On June 25, 2015, nearly four years after first agreeing to consider the question, the Supreme Court issued a decision holding that disparate impact claims are cognizable under the Fair Housing Act (FHA). Texas Dep't of Housing and Community Affairs v. Inclusive Communities Project, Inc., 576 U.S. __, 2015 WL 2473449 (2015).1 By a 5-4 vote, the Court concluded that Congress intended the FHA to permit claims of housing discrimination, including discrimination in residential real estate-related transactions such as mortgage lending, even where there is no evidence of discriminatory intent. Affirming the decision of the Fifth Circuit, the Court embraced the theory that, irrespective of such intent, a defendant may be held liable for a practice that, in effect, has an adverse impact on members of a particular racial, religious, or other statutorily protected class.
From one perspective, the Court's ruling is no surprise: almost all of the federal circuit courts and the US Department of Housing and Urban Development (HUD) have taken the position that the FHA permits disparate impact claims. On the other hand, the Supreme Court's grant of review in the case (and the two preceding similar cases) suggested a possible outcome to the contrary. As it turned out, the justices split in a predictable lineup, with Justices Breyer, Ginsburg, Kagan, and Sotomayor joining in Justice Kennedy's majority opinion, Justice Thomas dissenting independently, and Justices Roberts and Scalia joining in a dissent authored by Justice Alito.
Inclusive Communities, now remanded for further proceedings, does not involve financial institutions; however, both the holding and the reasoning of the Court's opinion offer guidance for banks, nonbank mortgage and consumer lenders, indirect purchasers of loans, loan servicers, and insurers as they consider the scrutiny to which their practices and policies may be put for fair lending and underwriting compliance purposes. Not only HUD, but also the federal banking agencies, the Consumer Financial Protection Bureau (CFPB), and the US Department of Justice (DOJ), have relied on the disparate impact theory of liability -- under the FHA as well as the Equal Credit Opportunity Act (ECOA) and its implementing Regulation B -- when reviewing a lender's business practices and lending portfolio.
The Court's decision approves of the disparate impact burden-shifting approach established in HUD's disparate impact rule2 and may lead other agencies to align themselves formally with that approach. Under that approach, as described in the Court's opinion, a complainant or plaintiff first bears the burden of demonstrating a prima facie case of disparate impact (typically through evidence of statistical disparities on a protected-class basis). Assuming that burden is met, it then is incumbent on the respondent/defendant to show that the challenged practice is necessary to achieve one or more substantial, legitimate, nondiscriminatory interests. If the respondent/defendant succeeds in that showing, the complainant/plaintiff may still establish liability by demonstrating that these substantial, legitimate, nondiscriminatory interests could be served by a practice that has a less discriminatory effect.
In its opinion, the Court provided a number of key indications as to what it expects of the lower courts in adjudicating disparate impact claims. The Court's statements to this effect reflect consideration of arguments made not only by the parties in Inclusive Communities, but also the many amici curiae entities who filed briefs with the Court. These statements merit note in considering arguments that might be made in litigation over disparate impact claims. For example, the Court made the following points:
- "[A] disparate-impact claim that relies on a statistical disparity must fail if the plaintiff cannot point to a defendant's policy or policies causing that disparity. A robust causality requirement ensures that '[r]acial imbalance ... does not, without more, establish a prima facie case of disparate impact' and thus protects defendants from being held liable for racial disparities they did not create. . . . Without adequate safeguards at the prima facie stage, disparate-impact liability might cause race to be used and considered in a pervasive way and 'would almost inexorably lead' governmental or private entities to use 'numerical quotas,' and serious constitutional questions then could arise."3
- "Courts must therefore examine with care whether a plaintiff has made out a prima facie case of disparate impact and prompt resolution of these cases is important. A plaintiff who fails to allege facts at the pleading stage or produce statistical evidence demonstrating a causal connection cannot make out a prima facie case of disparate impact. For instance, a plaintiff challenging the decision of a private developer to construct a new building in one location rather than another will not easily be able to show this is a policy causing a disparate impact because such a one-time decision may not be a policy at all. It may also be difficult to establish causation because of the multiple factors that go into investment decisions about where to construct or renovate housing units." 4
