Finance Commission of Texas v. Norwood: SettlePou appears as Amicus for Mortgage Lending Clients

Author: Barry D. Johnson, Bradley E. McLain, and Kristina A. Kiik

Recently, the Texas Supreme Court issued a Supplemental Opinion on a Motion for Rehearing, clarifying the rules relating to Texas home equity loans. SettlePou participated in this case – known as Norwood II – on behalf of two mortgage lending clients, appearing as a friend of the court. Norwood II clarifies that “loan discount” points can be treated as “interest” and accordingly can be charged at the closing of a home equity loan and somewhat liberalizes the use of powers of attorney in connection with home equity closings.

Texas has a long-standing tradition of protecting the homestead against creditors, including special protections memorialized in the state constitution. In 1998 the Texas Constitution was amended to allow for home equity loans. These loans were subject to over twenty-six specific restrictions. The Finance Commission was authorized to issue “Regulatory Authority” to interpret these restrictions and it is this regulatory authority which was challenged in the Norwood case. Norwood focused on two aspects of these regulations: (1) whether “interest” items paid at closing were included in a 3% limit on fees payable by the customer at closing, and (2) whether a home equity loan could be signed by an agent under a power of attorney.

As a threshold matter, the Home Equity Amendment known as Section 50(a)(a)(6) of the Texas Constitution prevents the borrower from being charged more than three percent in fees and third-party costs in connection with such loans, excluding from that 3% certain amounts such as “interest.” Likewise the Home Equity Amendment requires that a home equity loan can only be “closed” in the office of the lender, attorney, or title company. The Finance Commission issued interpretations of the Equity Amendment which, among other matters, asserted that the word “interest” as used in the Amendment had the same meaning as “interest” defined in the Texas Finance Code. The Finance Commission also issued a regulation which allowed a borrower to use a power of attorney to allow an agent to attend closing at one of the three authorized locations.

After the Finance Commission passed these regulations they were challenged by a group of consumers seeking to invalidate the regulations and the Norwood case began a long and twisting path through the Texas Court system.

In 2010, the Austin Court of Appeals upheld a 2005 district court decision striking down the Finance Commission’s interpretation of what constitutes “interest” for purposes of the 3% fee cap. The Austin Court of Appeals reasoned that including lender-retained fees would render the 3% cap meaningless. The appellate court, however, did not say that per diem interest and discount points are not interest, and must be included in determining the amount of fees and charges limited by the 3% cap. Rather, it invalidated the rule that specifically included per diem interest and discount points in the definition of what is “interest” and provided a safe harbor for the lender.

In Norwood I (the original Texas Supreme Court opinion), the Texas Supreme Court affirmed the appellate decision regarding discount points. The Court reasoned that such an interpretation allowing the legislature to define interest would permit the legislature to periodically modify that definition, thereby defeating the purpose of the constitutional home equity lending fee cap, which could only be amended by popular vote. The Court also noted that the definition of interest was modified to include lender-retained fees after the regulations became effective. The Court found that interest for purposes of the home equity lending provisions should be the general meaning of “interest,” or the amount calculated by multiplying the interest rate by the principal balance.

Section 50(a)(6)(E) caps fees to any person that are necessary to originate, evaluate, maintain, record, insure, or service the extension of credit at 3% of principal. The Court considered whether the Commission correctly gave “interest” the same meaning as Section 301.002(a)(4) of the Texas Finance Code, which includes fees paid to the lender, thereby removing lender fees from the 3% fee cap. The court of appeals had held the Commission did not give the correct meaning to “interest,” reasoning that the statutory definition of interest is purposely broad to protect borrowers from usury.

The Texas Supreme Court held that, according to the Commission the meaning of “interest” is as defined in Section 301.002(a)(4) of the Texas Finance Code and as interpreted by the courts. The Court stated that the flaw with the Commission’s interpretation is that it did not merely adopt the substance of the statute at the time the interpretation became effective, but also adopted whatever definition of “interest” the Legislature may enact from time to time. The Court further stated that the Commission acknowledged that the legislature could change the effect of its interpretation and the meaning of Section 50(a)(6)(E) simply by amending the statute, and that this actually happened.

