In a decision issued earlier this summer, the U.S. Court of Appeals for the Seventh Circuit vacated the district court’s order awarding restitution, mandating civil penalties, and issuing an injunction in an action brought by the CFPB against two mortgage-assistance relief companies and four lawyers associated with the companies.  The decision imposes significant limitations on the Bureau’s ability to recover both monetary and injunctive relief in enforcement actions.

In CFPB v. Consumer First Legal Group, LLC, the CFPB filed an enforcement action in 2014 in which it alleged that the defendants violated Regulation O while providing mortgage-assistance relief services by making misrepresentations about their services, failing to make mandatory disclosures, and collecting unlawful advance fees.  The district court ruled that the companies had committed the substantive violations alleged by the CFPB and that the lawyer defendants could be held personally liable for such violations and were not exempt from Regulation O because the work they completed did not qualify as the “practice of law.”  It ordered restitution in the amount of $21.7 million, assessed civil penalties totaling $34.1 million allocated among the four lawyers and a civil penalty of $3.1 million against one of the companies, and permanently enjoined three of the lawyers from providing debt relief services.

While affirming the defendants’ liability on the substantive violations alleged by the CFPB, the Seventh Circuit vacated all aspects of the district court’s remedial order.  The district court’s restitution award was based on the defendants’ “net revenues” during the relevant period, meaning gross receipts minus any refunds issued.  The Seventh Circuit concluded that based on the U.S. Supreme Court’s decision in Liu v. SEC, which was issued after the district court issued its restitution award, the award should have been based on the defendants’ net profits.  In Liu, the Supreme Court concluded that disgorgement is “equitable relief” available to the SEC provided it is limited to net profits from wrongdoing after deducting legitimate expenses.  The Seventh Circuit rejected the Bureau’s attempt to distinguish restitution from disgorgement, stating that Liu’s reasoning was “not limited to disgorgement and purported to set forth a rule applicable to all categories of equitable relief, including restitution.”

With regard to civil penalties, the district court had concluded that three of the lawyers had acted recklessly with respect to their violations, the fourth lawyer was liable for his violations only under a strict liability theory, and the company had committed reckless violations.  The CFPA established three tiers of penalties: strict-liability violations at $5,000 per day; reckless violations at $25,000 per day; and knowing violations at $1 million per day.  The defendants argued that they were not aware of a risk that their conduct was illegal because Regulation O prohibits conduct that is commonplace for lawyers, such as requiring advance retainer payments.  They also argued that because Regulation O is a complicated regulatory regime, their violations resulted from misunderstanding the regulation’s applicability rather than recklessness.

The Seventh Circuit concluded that although their conduct did not constitute the “practice of law,” it was “a step too far to say that they were reckless—that is, that they should have been aware of an unjustifiably high or obvious risk of violating Regulation O.” (emphasis provided).  Accordingly, the Seventh Circuit vacated the district court’s  recklessness findings with respect to the three lawyers and the company and directed the district court, on remand, to apply the daily penalty for strict-liability violations.  The Seventh Circuit also agreed with the defendants that the district court had used incorrect time periods to calculate the amount of the penalties and directed the district court to measure those periods differently on remand.

The Seventh Circuit also found that the injunction issued by the district court was too broad.  The three lawyers permanently banned from providing debt relief services argued that the record did not support such a broad injunction and that it would create undue hardship for them as career bankruptcy lawyers.  Having found the defendants’ violations were not knowing or reckless, the Seventh Circuit concluded that such a broad injunction “is not necessary to protect the public against future harm.”  It also observed that the companies were out of business and “were not a complete scam,” having obtained mortgage modifications for hundreds of consumers.  The Seventh Circuit ruled that the injunction “need only ensure that the individual defendants do not stray beyond the scope of the [CFPA] and its implementing regulations.”

More industry players have been litigating cases with the CFPB over the past few years, and decisions like this seem to suggest that litigating with the Bureau is sometimes necessary, especially when there is a significant mismatch between the Bureau’s and the industry member’s view of appropriate remediation.  We believe there is every reason to predict more Bureau cases going to litigation, reinforced by decisions like this, which make the prospect of litigating a CFPB enforcement matter seem more attractive to enforcement targets.