- "Governmental or private policies are not contrary to the disparate-impact requirement unless they are 'artificial, arbitrary, and unnecessary barriers.' Difficult questions might rise if disparate-impact liability under the FHA caused race to be used and considered in a pervasive and explicit manner to justify governmental or private actions that, in fact, tend to perpetuate race-based considerations rather than move beyond them. Courts should avoid interpreting disparate-impact liability to be so expansive as to inject racial considerations into every housing decision."5
- "While the automatic or pervasive injection of race into public and private transactions covered by the FHA has special dangers, it is also true that race may be considered in certain circumstances and in a proper fashion."6
- "[D]isparate-impact liability must be limited so employers and other regulated entities are able to make the practical business choices and profit-related decisions that sustain a vibrant and dynamic free-enterprise system. And before rejecting a business justification . . . a court must determine that a plaintiff has shown that there is " 'an available alternative ... practice that has less disparate impact and serves the [entity's] legitimate needs.' "7
These statements could be salient in litigation before both administrative agencies and courts. But avoiding litigation in the first instance deserves priority attention. Experience has shown that proactive steps taken by financial institutions can protect against possible disparate impact claims. Those steps include, for example:
- Internal Audits. Internal testing of a wide range of policies and practices that are race-neutral in intent but could have a disparate impact along racial lines. Financial institutions should be proactive in identifying areas of susceptibility to statistical challenge. One of the most reliable methods of doing so is to conduct routine statistical self-assessments on a portfolio-wide basis, appropriately structured to ensure the attorney-client privilege will apply. Institutions should conduct periodic assessments, analyze the results (including file reviews of any outliers), and tailor policies and procedures in accordance with such results, to ensure that the institution is alert to potential disparities and can address any fair-lending related issues before they become supervisory concerns.
- Policies and Procedures. Institutions should carefully review their policies and procedures to identify instances in which discretion is permitted in any aspect of underwriting or other credit processes, as discretion can potentially give rise to discriminatory results. To the extent policies and procedures allow for discretion or exceptions, institutions should build into their corporate governance structure mechanisms to approve such exceptions or departures from common practice, and recordkeeping procedures to ensure proper documentation. In effect, the financial institution is creating a record of why a departure from normal business practices was made and the reasons the financial institution made that decision. To the extent the institution considers any changes to its policies and procedures as a result of its review, senior management should articulate the business- or risk-related reasons why such changes were or were not made. In addition, institutions should identify any policies that create statistical disparities and consider whether there are alternative policies or procedures (or modifications to existing policies and procedures) that address the same credit concerns but that do not have the same impact or have less of a disparate impact.
- Corporate Governance and Documentation. With increased scrutiny from regulators on fair lending issues, any business decisions that may involve practices that could have a disparate impact on a protected class, such as changing or discontinuing a particular product or service, should be carefully considered and the justifications for them should be clearly documented. Institutions should establish corporate governance procedures that provide for review of material changes to product and services offerings by senior management and Fair Lending/Risk Committees. The results of the review, including assessments of the reasons for the business decisions at issues, should be documented through meeting minutes and other records.
Importantly, the implications of the Inclusive Communities decision extend beyond the primary mortgage lending and insurance industries, affecting the secondary market. As demonstrated by the CFPB, there is an increasing appetite among the federal agencies to bring actions against indirect lenders and other market participants under the fair lending laws, and these industry participants should employ controls similar to those suggested above, as appropriate. For example, it is critical for indirect lenders, purchasers, servicers, and other secondary market participants to conduct self-assessments of their operations to identify potential fair-lending risk and take appropriate measures to address the risks identified.
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The Inclusive Communities decision almost certainly will embolden private plaintiffs and government agencies to assert claims of disparate impact discrimination. Proactive steps taken now can head off years of litigation and costly settlements by preventing statistical disparities from ripening into cognizable claims of discrimination. Financial institutions would be wise to use the Court's decision as a trigger for aggressively reviewing and enhancing their compliance efforts to ensure the legitimacy of their business policies and practices.