  For the uninitiated, the term stands for Capital, Assets, Management, Earnings, Liquidity and interest rate Sensitivity.  It is a fundamental element of the relationship between banks and their regulators.  The rating impacts how much banks pay for federal deposit insurance, among other matters.  A bad rating increases the cost of this insurance.

There are very few bankers of any experience who have not in their heart of hearts wished that they could contest an unsatisfactory CAMELS rating. The prospect of an even-handed judicial review might be a popular choice for many bankers. Continue Reading

HB 67 Warrants of Attorney

Another attack on the use of warrants of attorney to confess judgment was recently introduced into the 132nd Ohio General Assembly.  H.B. 67 was introduced on February 16, 2017 by Representative Ron Young, a Republican of Leroy Township in Lake County.  The bill has not yet been assigned to a committee.

The bill seeks to amend R.C. §2323.13(A) to limit a confession of judgment to situations involving “the settlement of a dispute”. The bill does not further define that phrase.  Echoing the “dispute settlement” language, H.B. 67 would also amend R.C. §2323.12 to limit confessions of judgment to the “settlement of a dispute” under R.C. §2323.13 and makes a violation of the law a first degree misdemeanor.

The final amendment sought by H.B. 67 is to Ohio’s power of attorney statute, R.C. §1337.53 at subsections (F)(1), to prohibit the use of a general power of attorney with respect to claims and litigation to confess judgment. Echoing the changes to R.C. §§2323.12 and 2323.13, R.C. §1337.53(F)(2) would limit the use of a general power of attorney to confessing judgment “in connection with the settlement of a dispute.”

The absence of any explanation of the meaning of the phrase “in connection with the settlement of a dispute” is very problematic, and could be construed to mean that judgment cannot be confessed against a debtor who simply does not respond to payment demands, but does not “dispute” the debt; it could also be construed to mean that the debtor must consent to the entry of judgment against him after default, thereby “settling a dispute”, which renders redundant obtaining a warrant of attorney to confess judgment in the loan documentation phase of the transaction.

Attacks on warrants of attorney are becoming a biennial event: House Bill 291, which was introduced into the 131st General Assembly, sought to amend R.C. §2323.13 to limit confessions of judgment to instances of nonpayment of principal and interest under a debt instrument and require notice and an opportunity for a hearing to a defendant before entry of judgment pursuant to a confession of judgment.  The bill did not get out of the House Judiciary Committee before the 131st General Assembly ended, but we are seeing a fresh attack in H.B. 67.

There is not yet a bill analysis for H.B. 67, but look for this post to be updated once the bill analysis is available.

The Ohio Legislature Creates an Alternative to the Judicial Foreclosure Process for Certain Owners of Residential Property

The D.O.L.L.A.R. Deed Program for Ohio (the “Program”) was created following the passage of Substitute House Bill 303, and went into effect on September 28, 2016 in order to provide an additional loss mitigation option for homeowners in default of their residential mortgage obligations. The acronym “D.O.L.L.A.R.” stands for Deed Over, Lender Leaseback, Agreed Finance.  Substitute House Bill 303 was unanimously passed by the Ohio legislature as a cost effective and efficient way for borrowers to avoid incurring the expense of defending a foreclosure action while trying to refinance their property and stay in their homes.  As an alternative to the judicial foreclosure process, the law is meant to combat neighborhood blight and preserve home ownership by keeping borrowers in their homes while they try to refinance their defaulted mortgage obligations.  If the refinance is unsuccessful, the property can be transferred to the lender.  This affords Borrower with the opportunity to maintain and reclaim rights and possession of their real property while they try to address their outstanding mortgage obligations.

In order to qualify for the Program, a borrower does not have to be eligible for alternative mortgage loss mitigation, but his or her front-end and back-end debt-to-income ratios must fall below the current ratios set under the Home Affordable Modification Program (“HAMP”) at the time of the application to the lender. Further, the borrower must occupy the residence.  There is no requirement for a lender to participate in the Program, but the lender must provide a written decision to the borrower within thirty days of receiving a complete application. Continue Reading

Fumiko Bandit and Check 21

Bankers know that what is commonly called Check 21 is at the heart of our present payment system. The check images delivered pursuant to its terms have made check processing simpler and faster for more than a decade.

