A legal take on… Pragmatic developments on lending practices

By David Bailey, partner and head of services to lenders group at SGH Martineau LLP

On 19 December 2011, the FSA delivered what must have been on many lenders’ Christmas list: its revised Mortgage Market Review consultation paper, allowing for a pragmatic approach to lenders’ responsibility  for their lending decisions.

It adopts “common sense proposals”, according to FSA’s chairman Lord Turner, which no longer seem to wipe out entire business models or exclude whole categories of borrowers.

In that context, was the High Court’s decision in the Paratus AMC v Countrywide (14 December 2011) a stocking filler or one of those presents that could usefully have come with a handy gift receipt?

The High Court addressed two issues that had been rather vexing to lenders for many years. Former lender GMAC-RFC, now Paratus, started legal proceedings against Countrywide Surveyors in 2008 for overvaluing a property.

But Countrywide’s riposte was that GMAC-RFC was guilty of contributory negligence, as its loss had essentially been caused by its own careless lending practices.

First, Countrywide argued that GMAC could not maintain a claim for its own losses, because it has assigned its cause of action by securitising the loan. The court found that: “It would... be a sorry state of affairs if an unexceptional form of securitisation such as was employed in the present case meant that losses for which a negligent valuer would otherwise have been liable became irrecoverable and [this]would lead to both injustice and commercial inconvenience.”

Secondly, the court untangled the amalgamation that has often occurred between the “sub-prime”, higher risk end of the market and the lack of diligence in implementing income checking procedures.

This is the first significant case to examine automated underwriting practices, which makes the findings even more decisive. GMAC had not carried out the income checks that were necessary, even based on its own automated lending policy. This, rather than the sole fact that the LTV exceeded 85 per cent and the borrower was self-employed, was negligent.

As the court put it: “Insofar as the allegations of contributory negligence related to a business model rather than to the application of that model on the facts of this case, I reject them. GMAC’s practice of making loans at 90 per cent LTV on a self-certified basis was certainly at the high-risk end of the market. But the evidence... shows that it was in accordance with a significant, though small, sector of the market.”

Finally, however, the court ruled that GMAC had indeed contributed to its own loss by not carrying out the proper checks and as a result would have deducted 60 per cent of any money awarded, should Countrywide have been found liable. Some industry sources (perhaps hyperbolically) have already called this a “landmark case” and commented that it will defeat the purpose of most negligence claims by lenders against advisers.

At the other end of the looking glass, it may simply be seen as a healthy clarification of what is expected of lenders, whether operating within the main market or the sub-prime: clear criteria to assess affordability, careful consideration of market conditions and believable strategies for effective repayment of the loan are all notions that transpire through the findings in Paratus - and are exactly what the revised MMR is expressly seeking to achieve.