The U.S. Court of Appeals for the Fourth Circuit recently affirmed what seems commonsensical to most borrowers:  an overly generous home loan should be cause for celebration, not a lawsuit.

Interpreting West Virginia law, the Fourth Circuit concluded that a home loan is not unconscionable solely because the amount of the loan exceeds the value of the house securing the loan.  Similarly, a claim that a home loan provided no “net tangible benefit” to the borrower is insufficient to make the loan unconscionable.

The Fourth Circuit, however, interpreted the West Virginia Consumer Credit and Protection Act (the WVCCPA) to provide a stand-alone cause of action for unconscionably inducing a loan.  A borrower may be able to prove that a lender’s conduct leading up to a loan was so misleading or fraudulent that the borrower was unconscionably induced to take out the loan. 

For more than a decade, homeowners have brought lawsuits in West Virginia that seek to void their home loans based on the argument that the amount of a loan, itself, was too high.  Their loans are unconscionable, they claim, because they were allowed to borrow too much.

In the recent case appealed to the Fourth Circuit, Philip McFarland had sued Wells Fargo Bank. McFarland claimed that his $181,800 home loan from Wells Fargo was unconscionable because the amount of the loan exceeded the value of his house at the time of the loan. McFarland claimed that a retrospective appraisal showed his house was worth only $120,000 when Wells Fargo loaned him about $62,000 more.

In addition to claiming that the amount of the loan made the loan contract “unconscionable at the time it was made,” which the WVCCPA prohibits, McFarland also claimed that Wells Fargo had “unconscionably induced” the loan. McFarland argued that not only was his loan contract unconscionable but also that the mortgage broker’s or lender’s conduct before he entered his loan contract was unconscionable.

The trial court, the U.S. District Court for the Southern District of West Virginia, originally ruled for Wells Fargo. U.S. District Court Judge Robert Joseph Goodwin issued a decision in May 2014 that concluded that a home loan could not be substantively unconscionable—that is, have terms that are overly harsh or one-sided—simply because of the amount of the loan.  If anything, an undersecured loan disadvantaged the lender, Judge Goodwin said.  In order for a loan to be substantively unconscionable under West Virginia law, he said, it would have to have specific unfair terms such as the interest rate or term for the timing of payments.

Judge Goodwin also concluded that McFarland’s claim that his loan from Wells Fargo provided him no “net tangible benefit” did not equate to a claim that the loan was overly harsh or one-sided so as to be an unconscionable contract under the WVCCPA.  Having rejected McFarland’s two alleged bases for finding his loan unconscionable, Judge Goodwin dismissed McFarland’s claims against Wells Fargo.

McFarland appealed Judge Goodwin’s decision to the Fourth Circuit, the federal appeals court whose territory includes West Virginia.

On appeal, the Fourth Circuit agreed with Judge Goodwin that the amount of a home loan, in and of itself, cannot establish that the loan was overly harsh or one-sided.  “Whatever the pitfalls, receiving too much money from a bank is not what is generally meant by ‘overly harsh’ treatment, and we have no reason to think that the West Virginia Supreme Court of Appeals would apply its standard in such a counterintuitive manner,” the Fourth Circuit said.

Moreover, the Fourth Circuit cited a West Virginia Supreme Court decision for the proposition that if a borrower succeeds in having his loan declared unconscionable, the remedy is to return the parties to the status quo before the unconscionable loan was made.  That is, the borrower would have to return the remaining loan principal.  Thus, the Fourth Circuit reasoned, it makes no sense for a loan to be declared unconscionable because of the loan amount when the result would be that a plaintiff who cannot make monthly payments would have to return all remaining principal.

The Fourth Circuit also agreed with Judge Goodwin that a claim of no “net tangible benefit” does not establish that a contract was unconscionable under West Virginia law.  “Whether a contract provides either or both parties with a ‘tangible net benefit’ is an entirely separate question; contracts are made all the time that include terms that might not provide either party with a ‘net tangible benefit’ yet remain fair and even-handed — or at least fair and even-handed enough not to be considered substantively unconscionable under West Virginia’s standard.”

In sum, the Fourth Circuit agreed with Judge Goodwin that McFarland could not show that his loan contract, itself, was unconscionable.

The Fourth Circuit, however, disagreed with Judge Goodwin that simply because McFarland failed to show his loan contract was unconscionable, McFarland was out of luck.  The Fourth Circuit observed that the WVCCPA separately states that a loan may be “unconscionably induced.”  The West Virginia Supreme Court likely would conclude that this provides a stand-alone claim under the WVCCPA, the Fourth Circuit stated.

“We of course leave to West Virginia law the precise contours of an unconscionable inducement claim, but it appears that it will turn not on status considerations that are outside the control of the defendant, but instead on affirmative misrepresentations or active deceit.”

Accordingly, the Fourth Circuit returned the case to the District Court to consider whether McFarland can prove that his loan was induced by unconscionable conduct.

In the McFarland case, the federal courts interpreted West Virginia law.  Their decisions are not binding on West Virginia state courts, but their decisions are persuasive authority that may be cited to those state courts.  In other words, West Virginia state courts may agree with the reasoning in the Fourth Circuit’s decision, but they are not bound to follow it. 

Thus, the full effect of the Fourth Circuit’s decision in the McFarland case remains to be seen.  In particular, the law of unconscionable inducement claims will develop as that specific theory of lender liability is litigated.

At least for now, however, common sense has prevailed. A borrower who requests and receives more than his home might be worth at the time has not entered an unconscionable, and thus unenforceable, contract.