On December 8, 2023, oral arguments were held before a three judge panel of the U.S. Court of Appeals for the Seventh Circuit in the CFPB v. Townstone Financial case, in which the CFPB alleges that Townstone Financial, a non-bank mortgage company (Townstone), engaged in redlining in the Chicago area in violation of the Equal Credit Opportunity Act (ECOA). The tea leaf reading may now commence.

As previously reported, in February 2023 the U.S. District Court for the Northern District of Illinois granted Townstone’s motion to dismiss the CFPB’s complaint on the grounds that the ECOA applies to applicants and not to prospective applicants. While the ECOA only refers to applicants, Regulation B under the ECOA provides that a “creditor shall not make any oral or written statement, in advertising or otherwise, to applicants or prospective applicants that would discourage on a prohibited basis a reasonable person from making or pursuing an application.” (Emphasis added.) The CFPB argued that the court should follow Regulation B, and should defer to its interpretation of the ECOA reflected therein because the regulation is “reasonably related” to the objectives of the ECOA. The federal district court rejected this argument and concluded that the “plain text of the ECOA . . . clearly and unambiguously prohibits discrimination against applicants, which the ECOA clearly and unambiguously defines as a person who applies to a creditor for credit.” As a result, the court determined that a redlining claim could not be maintained under ECOA.

In April 2023, the CFPB appealed the ruling to the Seventh Circuit. The CFPB and then Townstone filed briefs with the court, as did other parties supporting the CFPB and supporting Townstone.

In its brief, the CFPB argued that the court should follow the “Chevron framework,” which refers to the approach set forth by the U.S. Supreme Court in its 1984 decision in Chevron, U.S.A., Inc. v. Nat. Res. Def. Council, Inc. for how courts should review a federal agency’s interpretation of a statute. Under the Chevron framework, a court will typically use a two-step analysis to determine if it must defer to an agency’s interpretation. In step one, the court looks at whether the statute directly addresses the precise question before the court. If the statute directly addressed the precise question, the court must follow the intent of Congress. If the statute is ambiguous or silent, the court will proceed to step two and determine whether the agency’s interpretation is reasonable. If it determines the interpretation is reasonable, then to follow the Chevron framework the court must defer to the agency’s interpretation.

In asserting that the Seventh Circuit under the Chevron framework should defer to its interpretation in Regulation B that ECOA applies to prospective applicants, the CFPB argued:

  • Under step one of the Chevron framework, the Seventh Circuit should conclude that Congress has clearly spoken to the precise question at issue in this case–whether, consistent with the ECOA, Regulation B can prohibit discriminatory discouragement. In delegating ECOA rulemaking authority to the Federal Reserve Board, Congress specifically intended the Board (and now the CFPB) to regulate conduct not specifically mentioned in the ECOA if the failure to regulate would frustrate the ECOA’s purpose or permit evasion of the ECOA. Regulation B has expressly protected prospective applicants from discriminatory discouragement since 1975 and Congress has never repudiated this interpretation of the ECOA. Congress evidenced its intent to protect prospective applicants by amending the ECOA in 1991 to add a referral provision that states specified agencies shall “refer [a] matter to the Attorney General whenever the agency has reason to believe that 1 or more creditors has engaged in a pattern or practice of discouraging or denying applications for credit in violation of section 1691(a) of this title.”
  • Even if the Seventh Circuit concludes that Congress has not specifically addressed the question at issue, Congress has not foreclosed the CFPB’s interpretation of Regulation B. Under the second step of the Chevron framework, the Seventh Circuit should find that Regulation B’s prohibition on the discouragement of prospective applicants is reasonable because it furthers the purpose of the ECOA to prohibit discrimination in credit transactions. “Absent a prohibition on discouragement, a discriminating lender could easily frustrate the intent of Congress by discouraging applications on the basis of race, sex, or any of the other protected categories listed in section 1691(a). Indeed, there may be no more obvious way to frustrate the central purpose of ECOA than by discouraging prospective applicants.”

That the CFPB focused on the Chevron framework is interesting, because on January 17, 2024, the U.S. Supreme Court will hear oral arguments in two cases in which the plaintiffs are asking the Court to overrule, or at least clarify, the Chevron framework. During the oral arguments in Townstone, Chief Judge Sykes noted that the Chevron framework may not be with us for long, but did not indicate that the Seventh Circuit might defer its decision pending the Supreme Court’s ruling on the Chevron framework.

Townstone in its brief countered that the interpretation in Regulation B that ECOA applies to prospective applicants does not survive an analysis under the Chevron framework. In particular, Townstone argued that:

