| Of Interest

A&B ABstract:

On November 21, 2022, the Federal Housing Administration (“FHA”) announced a final rule to provide for the acceptance of private flood insurance in connection with FHA-insured loans.

FHA to Permit Private Flood Insurance Policies

Effective December 21, 2022, the FHA has adopted a long-awaited final rule (the “FHA Rule”) permitting the acceptance of private flood insurance policies in connection with FHA-insured loans. Proposed nearly two years ago, the regulations align requirements for the acceptance of private flood insurance for FHA-insured loans with those that apply to loans made by federally regulated financial institutions (“federally regulated lenders”).

Background

In 2012, Congress enacted the Biggert-Waters Act Flood Insurance Reform Act, amending the National Flood Insurance Act of 1968 and the Flood Disaster Protection Act of 1973 (collectively, the “Flood Act”) to clarify the obligations of federally regulated lenders to accept private flood insurance – among other provisions. Specifically, Biggert-Waters included a provision requiring the federal banking regulatory agencies – the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve, the Federal Deposit Insurance Corporation, the Farm Credit Administration, and the National Credit Union Administration (the “Agencies”) – to adopt a rule directing regulated lenders to accept private flood insurance policies meeting statutory criteria, and to notify borrowers of the availability of private flood insurance coverage as an alternative to that available through the National Flood Insurance Program (“NFIP”). The Agencies first proposed such a rule in October 2013, and finalized it in February 2019 – with the provisions taking effect on July 1 of that year.

The FHA Rule

Neither the Biggert-Waters provision addressing private flood insurance nor the Agencies’ rule on the same topic, however, applies to FHA-insured loans. As a result, as of July 2019, there existed a significant disparity between most loans made by federally regulated lenders and those insured by the FHA: Private flood insurance was an option for the former, but prohibited for the latter because it did not comport with the requirements of FHA regulations. To address the differences, in November 2020, the FHA proposed to amend its regulations (24 CFR Parts 201, 203, and 206) to permit the acceptance of private flood insurance policies and provide other clarification on mortgagees’ obligation to ensure that appropriate flood insurance coverage is in place for FHA-insured loans.

Definition of Private Flood Insurance

Amending 24 C.F.R. 203.16a, the FHA Rule mirrors the definition of “private flood insurance” found in the Agencies’ rule, which includes four prongs. First, such a policy must be issued by an insurance company that is:

- Licensed, admitted, or otherwise approved to engage in the business of insurance by the insurance regulator of the State or jurisdiction in which the property to be insured is located; or
- Recognized, or not disapproved, as a surplus lines insurer by the insurance regulator of the State or jurisdiction in which the property to be insured is located in the case of a policy of difference in conditions, multiple peril, all risk, or other blanket coverage insuring nonresidential commercial property.

Second, the policy must provide flood insurance coverage that is at least as broad as the coverage provided under an NFIP Standard Flood Insurance Policy (“SFIP”) for the same type of property, including when considering deductibles, exclusions, and conditions offered by the insurer (and as further specified in the definition).

Third, the policy must include:

- A requirement for the insurer to give written notice 45 days before cancellation or non-renewal of flood insurance coverage to the insured and the federally regulated lender that made the designated loan secured by the property covered by the flood insurance, or the servicer acting on its behalf;
- Information about the availability of flood insurance coverage under the NFIP;
- A mortgage interest clause similar to the clause contained in an SFIP; and
- A provision requiring an insured to file suit not later than one year after the date of a written denial of all or part of a claim under the policy.

Finally, the policy must contain cancellation provisions that are as restrictive as the provisions contained in an SFIP. The Agencies’ rule also gives a federally regulated lender discretion to accept a policy offered by a private insurer that does not meet all of the above criteria – such as a policy offered by a mutual aid society.

Like the Agencies’ rule, the FHA Rule includes a compliance aid intended to help mortgagees identify whether a private flood insurance policy meets the regulatory standard. The FHA Rule makes clear, however, that regardless of the presence of the compliance aid statement, a mortgagee may make its own determination of whether a private flood insurance policy meets the definition above. Unlike the Agencies’ counterpart, the FHA Rule does not provide discretion for a lender to accept a policy that does not meet the definition of (or other criteria for) private flood insurance as set forth in the rule. As a result, in its Federal Register notice of the rule adoption, the FHA emphasized that a policy acceptable under the Agencies’ rule may not satisfy the FHA standard.

