Warehouse Lender Wins Massive Judgment

Starting in 1997 until mid-July 2000, AppOnline, a holding company, operated a mortgage banking and brokerage business through its principal operating subsidiary, licensed mortgage banker Island Mortgage Network, which originated and sold residential mortgages through a national branch network. Most of the loans were funded with monies advanced under warehouse lines of credit or mortgage purchase agreements provided by HSA and another company.

In its heyday, Island had 58 offices in 22 states and about half its mortgages, which it didn’t service, were FHA and VA loans.

But court papers say wired escrow funds for the closings or purchases of specific mortgages were diverted with State Bank’s knowledge for the benefit of Island affiliates including Action Abstract, Island Mortgage Network and AppOnline.

After receiving numerous complaints from consumers in the state and banking authorities in other states, New York’s State Banking Department revoked Island’s mortgage banking license in 2000.

The company filed for bankruptcy in 2000, and many of it’s principals have since pleaded guilty to several felonies.

In a trial lasting three weeks, HSA sued the bank for millions of dollars in losses it suffered from the collapse. The lender claims State Bank looked the other way when Island, one of the bank’s largest clients, deceived HSA “into providing monies to fund mortgages which, once deposited in an escrow account with State Bank, were diverted for improper purposes.”

Neither HSA nor its attorneys responded to MortgageDaily.com’s request for a statement.

But Andrew T. Gardner, State Bank’s outside counsel and an attorney in the New York office of Fried, Frank, Harris, Shriver & Jacobson LLP, described it as a “big Ponzi scheme.”

At trial, the bank argued that it did not have actual knowledge of the fraud — a required element for proving the claim. The bank also claimed nothing it did constituted assistance of the fraud — another required element. The bank said it was merely a deposit bank and that the customer has the right to move monies in the way that it wants.

Gardner declared the jury to be wrong in view of a decision issued several weeks ago by the Second Circuit, Crigger v. Fahnestock and Company, Inc. et al. that focused on whether a sophisticated plaintiff has a duty to inquire into the actions of the entity with which it is dealing before it can sue for fraud.

Gardner accused HSA of ignoring “all sorts of red flags” about Island Mortgage and said that HSA had “much more” reason to be concerned about Island Mortgage’s business practices than did the bank. He said that even when “returned wires” dramatically increased and Island Mortgage took weeks instead of days to return the money, that HSA’s response was merely to increase the return fee — at the time a lucrative move for HSA.

In a post-verdict motion, Gardner said he has asked the court to set aside the jury’s decision and rule in the bank’s favor. He has also asked for a new trial and that the judge reduce the jury’s $44 million award to $7 million. Gardner said the amount relates to when the outgoing president of HSA, in a meeting with the incoming president and several members of the company’s management team, warned them about further dealings with Island. The company lost $35 million in mortgage fundings after the warning was made, Gardner said, hitting home the point that the company ignored a warning from its own president. Gardner said the ex-president’s tape-recorded testimony was played for the jury.

“So while there is an adverse verdict, things are very much up in the air as to whether there is actually going to be a judgment against State Bank or if so, in what amount,” he said.

Lisa D. Burden is a legal analyst for MortgageDaily.com and holds a law degree from the University of Maryland. She is currently a freelance journalist who previously wrote for Institutional Investor publications and the Baltimore Daily Record.

e-mail Lisa at: burdenlisa@yahoo.com