In overturning the Commission’s regulations with regard to the fee cap, the Court held that, consistent with the history, purpose, and text of Section 50(a)(6)(E), “interest” means “the amount determined by multiplying the loan principal by the interest rate.” A footnote indirectly addresses discount points, noting that this narrower definition of interest does not limit the amount a lender can charge for a loan; rather, it limits only what part of the total charge can be paid in front-end fees rather than interest paid over time. Lenders are now incentivized to determine borrowers’ creditworthiness more carefully and help borrowers better assess the costs of credit.

The Norwood decision extended beyond a discussion of “interest” and “discount points.” The Court also invalidated regulations interpreting the constitutional requirement that a home equity loan be closed only at the office of the lender, an attorney at law, or a title company to mean that the borrower could consent to the creation of a lien on the homestead by mailing the lender the required consent or attend the closing through an attorney-in-fact. Here, the Court focused on the idea that a power of attorney could be executed anywhere (specifically not in one of the three authorized locations for closing) and used to close a home equity loan.

The Court reasoned that this regulation defeated the purpose of the provision that was implemented to prohibit the coercive closing of an equity loan at the owner’s home. Further, the Court upheld a regulation establishing a rebuttable presumption that the notice prescribed in Texas Constitution Article XVI, Section 50(g), is received three days after it is mailed.

After the Court issued the Norwood I opinion, the Finance Commission asked the court to “rehear” the case as allowed under Texas law. In essence a motion for rehearing tells the court that it made a mistake or failed to fully understand all of the issues. Given that the court has decided a case, they seldom agree to rehear a case. At this stage in the proceedings, SettlePou was engaged to appear as an “amicus,” or friend of the court (a party interested in the proceedings, but not a party to them), to urge the court to reconsider the holding of Norwood I.

The Texas Supreme Court took the motion for rehearing under advisement and in January issued a “Supplemental Opinion” (Norwood II) adopting in part the argument made by SettlePou and other parties aligned with the Finance Commission. Norwood II clarifies the prior Norwood I decision in two important aspects.

First, Norwood II clarifies when a charge is “interest” and when it is a “fee.” Per diem interest charged at closing is categorically classified as “interest” and therefore excluded from the calculation of the 3% fee cap. Of greater import, the Supreme Court held that “bona fide” loan discount points are likewise excluded from the 3% fee cap. A “bona fide” loan discount point is a concept borrowed from the Consumer Financial Protection Bureau regulations, but essentially is a loan discount point charge which actually reduces the loan interest rate by some predetermined formula. The Court recognized that consumers, when closing a mortgage loan of any type, choose between a slurry of closing costs and mortgage note rates. Generally, the more the consumer is willing to pay at closing, the lower their note rate will be. While the court did not adopt a “bright line” rule allowing anything called “loan discount points” to be excluded from the borrower charge, the Court did allow lenders and consumers to negotiate the payment of discount points as part of the tradeoff between closing costs and interest rates. Going forward, a lender will need to carefully document their origination files to show that discount points paid at closing resulted in a lower mortgage note rate.

The second part of Norwood II related to powers of attorney. While Norwood II did not reverse what was done in Norwood I, the Court met the industry at least half way. The Court recognized certain situations where the use of a power of attorney would be appropriate for closing a home equity loan. Therefore, powers of attorney can be used in connection with a home equity closing in certain instances. Nevertheless, the Court also noted that the Home Equity Amendment contemplates a certain “gravity” to a home equity loan closing. Accordingly, Norwood II requires powers of attorney used in connection with a loan closing to be executed in one of the three places authorized for loan closings.

Norwood II represents a significant victory for the mortgage lending community by allowing flexible loan pricing and consumer choice. SettlePou was proud to be a part of this landmark holding on behalf of our mortgage banking clients. The matter was handled by shareholder Barry D. Johnson, who heads the firm’s Consumer Finance practice and is also a member of the firm’s Commercial Lending practice, and associates Brad McLain and Kristina Kiik, both of whom work in the firm’s Commercial Litigation and Financial Services Litigation practices.