On Monday, the Second Circuit overturned a jury verdict and $1.27 billion penalty against Bank of America imposed under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA), 12 U.S.C. § 1833a. Because the Government failed to demonstrate that Countrywide Home Loans, Inc. (Countrywide) intended at the time of contracting to defraud Fannie Mae through the sale of loans that were not investment quality, the Government failed to prove the level of intent required for promissory fraud. The Court held that even evidence of a willful breach of contract cannot sustain a claim sounding in fraud without proof that the defendant had a fraudulent intent not to perform at the time of signing the contract.
The civil penalties provision of FIRREA provides the Government with broad power to investigate financial institutions and seek civil penalties. The statute allows the Government to bring civil actions for violations of—or conspiracies to violate—fourteen enumerated criminal statutes. In doing so, FIRREA creates a civil cause of action for violations of these criminal statutes, reducing the requisite burden of proof to a preponderance of the evidence, rather than beyond a reasonable doubt. See 12 U.S.C. §§ 1833a(c) and (f).
In U.S. ex rel. O’Donnell v. Countrywide Home Loans, Inc., the Government intervened in a qui tam suit brought under the False Claims Act and added FIRREA claims alleging violations of the federal mail and wire fraud statutes, see 18 U.S.C. §§ 1314, 1343, in a manner affecting a federally insured financial institution. The essential elements of these federal fraud crimes are (1) a scheme to defraud, (2) money or property as the object of the scheme, and (3) use of the mails or wires to further the scheme. The Government’s allegations were based on a contract between Countrywide—a predecessor in interest of Bank of America—and Fannie Mae, wherein Countrywide represented that, “as of the date [of] transfer,” the mortgages sold by Countrywide to Fannie Mae would be an “Acceptable Investment,” or investment quality. Investment quality mortgages carry less risk and are generally considered adequately secured, therefore providing would-be purchasers with more confidence that investment quality mortgages will eventually be repaid by the borrowers.
The Second Circuit held that the common law principle of “contemporaneous fraudulent intent” is incorporated into fraud claims alleged under the federal mail and wire fraud statutes, and, accordingly, that:
“[A] contractual promise can only support a claim for fraud upon proof of fraudulent intent not to perform the promise at the time of contract execution. Absent such proof, a subsequent breach of that promise—even where willful and intentional—cannot in itself transform the promise into a fraud. . . . Thus, what matters in federal fraud cases is not reliance or injury, but the scheme designed to induce reliance on a known misrepresentation.”
The Second Circuit found that the Government had presented no evidence that Countrywide knew at the time of contracting that the mortgages it would later sell to Fannie Mae would be less than investment quality. On that basis, the Court overturned the jury’s $1.27 billion verdict against the financial institutions and remanded the case to the district court with instructions to enter judgment for the defendants. The Court found the evidence to be insufficient despite the lowered, preponderance of the evidence burden of proof under FIRREA.
Notably, despite being the first federal appellate court in the country with the opportunity, the Second Circuit declined to rule on the validity of FIRREA actions brought against financial institutions under the “self-affecting” conduct theory. This theory applies where the defendant’s actions are held to have “affect[ed] a federally insured financial institution” under FIRREA because they affected the defendant itself. Nonetheless, this opinion will be useful to financial institutions facing federal fraud allegations arising out of a contract, because the Second Circuit expressly prohibited the Government from “convert[ing] every intentional or willful breach of contract in which the mails or wires were used into criminal fraud” absent “proof that the promisor intended to deceive the promisee into entering the contractual relationship.”
