On November 3, 2014, the U.S. District Court for the District of Columbia issued a major ruling that could ultimately change the way financial institutions look at lending compliance. As the Supreme Court readies itself to hear the same issue, the D.C. District Court vacated the Department of Housing and Urban Development's ("HUD") 2013 disparate impact rule (the "Disparate Impact Rule"), which formalized recognition of discriminatory effects liability under the Fair Housing Act (the "FHA"). The D.C. District Court in American Insurance Association v. U.S. Department of Housing and Urban Development forcefully stated that the FHA only allows for disparate treatment liability (i.e., intentional discrimination), not disparate impact liability (i.e., facially neutral practices with discriminatory effects), and that the Disparate Impact Rule was "yet another example of an Administrative Agency trying to desperately write into law that which Congress never intended to sanction."
The use of the disparate impact theory of liability has been a controversial issue for a number of years, even prior to HUD's adoption of the Disparate Impact Rule, as it does not involve intentional discrimination, but rather the discriminatory effects of a policy or practice. Under the disparate impact theory, if a financial institution's lending policies or practices, which are facially neutral and applied equally to all individuals, disproportionately affect members of a protected class, that financial institution may be liable to those affected even though the financial institution did not intend to discriminate. Conversely, the disparate treatment theory of liability requires a showing that the financial institution intentionally discriminated against a protected class.
The distinction between these two theories is one that impacts all financial institutions and is heavily relied on by the federal enforcement agencies. In just the past three years, the U.S. Department of Justice (the "DOJ"), in conjunction with the federal banking agencies and the Consumer Financial Protection Bureau (the "CFPB"), commenced a significant number of fair lending investigations, primarily relying on the disparate impact theory of liability. Moreover, the CFPB has indicated that fair lending enforcement is a top priority and that it will use all available legal avenues, including disparate impact, in meeting that priority. This aggressive enforcement environment is having a profound impact on financial institutions as they grapple with how to allocate compliance spending and how to cover the immense costs of defending a fair lending investigation and the potential reputational damages resulting from such an investigation.
In October of 2014, the Supreme Court accepted review of Texas Department of Housing and Community Affairs v. Inclusive Communities Project, Inc., where the Court will hear arguments on whether the FHA recognizes a disparate impact theory of liability. The D.C. District Court's ruling may impact the Supreme Court's upcoming decision on the same issue. Should the Supreme Court reach the same conclusion as that reached by the D.C. District Court, the federal enforcement agencies would be prohibited from using of the disparate impact theory of liability under the FHA in all U.S. jurisdictions.
Although the D.C. District Court's ruling does not specifically address the Equal Credit Opportunity Act (the "ECOA") or the permissibility of disparate impact liability under the ECOA, it is likely that the D.C. District Court's rationale would also apply to the ECOA since the ECOA, like the FHA, does not contain disparate impact language. Both the CFPB and DOJ have publicly taken the position that disparate impact claims can be brought under the ECOA. The application of the D.C. District Court's ruling to both of these statutes or a ruling on the issue by the Supreme Court will be an important issue to watch moving forward.
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