By Amanda Whorton

On January 15, 2016, the Fourth Circuit issued a published opinion in the civil case McFarland v. Wells Fargo Bank. The court agreed with the district court that, under West Virginia law, the amount of a mortgage loan alone cannot show substantive unconscionability. However, the court disagreed with the district court in that a claim for “unconscionable inducement” is proper even if the substantive terms of a contract are not unfair.

The Mortgage Agreement

Philip McFarland (“McFarland”) bought his house in West Virginia for roughly $110,000 in 2004. In June 2006, two short years later, McFarland, with an interest to consolidate his $40,000 in student and vehicle debt with his mortgage, sought to refinance. Greentree Mortgage Corporation (“Greentree”) informed McFarland that the market value of his home had increased to $202,000. McFarland entered into secured loan agreements with Greentree and Wells Fargo Bank (“Wells Fargo”).

For a year, McFarland paid his Wells Fargo loan without issue. However, he began to fall behind on his mortgage payments in 2007. In 2010, Wells Fargo and McFarland entered into a loan modification, but even under this arrangement, McFarland faced an unaffordable mortgage. Wells Fargo initiated foreclosure on McFarland’s home in 2012.

With the looming foreclosure, McFarland brought suit against Greentree and Wells Fargo, along with U.S. Bank National Association, the trustee of the Wells Fargo loan. McFarland settled with Greentree, leaving Wells Fargo and U.S. Bank National Association the defendants in the present suit (“the Banks”).

McFarland alleged that Wells Fargo granting him a loan that was far in excess of his home’s actual value constituted a “substantive unconscionability” contract under the West Virginia Consumer Credit and Protection Act (“WVCCPA”). McFarland stated that the excess loan made his mortgage unaffordable and put his home at risk. McFarland alleged alternatively that even if the loan itself was not unconscionable, that it was “unconscionably induced,” focusing on the bargaining process and alleged misrepresentations by Wells Fargo.

The District Court Granted Defendants’ Motion for Summary Judgment

The Banks filed a motion for summary judgment, which the district court granted because it did not find any evidence of substantive unconscionability. The district court did not discuss the “unconscionably induced” claim. It reasoned that there was no need to consider the bargaining process because West Virginia law requires a finding of some substantive unconscionability.

West Virginia’s Unconscionability Doctrine

West Virginia’s traditional unconscionability doctrine requires both a showing of substantive unconscionability (unfairness in the contract and the loan terms themselves) and procedural unconscionability (unfairness in the bargaining process). McFarland stated that the loan was unconscionable in two ways: (1) that the loan exceeded the value of the home and (2) that it provided no “net tangible benefit” to McFarland.

A contract is substantively unconscionable only if it is “one-sided” with an “overly harsh effect on the disadvantaged party.” The Fourth Circuit agreed with the district court that a mortgage agreement is not substantively unconscionable only because it provides a borrower with more money than the home is worth. The bank, not the borrower, is typically the one disadvantaged by an under-collateralized loan. McFarland argued that it is this widespread practice of overvaluing homes and excess lending that contributed to the foreclosure crisis, of which his loan is an example. It is the harm to borrowers that makes the loan unconscionable. The Fourth Circuit agreed that consumers may be harmed when they take on more mortgage debt than their homes are worth, but noted that a harmful practice alone did not make it substantively unconscionable under West Virginia law. An under-collateralized loan will benefit the borrower at least in some ways, even if it ultimately causes harm to the borrower. Excess loans carry risk for all parties involved, the Fourth Circuit reasoned.

The Fourth Circuit further determined that the “net tangible benefit” theory McFarland raised is irrelevant to the substantive unconscionability inquiry because that test appears in West Virginia’s anti-predatory lending statute and McFarland did not allege that Wells Fargo violated that statute.

However, the Fourth Circuit, in disagreement with the district court, found that the WVCCPA plainly authorizes a stand-alone unconscionable inducement claim. This claim does not require substantive unconscionability, but may be based only on procedural unconscionability and the bargaining process. The WVCCPA authorizes a court to not enforce an agreement if that agreement was “unconscionable at the time it was made, or [that was] induced by unconscionable conduct.” The Fourth Circuit determined that the legislature including “or” in that context meant that there were two stand-alone claims for unconscionability under the WVCCPA: one for traditional unconscionability, which requires substantive and procedural unconscionability and one for unconscionable inducement, which only looks to conduct that causes a party to enter into a loan.

Fourth Circuit’s Holding

The Fourth Circuit affirmed the district court in that West Virginia law requires a showing of substantive unconscionability in a traditional unconscionability claim. However, the Fourth Circuit reversed the district court’s dismissal of McFarland’s claim of unconscionable inducement on the grounds that substantive unconscionability is necessary under the WVCCPA. The Fourth Circuit remanded to the district court to consider whether McFarland’s loan agreement was unconscionably induced and whether this allows him to proceed in his suit against the Banks.