  • Under step one of the Chevron framework, the ECOA unambiguously bars discrimination only against “applicants” with respect to any aspect of a “credit transaction.” The ECOA definition of “applicant” is limited to an identifiable person who requests credit from a creditor. Adding “prospective” to “applicant,” as the CFPB does in its anti-discouragement rule, obliterates this limitation. Also, the anti-discouragement rule cannot be reconciled with the unambiguous meaning of “discrimination” and “credit transaction” in the ECOA. Section 1691(a) prohibits discrimination “with respect to any aspect of a credit transaction.” As defined by Regulation B, a “credit transaction” includes “every aspect of an applicant’s dealings with a creditor regarding an application for credit or an existing extension of credit.” Thus, a “credit transaction” requires two or more identifiable individuals acting in concert with the goal of obtaining credit from the other. While the ECOA does not define “discrimination,” Regulation B defines “discriminate against an applicant” as “treat[ing] an applicant less favorably than other applicants.” Thus, to discriminate on a prohibited basis, a creditor must treat an applicant differently than other applicants because of the applicant’s race or other protected characteristics. “Discourage” is a far broader term that is much less susceptible to an objective definition than “discrimination.” Discrimination under section 1691(a) turns on the actions of the creditor and is fact-based and objective. Discouragement, under the rule, turns entirely on the listener’s subjective reaction.
  • To be entitled to reach step two of the Chevron framework, an agency must show either ambiguity in the statute or an explicit gap that Congress left for the agency to fill. The ECOA provision that directs the CFPB to enact regulations that “are necessary or proper to effectuate the purposes of [the ECOA] [and] prevent circumvention or evasion thereof” is a general rulemaking provision and not a gap-filling provision because it did not direct the CFPB to elaborate on a particular statutory term or provision. If a statement that an agency can issue rules to prevent “evasion or circumvention” can justify the anti-discouragement rule, it could be used to justify virtually any change to the ECOA.

In addition to challenging the anti-discouragement rule in Regulation B under the Chevron framework, Townstone argued that if the rule is determined to be valid under that framework, the Court should hold that the rule is unconstitutional because it violates the First and Fifth Amendments. Townstone asserted that the rule violates the First Amendment for reasons that include (1) it gives the CFPB unbridled discretion to decide who may speak and what they may say because violations of the anti-discouragement rule turn entirely on the subjective views of the listener, which is no standard at all, and (2) the CFPB is enforcing the anti-discouragement rule against Townstone because of its views. Townstone also argued that the rule is unconstitutionally vague and overboard in violation of the First and Fifth Amendments because a person of ordinary intelligence cannot know, in advance, what it prohibits.

During the oral argument, the CFPB attorney focused on the ECOA delegation of authority provision, which provides:

“The Bureau shall prescribe regulations to carry out the purposes of this subchapter. These regulations may contain but are not limited to such classifications, differentiation, or other provision, and may provide for such adjustments and exceptions for any class of transactions, as in the judgment of the Bureau are necessary or proper to effectuate the purposes of this subchapter, to prevent circumvention or evasion thereof, or to facilitate or substantiate compliance therewith.”

The attorney argued that through this provision Congress empowered the CFPB to address any loophole in the ECOA. Chief Judge Sykes disagreed that the provision conveyed broad authority on the CFPB regarding the scope of ECOA, noting that the prevention of circumvention or evasion language is tethered to language that precedes it. Chief Judge Sykes believed the provision gave the CFPB the power to make adjustments and exceptions to a class of transactions to prevent the circumvention or evasion of the statutory non-discrimination provision, but did not give the CFPB the power to expand the statutory non-discrimination provision. The ECOA provision that prohibits discrimination provides:

“It shall be unlawful for any creditor to discriminate against any applicant, with respect to any aspect of a credit transaction-

(1)  on the basis of race, color, religion, national origin, sex or marital status, or age (provided the applicant has the capacity to contract);
(2)  because all or part of the applicant’s income derives from any public assistance program; or
(3)  because the applicant has in good faith exercised any right under [the Consumer Credit Protection Act].”

The section clearly refers to discrimination against an applicant, but not a prospective applicant, whatever that is. Chief Judge Sykes also noted that with regard to civil liability, the ECOA limits liability of a creditor to an “aggrieved applicant,” and asked doesn’t the Court need to focus on that in interpreting the scope of the ECOA non-discrimination provision.

Addressing an assertion made by the CFPB in its brief, Judge Rovner asked the attorney for Townstone that if the anti-discouragement provision in Regulation B is held to apply to only applicants, wouldn’t that permit lenders to place “Whites Only” signs at the entrance to their offices. The attorney responded that such conduct would be prohibited by the Fair Housing Act and the Illinois Human Rights Act, and considered the CFPB assertion to be a fanciful hypothetical. Judge Rovner nonetheless raised a concern of the result in a non-mortgage credit situation, in which the Fair Housing Act does not apply. The attorney for Townstone countered that if there is a loophole in the ECOA regarding prospective applicants, then it is for Congress to fix the loophole. Judge Rovner also appeared to be skeptical of Townstone’s First Amendment argument, although Chief Judge Sykes appeared to be more receptive to the argument.

Judge Ripple did not ask any questions during the oral argument. That complicates the assessment of how the Seventh Circuit may rule. In our view, the statement of Chief Judge Sykes that the ECOA’s delegation of authority provision does not give the CFPB the power to expand the ECOA’s non-discrimination provision is spot on. If one or both of the other judges agree with Chief Judge Sykes on this point, that likely will not bode well for the CFPB. In the end, however, it may not matter how the three-judge panel rules. The party that does not receive a favorable opinion may well request a rehearing by the entire Seventh Circuit, or seek review by the Supreme Court. If the case gets to the Supreme Court, the CFPB likely would face strong head winds in arguing that the ECOA applies to prospective applicants.