FHA Loan Originator Is Not liable for Failing to Test for Arsenic in Water Well

There are a line of cases where plaintiffs have tried to hold banks liable for not disclosing environmental issues known to the lender but not disclosed to the owner . Most of these cases involve foreclosure sales. However, a few involve borrowers who obtain loans to purchase property.

In Voelker v Home Office Realty,  home owners in Michigan claimed that banks involved in the FHA loan process failed to sample well water for arsenic despite knowledge that a local landfill might have impacted the drinking water supply. The plaintiffs noted that the FHA Mortgagee Letter 95-34 (July 27, 1995) requires Direct Endorsement Lenders to sample drinking water in accordance with local and state private well regulations as well as for contaminants of local concern.

The loan originator authorized retained a contractor to test the well for the usual potable water parameters. Years after buying the house, two of the plaintiffs developed cancer that they alleged was a result of exposure to arsenic in the potable water.

The trial court dismissed the claims on the grounds that alleged lender was just a loan originator and that it had no obligation to test the well water. The appeals court affirmed.

Borrowers often confuse a lender concluding that a phase 1 was acceptable from a determination that a property is "clean". The phase may identify environmental conditions that fall within a lender's risk tolerance. Indeed, during the CMBS craze, many originating banks were not concerned about environmental issues since they knew they would be selling the loans to the CMBS collective and thus were not exposed to collateral or payback risk. 

In a separate string on radon, there has been an extended exchange on why banks are not requiring radon sampling for properties located in radon zones 2 and 3 since radon is a carcinogen. This case illustrates why banks are reluctant to go go beyobd minimum environmental requirements. In this case, the plaintiff argued that the loan originator had an obligation to interpret the FHA letter to determine if additional parameters had to be tested as part of the water quality sampling. Fortunately for the loan originator, the count found it was not a "lender" for purposes of the FHA loan process and therefore had no obligation to determine what sampling was appropriate. 

Presumably, even if the loan originator could have been deemed to be a lender, it could stil have avoided liability by arguing that it relied on the expertise of the well tester to determine what parameters had to be analyzed. Of course, the FHA letter seemed to go require more than what was required under state or local drinking water regulations if there were local conditions that warranted sampling additional chemicals of concern, and the well tester might not have known about this additional FHA requirement. By ruling that the loan originator was not an FHA "lender", the court did not have to address the merits of the claims.