So it may come as a surprise that basic legal questions under the Expedited Funds Availability Act (the formal name for Check 21) continue to arise. What happens for example when two of the regulations intend to implement the Act require contrary conclusions.  Such as for example, the question of the meaning of the warranty under Regulation J that an electronic check image “must accurately represent all of the information on the front and back of the original check….” when another regulation, Regulation CC, suggests that is not always required.

The question raised by the Fumiko Bandit case is the meaning of the Regulation J warranty when a paper check is imaged in the manner required by Regulation CC so the image can be presented for collection. Under Regulation CC, it is clear that some information on a paper check is not required to survive the imaging process.  But Regulation J requires check images show “all of the information” on paper checks.

The case that turn on the answer to this question started simply enough. A Chicago lawyer received an email inquiry from a new client named “Fumiko Anderson.”  She was seeking legal representation in her divorce.  The lawyer was willing to provide assistance.  One of the commentators on the ensuing litigation suggested the lawyer may have been “naive.”

Shortly thereafter the lawyer received a check from the husband in the amount of $86,176.96. The check was drawn by First Aid Corporation on its account at First American Bank.  The lawyer promptly deposited the check in his trust account, and shortly thereafter he wired “some or all” of the funds to Japan.

Later, the lawyer received a similar check but this one was in the amount of $486,750.33 which he again endorsed and deposited into his trust account. He again promptly caused “some or all” of the funds to be wired to Japan.

Litigation ensued because both of the checks were fraudulent and not properly payable. Fumiko Anderson was in fact the person or persons known to law enforcement as the “Fumiko Bandit.”

First American brought the litigation to recover its loss on the larger check which arose because it was the payor bank. Under the Uniform Commercial Code that applies in every state, the payor bank makes the basic promise that, as the bank administering the checking account, it will only pay checks written by the owner of the checking account.

So the litigation was an opportunity for First American to marshal the best legal arguments it could to recover the proceeds of the check which First Aid Corporation had forced the bank to return to First Aid’s account at First American.

What makes the case notable from a commercial law perspective is one of the arguments that First American raised in its attempt to recover its funds. It claimed that there had been a breach of the Regulation J warranty by the banks that presented for payment an electronic image of the check.  The alleged warranty breach was that the check image did not contain all of the information on the front and back of the paper check.  Had the check image been complete, First American argued, it would have caught the forgery.

The defendant banks admitted that some information was omitted in the imaging process. Their claim was that the omitted information was not required by Regulation CC and that with respect to this aspect of the Check 21 imaging process, Regulation CC trumped Regulation J.

The District Court, and ultimately the Seventh Circuit Court of Appeals, agreed there had been no breach of warranty based on the requirements of Regulation CC regarding imaging.

The basis for First American’s claim was that the electronic image of the paper check did not accurately present all of the information that was contained on the original check as Regulation CC requires. This was so, First American argued, because the check did not show watermarks, micro-printing and other physical security features.  First American argued the image of the check was poorly prepared and that some of the preprinted information describing the security characteristics of the check stock should have survived imaging.  First American argued that its personnel were trained to watch for signs of counterfeiting such as irregularities in the physical characteristics of the stock on which the check is presented.  Had the image been proper, the bank argued, it would have caught the forgery of the drawer’s signature.

The courts faced with this argument found the language in Regulation CC to be dispositive. The regulation acknowledges that some information on a paper check may not survive the imaging process and are therefore not required.  This information includes “. . . characteristics of the check, such as watermarks, micro printing, or other physical security features that cannot survive the imaging process or decorative images . . .”  12 C.F.R. Part 299, Appendix E, XXX(A)(3), regarding the imaging requirements of section 12 C. F. R. section 229.51(a).

In this case First American as the payor bank bore the loss caused by the Fumiko Bandit notwithstanding First American’s creative legal argument pitting Regulation CC against Regulation J.  The Court’s opinion is here.