Other Provisions

The FHA Rule includes other important clarifications regarding the maintenance of flood insurance on FHA-insured loans.

First, under the Flood Act and the Agencies regulations, the minimum amount of coverage that must remain in place on property securing a loan throughout the life of the loan is the lesser of: (1) the outstanding principal balance of the loan; (2) the maximum limit of coverage available for the particular type of property under the Flood Act; or (3) the insurable value of the property. The FHA Rule states that for an FHA loan, the insurable value should be calculated as “100 percent replacement cost of the insurable value of the improvements, which consists of the development of project cost less estimated land cost.”

Second, the FHA Rule clarifies the application of flood insurance obligations to Home Equity Conversion Mortgages (HECMs), adding language to mirror the loss payee and compliance aid provisions of the rule applicable to forward mortgages.

Takeaway

The FHA Rule provides long-awaited clarity for lenders, brings FHA requirements relating to the acceptance of private flood insurance policies more into line with those applicable to federally regulated lenders, and expands the options that FHA borrowers have when their properties are located in special flood hazard areas.

A&B Abstract: In an effort to incent large depository institutions to return to FHA lending, the U.S. Department of Housing and Urban Development (“HUD”) and the U.S. Department of Justice (“DOJ”) entered into a Memorandum of Understanding (“MOU”), on October 28, 2019, that delineates HUD’s process for determining whether violations of FHA guidelines should be referred to the DOJ for prosecution under the False Claims Act (“FCA”). In recent years, HUD and the DOJ have used the FCA to obtain approximately $7 billion in recoveries from FHA lenders, driving depository lenders away from FHA lending.[1] Since 2010, the percentage of FHA-insured mortgages made by these institutions has dropped from approximately 45% to below 14%.[2] The result of the MOU, according to HUD Secretary Carson, is that “[t]he monster [of the FCA] has been slayed.”[3]

An Overview of the Memorandum of Understanding

The MOU describes “HUD’s process for determining whether certain conduct by FHA-approved mortgagees should be enforced through administrative proceedings or other remedies directly available to HUD or referred to DOJ to pursue under the FCA.”[4] To do so, it details a five-step process for how FCA enforcement will be handled going forward. This process will apply to origination and servicing activities in connection with all single-family mortgage insurance programs, including forward and reverse FHA-insured mortgage loans. The MOU does not address referral of criminal activity, which is out of scope.

The Five-step Process

(1) Preference for Administrative Action – HUD will review FHA violations to determine whether they are best addressed by administrative action. “HUD expects that violations will be enforced primarily through HUD’s administrative proceedings, except when action beyond HUD’s administrative capabilities is warranted.”[5] This would potentially result in administrative fines, though any such fines would be drastically smaller than the civil liability imposed by the FCA.

(2) Referral to MRB – HUD identifies violations of FHA requirements under HUD’s Defect Taxonomy, which is the assessment methodology that categorizes violations of FHA requirements into four severity tiers. When a violation meets HUD’s FCA Evaluation Standards, as discussed below, the violation will be referred to the Mortgage Review Board (“MRB”), which is made up of senior HUD personnel, including personnel from HUD’s office of general counsel and office of the inspector general (“OIG”). The MRB will evaluate the matter for potential action under the FCA.[6] The MRB intends to refer FHA mortgagees to DOJ for potential FCA litigation where the following standards are met: (1) Tier 1 (i.e., evidence of fraudulent or materially misrepresented information about which the mortgagee knew or should have known) or equivalent violations exist in at least 15 loans or in loans with unpaid principal balance or claims of at least $2.0 million; and (2) there are aggravating factors warranting pursuit of FCA litigation, such as evidence that the violations are systemic or widespread (collectively, the “FCA Evaluation Standards”).[7]

HUD indicated that it intends to “provide a written referral for FCA litigation to DOJ for any allegations approved by the MRB.”[8] HUD’s position is that it will refer “FCA matters [to] be pursued only where such action is the most appropriate method to protect the interests of FHA’s mortgage insurance programs, would defer fraud against the United States, and would generally serve the best interests of the United States.”[9]

(3) Referred Cases – Where a party other than HUD, such as a qui tam relator (i.e., a private party) or HUD’s OIG, refers a matter to DOJ for potential FCA litigation, or DOJ directly initiates a matter that is based on alleged FHA violations, DOJ will confer with HUD prior to initiating FCA litigation. The purpose of this step is to ensure DOJ confers and works with HUD during the investigative, litigation, and settlement phases of the matter to obtain HUD’s input, such as whether HUD supports or opposes FCA litigation. Ultimately, the MOU contemplates that HUD “will make known to DOJ whether and to what extent any alleged defects or violations regarding the relevant FHA requirements are material or not material to the agency so that DOJ can determine whether the elements of the FCA can be established.”

