On September 4, 2020, the Department of Housing and Urban Development (“HUD”) issued a final rule revising its 2013 Fair Housing Act (“FHA”) disparate impact standards (“2013 Rule”) to reflect the U.S. Supreme Court’s 2015 decision in Texas Department of Housing and Community Affairs v. Inclusive Communities Project, Inc., which held that disparate impact claims are cognizable under the FHA. The final rule also establishes a uniform standard for determining when a housing policy or practice with a discriminatory effect violates the FHA and clarifies that application of the disparate impact standard is not intended to affect state laws governing insurance. The final rule largely adopts the proposed disparate impact rule HUD issued in 2019, with several clarifications and certain substantive changes. In the preamble to the final rule, HUD noted that the agency received an unprecedented 45,758 comments on the proposed rule.
On October 7, 2020, from 12:00 p.m. to 1:00 p.m. ET, Ballard Spahr will hold a webinar on the final rule. To register, click here.
HUD’s final rule codifies a new burden-shifting framework for analyzing disparate impact claims to reflect the Inclusive Communities decision, and requires a plaintiff to sufficiently plead facts to support five elements at the pleading stage that “a specific, identifiable policy or practice” has a discriminatory effect on a protected class group under the FHA. Those five elements include that :
- the challenged policy or practice is arbitrary, artificial, and unnecessary to achieve a valid interest or legitimate objective;
- the challenged policy or practice has a disproportionately adverse effect (i.e., disparate impact) on members of a protected class;
- there is a robust causal link between the challenged policy or practice and disparate impact on members of a protected class, meaning the specific policy or practice is the direct cause of the discriminatory effect;
- the alleged disparity caused by the policy or practice is significant; and
- there is a direct link between the injury asserted and the disparate impact alleged.
These elements are designed to harmonize the existing burden-shifting test with the safeguards against “abusive” disparate impact claims discussed in Inclusive Communities.
To establish that a policy or practice has a discriminatory effect, the plaintiff must prove by a preponderance of the evidence each of the elements in (ii) through (v) above. The defendant may then rebut the plaintiff’s allegation under (i) above that the challenged policy or practice is arbitrary, artificial, and unnecessary by producing evidence showing that the challenged policy or practice advances a valid interest(s) and therefore is not arbitrary, artificial, and unnecessary.
If a defendant successfully does so, the plaintiff must then prove by a preponderance of evidence either that the interest(s) advanced by the defendant are not valid or that a less discriminatory policy or practice exists that would serve the defendant’s identified interest in an equally effective manner without imposing materially greater costs on, or creating other material burdens for, the defendant. In the preamble to the final rule, HUD states that what is considered “valid” is a fact-specific inquiry, and the agency cites to profit as an example of a valid business interest that was expressly recognized by the Supreme Court in Inclusive Communities. However, “an interest that is intentionally discriminatory, non-substantial or otherwise illegitimate would necessarily not be ‘valid.’”
The final rule also clarifies which defenses are available to defendants at each stage of litigation.
At the pleading stage, a defendant can argue that the plaintiff has failed to sufficiently plead facts to support an element of a prima facie case, including by showing that its policy or practice is reasonably necessary to comply with a third-party requirement (such as a federal, state or local law or a binding or controlling court, arbitral, administrative order or opinion or regulatory, administrative or government guidance or requirement). In the preamble to the final rule, HUD stated its belief that this is an appropriate defense at the pleading stage where the defendant can show, as a matter of law, that the plaintiff’s case should not proceed when considered in light of law or binding authority that limits the defendant’s discretion in a manner demonstrating that such discretion could not have been the direct cause of the disparity.
Following the pleading stage, the defendant may establish that the plaintiff has failed to meet the burden of proof to establish a discriminatory effects claim by demonstrating any of the following:
- The policy or practice is intended to predict an outcome, the prediction represents a valid interest, and the outcome predicted by the policy or practice does not or would not have a disparate impact on protected classes compared to similarly situated individuals not part of the protected class, with respect to the allegations under paragraph (b). To illustrate this defense, HUD uses an example where a plaintiff alleges that a lender rejects members of a protected class at higher rates than non-members. The logical conclusion of such a claim would be that members of the protected class who were approved, having been required to meet an unnecessarily restrictive standard, would default at a lower rate than individuals outside the protected class. Therefore, if the defendant shows that default risk assessment leads to less loans being made to members of a protected class, but similar members of the protected class who did receive loans actually default more or just as often as similarly-situated individuals outside the protected class, then the defendant could show that the predictive model was not overly restrictive.
- HUD’s final rule provides that this is not an adequate defense, however, if the plaintiff demonstrates that an alternative, less discriminatory policy or practice would result in the same outcome of the policy or practice, without imposing materially greater costs on, or creating other material burdens for the defendant.
- In the preamble to the final rule, HUD states that this defense is intended to be an alternative to the algorithm defense it eliminated from the proposed rule. In our view, this defense seems just as useful and perhaps easier for a defendant to prove.
- The plaintiff has failed to establish that the defendant’s policy or practice has a discriminatory effect; or
- The defendant’s policy or practice is reasonably necessary to comply with a third-party requirement (such as a federal, state or local law or a binding or controlling court, arbitral, administrative order or opinion or regulatory, administrative or government guidance or requirement).
As noted above, HUD did not adopt in the final rule the proposed defense for reliance on a “sound algorithmic model.” HUD stated that this aspect of the proposed rule was “unnecessarily broad,” and the agency expects there will be further developments in the laws governing emerging technologies of algorithms, artificial intelligence, machine learning and similar concepts, so it would be “premature at this time to directly address algorithms.” Therefore, HUD removed that defense option at the pleading stage for defendants. As a practical matter, this means that disparate impact cases based on the use of scoring models will be based on the general burden-shifting framework set forth above, which ultimately would require a plaintiff to show that a model’s predictive ability could be met by a less discriminatory alternative.
In cases where FHA liability is based solely on the disparate impact theory, HUD’s final rule specifies that “remedies should be concentrated on eliminating or reforming the discriminatory practice.” The rule also states that HUD will only pursue civil money penalties in disparate impact cases where the defendant has been determined to have violated the FHA within the past five years.
The final rule becomes effective 30 days from the date of publication in the Federal Register.
As expected, criticism from consumer advocacy groups was swift. For example, the National Fair Housing Alliance’s September 4, 2020 press release condemned the final rule for its “evisceration” of the disparate impact theory as a civil rights legal tool and stated that it was the “worst possible time” for HUD to issue the final rule during the concurrent COVID-19 pandemic, economic crisis and social unrest concerning racial inequalities. In its press release issued on the same date, the National Community Reinvestment Coalition took aim at the final rule as an attack by the Trump Administration on the Fair Housing Act, noting that the rule places an “impossible burden” on plaintiffs in disparate impact cases before discovery can even begin. In their public statements, both organizations emphasized that HUD’s pleading and burden of proof requirements in the final rule will make it significantly more difficult for plaintiffs to challenge discriminatory lending policies and practices going forward.
We believe it is likely that these groups or others may mount a legal challenge to the final rule under the Administrative Procedure Act. Any legal challenge may face obstacles based on the Inclusive Communities decision itself, which is incorporated into HUD’s final rule, and prior Supreme Court precedent. We will discuss these issues during our upcoming webinar.