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'Hustle' Case Reversed: BofA Escapes $1.3 Billion Penalty

By Jonathan R. Tung, Esq. on May 27, 2016 12:58 PM

The Second Circuit just handed Bank of America a huge win when it reversed the trial court's order for the mortgage lender to pay up to the tune of $1.27 billion. This penalty was initially ordered for alleged violations by its Countryside unit when the mortgage-crisis reached a fever pitch. The case became known as the "Hustle" case because of its focus on the banking industry tactic of continuing to issue bad loans despite their quality.

The case is a curious one and is sure to infuriate now disbanded members of "Occupy Wall Street." In the opinion of Michael Hiltzik of the L.A. Times, the decision amounted to a kangaroo decision that turned on the following issue: "When is a fraud not a fraud, but just, sort of, a lie?"

"High Speed Swim Lane"

Back when Federal District Court Judge Jed S. Rakoff oversaw the case, it was determined that BofA set up a mortgage-mill program called the "High Speed Swim Lane" (HSSL), a bank "hustle" program that encouraged the issuing of low-quality mortgages and selling those loans to Fannie and Freddie despite the dangers.

Rakoff concluded that BofA's head Rebecca Mairone threw caution and all the traditional quality-control due diligence QC protocols to the wind when the company substantially pulled back on the use of traditional underwriters to "volume focused loan specialists" who were encouraged to pull out commission-reducing software, allowing approval and turnaround time to be chopped down to as low as two weeks.

In Rakoff's view, this practice of placing volume over quality was telling. When the dust settled, approximately 42 percent of the loans were "materially defective," and yet were still represented by BofA and Countrywide as being "investment quality."

Circuit Reverses

Despite Rakoff's scathing words and analysis, the circuit largely ignored the settled issues of whether or not BofA sold junk-mortgages to Fannie and Freddie, and reversed on the theory of fraud.

The circuit judges called the case before them "hyper-technical" and actually saw the facts as one implicating contract law rather than fraud -- a difference, really, that makes a distinction between goldenrod and mustard. The view of the circuit was that BofA officials who signed the contracts didn't intend for everything to go south -- it was just coincidence and bad luck.

Breach Versus Punitive Damages

Any attorney understands that damages associated with breach of contract are far lower than for fraud, the latter of which generally requires willfulness and some part of bad faith. In most cases of breach, damages are calculated either through the expectation measure as well as consequential and foreseeable damages. In the case of fraud, the potential damages must also include punitive hits. The circuit's reversal essentially unhooks BofA for billions.

Grand Enabling

The case shines a light on that gray area that exists between contract law and fraud -- willful breach of contract with intent to defraud. As far as large institutions are concerned, the contract represents a coupon for all sorts of bad-faith business dealings. Instead of defrauding another party into entering into a losing relationship, a party can defend itself easily by producing a contract and arguing that it merely breached its terms.

In a strange way, one can almost feel for courts, hemmed in by precedent, unable to set an example for public policy. And then what happens? New laws get created at the legislative level that more often than not make things worse than make them better.

So, the analysis goes like this: willfully defraud (or at least, recklessly do business) and pocket the proceeds. If everything goes well, everybody "wins." If someone sues, the circuit's decision means the plaintiff has no cause of action for fraud if you were prescient enough to execute a contract. If you lose, then you need only disgorge the profits. There's no ultimate out of pocket save time and tiny litigation expenses. Who doesn't love that sort of business arrangement?

Still, the DOJ has managed to take a chunk of skin out of BofA before -- the largest federal settlement in Wall Street history.

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