Thomas P. Vartanian, Robert H. Ledig and Alisa Babitz*

The Fifth and Ninth Circuit Court of Appeals have each recently issued opinions which are relevant to fair lending litigation. In each case, the appellate court reversed a lower court of agency ruling that the defendant(s) had illegally discriminated against the plaintiff(s) and the award of monetary damages to the plaintiff(s). The decision provides important guidance as to the standards these circuits will apply in cases involving allegations of discrimination under the Fair Housing Act ("FHA") based on a theory of disparate impact.

In Simms v. First Gibraltar Bank, the Fifth Circuit reversed a decision by the district court that First Gibraltar Bank's ("Gibraltar") refusal to issue a commitment letter to refinance its existing loan on the plaintiff's property constituted intentional discrimination based on race and had a disparate impact on minorities in violation of the FHA. Simms v. First Gibraltar Bank, 83F.3rd 1546 (5th Cir. 1996). The district court had awarded $1.21 million in compensatory damages and $2 million in punitive damages to the plaintiff, a white landlord. The plaintiff alleged that Gibraltar refused to issue the commitment letter because it did not want to issue a loan to a co-op that was in a minority area and would probably be minority owned.

The Fifth Circuit held that because the plaintiff presented no evidence that race was a factor in Gibraltar's refusal to give him the commitment letter, a jury could not reasonably infer that race a was significant factor in Gibraltar's decision and that the bank had intentionally discriminated against him. The plaintiff also alleged that Gibraltar's denial of his application had a disparate impact on minorities because almost all of the prospective owners of the cooperative units were minorities and the cooperative project would have benefited the predominantly minority community in which it was located. However, the Fifth Circuit stated that "[t]he relevant question in a discriminatory effects claim against a private defendant, however, is not whether a single act or decision by the defendant has a significantly greater impact on members of a protected class, but instead the question is whether a policy, procedure, or practice specifically identified by the plaintiff has a significantly greater discriminatory impact on members of a protected class." Because the plaintiff failed to identify any such policy, procedure or practice, the Fifth Circuit held that he did not present sufficient evidence to establish a violation of the FHA under a discriminatory effects theory.

In Pfaff v. U.S. Department of Housing and Urban Development, the Ninth Circuit reversed the decision of an Administrative Law Judge (an "ALJ") finding that the defendants' facially neutral numerical occupance restriction illegally discriminates against families with children. Pfaff v. U.S. Department of Housing and Urban Development, 1996 U.S. App. LEXIS 15770 (9th Cir, 1996). The ALJ had awarded approximately $24,000 in compensatory damages and assessed a civil penalty of $8,000 against the defendants, who are private landlords. The Ninth Circuit held that the Department of Housing and Urban Development ("HUD") had acted arbitrarily and capriciously when it brought an enforcement action against the defendants and the HUD ALJ required them to prove that their numerical occupance limit was a "compelling business necessity," and to show that this limit was the least restrictive means to achieve that end.

The compelling business necessity standard was announced by the Secretary of HUD in HUD v. Mountain Side Mobile Estates, 2 Fair Housing-Fair Lending (P-H) 25.053 (HUD Sec'y, July 19, 1993) but ultimately rejected by the Tenth Circuit, which ruled instead that a defendant must demonstrate that the allegedly discriminatory practice has a "manifest relationship" to the housing in question. Mountain Side Mobile Estates v. HUD, 56 F.3rd 1243 (10th Cir. 1995). Like the Tenth Circuit, the Ninth Circuit, in this instance, rejected the compelling business necessity standard, concluding the HUD's application of this standard was an abrupt departure from previous statements that occupancy requirements based on factors such as the number of bedrooms in a dwelling unit would be judged against a "reasonableness" standard. The Ninth Circuit also criticized HUD for failing to provide guidance adequate to enable the public to comply with the Fair Housing Act.

As attention continues to be focused on fair lending issues, lenders are increasingly likely to be faced with claims that facially neutral practices that are used in their loan underwriting process have a disparate impact on a particular protected group or groups, a form of proof that has been widely interpreted not to require any showing of intent. The Simms, Pfaff and Mountainside cases indicate that Courts of Appeals appear inclined to look carefully at the standards used to support such claims of discrimination in the absence of direct evidence or an inference of an intent to illegally discriminate among loan applicants.

* Messrs. Vartanian and Ledig are partners and Ms. Babitz is an associate in the Washington, D.C. office of Fried, Frank, Harris, Shriver & Jacobson. Mr. Vartanian was formerly General Counsel of the Federal Home Loan Bank Board and is a member of the Advisory Board of the Electronic Banking Law and Commerce Report. The authors are co-authors of a recently published book, The Fair Lending Guide.