The U.S. Department of Housing and Urban Development (“HUD”) issued a final rule (“Rule”) on February 8, 2013, which provides additional support to potential government and private plaintiffs seeking to challenge “facially neutral” practices as violations of the Fair Housing Act (“FHA”). At the same time, it declined to provide any meaningful guidance to lenders, insurers or landlords as to practices that would likely be protected from liability. HUD’s action follows a rare action by the Department of Justice to pursue a fair lending claim based on a disparate impact theory. See our DechertOnPoint, U.S. Department of Justice Turns Spotlight on Disparate Impact Claims.
HUD’s action comes at a time when lenders are concerned about the fair lending issues that they will face as they make decisions as to how they will structure their residential mortgage lending activities once those operations become subject in January 2014 to the three-category approach (Qualified Mortgage (“QM”) safe harbor, QM rebuttable presumption, and non-QM) to the ability-to-repay requirements that were recently established by the Consumer Financial Protection Bureau. See our DechertOnPoint, U.S. Consumer Financial Protection Bureau Issues Rules on Qualified Mortgages and Ability to Repay.
HUD’s Rulemaking Proceeding
In issuing the Rule, HUD stressed that its position was supported by decisions of the 11 federal courts of appeals that have considered whether FHA liability can be established based on disparate impact. HUD noted that there were certain differences in the approaches that the courts of appeals have taken in applying a burden-shifting test used in regard to disparate impact claims, and took the position that all parties would benefit from a regulatory statement explaining how disparate impact claims should be evaluated.
HUD’s Rule was strongly opposed by industry representatives, including the American Bankers Association. At the time the Rule was proposed, the Supreme Court had agreed to hear an appeal by the city of Saint Paul, Minnesota which would have challenged the use of disparate impact under the FHA in connection with a challenge by landlords to the city’s housing code enforcement practices. The city then asked the Court to dismiss the case, which the Court did on February 10, 2012. The city explained its action by stating that national civil rights organizations believe that if the city were to prevail before the Court, such a result could completely eliminate disparate impact civil rights enforcement, including under the FHA and the Equal Credit Opportunity Act. The Supreme Court is currently considering whether to hear a similar challenge by the town of Mount Holly, New Jersey to the use of disparate impact discrimination in an FHA action.
HUD’s Burden-Shifting Formula
The Rule sets out a three-step approach to determining FHA liability.
Step One – Plaintiff Has a Burden to Demonstrate That a Practice Has a Discriminatory Effect
Liability may be established based on a practice’s discriminatory effect, even if the practice was not motivated by a discriminatory intent.
A charging party or plaintiff (“Plaintiff”) has the burden of proving that a challenged practice caused or predictably will cause a discriminatory effect.
A practice has a discriminatory effect where it actually or predictably results in a disparate impact on a group of persons or creates, increases, reinforces, or perpetuates segregated housing patterns because of race, color, religion, sex, handicap, familial status, or national origin.
Step Two – Defendant Must Provide a Legally Sufficient Justification For the Challenged Practice
Once a Plaintiff demonstrates that a practice has a discriminatory effect, the burden shifts to the responding party or defendant (“Defendant”).
The Defendant must prove that there is a legally sufficient justification for the challenged practice.
Under the Rule, a legally sufficient justification exists where the Defendant demonstrates that the challenged practice is (i) necessary to achieve one or more substantial, legitimate, nondiscriminatory interests of the Defendant, and (ii) those interests could not be served by another practice that has a less discriminatory effect.
Step Three – Plaintiff May Still Prevail By Showing That Another Practice With a Less Discriminatory Effect Could Be Used
If the Defendant satisfies its burden under Step Two, the burden shifts to the Plaintiff.
In order to prevail, the Plaintiff must prove that the substantial, legitimate, nondiscriminatory interests supporting the challenged practice could be served by another practice with a less discriminatory effect.
In the preamble to the final Rule, HUD acknowledged receiving numerous comments seeking clarification as to circumstances under which lenders would be subject to or protected from liability. HUD generally rebuffed these requests, indicating in effect that the unique facts and circumstances of each case would be subject to judicial consideration under the three-part balancing test.
As a practical matter, lenders and other parties likely would prefer regulatory assurance that their practices will not be deemed to be in violation of the FHA, rather than potentially having to defend particular practices that do not have a discriminatory intent in an expensive, lengthy court proceeding.
Level of Proof to Demonstrate a Discriminatory Effect
Commenters sought guidance as to what type of impact a practice would have to have in order for it to be deemed to violate the FHA. One commenter suggested defining a disparate impact as a 20 percent difference between relevant groups.
HUD declined to provide the requested guidance. It noted that in order to establish a prima facie case, the Plaintiff must show that members of a protected class are disproportionately burdened by the challenged practice. HUD, however, expressed the view that whether a practice results in a discriminatory effect is a fact-specific inquiry.
What Constitutes a Legally Sufficient Justification
The central issue facing lenders is what will be considered to be a practice that is necessary to achieve one or more substantial, legitimate, nondiscriminatory interests of the lender. In this regard, HUD explained that it considers a “substantial” interest to be a core interest of an organization that has a direct relationship to the function of that organization.
HUD noted that commenters requested that the Rule expressly state that increasing profits, minimizing costs, and increasing market share qualify as legitimate, nondiscriminatory interests and that the Rule include tenant screening criteria (such as rental history, credit checks and income verification) as practices that would be presumed to qualify as a legally sufficient justification.
HUD again declined to provide the requested assurances. It stated that the determination of what qualifies as a substantial, legitimate, nondiscriminatory interest for a given organization is fact-specific and must be determined on a case-by-case basis. Accordingly, it declined to provide examples of what it described as interests that would always qualify as substantial, legitimate, nondiscriminatory interests for every Defendant in any context.
In this regard, it should be noted that in the 1994 Joint Policy Statement on Discrimination (“Statement”) issued by ten federal regulatory agencies, including HUD, the agencies noted that a finding of disparate impact could be overcome by a determination that the challenged practice is justified as a “business necessity.” The Statement noted that factors that “may be relevant to a justification could include cost and profitability.”1
Application of Discriminatory Effects Liability
HUD noted that commenters raised concerns that the ability-to-repay requirements and qualified residential mortgage provisions of the Dodd-Frank Act may result in disparate impacts because of demographic differences. It also noted that a commenter stated that a lender’s consideration of credit scores or debt-to-income ratios could have a disparate impact because of demographic differences.
HUD downplayed these concerns. It stated that it did not believe that the Rule would encourage lawsuits challenging credit scores, other credit assessment standards, or the requirements of the Dodd-Frank Act. HUD based this view on the ground that the Rule does not change the substantive law recognizing discriminatory effects liability which has long been in effect.