The first wave of class actions relating to the COVID-19 pandemic is here, including a number of cases concerning so-called “gating” eligibility rules that are legitimately applied by many lenders to manage the flow of applications for the U.S. Small Business Administration (SBA) Paycheck Protection Program (PPP). We expect these lawsuits will face serious difficulties in the days ahead, but the filings already show that industry responses to the pandemic will be closely scrutinized.
As financial institutions prepare to process and fund a new round of PPP applications, they should be aware there are already indications that subsequent litigation waves may focus on whether minority group consumers or businesses are being disproportionately and adversely impacted by COVID-19-related changes in business practice. This is the first of several client alerts that will highlight fair lending issues that may arise in this rapidly changing business and compliance environment. This alert focuses on fair lending issues in connection with PPP loan applications, and provides practical advice on how to mitigate those risks in real time.
APPLICATION OF FAIR LENDING LAWS: A BRIEF REFRESHER
In light of challenges posed by the pandemic, regulators have already begun giving leniency and regulatory relief to lenders. For example, the Consumer Financial Protection Bureau (CFPB) has temporarily lifted requirements for large lenders to report Home Mortgage Disclosure Act (HMDA) data quarterly, and bank regulators have provided flexibility to banks in the classification of troubled loans if the bank works with borrowers to provide a modification or payment plan.
But financial institutions should expect increasing public and regulatory scrutiny as to how they are meeting their fair lending obligations under statutes such as the Equal Credit Opportunity Act (ECOA), the Fair Housing Act (FHA), and the Dodd-Frank Act’s rule against unfair, deceptive, or abusive acts or practices (UDAAP).
- ECOA. The ECOA, which applies to all creditors and most loan servicers, prohibits discouraging or discriminating against any applicant – both consumer and commercial – on a prohibited basis with respect to any aspect of a credit transaction. The ECOA also sets forth specific requirements for how lenders and loan servicers must respond to applications for credit from both consumers and businesses – an increasingly prevalent issue given current conditions –including requests for new credit under the PPP.
- FHA. The FHA prohibits discrimination of individuals when they are renting or buying a home, obtaining a mortgage, seeking housing assistance, or engaging in other housing-related activities, including seeking modification to existing housing credit. Even where a transaction is not covered by the statute, the FHA has been the most fertile area of fair lending study, enforcement, and litigation, so its precedents and lessons are always instructive in considering fair lending issues.
- UDAAP. Even where a lending practice does not violate a statutory requirement, it may be challenged by regulators and private litigants under a UDAAP theory that a practice is harmul or likely to harm consumers.
FAIR LENDING ISSUES WITH RESPECT TO PROCESSING PPP LOAN APPLICATIONS
On April 3, 2020, just a week after the CARES Act was signed into law, the SBA opened up its portal to accept PPP loan applications. Fourteen days later, the $349 billion in PPP funds was committed. On April 23, 2020, an additional $310 billion was appropriated to the PPP (PPP Round 2).
Struggling to manage the deluge of applications, and rapidly changing guidance from Treasury and the SBA, many lenders have implemented what is being referred to generally as “gating” requirements for PPP loan applications. These standards, including prioritizing existing customers or customers without other existing lending relationships, are said to limit the identity of businesses who can apply for a PPP loan with the lender.
It is not facially inappropriate for lenders to implement such gating or preference approaches, and there are very strong justifications for implementing gating or preference approaches, including that participation as a lender in the PPP program is voluntary, and there is no express prohibition on gating. Nonetheless, restricting applications or the prioritization of some applications over others introduces the risk that not all similarly situated businesses will be treated the same, and facially neutral policies such as these might be said to have a disparate impact on women- or minority-owned businesses.
As financial institutions process PPP Round 2 loan applications, we recommend the following to mitigate potential fair lending risks:
- Evaluate. The SBA and the federal banking regulators have granted financial institutions leeway in how they process PPP applications. Carefully consider whether policies or practices for processing and “stacking” PPP loan applications could result in a potential racial or gender disparity because of existing disparities relating to geography or credit background issues. Consider whether you should adjust your policies to mitigate any potential risks.
- Document. Actively document in written policies the legitimate business justifications for the policies in order to create a contemporaneous record and avoid any subsequent claims of after-the-fact justifications being created. We recognize that with the scope and speed of execution of the PPP, financial institutions may not have the ability to create an exhaustive record, but even a brief written record (such an email memorandum to relevant decisionmakers reflecting the rationale for any prioritization method) could prove helpful down the road.
- Communicate. Actively communicate with federal and/or state regulators about PPP loan processing policies and practices, underlying business justifications, and mitigation efforts.
- Monitor. After you enact your policies, closely scrutinize any complaints you receive and continue to monitor how the policies are affecting your customers, including whether they are having any unintended effects or whether further mitigation efforts are appropriate.
There are, of course, a wide variety of legitimate business needs that justify application prioritization, such as limited resources at the financial institution, the availability of capital, Know Your Customer obligations, fraud protection, uncertainty with program operation, and a financial institution’s lending focus, like a community bank lending to smaller clientele. Whatever the legitimate business objective, financial institutions should look to produce strategically worded, contemporaneous documentation of their decision-making, combined with active monitoring of the new program, to mitigate the risk that some aspect of the lending process may result in an unforeseen disparate impact in violation of Federal fair lending laws.