(4) Relator Cases – Where a case is filed by a qui tam relator, HUD may recommend that DOJ seek dismissal of the case if HUD does not support the FCA litigation. Among other reasons, the MOU contemplates that HUD may recommend dismissal where the:

- Alleged conduct fails to meet the HUD FCA Evaluation Standards;
- Alleged conduct does not represent a material violation of FHA requirements; or
- Litigation threatens to interfere with HUD’s policies or the administration of its FHA lending program and dismissal would avoid these effects.

The MOU makes clear that “[w]hile the decision of whether to seek dismissal remains the exclusive authority of DOJ, DOJ will consult with HUD in making such a decision.”[10]

(5) MRB Action – Where the MRB decides to decline referral or recommends against FCA litigation, the MRB may still exercise its discretion to seek administrative action, indemnification, or civil money penalties for any FHA violations. For example, “HUD may request DOJ approval to file a complaint under the Program Fraud Civil Remedies Act.”[11]

Takeaway:

Given the focus of the MOU, institutions managing regulatory risk and the risk of potential investigations should consider whether alleged FHA violations fall within HUD’s Defect Taxonomy and, if so, whether the violations meet HUD’s FCA Evaluation Standards, as such violations will be referred to the MRB to determine whether FCA litigation is warranted.

Also, the MOU likely provides a new lens for settlement negotiations with HUD and the DOJ. Disproving systemic or widespread FHA violations could potentially take an investigation off the path towards FCA litigation, dramatically decreasing the cost of settlement.

The MOU is a significant development concerning both HUD’s and DOJ’s approach to FCA litigation. It could signal reduced FCA litigation related to violations of FHA requirements in the future. That said, even though the risk of potential FCA prosecution appears to be reduced, it is not eliminated. Accordingly, it has yet to be seen if Secretary Carson is correct in his prediction that the “monster” of the FCA has been slain.[12]

[1] Ben Lane, Housing Wire, HUD, DOJ changing use of False Claims Act in order to bring big banks back to FHA lending (referencing call with reporters by FHA Commissioner Brian Montgomery) (Oct. 28, 2019).
[2] DOJ Press Release, Departments of Justice and Housing and Urban Development Sign Interagency Memorandum on the Application of the False Claims Act (Oct. 28, 2019).
[3] Ben Lane, Housing Wire, Exclusive: HUD’s Carson on False Claims Act – “The monster has been slayed” (Oct. 28, 2019).
[4] MOU at 2.
[5] MOU at 2-3.
[6] MOU at 3.
[7] Id.
[8] Id.
[9] Id.
[10] MOU at 3-4.
[11] MOU at 4. The Program Fraud Civil Remedies Act (“PFCRA”), 31 U.S.C. §§ 3801 et seq., is an administrative remedy designed to reach cases of fraud not selected for False Claims Act cases. The PFCRA imposes civil money penalties and an assessment, of up to twice the claim amount, on “[a]ny person who makes, presents, or submits, or causes to be made, presented, or submitted, a claim that the person knows or has reason to know (A) is false, fictitious, or fraudulent; (B) includes or is supported by any written statement which asserts a material fact which is false, fictitious, or fraudulent; (C) includes or is supported by any written statement that (i) omits a material fact; (ii) is false, fictitious, or fraudulent as a result of such omission; and (iii) is a statement in which the person making, presenting, or submitting such statement has a duty to include such material fact; or (D) is for payment for the provision of property or services which the person has not provided as claimed.” 31 U.S.C. § 3802(a).
[12] See Ben Lane, Housing Wire, Exclusive: HUD’s Carson on False Claims Act – “The monster has been slayed” (Oct. 28, 2019).