(CN) – Freedom Mortgage can sue title insurers, appraisers and a broker over their alleged participation in a mortgage-flipping scam, the 7th Circuit ruled, urging the lower court to resolve the dispute quickly. “This suit has passed its sixth anniversary,” Chief Judge Easterbrook wrote, “and should not be allowed to grow a beard.”
The Chicago-based federal appeals court overturned an order dismissing the case on the ground that the federal suit is barred by Freedom’s victory in state court.
The state court had awarded Freedom the properties and default judgments after the buyers defaulted.
Freedom claimed that the defaults were part of a mortgage-flipping scheme in which phantom buyers took out loans based on overvalued appraisals, then vanished without making any payments. A go-between and the buyer split the difference between the house’s actual value and the higher loan amount.
When Freedom foreclosed on the properties, it took a $600,000 hit.
The main defendants in Freedom’s federal lawsuit are broker Burnham Mortgage and its manager, John Jeffrey Hlava, the alleged go-between.
Freedom also sued Exeter Title and Ticor Title, claiming they closed the deals with phantom buyers, at phony prices, and without the promised down payments.
The insurers argued that they had simply followed Freedom’s closing instruction.
Freedom demanded actual and punitive damages from Burnham and the insurers, and further accused them of violating federal racketeering laws by conducting the scam via email and interstate phone calls.
However, the claims were complicated by the fact that Freedom had bought some of the foreclosures with credit bids, meaning it bid some or all of the outstanding loan balance instead of cash.
As a result, U.S. District Judge Filip barred Freedom from recovering damages that exceeded its credit bids, even when it sold the properties for less.
Filip later resigned from the bench and was replaced by U.S. District Judge Gettleman, who dismissed the federal suit as barred by the state judgments. In Gettleman’s view, Freedom was trying to wage a collateral attack on the state judgments.
But the 7th Circuit saw no reason to dismiss the claims against the insurers, broker and appraisers, because the state judgments were against the borrowers.
“Why would either issue or claim preclusion block all recovery against non-parties to the state proceedings?” Easterbrook asked.
“Whether the borrower is paid is distinct from whether these defendants committed fraud that induced Freedom to make these loans, or whether Burnham followed Freedom’s prescribed closing procedures.”
And though Freedom is stuck with its credit bids, the defendants might be liable for the $600,000 shortfall if the lender prevails on its racketeering claim, the court concluded.