Court Revives Claims of Developers’ Subprime Fraud

(CN) - California homeowners can sue many of the nation's largest builders over the economic and social fallout of the housing bubble, the 9th Circuit ruled Wednesday, finding that the penchant for marketing to high-risk buyers could be responsible for today's plummeting home values and blighted neighborhoods.

The federal appeals court in San Francisco reversed a lower court's dismissal of claims brought by 19 homeowners against D.R. Horton, Richmond American, Shea Homes, Lennar Homes, and other top developers, their parent companies and subsidiary mortgage companies.

The homeowner plaintiffs each put down at least 20 percent on a home in a new development between 2004 and 2006. They seek damages and the option to rescind their purchase based the builders' alleged fraud, misrepresentations and violations of state law. Though developers allegedly promised that they were building "stable, family neighborhoods occupied by owners of the homes," they actually sold houses to unqualified buyers and investors prone to foreclosure.

"Plaintiffs contend that by marketing homes to high-risk buyers, and by financing buyers who may not have been able to obtain other financing, defendants created a 'buying frenzy' that artificially increased demand and home prices," according to the ruling.

These very practices are to blame for neighborhoods blighted by foreclosure signs and empty homes, increased crime, and dismal home values, the homeowners said.

U.S. District Judge Virginia Phillips in Los Angeles was not convinced, however. She dismissed the lawsuit for lack of standing, finding no true connection between the developers' alleged fraud and the plaintiffs' alleged injuries. She also denied the homeowners' request to amend their complaint.

On appeal, a three-judge panel of 9th Circuit judges disagreed unanimously.

"Plaintiffs state that they would not have purchased their homes had there been proper disclosure of defendants' lending practices," Judge Betty Fletcher wrote for the court. "There is a direct causal link between defendants' allegedly faulty disclosure and plaintiffs' injuries."

The panel also rejected the District Court's conclusion that the homeowners' injuries were merely conjectural because a strong housing market in the future could cure all of their present woes.

"Future recovery in the housing market will not cure plaintiffs' injuries - if plaintiffs had paid what the homes were worth at the time of sale, they would obtain greater returns if they sold during a time of economic improvement," the panel found. "Further, if plaintiffs would not have purchased their homes absent defendants' misconduct, the injury was created at the moment of fraudulent purchase, and is not affected by any changes in the housing market."

Since the consolidated class action still needs some work, the judges said the plaintiffs will get the chance to amend their claims at least once.

"While we agree with the District Court that, on the current record, plaintiffs have not established a sufficient causal connection between any decreased value and desirability and defendants' actions, plaintiffs should be permitted to amend their complaint and attach expert testimony on causation," the ruling states.

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