California Federal District Court Affirms Lender's Sole Discretion to Change Rate Index for ARM Loan

Mortgage Origination Mortgage Servicing Class Action Preemption

On October 3, the U.S. District Court for the Northern District of California held that a lender had no duty to abandon the index to which certain adjustable rate mortgage rates were tied when the index experienced an unprecedented jump. Haggarty v. Wells Fargo Bank, N.A., No 10-02416, 2012 WL 4742815 (N.D. Cal. Oct. 3, 2012). The borrowers, who had entered into two adjustable rate mortgages, sued the lender when their rates increased substantially following a jump in the index to which the adjustable rates were tied. On behalf of themselves and a putative class, the borrowers claimed that the bank breached an implied covenant of good faith and fair dealing by failing to substitute a new index under a clause in the Notes that allowed the lender to choose a new index if the original index was “substantially recalculated.” The court held that the Note language granting the lender ”sole discretion” to determine whether the index had been substantially recalculated insulated the lender from claims that it was required to reach a certain conclusion about the index and the need to substitute a new index. Further, the court held that the borrowers’ attempt to use implied covenants to add contract terms or establish a breach was preempted by the Home Owners’ Loan Act, which in relevant part was intended to avoid inconsistent obligations for lenders regarding interest rate adjustments. The court granted summary judgment in favor of the lender.