The Second Circuit on Monday reversed $1.2 billion in civil penalties that had been imposed on Countrywide and Bank of America under the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA), holding that an intentional breach of contract is not fraud under the federal statutes for whose violation FIRREA provides civil penalties, unless the defendant never intended to comply with the contract in the first place. The Court of Appeals did not reach the question, also presented in the same appeal, whether a bank “harming” itself can give rise to FIRREA liability.
In United States ex rel. O’Donnell v. Countrywide Home Loans, Inc., the relator (a former Countrywide employee) brought claims against Countrywide under the False Claims Act (“FCA”), arising from those entities’ sale of loans to Fannie Mae and Freddie Mac that they allegedly knew were not of the quality promised in the relevant contracts. The claims involved a loan origination process called the “High Speed Swim Lane” or “HSSL.” The Government intervened and added claims under the Financial Institutions Reform Recovery and Enforcement Act of 1989 (“FIRREA”). The FCA claims were dismissed, and the FIRREA claims were tried to a jury, which found in favor of the Government. The District Court then imposed civil penalties of approximately $1.2 billion on the corporate defendants and $1 million against a former executive.
Section 951 of FIRREA imposes civil penalties on persons who violate any of a number of federal criminal statutes, usually in ways that affect federally insured financial institutions. In this case, the Government alleged that Countrywide and Bank of America had violated the federal wire fraud and mail fraud statutes by intentionally breaching their contracts with Fannie Mae and Freddie Mac. An essential element of each of those statutes is fraudulent intent.
The Court of Appeals held that, as at common law, a mere breach of contract—even if intentional—cannot constitute the crime of mail fraud or wire fraud. Since there was no evidence that the defendants had entered into the contracts while intending at that very time not to comply with them, there was no fraudulent intent in connection with any relevant act. The Court of Appeals noted that a contrary result would turn every intentional breach of contract into a federal crime.
The holding of O’Donnell does not extend to cases where a separate fraudulent communication is made, such as a false certification at the time each loan is sold, and explicitly leaves open the question of how fraud through silence while under a duty to disclose material information would work in the context of a contractual relationship.
The Court of Appeals also did not address the Government’s “self-affecting” theory of FIRREA liability, wherein an insured financial institution would be subject to liability for violating a federal criminal statute in a way that harmed the institution itself (where FIRREA liability requires that the fraud “affect” an insured financial institution).
The WBK Firm regularly represents companies throughout the United States in litigation, including suits under the False Claims Act and FIRREA.