While fee-splitting arrangements (such as existed in Armstrong) are subject to criticism, a broker has no fiduciary duty to disclose his or her own fees, under the Maryland decision in Holzman v. Blum, which drew a distinction between a mortgage broker's fiduciary duty in relation to his services and his duties vis-a-vis his fees. In fee arrangements with prospective borrowers, the Maryland court held that brokers and borrowers deal at arm's length; but with respect to a broker's services, the broker has a duty to act in the borrower's best interests.

In addition to the duty to act in the borrower's best interest and to fully disclose all facts pertinent to the loan, a mortgage broker has a duty to act in good faith in dealings with borrowers.

In the Missouri case Jefferson v. American Financial Group Inc., the court held that Mortgage Source failed to act in good faith and with reasonable skill, care and diligence for the benefit of the borrower, and breached its fiduciary duty in a number of ways: It obtained an appraisal that was unreasonably inflated, obtained a loan on terms it knew the borrower could not repay, failed to keep the borrower informed about the terms of refinancing and made false representations that the borrower could refinance in six months.

In Texas, a broker was held to be in a fiduciary relationship with a borrower in Rauscher Pierce Ref-snes Inc. v. Great Southwest Savings FA. The broker was supposed to issue seasoned loans (existing loans, more than 6 months old, with no defaults), of grade-A investment quality. The broker breached his fiduciary duty of reasonable investigation and proper delivery of all information when he delivered loans that were "not insured, not seasoned and of poor quality," stated the Rauscher decision.

Rauscher cited Magnum Corp. v. Lehman Brothers Kuhn Loeb Inc., stating that "the relationship between a broker and its customer is that of principal and agent."

In states whose courts have not considered mortgage brokers' agency or fiduciary roles vis-a-vis prospective borrowers, statutes governing mortgage brokerage, including broker license laws, may (but will not always) shed light on the issue. In Koch v. First Union Corp., a Pennsylvania court found that a fiduciary duty exists even though the Pennsylvania Mortgage Bankers and Brokers Act imposes no fiduciary duty on mortgage brokers.

The Koch decision cites Frowen v. Blank, stating that "[a confidential relationship] appears when the circumstances make it certain the parties do not deal on equal terms, but, on the one side there is an overmastering influence, or, on the other, weakness, dependence or trust, justifiably reposed." Thus, in Pennsylvania, notwithstanding the mortgage broker licensing law, the confidential nature of broker-borrower relationships may impose fiduciary duties on brokers.

Supplementing case law and mortgage broker licensing laws, some state statutes contain express "good faith" requirements applicable to mortgage brokers, including several enacted in 2007. Colorado H.B. 1322 and S.B. 216 establish a statutory duty of good faith and fair dealing for mortgage brokers in all communications and transactions with borrowers, including a duty to take into consideration a borrower's financial condition when brokering a loan.

On June 11, 2007, Maine Governor John Baldacci signed L.D. 1869, an anti-predatory-lending bill that imposes a duty on loan brokers to "act in good faith and with fair dealing" toward borrowers. (Most of the provisions of L.D. 1869 become effective Jan. 1, 2008.)

Minnesota H.F. 1004 specifies that a residential mortgage loan originator has an agency relationship with the borrower unless he expressly disclaims such a relationship in writing within three business days of accepting a residential mortgage loan application. If a loan originator accepts or solicits an advance fee for obtaining a Minnesota residential mortgage loan, he automatically creates a fiduciary relationship with the borrower.

With enactment of H.F. 1004, Minnesota raised the bar for mortgage broker duties to prospective borrowers statewide. (Prior to adoption of H.F. 1004, Minnesota law was undecided about whether brokers owed a fiduciary duty to borrowers. See, for example, Brancheau v. Residential Mortgage, 182 F.R.D. 579 [D. Minn. 1998], a case rejecting the notion that a fiduciary relationship exists between all brokers and borrowers.)

Current law demonstrates that mortgage brokers are likely to be deemed agents of prospective borrowers in the context of loan origination. This is especially true when borrowers lack knowledge of financing transactions, when brokers have special knowledge or skills, and when borrowers rely on the brokers' expertise and counsel or are otherwise at a disadvantage in obtaining information from other sources.

As agents, certain legal duties are required of mortgage brokers--i.e., the duty of fairness and honesty, the duty of good faith and the duty to disclose all material facts. Failure of mortgage brokers to embrace and abide by these general and well-established duties will likely lead to enactment of a complex patchwork of non-uniform state statutes defining with precision the duties of mortgage brokers to the borrowing public.

Andrea Lee Negroni is of counsel with the Washington, D.C., law firm Buckley Kolar LLP (www.buckleykolar.com). Joya K. Raha, a 2007 summer associate at Buckley Kolar, is a student at California Western School of Law, San Diego, class of 2008. They can be reached at alnegroni@buckleykolar.com and joya.raha@gmail.com